Jeremy Witbeck:

Welcome to our Polaris Podcast. I’m Jeremy Witbeck and I have with us Jeff Powell, our managing partner and Chief Investment Officer.

Jeff Powell {0:13}
Good morning, Jeremy. How are you?

Jeremy Witbeck – 0:15
Yeah, doing really? Well, Jeff, I’m really looking forward to our conversation today, there was an interesting article in Barron’s a couple days ago that talked about the amount of cash that the US population has collectively with that number being 16 trillion with a tea. And so I’m really looking forward to hearing your thoughts and insights as you What should people be doing with that cash, especially given the context of where interest rates are at where they are at the moment?

Jeff Powell – 0:44
Yeah, you know, it’s, it’s really a pretty remarkable number, I think, you know, added to when we first saw COVID head, I mean, if you remember, back, in the initial few months of COVID, we actually hit record savings rates in the United States where we were over 30% savings rates, but this is also a lot of people that I would say I’ve made mistakes with going to cash at exactly the wrong time. So what are these 16, you know, these households with $16 trillion, I mean, you and I kind of played around with the math, that’s $50,000 per person in the United States, that means my, my youngest should have $50,000, sitting there, your two year old should have $50,000, already to his name, and so on, and having it all sitting in cash. So we obviously know that a lot of this is is held by the wealthy, and they’re sitting on a lot of money, waiting to put it to work and trying to make a decision on what that really looks like. The thing that amazes me out of a jermy, when I’m kind of just eyeballing it is that $16 trillion, where you’re saying, I am willing to lose money on this money, you know, that’s when you’re sitting in cash. And we all know that right? Now, money markets are paying virtually nothing. savings rates are basically nothing, you put it in a checking, and you are gonna get nothing, you’re willing to lose almost 2% per year on that 16 trillion. So what is it going to be that gets people to step off the sidelines and into the markets? And really, where do they want to put their money? So I mean, one of the things that you kind of you and I were kind of going back and forth is where where they put their money, so it’ll kind of to reverse it on Jeremy. I mean, bonds stocks, believe in cash, we’re, what are you recommending to your clients right now, to put that kind of money?

Jeremy Witbeck – 2:38
It’s a great question, and one that I, to be quite frank don’t necessarily always have a perfect answer for I think that the answer differs for everyone. One of the big things that I recommend to people is to think a little bit outside the box on how they can keep liquidity within their portfolio. So for example, one of the ways that you can do it is by having cash in the bank. And historically speaking, when you could get a decent rate of return in cash, not such a big trade off to do it that way. However, we haven’t really been in an environment where you can get a decent return on cash since what 2012 2013 and doesn’t look like that’s changing anytime soon. So one of the things that I recommend with people as we do their financial planning is looking at other assets that can give them access to equity so that they don’t have to sit on such a big cash pile. So a home equity line of credit is a great example of that, where you if you have equity in your home, you can have a line of credit there ready, available for a time of need. And you’re in essence sitting there on the bank’s money earning nothing and not your own. And that’s where I would recommend, then if we can earmark or carve those other cash funds for longer term goals, then we can start investing them in real returning assets. So that’s that’s typically what I would recommend something along those lines. Of course, there’s a lot of different ways to get to that same conclusion. But same question for you, Jeff, what are you typically recommending to people?

Jeff Powell – 4:04
Well, one of the first things I’m talking to them about as being, you know, being correct. And I know that sounds like a really silly thing to sit there and tell somebody, but I mean, if you can sit there and tell somebody, okay, whatever we’re going to do here, we’re going to be right about it. Sitting 100% in cash, you’re either gonna be right or wrong, okay, there’s, there’s no in between going on here. So what I’m telling people is, look, you’re sitting on a bunch of cash, you don’t know when to put it to work. So let’s remove the emotion from it. Let’s push in a quarter, maybe a third into the market right now. You know, the expectations for next year, whether the stock market is actually very strong, and 2022, for that matter. So let’s push this into one of our strategies. Let’s get this money working for you. And what I mean by being right, if the markets keep going up, you’re right, you push some of your money into the market, and then you systematically put your money to work from there. You’re also right if the markets go down. Guess what? You kept back three quarters your money you didn’t put it all work, you didn’t sit there and throw all, you know, caution to the wind and here you go, here’s all my money, you put a quarter of it to work. And then you’re right, you kept 75% and dry powder to put to work if the markets pullback. So either way, you’re right within that. And that way you stop sitting there trying to pinpoint the perfect time to get involved with the markets, which you and I both know is never gonna happen. Now, the one thing about what we do in our jobs every day and the investment management team, as it’s about being partially correct, you know, I you hear me saying this all the time, I’d rather be partially correct and completely wrong. Okay, well, that’s great, you know, I don’t want to sit there and be all in are all out of something. So somebody’s sitting on way too much cash, they’ve made the decision, you know, to be extreme. And that’s one of the things that we always talk about is to, to move away from extreme. One of the things that were you and I have been talking about offline before this call was, you know, a lot of people are also making the mistake of going into the fixed income marketplace. And they think, Okay, well, you know, if I’m going to go, and I’m going to wait into the pool a little bit here. Bonds are the safe place to go. And I can at least make a little bit more money there. Well, as you and I’ve talked about, I mean, there’s not a really good place for you to go within the within the bond market. I mean, if you’re looking at US Treasuries right now, I mean, if you’re going out 10 years, you’re getting a just under 1%, you’re getting 95 basis points under money, inflation, so a little under 2% 1.7, to be exact. So you’re saying that you’re willing to lose seven tenths of 1%, every year for 10 years straight? Now, and again, not to be too rhetorical with with this question for you, Jeremy. But you know, if you wanted to, you could give me a million dollars. And in 10 years time, I will give you a $930,000 back. That sounds like a good investment.

