Results from the 3 energy stocks in my portfolio March 3, 2014Posted by shaferfinancial in Uncategorized.
add a comment
I will start with a thought on stock investment from Warren Buffett: He believes you invest in a small [for me] piece of a company and therefore should not invest in any company you don’t have confidence in the management. That sums my thinking on these three investments. I mention this because 1 of the stocks has had a dramatic last month due to a couple of analyst assertions that the dividend was in trouble. But I am getting ahead of myself. I will talk about these stocks in order of the size they represent in my portfolio.
SFL [Ship Finance International] is a owner of various ships including drill ships, which it leases out. They have added several ships over 2013 and will continue to add over 2014. They have a relatively large store of cash for which to increase their asset base [$216M]. Their debt maturity is staggered with very little coming due until 2018-2019 because they were able to refinance much last year under good terms.
Net income for 4th quarter compared to 3rd quarter increased 36%. Their backlog is $4.8B. Recently, they sold 2 underperforming ships for a profit. They have 4 ships scheduled for delivery Q4 2014/Q1 2015 that are already chartered out. They have 2 ships that the shipyard is behind schedule on and might be canceled.
Finally, the one area of concern in the past, their charters to troubled Frontline, have been managed well and those 15 ships will start sending much cash to SFL in 2014 under the new agreement. Meanwhile any remaining loans on those ships are below scrap value. So, if that counter-party would fail their would be no negative repercussions to the cash flow or dividend. They also just put a drill ship into lease and will start getting cash flow from it at good rates. Finally, they note an improving oil tanker environment that could increase cash flow even more.
They increased the dividend to $.40 per share an increase of 3% over last year. But my analysis points to a significant rise in dividend toward the end of this year. My yield on cost is now 11%. Bottom line is a safe dividend currently compounding at 11%.
Seadrill owns and leases out drilling ships to the biggest energy companies in the world. About 1 month ago some analyst woke up and discovered that it is highly leveraged at the current time in order to purchase the latest rendition of deep water drill ships know for its increase safety and efficiency. In fact it brought on 13 drilling ships in 2013 and has 20 more rigs under construction. It has a total of $20.3B order back log including long term contracts on 3 of the rigs still under construction. It has contracts on almost all of it’s rigs for 2014 and over 72% of its rigs in 2015. In short, the next few years are covered with good contracts for the majority of its fleet.
It has plenty of financing in place to complete its purchases. For the time being, it will take a break from ordering more ships until it has a clearer picture of the demand post 2015. Now here is what the analyst have gotten all upset about. It has sold old assets to a sister company to have the cash flow to pay out its generous dividends [10.7% yield]. This is the model, purchase the newest and best drill ships that will command the highest day rates and attract the strongest counter-parties using debt and cash from sales of older drill ships. Maintain an exceptionally high dividend as a reward to its owners. I knew this when I bought in last fall. Yet, suddenly some analyst find this troubling and downgraded the company. Over the last few months these analyst have driven down the price around 10%. Good for them and me. I bought about 20% more at substantially lower prices than my earlier purchase.
Buffett March 1, 2014:
“It should be an enormous advantage for investors in stocks to have those wildly fluctuating valuations placed on their holdings – and for some investors, it is. After all, if a moody fellow with a farm bordering my property yelled out a price every day to me at which he would either buy my farm or sell me his – and those prices varied widely over short periods of time depending on his mental state – how in the world could I be other than benefited by his erratic behavior? If his daily shout-out was ridiculously low, and I had some spare cash, I would buy his farm. If the number he yelled was absurdly high, I could either sell to him or just go on farming.”
Now on to last quarter:
Net cash from operating activities went up 7% year on year. Cash available doubled.
During the last quarter of 2013 SDRL had 23 floaters, 22 jack up rigs and 3 tender rigs available. They expect to take delivery of 7 new drill ships in 2014, 11 in 2015 and 3 in 2016. Well over 90% of their fleet is last generation meaning they are the highest demanded version in the market. All current rigs were leased. The jack up rig had a utilization rate of 97% while the tender rig utilization rate was 95% and floater were 94%.
One oil driller with an old group of drill ships had issues getting a couple of its ships leased and took a cut in day rate in order to accomplish it. This was another issue that sent he market into a tail spin. However, the company has stated that it doesn’t see issues with getting its modern drill ships leased at good rates. There is some downward pressure as energy companies face increasing cost of exploration and recovery. Expenses on land based wells in the shale oil regions of North America have gone up as well as the cost of exploration. Movement to the Arctic, off of Africa and Brazil have increased expenses. However, Mexico has now decided to be more aggressive with its off shore drilling programs and SDRL has entered into a partnership with a Mexican private equity group to own and drill off of Mexico using 5 SDRL ships. This is the first time a non-Mexican company has been allowed to do this. By getting an established relationship, SDRL should be able to leverage more leases in the GOM off of Mexico. Despite all this teeth knashing the future looks very bright for SDRL and its asset positioning.
They raised the dividend another 3% and plan on keeping it there for a few quarters. Meanwhile they are creating a special dividend account and placing 20% of the profits from sales of old rigs in it. My current yield to cost is 9%. So, while we wait for the new ships to come on line and start producing cash flow, I will take the 9% dividend. And by re-investing the dividends that dividend should compound. Hopefully, the price remains attractive during this process!
