Try Hard Investments vs. Hope For The Best Portfolios

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Raymond “Scott” Stone

Partner/ Investment Manager

Stone House Investment Management, LLC

rstone@stonehousemail.com

http://StoneHouseInvestmentManagement.com

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For our current clients and those of you who are considering using our services, I want to give you a quick guide for whether you should be choosing an active or passive investment management strategy. I want to keep it brief and easy to understand, so I won’t be able to go through all of the details, but my hope is that it will give you enough information to make an educated decision.

We have designed Stone House so that it offers our clients the best chances of achieving their financial goals. One of the ways that we have done this is by offering several very different investment management strategies that can be used in tandem with one another to create a “Super Portfolio”. The strategies we offer function very differently and can consequently have very different outcomes year to year. I would like to pretend that I know which one will be the best over any given time, but I have invested money for people long enough to know that the best we can do is make smart decisions to protect and grow our clients assets and then adjust as the world changes (And boy, does it change). I want to talk about three of our portfolios management styles and how their performance has differed over the years to illustrate this point.

First, is our “Flagship” portfolio strategy that we call Keystone. Keystone is a strategy that we built in-house that is very different from almost any other portfolio in which you may currently invest. Keystone allows us to evaluate the market daily, then determine if we feel there is a strong reason to stay invested based on historical behavior of the stock market. It has done extremely well for our investors in some years, but more recently the performance of this strategy has been lackluster. That isn’t to say that it has been bad, but it hasn’t kept up with some investment benchmarks like the S&P 500. The investment decisions we make inside of Keystone are well educated preparations for an uncertain future. Because the future is uncertain, no amount of intelligence can guarantee that any decision today will pan out to be correct in the future. In a “normal” year, the markets may be…. 60% to 70% predictable and 30% to 40% unpredictable. The past few years have been unusual to say the least.  The unprecedented actions taken by governments around the world have manipulated the functioning of most equity, commodity and fixed income markets. As there is no precedent to rely on to understand how certain actions will effect our clients’ investments, it dramatically raises the unpredictability of the markets leaving investment managers in a very difficult position. Seemingly, the more we try to protect and grow our clients’ portfolios, the more Congress, or the President, or the Federal Reserve Chairman, or some foreign central banker want to ruin our plans.

Additionally, because of the uncertainty in the United States, we thought it prudent to diversify internationally in case our government made choices that did not favor our stock market. Europe was a mess with its own issues, so we ended up weighting our less conservative Keystone portfolios to Emerging Markets.  Unfortunately, the actions taken by our government to prop up our stock market have had a negative impact on Emerging Market countries causing many of their markets to fall precipitously even as our stock market has moved higher. This has added to the disparity of globally diversified investments verses the S&P 500 over the past few years. Again, in our attempt to protect our investors, we missed out on some gains.

As an alternative, you could choose a more buy-and-hold management strategy like that of our Essential and Diversidex Investment management strategies. These portfolios each invest expecting the stock market to go up over time, but are less concerned with the day to day movements in the market. These strategies have worked great over the past few years. No matter how dark the economic skies got, no matter how dysfunctional our government is,  no matter how high our national debt goes or how low the US dollar goes, our stock market keeps going up! Being fueled by the “money printing” of the Federal Reserve, our Stock Market has either blissfully ignored the dangers, or quickly recovered from any downturns due to these accumulating economic risks.  So that’s the answer, right? Just buy and hold? Not so fast!

The reason that this strategy has worked is because the governments of the world (particularly our own) have taken a series of deliberate actions to favor the short-term performance of the stock market at the cost of addressing our long-term sustainability. That is not to say that this is not a “smart” economic policy, only time can tell us that, but it is important to remember that every 3 months or so, an organization within some nations’ government has chosen to take unpopular actions to bolster their financial markets. Had they chosen a different path, buy-and-hold portfolios would likely look very different. For example, in the latest debt ceiling debate, there was talk by certain members of Congress of letting the government default on its debt. Even if they had chosen to do this for a very short time, it would have been disastrous to our economy and a buy-and-hold portfolio. A catastrophic mistake like this would have had you wishing that your advisor put your money on the sidelines leading up to the decision. Such events have happened in the recent stock market crashes of 2000-2002 and 2008-2009. However, because in recent years the governments of the world have taken extraordinary actions time and time again to prop up the stock market,  the market rose significantly and had you been sitting on the sidelines, you would have fallen behind the averages.

So which is better? Trying to protect your portfolio at the risk of potentially missing out on some return, or to blindly hope that the boogieman never comes out of the closet and that your buy-and-hold stock portfolio doesn’t get eaten? There is no right answer to this question. It largely comes down to your attitude as an investor. However, Stone House offers the option to take part in both of these categories of investment strategy. We encourage our clients to choose to divide their investments into multiple strategies to give them the best chance of success. Additionally, we offer our Cornerstone portfolios which have elements of active and passive investment management.

When you partner with Stone House, we do our best to help you prepare for an uncertain future. Through helping clients invest using multiple investment philosophies, we promote more stable portfolios and hopefully a return that allows our clients to achieve their financial goals. Over the past few years, buy-and-hold management has beaten out more actively managed portfolios, but as asset values inflate, the potential for return decreases and the risk of a correction or bear market goes up.  Only time will tell how long buy-and-hold strategies will hold out. One thing is for sure, in a buy-and-hold strategy, you will make a lot of money when things do well and lose a lot of money when things are bad. Markets move in cycles and the longer this bull market runs, the more likely we are to see a bear. Active management strategies may help protect you from the next inevitable market downturn, but may not return as much while the Bull market rages on. It might be a good time to try some of each in your portfolio.

-Raymond “Scott” Stone

Hey Royalty Owners… Lower Your Taxes!

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Robert J. Brown, CFP®

Partner/Investment Manager

Stone House Investment Management, LLC

210 Maple Street, Montrose, Pa 18801

570-278-6926

rbrown@stonehousemail.com

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We are often asked if there are ways to contribute royalty income to IRA’s or retirement plans. The answer is no, but there is a work around you may want to consider. Think about increasing your contributions to a retirement plan at work.

Who does this work for?  Anyone receiving royalties AND who is employed somewhere that offers a retirement plan or is self-employed.

What you need to do?  Dial up your contribution amounts from your paycheck and into your retirement plan.  It’s that simple.

Why does it work?  It works because you are only allowed to contribute EARNED income to a retirement plan/account. Royalties do not qualify, but you can spend your royalties for your daily expenses and instead contribute your earned income from work to your retirement plan or IRA.

Here’s an example:  Let’s say you’re making $60,000/yr at your current job.  You were putting 3% ($1,800/yr) into your retirement plan at XYZ Company because the company would match it.  However, NOW you’re seeing royalty checks of $2,000/month! You can spend that $2000/month of royalties  on living expenses such as groceries, your mortgage payment, your car payment, etc (after you set aside enough for taxes).  Then you can instruct your employer to hold out much more from your paycheck to put into your retirement account at work.  How much you can contribute depends on your company’s plan.  Some plans allow for more than $20,000 per year!

What if you’re self-employed and don’t currently have a retirement plan in place?  Now might be the perfect time to set one up.  There are many types of plans to choose from depending on the size of your business and what type of contributions you want to make to your own retirement and the retirement of your employees.

For many people, this will give you a great chance to save more for the future and pay less in taxes today.  That’s a win-win in most investors’ minds!