Jeff Powell – 6:59
And we are.

Jeff Powell – 7:01
So I mean, again, obviously, you know, when I say that to people live, there’s quite a kind of have a laugh behind it just like you did, and a kind of a smirk that you can hear not necessarily see unless you’re doing video conferencing. And you’re absolutely right. I mean, what kind of investment is that? They’re seeing on their statement, slow progress. So in 10 years time, their statements gonna say $1.1 million. So they think, Oh, I’m making progress, but they’re able to buy $930,000 in 10 years time. And that’s assuming that inflation remains low at 1.7%. Also, I mean, historically, our inflation has been in the threes, three and a half to be exact. So if you’re really looking at it in true context, and we go back to any kind of normal inflationary environment, you’re really promising yourself to get really badly beaten up in this market, between either currency risk, or inflation risk, or both.

Jeremy Witbeck – 7:52
So Jeff, can you can you elaborate a little bit more on that for those that aren’t as familiar with why inflation is a bad thing for income generating assets like bonds? So why is it that a rising inflationary environment is going to severely potentially severely negatively impact things like bonds or other safety type assets?

Jeff Powell – 8:14
So I think that in order to explain this properly, I think that it’s really necessary for us to kind of take two steps back and just talk first of all, how the bond market works. So when you buy a bond, you’re buying somebody borrow, I mean, you’re buying debt. And so if you think about it, you when you went and bought your house, I’m assuming you’ve got a mortgage, right? Yeah. So you were the borrower, the bank was the lender. And I’m assuming that at some point in time during your homeownership, that the bank sold your loan to somebody else, and all of a sudden, you know, your Wells Fargo loan became a Citibank loan or became a whatever loan, those are the banks buying and selling different credit between each other, that goes on within the bond market to the bond markets actually just as big, if not slightly bigger than the stock market, people just don’t realize it because it doesn’t make the news nearly as much just sit there and talk about a few basis points here or there that the bond markets moving up or down. And when the rates right now are as low as they are. The only thing that’s making news is how low they are and being able to borrow at a low rate, rather than to be looking at it in a different context. So think of it this way, you are the bank, not the borrower. Okay, you’re the one who’s getting the interest, not paying interest in this case. So when you are buying a bond, you’re lending money. And the width of the bond market is priced is really based upon multiple factors. So kind of think about it as a seesaw part of it once a bond is issued, price and interest rates fluctuate. And it will be related to that. But when you’re actually pricing an original bond, just like when a bank Was evaluating you for a loan, they’re gonna say, Okay, how long is the long? You know, what is the credit quality of that person, you know, and so on. So they’re going to sit there, you know, obviously US Treasuries, there’s not going to be an evaluation. But if you’re going up looking at a municipality, or looking at a corporation, you’re looking at the credit quality ness of it, just like you would, for example, if you were looking at foreign nations, so for example, Italy is a lot more risky nation than, say, Germany, within Europe. And so the pricing is going to be radically different, you’re going to expect to get paid more for somebody that’s more risky. So if you’ve got a friend who was, you know, never pay their credit card bills, they’ve got horrible credit, when they go to the bank and try to borrow money, they’re paying one to 3% more, because the bank’s worried that they’re not going to get their money back. And so, so you’ve got to think about it in that kind of context. From there, when most people are looking to buy bonds, based upon safety, and so they’re going to buy bonds, they’re gonna say, you know, okay, I want short term, intermediate or long term, again, the likelihood of you defaulting on a loan, if even if your credit stock rate, if you did a five year loan versus a 30 year loan, or 30 year time period is much greater that you’re going to have the default, let’s say, a five year. So the pricing again, is going to be based upon some of this.