Awilco Drilling [AWLCF]
This is the simplest to deal with and the riskiest. AWLCF own and operate two drill ships in the North Atlantic. There is currently a wide moat around drilling in this area so it is unlikely to see much increased competition. It all comes down to performance, or more specifically how many days it keeps its drill ships working and what its expense are.
It has a current back-log of $724M. Current leases go through to February of 2016 with one 3 month window that could be picked up by the current leasee but hasn’t. They had 99% operational up-time in the last quarter, but weather caused significant “waiting on weather” which are lower rates bringing the revenue efficiency down to 95%.
Operational cost were $88K per rig per day in-line with expectations. Day rates remain solid because of tough UK rules on adding drillers in the North Sea. As long as oil remains in the same value range, AWLCF will continue to make outsize profits.
The dividend declared for $1.10. My yield on cost is 21% before the current dividend is paid in 2 weeks.
Currently, the dividend looks solid going forward, but if there were some performance issues and the dividend needed to be cut obviously there is much to work with.
I intend on increasing my position by about 50% after I receive my dividend as long as the price remains attractive.
Now here is the part that is most important. I believe in the management of all 3 companies.
I believe that all 3 are well managed and capable of dealing with issues as they come up.
Short term 2 out of the 3 are down since I bought them.
For the total of the 3 I am up around 8%. But that is really irrelevant to me because I have no intention of selling the three anytime soon. Combined, my dividend yield on cost is 12%. Compounding 12% plus any dividend increases is not bad. And over time the price of the stock has to connect with the dividend.
I am long on all three.
My Thinking on Energy Stocks March 2, 2014Posted by shaferfinancial in Finance, Uncategorized.
Tags: AWILCO, Energy investing, My Portfoilio, SDRL, SFL
add a comment
Buffett in his letter to investors March 1, 2014.
“What the economy, interest rates, or the stock market might do in the years immediately following [two personal investments he made in 1987 & 1994] was of no importance to me in making those investments. I can’t remember what the headlines or pundits were saying at the time. Whatever the chatter, corn would keep growing in Nebraska and students would flock to NYU.”
Does anyone think that the global use of oil products is going down in the future? So my analysis starts with that premise, backed up by data of increasing demand [even with China economically in a lull], that oil will continue to be in demand.
Again Buffett: “Focus on the future productivity of the asset you are considering.”
Now some people have asked me why I invested in deep sea drilling companies instead of land based oil & gas drilling companies? My analysis was pretty simple here. Even a cursory look at what is happening would draw into question the “future productivity” of land based shale oil plays. That is, the wells drop in productivity by as much as 60%-70% in the first year and are played out in a few short years. This forces companies to continually drill wells incurring expenses not yet accounted for.
Now SDRL, AWILCO and SFL all have future productivity that under the premise of growing long-term world demand for oil, are assured barring major management miscues.
Buffett: “If you instead focus on the prospective price change of a contemplated purchase, you are speculating. There is nothing improper about that. I know, however, that I am unable to speculate successfully, and I am skeptical of those who claim sustained success at doing so.”
Hence, I look at the dividend payments schedule for these companies. Consider shale oil drillers Chesapeake Energy at a dividend yield of 1.35% or Encana Co. at 1.48%. I note that these independent drillers spend $1.50 for $1 worth of profits. Continental Resources reported increase production of 35%, yet net income decreased 39% from the last quarter due to increase expenses and derivative losses. Expenses increased 69% over last year! They pay no dividend. Their issue is the rising cost of getting that oil against the supply/demand equation. The more oil they produce, the greater chance the price of oil decreases meaning they will lose even more money. Sitting out there is OPEC which could increase its production decreasing the price of oil. That’s why we are seeing major energy companies selling their land [Shell, Hess, BP]. They simply don’t like the economics of the shell oil play. They need to drill and produce more oil to make a profit, and yet if they do that the price of oil could drop below their cost of drilling.
Current yield for the three energy companies I purchased are 10.7%, 8.5%, and 21.2%. All those companies have billions of dollars in order backlogs securing their current dividends. [I will discuss specifics of this in a later post]. All have increased their dividends over the last year.
So looking at future productivity and current yield leads me to the place of investing in drillship owning companies with huge backlogs of leases. And if the price of oil goes down they can simply lower their dividends temporarily.
Now a long term decrease in the use of oil products is the major risk here. I am comfortable assuming that risk while my dividends are reinvested causing my dividend income to increase exponentially over the long term.
Finally, Buffett: “It should be an enormous advantage for investors in stocks to have those wildly fluctuating valuations placed on their holdings-and for some investors, it is. After all, if a moody fellow with a farm bordering my property yelled out a price every day to me at which he would either buy my farm or sell me his-and those prices varied widely over short periods of time depending on this mental state- how in the world could I be other than benefited by his erratic behavior?”
I picked up some more SDRL last week when the market pushed it down into the $35 range. I was happy to buy it at $41, and more than happy to buy some for less than $36. I sold some Berkshire and will increase my AWILCO after I get my dividend. All part of the plan to develop dividends enough to live off of in retirement.
Comparing leaving money in a 401K/IRA or paying penalty and putting it into a EIUL February 25, 2014Posted by shaferfinancial in Finance, Uncategorized.
Tags: EIUL versus 401K/IRA, Taking money from your 401K for premium on a EIUL
add a comment
This subject is somewhat controversial because of the penalties involved in taking money out of a 401K/IRA before age 59 1/2. But I thought the readers would like to see the math behind this suggestion. I will do it for both age 45 male and age 60 male which wouldn’t have to pay the 10% penalty, just taxes.
I assume the same 45 year old man as in the last post. He takes out $135,000 which ends up being $100,000 after taxes and penalty. The comparison is leaving the $135,000 in his 401K compared to putting in $100,000 over the minimum time [4 years + 1 day] into an EIUL. I use actual index returns from the last 22 years on both sides of the equation. Again, I take out no expenses from the index mutual fund and take out actual expenses from the insurance policy.
The $135,000 left in his 401K for the last 22 years would be $593,285. Using the same safe 4% withdrawal rate puts his pre-tax income at $23,731. But it is taxable, so assuming the same 25% income tax rate your have approximately $17,800 in post tax dollars to spend each year from the 401K/IRA.
If this man had put $20K for 5 annual payments into an EIUL what would he be able to take out? The tax free annual income would be around $43K per year from age 68 until age 90. At age 67 he would have $457,000 or slightly less than in his mutual fund. But remember the point here is what you have in your pocket each year. $43,000 or $17,800???? The math is the same. Pay taxes up front and not wait to pay taxes when the amount is several times larger. No sequence of return risk. And life insurance which will still pay to his heir more than he put in no matter when he dies.
Once again, using the assumption that the next 22 years will be similar to the last renders a large advantage for the EIUL. As well as a large reduction in risk both to your retirement income and your family.
Our second example, is really pushing it for the strategy. Generally I suggest leaving the total amount in the life insurance policy for a minimum of 15 years. That would take a 60 year old to 75 years of age. However, since the rules require distribution from the IRA at age 70 1/2 I decrease the length of time to 10 years.
I use a 60 year old man [women work just as well if not better], in generally good, but not perfect health.
He pulls $125,000 out of his IRA/401K and pays his 25% tax leaving $100,000 for the premium.
That $125,000, using actual returns for the last 10 years, renders $206,293. He can safely take out $8,251 in pre-tax dollars or using the same 25% tax rate $6,189 after the tax man is paid.
So how about the life insurance policy? We have now stressed the policy to its max with taking out income after only 10 years. You can take out around $14,000 per year from age 70 until age 90.
So even in the worst case situation, stressing the life insurance policy, it renders higher annual income.
One more comment. Recently, I have been working with a someone who wants to leave a non-profit an inheritance. He doesn’t want to take a risk and give the money now in case he would need the money later in life. So, we are structuring a life insurance policy that will keep him in control of his money. If he wants to he can take cash out and use it for himself or give it away. Or, he can just let the policy ride and the death benefit increase. Each year he can make this decision differently if he wants. Finally, he will start it with his wife as the beneficiary, but hopes to change that as he gets older and the risk of needing the money decreases to the non-profit. He can even split the beneficiary for his wife and the non-profit. All this can be changed as he wants to. This leaves him in control of his money.
Recently, I was advised that 401Ks can have life insurance policies in them. So if you own a business and have the ability to write the rules for your 401K, you can avoid paying the tax and hold the life insurance inside of your 401k. There are some benefits to doing this.
Just a thought!
Comparing EIUL versus 401K with Mutual Fund February 24, 2014Posted by shaferfinancial in Finance, Uncategorized.
Tags: EIUL versus 401K
add a comment
I haven’t done this in a while, and have had several folks ask for it, so I thought I would do this comparison again. Their will be two comparisons. First, comparing putting money into an 401K versus putting money into an EIUL. Second, taking money out of a 401k, paying the penalty, and putting it into a EIUL. Here is the first comparison. I will add a second post for the rest of the analysis.
For simplification I am using a Male, age 45, in good health. Younger folks get more of an advantage to the EIUL.
I assume a 25% total tax rate [higher tax rates create additional advantages to the EIUL]
I assume $12,500 pre tax dollars going into the 401K, which means $10,000 into the EIUL after tax.
I have the payments going until SS retirement age of 67.
I have retirement income starting at that point.
A little discussion is needed first. The strategies and expenses are very different between the 401K and the EIUL so it is tough to compare side by side each year. So, instead of creating that apples to oranges comparison I simply compare how much annual income one can have at retirement. For the 401K I do two calculations, one what the average person has gotten from their 401K/mutual fund investments over the last 20 years and what the actual index got. I do this because it would really be a big disadvantage to the 401K by using REAL returns. The reader can make their decision as to their ability to get higher than average returns in their 401K. For the EIUL, I use the 20 year look-back at current cap rates which is lower than REAL returns over the last 20 years. I am also assuming tax rates don’t go up. So in short, I am creating an uneven playing field with the 401K having a tremendous advantage over what has happened.
At age 67, putting in $12,500 into a 401K with an S&P 500 Index inside and NO expenses this saver would have $585,047 using actual data for the 22 years. The accumulation value in an EIUL with expenses and the same actual returns would be $623,771. But this is just the beginning. The 401k Saver must pay income tax on any money he takes out, while the EIUL saver will get tax free distributions. But, there is more. The 401K saver can only take out 4% safely because of sequence of return risk [this is the generally accepted ratio]. While the EIUL saver can take out a higher percentage because there is no sequence of return risk.