Jeff Powell – 11:19
Well, we’re talking about, you know, again, with like, portfolio management, however, is how bonds fit into your portfolio. And, you know, do you want rescue not want rescue me, we could get into all sorts of other complexities of high yield, which is junk bonds, which are the high risk part of the marketplace, or, you know, again, treasuries, convertibles, or all sorts of different instruments. But to make this easier, let’s just stick with us, let’s just stick with government bonds. So we’ll compare like us bonds to other bonds and other countries. But for right now, for example, we already talked about that a 10. year Treasury is earning you only about 1% per year. And the reason for that is it’s a very low risk investment. The Federal Reserve has lowered rates all the way down to zero. So normally, the Treasury market is based upon where Fed Funds rates are. And so the lower those rates are, you’re basically getting a spread between what the Federal Reserve is going to provide for you, and what’s going on from here. So I don’t know if that it kind of explains it to a degree for you. But once the bond has been issued, if rates go up, prices go down. So again, think about it as a seesaw, where, again, you’ve got interest rates on one side, you’ve got price on the other side. So if you and I were talking about US Treasuries at 1%, just to make the math simple. At a zero Fed Funds rates, if the Federal Reserve raises rates by 1%, then the US 10 year Treasury, presumably which should be going for 2%, not 1%. So now you’re talking about getting twice the income, which is worth more money to a bond investor, than if it was sitting at 0%. Fed funds, right. So again, interest rates going up, price goes down to offset that in order to is, if you’ve already locked in a bond that’s only paying $1,000, you know, or 1% $1,000, per 100,000. And then all of a sudden, a new going rate is $2,000 per 100,000, you need to discount that bond in order to offset that $1,000 difference.

Jeremy Witbeck – 13:18
If I were to summarize that, then it sounds like the real risk, the real concern is that at some point rates will probably go up from here, because they’re at rock bottom. And when that occurs, the bonds or other fixed income generating assets are going to lose value, because they’ll just be they will pay less than future bonds issued. So there’ll be become worthless. So that kind of adds insult to injury where not only are we getting very low yields right now, on top of that, if you have principal erosion down the road, it’s going to wipe out most if not all, the return and maybe then some, is that that pretty fair summary.

Jeff Powell –13:51
I think that’s a very first summary. I mean, a lot of people talk about owning their bonds and owning them to maturity. So technically, you know, that person that buys a 10 year Treasury right now, you know, they could lock in that 95 basis points per year for the next 10 years, not really lose principle, but lose buying power, losing opportunity costs. If we were to see Fed Funds rates go up, and they were to then turn around and need that money and needed to sell it, they would definitely lose money on it, the bond prices would have fallen, and they would be in that situation. The biggest issue for us is when you’re really kind of looking at traditional asset management and, you know, looking at modern portfolio theory, where people are looking at what worked in days past versus what’s going to be going on going forward. And really, when you’re looking at it in this kind of context, you know, people are putting far too much money into the bond market with the understanding that they’re going to lose money here. Right now, the the bond market is really, the yields are very suppressed because you still have trillions, and the last time I checked, it was over 10 trillion dollars of foreign debt, that’s paying a negative yield right now. So for example, I mean, the United Kingdom, if you buy any government issued of fixed income under five years, you’re losing money on it, not just buying power, you’re losing money. If you look at the German bond market, same thing, it’s actually negative through all 30 years of their yo curve. If you look at Italy now, and here’s a place that, you know, typically in days past, if you wanted to pick up some high yield, being involved in foreign debt, Italy was normally a place that was kind of that, that good mixture of risk, but you knew that they if they were really gonna fall apart that Germany and France would kind of sneak in and, and help them out, not anymore. mean their 10 year Treasury is actually lower than ours, you’re getting 54 basis points for a tenure, Italian lira bond. If you’re under five years, you’re losing money, again, negative yield, you can do the same thing with France, you can say the same thing with Japan, you’ve got all these countries that are kind of playing around and experimenting with negative yields, which we’ve really again, only in the last few years, have we run into a situation where people were being penalized for putting money into safety?

Jeremy Witbeck – 16:19
Yeah, that’s that’s very interesting. And, Jeff, do you mind taking a couple moments? Why do the international bond rates matter to a US bond investor, so what typically happens if a country goes to negative interest rates with us bonds or any high credit quality bond for that matter?