At age 45 a man in average health puts in $12,500 annually in his 401K with an index fund with 0 expenses until he retires at age 67. He then starts taking our 4% per annum for retirement income. At the same time he puts in $10,000 after tax dollars into his EIUL for the same time period. At retirement he starts to withdraw tax free dollars.
At age 68:
401K disbursement will be $23,401 before taxes [$585047 X .04]. But wait he needs to pay taxes on that. Assuming the same 25% tax rate he is getting $17,551 after taxes.
Making the same assumptions for returns [actual 22 year returns] at age 67 he has $623,771 is cash value AFTER EXPENSES. He will be able to take out $58,279 per year until age 90 tax free.
What Wall Street wants you to do $17,551 annually.
What I suggest you do, $58,279 annually.
OK now lets get back to reality on the 401K. There will be expenses. People will make mistakes because of emotions. Dalbar has been tracking actual performance of investors for the last 15 years. Here is their 20 year average for investors in mutual funds: 4%.
So using a 4% average, you would have $445,223. That is after expenses and based on actual investor returns. However, that is really not the real number you would have, because that is an average number and doesn’t take into account the large negative numbers in the data set. But for our purposes this is fine to use because it points to the complete failure of the strategy being pushed by Wall Street and the government. So for those who are wondering that means $13,375 annually [$445,223 X .04 X .75].
Now you know why the median 401K is well south of $50K and even for the older age groups less than $100K.
Real numbers [well at least on the EIUL side], real comparison.
Those that are new to the concept of saving in an EIUL might be wondering why such a big difference. I have been writing posts on this for years now, but here is a synopsis:
1. You end up paying more taxes if you defer your taxes to a time after you have compounded gains in an account. The old adage, rather pay tax on the seed rather than the crops at market helps people visualize the difference.
2. Sequence of returns matter. Large negative years hurt more than large positive years help. If you can cut off the negative years as the strategy inside an EIUL does, even with a cap on the positive returns you end up with much higher accumulations. Further, large negative years at the end of your savings years or the beginning of your retirement years would destroy your ability to use the money as income. You simply don’t have time to make up for the loss in value.
3. With little expenses at the end of your savings years when the accumulation is highest, you gain an advantage over a vehicle which charges expenses by a ratio throughout all years.
4. The loans you take out of your policy are at little or no cost in an EIUL.
5. If you are the wrong side of the death curve and die early, the insurance will complete your financial planning for your family.
6. If you want your money early, you can get at it without penalties or taxes. Never underestimate this because about half of all people take money out of their 401Ks early and pay a hefty penalty for doing so.
7. You control your money not your employer.
8. Since death and taxes are the only sure things, this is a way to take advantage of both.
9. You sleep better not worrying about when the stock market will swoon.
10. The historic data is so overwhelming in favor of the EIUL that you have to wonder why anyone would go that way once they understand it. Bottom line stock market investing is much riskier than most people understand, so why bet your retirement on it?
HCN has its best year in a long time! February 20, 2014Posted by shaferfinancial in Finance.
Tags: HCN 2013 results, My Portfoilio
add a comment
My second longest holding is Health Care REIT. As regular readers know, last year I sold a good percentage of my holdings when the price went up well into the 70s [I actually sold in the high 60s]. I felt it was overvalued then and used the funds to purchase higher yielding stocks. Also regular readers know that I have been unhappy that the dividends have not been rising enough.
In order to keep raising dividends, REITS need to get more for their leases and to grow by purchasing new assets. HCN invested $5.7 Billion in 2013. In the last 5 years it has acquired $20B of assets while shedding $2B. So it is doing well in its acquisitions. Growth in the senior housing portion [60% of its income] was 7.4%. This means that their leases were doing well. Skilled nursing increased 3.1%. Medical office buildings saw a 2.2% increase for the year.
It seems as if HCN is hitting on all cylinders at this point. Which gets me to my main worries.
Management still sees much opportunity to invest in high quality properties. But at some point those opportunities will start to get harder to find. Currently they operate in three countries [USA, Canada, UK] all of which have done well after the recession. Hopefully, the investment opportunity will continue for quite a few years, but eventually there will be a lull.
Secondly, even though HCN continues to lower debt [42.6% of book value] with a goal of 40% and a coverage ratio of 3.4X this is a double edge sword. Leverage allows for greater growth. While the current debt environment is at a very low interest rate. Therefore in the future one should assume higher interest costs which will lower funds available for distribution.
Perhaps this is why they have not raised the dividend as much as one would think. FFO and FFD payout ratio’s for the last quarter were lower at 77% and 89%. They paid dividends that were up 3.9% in 2013. This despite having FFO and FAD increase 8% for the year. Their prediction for 2014 is for FAD increase from 5-8%.
I understand they are like a squirrel putting away nuts for the winter, but at some point I would like to see dividend increases over 5%. Maybe this year?
So, I will continue to hold onto this stock. If it does get over valued again I would consider selling some more shares to fund purchases of other faster growing companies. For the year of 2013 the value of the stock went down 14%. With dividends included my unrealized loss on the stock in 2013 was 8%. It peaked at $77.95 in May which is absurdly overvalued. Currently sits at $57.33 and is fairly valued. Year to date is has risen 7%. My yield on cost is 16% at this point with the current yield at 5.5%. I have done very well in my 10+ years of ownership but haven’t purchased any shares since 2009. For me this is a sit, wait, collect dividends, and watch for opportunity to sell.