Jeff Powell –16:34
 So So two things that are going on with negative yields? One is that that government is trying to get their, their population to put that money to work to not have it sitting in cash, so to either invest it, or to spend it one of the two. So they’re penalizing them to not have their money sitting in a bank account. So that’s, that’s part of the experiment is to sit there and say, Okay, well, let’s see if we can get this money working one way or another. The problem with that is, you know, it doesn’t necessarily always work that way. So from there, we’re looking at is, you know, imagine us, Jeremy. I mean, instead of being a US resident, you’re a German resident. Now, if you’re sitting there trying to buy something that is a secure investment, that’s going to pay you positive interest on negative interest, would you buy your German bonds? and I do mean bond bu MD? Or do you know you’re going to lose money? Or would you potentially come to the United States and buy a treasury? Now the biggest risk that you take as a German citizen doing that is currency risk on so you would buy the Treasury knowing that we’re going to bank 1% versus losing money. So again, if you’re looking at let’s just, again, go back to the tenure, what we’re talking about within that, the 10 year German bond is negative point 6% per year. So we’re not talking just losing based upon buying power, we’re talking about truly losing over a 10 year time period, 6% of the value of your money, plus whatever interest rates are on top of that, or inflation, I should say on top of that. So if you’re a German citizen, you’re going to look outside of Germany to invest that money. And so when you’ve got buying pressure on a treasury, again, if you’re thinking back to what we were saying before, price and yield have an inverted relationship. So let’s say that you and I both want a cup of coffee, and there’s only one cup of coffee left, what happens to the price of if you and I both really want it goes up, price goes up. Simple, simple auction, right. So back and forth, I’m gonna pay $1 for that cup of coffee $1 20. And a lot a lot. Finally, one person says that’s more than I’m willing to pay, and they’re done. That’s what happens within the ball market. It’s a negotiated marketplace. So back and forth. So it’s it’s kind of like buying a home. It’s worth only what somebody else is willing to pay for it. And it’s not done in an auction situation. It’s done in a negotiated environment. And so when we’re looking at it from this context, really, again, when you’ve got more buyers and sellers, so we’ve got Germans we’ve got basically almost all of Europe is paying negative yields right now. You’ve got Japan paying negative yields. These people are going to be looking for a better yield on their money. So they’re going to come to the US so more buying pressure means prices go up and yields come down. So again, it is a yield suppression that we should see continuing for an extended time period until we see negative yields and foreign markets go away.

Jeremy Witbeck – 19:47
Yeah, that’s that’s all very interesting, Jeff. And he kind of brings together then what should people be doing then within their portfolio and I guess to stated a little bit differently. Fixed Income is typically held Because of the lack of volatility, and although there are times where bonds can be somewhat volatile, they’re typically thought of as a safety asset. How should people then construct their overall portfolio given this information and knowledge?

Jeff Powell – 20:13
Yeah, I mean, that’s a great question, obviously, one that we need to sit there. And I mean, I would not take lightly. If we run into it in conversations with clients, where they’ll come back and say, You do realize I’m this age. I’m like, Yeah, I realized you’re this age. I’m 70. I’m 75. I’m 80. Should I be this bunch of equity? Typically, again, like you said, Jeremy, when modern portfolio theory was created, when, when finance was taught to you, and I, and the 80s, and 90s. And 2000s, really, there was a rule of thumb, which is that, you know, you take 120 minus your age, and that’s what you should be, and the equity market. So if you’re 30 year olds, you take 120 minus 30, should be 90%, stock, 10% bonds. And so the older you get, the more you take a a more conservative stance within the market. So you go more and more into fixed income. When you can’t even outpace inflation, you’re gonna run into a huge issue. So somebody that’s sitting there saying, Oh, I want to be moderate, I’m gonna go 5050 and the stocks and bonds, okay, well, you just said to me, that you’re, you’re going to be willing to give up half your portfolio is now going to earn you nothing. In fact, you’re going to lose buying power. And from there, the other half has to work twice as hard in order to pick up the slack. We’ve had a really interesting market this year, obviously, with with COVID. And markets dropping as much as they did. And the rebound, we obviously had a lot of turmoil back in 2007, through 2009, we had the.com bubble burst all during my career. So it’s about a once every decade type of situation, where you have, you know, a lot of turmoil, not to sit there and say, you know, 2018 wasn’t a lot of fun as well, during Christmas. We’ve had other drops in the markets between 2008. And now I mean, we had 2015 was, it was a tough year 2011 was a tough year, really, the only easier was 2017. We still have people worried about that. But we’re what I’m really suggesting to the average investor is to really rethink what risk is, and we’ve written about this multiple times, but as risk, you know, a few months, or even a year of downside in the stock market, or is it a multi decade timeframe in which you’re going to lose buying power. And, you know, again, back into, you know, 80s 90s 2000s, you could be in a lot of fixed income and still outpaced the inflation rate, the average yield or average return in the bond market in the Treasury market, 10 years, was a 9% return from 1982 to 2012, a 30 year time period, in which you outpaced inflation by about 6% per year, I mean, ridiculous returns. And so only 5050, you weren’t sacrificing anything with your total return for your portfolio. Whereas today, if you were to do that, again, we just talked about at a 10 year Treasury is going to lose you money with buying power. And then let’s just say that you do get a 10% return just to make the math easy. That gives you 8%, after inflation, but it’s only 50% of your portfolio, so you’re gonna get a 4% return. If you’re drawing and again, your other part of your portfolio is losing you about 1%. So, if you’re going and going back and forth, you’re getting under a 4% total return out of your portfolio by being 5050. And if you look at like, I mean, you’re a CFP, what is the average that they say that you can draw per year safely?

Jeff Powell – 24:06
And typically, it’s around three, three and a half percent these days.

Jeff Powell – 24:11
Okay. So the one that I’ve always heard historically is for just use safe math is that that was the safe rate of withdraw. Okay, well, let’s see if it say it is three, three and a half percent. You’re making no traction whatsoever with your with your portfolio. And if you have any emergency or if you want to go I mean, how often do we run into people that go over their budget in retirement. So all of a sudden, now, you’re deteriorating or not worth, because you’re not taking care of yourself when it comes to the higher investor. So to me, the biggest thing that I look at is I don’t need to be traditional. I don’t want to be traditional. I need to be thinking outside of the box on your behalf as a client, and making sure that the way that I’m investing my money for you is taking Have you properly? It’s not, you know, again, you know, sometimes the best advice is advice that people don’t want to hear, but it’s the best advice. Kind of like with your kids, you know, your kids may not want to go to bed at their bedtime, but when they’re younger, getting a specific amount of sleep every single day is absolutely necessary. Not the most popular thing in the world. But the best thing, you know, eating one’s vegetables, you know, depending on on what vegetables and how much you like that. I mean, oftentimes, you know, people view that as the worst part of their meal, okay, well, it’s still necessary, you still need a balanced diet. And we so it’s the same thing here. It’s It’s telling people, you know, what they may not want to believe, or, again, what’s not traditional, but it’s what’s the best thing for them. So their portfolios might be a little bit more volatile than what you would see in days past, but at least it will help them accomplish their financial goals long term.

25:55
Yeah, Jeff, thank you very much for that very thorough answer. And I think something that we all need to really think about is really evaluating risk. And I know you put out a few different articles on this. But when we talk about risk, we really have to, to define both of them both volatility risk, which is what I think everyone really reads about focuses on, but also the purchasing power risk, as you stated earlier, and arguably, the purchasing power risk is the big risk factor over the next decade or two that I don’t think we’re talking enough about and certainly one that we’re going to have to be very conscientious of and make proactive decisions in order to combat angelyn portfolios.

26:34
I know that we’re running out of time, but I want to throw out one last thing to kind of keep it in the back of one’s mind here. Because there’s really kind of two other elements that are coming into play here. We don’t have when we’re sitting on all of this $30 trillion of debt. If we have the other the next stimulus package, and the kind of two $3 trillion levels will be at that will be at 30 trillion at that point. If you’re talking about that much money and debt, we’re kind of stuck, we don’t really have the ability to have the Federal Reserve raise rates too much to combat inflation, because we can’t afford it from a fiscal standpoint. So the one thing to keep in mind is not only are rates low, right now, they’re going to remain low, and perhaps even manipulated, for an extended time period, because we can’t afford it. Now, that’s number one. The other thing is, if you’re sitting on $30 trillion worth of debt, what’s the easiest way of getting rid of that. And that’s, you know, having a currency of devaluation. And you’re already saying I’m in the US to two euro is already dropped by more than 5% on the year. If you continue to see that go on. Think about it in the context of if $1 is worth 50 cents in the future, your debt went from 30 trillion down to 15. Not that it’s easy to be 15 trillion, but it’s a whole lot easier than paying off 30. And so the other thing to kind of keep in mind with all this is that we need to continue to grow money even in retirement to offset these things. And again, these are the silent killers that will come back and bite somebody in the backside at exactly the wrong time when they’re later age and are unable to sit there and offset it. So it’s best to attack this now and to attack it efficiently.

Jeremy Witbeck –  28:22
And Jeff, thank you very much for all those insights. And always, as always, really appreciate you taking the time to speak with us today. So that we’ll go ahead and wrap up and everyone stay safe stay healthy.

28:39
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