Don’t fall for the Red-Herring arguments about your Retirement Accounts February 17, 2014Posted by shaferfinancial in Finance, Uncategorized.
Tags: Passive versus Active Investing, scientism, The problem with 401Ks, the problem with mutual funds
add a comment
Often I talk to people about their retirement. It is a depressing situation because not only are many people not putting enough into their retirement accounts, but most are totally dependent upon 401Ks with mutual funds. Many can’t seem to wrap their head around the trouble coming down the pike at them from using these vehicles to fund their retirement. It is human nature to forget painful experiences so most of what happened in 2008-09 is now so far into the rear view mirror that it is forgotten. This post is aimed at those still hanging on to the myth that a 401k [with or without a employer match] is going to create sufficient retirement income for them.
Recently I was looking at a Seeking Alpha, a popular financial website which features many authors, both professional and non-professional. What attracted my attention was a post by Larry Swedroe. Mr. Swedroe is a financial professional with a history of working deeply in Wall Street. Of late, he has published multiple books on passive investing, specifically why people should put their money into passively managed mutual funds that he sells. He offers up reams of evidence that no one can beat “the market” over time, so it is at best a waste of time and effort to try and at worst a way to lose all your money. This evidence comes in the form of academic studies of which there is a mountain of supporting his points. He argues persuasively that an investor should just dump their money into a variety of passively managed index funds and sit while it grows into a retirement account you can retire on. He relies on what Neil Postman coined “scientism.” Which basically means using the moniker of science to wrap your ideas into, so that it will be more readily accepted. Mr. Postman thought this was a sign of our times and I agree with him. He had some pretty amusing research himself that proved his point, but that was the ironic point. Mr. Swedroe liberally uses the terms “risk adjusted returns,” “alpha,” “beta,” etc. to demonstrate his point, but this is just a way to impress and have people not question his main thesis.
So what is the red-herring argument here? All his evidence looks at the performance of money managers. But what he should be really talking about is the performance of individual investors that invest in the mutual fund industry. Folks like him will argue all day long about the ability of money managers to beat the market, but who really cares? It is how much retirement income you have at the end of the day that matters. And that is really not very dependent upon whether some money manager beats the market or doesn’t. It is much more dependent upon your behavior as an investor and the returns you receive not as an average but the order of returns you receive.
Now Mr. Swedroe is a very smart and informed fellow, so he must be aware of the data that demonstrates that individuals get returns that are 3-4% less than the returns of the investment vehicles they put their money into. Why isn’t he talking about that? I think he is doing a service by pointing out the obvious truth that it is really hard to beat the market over time for a money manager or an individual investor. And I am sure he has clients that, like him, are true believers in passive index investing. But the real problems of individual investing is one of human psychology and market variability that his passive approach does nothing to alleviate.
Greed and fear are a staple of the human psyche and it comes out in force when we have money involved. Greed is what causing folks to move from one hot mutual fund to another [too late to take advantage of the over performance unfortunately] and his approach should help with this emotion. But that fear part is really an issue. Fear is what causes people to sell their shares in mutual funds after a major downward movement. Greed is what causes them to buy it back after the market moves up. It is this cycle that causes the individual under performance. Now I bet he would say that if people just listened to his advice then they would avoid this. But lets be honest here, human emotions run our lives and no one is excluded from them. The data he ignores demonstrates this cycle happening every time, with people selling low and buying high. Even passively managed funds go down in bad markets and no matter how persuasive he is, people will sell from fear or from real need [losing a job in a recession isn't a rare occurrence]. Nothing he offers will change this fact.
I have covered sequence of return risk often here, but it bears repeating. You can get an adequate average returns and still fail to have sufficient retirement funds if the actual returns include some really bad years within 5 years before or after your retirement. You simply don’t have enough time to recover. Its simple math and you don’t need all those academic studies to understand this.
This gets me to the final point. It is a red-herring argument to tell people that if they keep their expenses low, buying those indexed mutual funds, that it will create a bountiful retirement. Is it the amount of expenses you pay or the amount of retirement income that is the important part here? I think most people would say they really don’t care about expenses but really care about that monthly check they receive in retirement. By collapsing those two parts into one, saying that keeping expenses low will automatically increase your retirement income, is not only untrue, but is the second red-herring argument made by these folks.
So they hide behind “scientism” and low expenses with the expectation that people won’t actually take the time to understand the failure of their advice to the majority.
Do yourself a favor and not enter into the argument over passive versus active investing or risk adjusted returns or low expenses=more money. They are all red-herrings to the true issue of failure of the mutual fund/401K strategy itself.
Pre-Snowstorm Musings February 12, 2014Posted by shaferfinancial in Finance.
Tags: AWILCO, Berkshire Hathaway, EIULs, Lies of Wall Street, Market risk, Sequence of Return Risk
1 comment so far
We are expecting another snowstorm up here starting Thursday so in honor of that, I thought I would type some thoughts.
1. The market correction might be over, or not, but it doesn’t change the fundamental issues for those that assume market risk. If you can see retirement in the windshield coming up, you need to be very careful and unload as much market risk as possible. Don’t let all that Wall Street propaganda fog you to the reality of market losses destroying your retirement income.
2. Once again those that have put their money into an EIUL are sitting pretty. After a great year they have their profits locked in forever. The EIULs are working exactly as designed, the companies [I use] are strong, and my clients with there properly structured EIULs are marching toward success.
3. I continue to be happy with my investment portfolio even though I am breaking all the “rules.” Mainly the diversification rule and ignoring the so-called analyst. Using my own brain has been the best thing that has happened to me.
4. I expect a really good year end report from Berkshire Hathaway. The market will probably ignore it in favor of fear-mongering on his age or some other irrelevant issue.
5. Energy stocks I invest in are all looking solid and I expect increasing dividends to add to my portfolio. Only issue is how to re-invest my dividends on AWILCO, because the foreign stock charge of $70 is a little much for less than $1K of dividends to reinvest from them. Will have to figure that one out.
6. Wonder when the masses will wake up to the lies of Wall Street? It could be ugly when that happens.
7. Have a great Valentines day.
Musings on the Current Market January 29, 2014Posted by shaferfinancial in Finance.
Tags: Market Musings, Risk goes up in market, Stock Market Movement
1 comment so far
I have been answering questions from some folks about my opinion on the current stock market.
Let it be known, I have no idea short term the movements of any market. However, I do have some opinions about what we are seeing.
The market is very choppy and the big question is if we are seeing a typical pull-back in a bull market or this is the start of a large drop? The market is reacting to some companies reporting lower growth in revenue in many cases based on weakness in China. Europe is starting to rebound and the American economy is still growing steadily. But we have been on a tear lately with stock prices going up substantially over the last 3+ years. Highly varied reporting in earnings the last quarter of 2013 is starting to become apparent.
If I had money in the market that wasn’t producing substantial dividends I would start to remove that market risk from my portfolio. I can not tell you when or whether the market will take a big drop, but I know it is coming along over the next few years.
For those of my clients that we have removed the downside market risk with EIULs and annuities, you are situated perfectly for the coming few years and can sleep well at night. For those of you still having significant market risk now is the time to really consider if that is what you want to do. For the young there will be time to recover, for the older set, not so much.
For me, I will ride with my Berkshire Hathaway because it overproduces in poor markets. It is the poor market where Buffett shines. The rest of my portfolio serves me up with spectacular dividends to wait out the market drops. My EIUL won’t go negative if the market does. So the bottom line is that I feel comfortable where I am now.
Just be warned that if the choppiness continues the risk goes up for a major market correction. So the risk has gone up for those of us in the market.
Why I Invest in the Stock Market the WAY I DO?????? January 23, 2014Posted by shaferfinancial in Finance, Uncategorized.
Tags: AWLCF, BRKB, HCN, MMP, My Portfoilio, SDRL, SFL, Why I Buy the stocks I do
There is much out there about how to invest in the stock market. Most of the advice has proven to be really bad. I researched this extensively back in the 1990s well before the current issues with commonly advised strategies were apparent. Nothing that has happened since then in either the market or my personal investing has made me change that conclusion. In fact, as soon as I changed my strategies, my rates of return dramatically increased. Note: this is about how I invest and should not be considered advice as to investing in any particular stock.
My main realization was that investing in mutual funds as a single strategy was a losing proposition. Can anyone that actually looks at the data on individual’s investing doubt this? Both from an individual psychological perspective as well as a pure numbers perspective this strategy is a loser. I understand the propaganda is strong, but really anyone can look at the data of investor performance over the last 20 years and see the failure.
My next realization is that one could, with some basic financial understanding, get to know companies and their books well enough to make some decisions on what kind of company it is and how well they are doing. This is Warren Buffett’s basic premise; Look at the companies first, management, what they do, how well they have done it, whether they have some moat to their business, etc. Those that follow this premise do well, those that don’t….well just speculate. Buffett goes on to point out that for those that don’t want to actually look at companies it is best to just invest in a cheap index fund and plan on a rising tide raising all boats. For me, I look at what he does [and he admits it is not high math] and figure that for what he charges I can afford to have him invest for me.
So that was my first realization and still have 60% of my portfolio riding with Warren.
My second realization is that I was investing for retirement income, not some value that could be turned into income. So, in addition to my Berkshire Investment I needed to use a set of strategies that would give me income. There are 2 main strategies that historically has demonstrated the ability to build income. Real Estate and dividend producing equities. I started off doing both, but have found for me that the latter seems to work better [even though for most I believe real estate would be the better choice]. So, even though I do both of these, I mostly develop my dividend producing portfolio. As you now know, that is 40% of my overall stock portfolio.
I started off dividend investing in a REIT [HCN] to go along with my Berkshire Hathaway. Following Buffett’s and others advice I bought shares of HCN whenever I had the cash AND the market was undervaluing it IMO. Because I was mostly purchasing HCN when the yield went over 6% and they were increasing dividends on a regular basis, my yield on cost is now over 15% on my shares. This is not an example of my superior ability, but of just following a strategy that has proven to work [Buffett bought several positions in his portfolio that have over 100% yield on cost]. You will find several sites on the internet where the authors have better results than me for their portfolio, so once again it is the strategy not the stock picker that is important here.
Buffett also stated that it was better to not diversify broadly because why buy your 20th best idea instead of sticking with your absolutely best ideas. Again, Buffett started [and remains as much as possible] with a concentrated portfolio. So for a long while I owned two stocks [85% or so in BRK and the remaining in HCN. But here is an important point; I understood these two businesses well, paid close attention to the details of both the business and the global economy in which they operate.
Then came the great recession and I found a little known energy stock that had been beaten down [MMP]. They were a midstream oil company meaning they transported oil and gas from the drillers and refineries to the end users. Much of their revenues was protected by the tariff system and they were growing smartly despite the stock markets opinion of them. I bought when the dividend yield was 8-9% in 2008-2009. It wan another Buffett pearl of wisdom about buying when there was blood in the streets. As we clawed our way out of the recession their revenues and dividends increased smartly and by the time I sold the shares in 2013 for triple what I had paid for them, my yield on cost was around 15%. The only reason I sold this was because it had become severely over valued by the market [in my analysis] and I could trade ownership of a stock that was yielding 4.3% with stocks that yielded significantly more and were undervalued in my analysis.
Now I am not perfect and want to describe some buys and sells that showed undisciplined behavior that was not in line with my established strategy. Some worked out and some didn’t.
I call this the “story” stocks because I fell in love with the story but didn’t attend to the fundamentals of what the companies were really about.
I had a friend working for a high tech company going IPO and she put us on the friends and family list. We got in to that IPO and 2 months later sold for a hefty profit. I knew that it was unlikely to hold its value because it was really a company with 1 product that could be surpassed at any time by competition so I got out before the enviable happened and it dropped in price significantly eventually to be bought out by a bigger company. That was a success, but more about luck of timing and friendship than anything else. I took that money and invested in an on-line mortgage company in California. This was before all the on-line companies we now know were around and since I was in the mortgage business I though this was a pretty good idea. They had some good managers, but when I purchased little in revenues and big losses. This did not turn around and soon the stock started dropping like rock. I got out, but not before I had lost all the profits I made from the friends and family purchase and then some. Lesson learned there, never will I be involved in investing in a company with no profits again.
I have also owned stock in a small bank that my wife worked at. The first couple of years the stock went up dramatically. However after she left the bank, I stopped paying close attention. Leading up to the recession their profits stopped [like a lot of banks] and the stock started to drop. Because I wasn’t paying attention it was 6 months before I realized the fundamentals changed and by then it had dropped 75%!
Lesson learned; pay attention!
Last year I bought two stocks because of the stories and I thought the fundamentals were adequate. But they did not have a strong history of dividend payments and their future products that I thought would push them forward were new to the market. I went on vacation for the entire summer and during that vacation came to my senses about how those stocks didn’t fit into my strategy of stock ownership. Fortunately, both companies stocks went up double figures during the summer and with the dividends I got showed around 15% profit in my short ownership [they have both gone down to around my purchase price since then]. I think lady luck was with me on those two too! The lesson learned was not to fall in love with a story, and again pay attention to how the current products are doing, not what some imagined product might do in the future. The other lesson learned is if you want to take chances a bull market is the time to do it! Lots of margin for mistakes.
I had been reevaluating my ownership in HCN for a couple of years because the dividends were only rising 3% annually on average. Even though I still liked the fundamentals, the management, the products, the strategy, I need dividends to increase faster than that in order to reach my dividend income goals. So I sold a minority of my position when the stock seemed a little overvalued this summer. It has since dropped about 12%. I wish I would have sold a larger chunk back then, but I think the price will come back up this coming year and provide more opportunity to sell. If it doesn’t I am still getting a 5% dividend [over 15% yield on my cost] and it is still growing, albeit slowly.
Finally, I have purchased several high dividend energy companies of late. I did ample research into these 3 companies and feel comfortable with their business models, that their product is and will be in great demand and that their management teams are top notch. My yield on cost for these three are 11%, 8% and 20% [the order is the same as the percentage in my portfolio with the 20% yielder being the smallest percentage of my portfolio]. The prices have gone up a little, then down, then up and now down a little meaning they are basically exactly where I purchased them. But, that doesn’t really matter to me. I am looking at the dividends they are paying and 2 out of the 3 have increased dividends in the short time I have owned them.
NOTE: All my moves after 2007 are recorded in this blog for all to see and judge. I go into much more detail about all my stocks I own and sell in various blog posts.
Just one more comment. I do have other income producing investments [EIUL, Real Estate] that complement my dividend producing stocks but those go beyond the scope of this post. They both have significant tax reduction strategies accorded them which is the other piece of the puzzle I haven’t gone into with this post.
Postscript: Found this link from one of my readers. Thought you all would like it. http://maassinnovations.wordpress.com/2013/12/07/now-this-is-a-surprise/
Why purchase an Equity Indexed Universal Life Insurance Policy? January 21, 2014Posted by shaferfinancial in Finance, Uncategorized.
Tags: equity index universal life, Equity Index Universal Life Insurance versus Mutual Funds
add a comment
Its been several years since I have written a post outlining the basics of Equity Index Life Insurance Policies [EIUL]. EIULs are life insurance policies that credit the cash value with interest tied to a stock index or group of stock indexes with a floor of 0% and a moving cap [currently between 13-16%]. Here is a key point; when we structure it for future tax free cash flow, we minimize the amount of life insurance to its lowest level allowed under IRS rules. By lowering the face value of the insurance we drop the expenses within the life insurance policy significantly [including the commissions] increasing the internal rates of return received on the premiums paid into the insurance policy. When one needs money from the policy you access it via policy loans. These are loans against the face value of the policy. Most EIULs have loans that are at “no cost” or “minimal cost [.1%].”
One important factor is that most of the expenses are taken out in the first 10 years. There are also surrender fees that go on for 10-15 years. This combination makes this product unsuitable for those looking for short term or even medium term products that can be liquidated over 15 years. No one should enter into an EIUL unless the plan is long term in nature. Obviously in emergency situations the cash value can be accessed any time after year 1 so it does serve as an emergency reserve fund, but this should not be the plan for this product.
Here is how it works:
Premium must be paid in over no less than 4 years. It can be paid in for as long as someone needs to.
Each year expenses are subtracted from the premium each month. The balance is put into an index leg chosen by the policy holder. At the end of 1 calendar year each leg is given an interest credit that matches an index or group of indexes. That interest credit is locked in at this point. The following year the locked in amount plus the additional premium added is given the interest credit. Each year the worst thing that can happen is if the index has gone down you get no gain [and no loss]. So a big fat 0%. So if the stock market does one of its usual swoons [averages 3 times a decade] you lose nothing. If the stock index goes up you get the gain up to the cap. This strategy testing backdated data for almost any period of time gives you higher rates of returns than the actual index.
The math in this strategy is that losses hurt more than gains help. An easy way to look at this is a simple example: You put $1,000 into an stock index fund. The first year it goes down 33%. You now have $667 of value. The second year it goes back up that 33%. It is now worth $889. What happened to the other $111? It is lost in the “average” returns. Your average return was 0% [-33% + 33%/2] but you actually loss 11% of value! Now you know why Wall Street loves to talk about average returns! In your EIUL what happens. The first year your value stays at $1,000 even though the market dropped 33%. The second year you get the cap of 16% so have $1,160 in your account [compare that to the $889]. Now you know why in most markets the EIUL strategy will give you higher rates of returns.
Expenses are very different in the EIUL as opposed to your basic mutual fund. In your mutual fund there is usually an expense ratio applied to your premium dollar. This is subtracted annually no matter whether there were gains or losses in the account. And more importantly the bigger the account gets the higher the actual expenses are. In an EIUL the expenses are fixed up front and with the exception of the premium load and insurance costs are subtracted from the premium over the first 10 years [in the ML EIUL]. Once you stop paying premium and get beyond the first 10 years the expenses basically stop. So in the years that you have the most cash value your expenses are extremely low. This difference is hard for folks to get their head around, but when we look at total expenses over a lifetime we find that the cost of the life insurance policy is generally between .5% and 1.7% depending on what age you start the policy. Bottom line is that you can get lower expenses if you have absolute control over your money [not in an 401K for example], but the expense are generally in-line between what most people have in their 401Ks and these policies.
The one risk Wall Street hates to talk about is sequence of return risk. This is the risk that even though the “average” rate of return is sufficient, the actual sequence of returns could leave your retirement nest egg insufficient. Take someone that retires within 5 years before or after a major market downturn. They simply don’t have the time before they need the money to make up for a -30% year or heaven forbid another -40% year. And if you are unlucky to retire close to a series of market downturns [remember the 2000s] your anticipated retirement income could go down over 50% annually just because of bad luck. Do you really want to leave your retirement to pure luck??? Might as well walk into Vegas and put it all down on black!
Now under current IRS rules [revisited three times by the IRS], you can take loans against your face value and there are no tax consequences as long as you keep your life insurance policy intact. So tax free distributions from your EIUL.
Finally, these are insurance policies so they work to complete one’s financial planning. Most people never imagine an early death but it does happen to 24% of individuals who die before retirement age. 16% of men [12% of women] die between the ages of 45 and 67, which happens to correspond to the years most people are able to put the most money aside for their retirement. It also corresponds to the years most people are not insured because they have dropped their term life insurance. This is often a disregarded function of these life insurance policies, but for 16% of folks having a substantial death benefit can help complete their family financial planning.
1. These are for people with a long term savings strategy
2. History suggests a higher rate of return over the long term using the step up and lock in strategy inside EIULs
3. Sequence of return risk is eliminated
4. Expenses in line with most mutual funds inside 401Ks
5. Tax Free Distributions
6. Death protection against an early demise
7. You own these yourself so the company you work for can’t lock you away from your money
8. No penalties if you need to take money out in an emergency. You would get a 10% penalty in an 401K/IRA
9. Your money doesn’t go down in bad market years
10. You sleep better at night not having to worry about “the market,” something totally out of your control
At last a reasonable way to save money and get a decent rate of return is available to those who can think outside the box Wall Street has created with its propaganda. Now, I always suggest combining an EIUL with other investments that will diversify yourself and provide potentially higher rates of return [like real estate investing and dividend producing stock]. The beauty of starting an EIUL is that it only takes a monthly commitment and not large sums of capital to start like real estate. So, no matter what the age we can structure an EIUL that will create a bountiful retirement. Don’t you owe it to yourself to look into this savings vehicle? Contact me and we will create an illustration that fits your particular situation so you can make a comparison to what you are currently doing.