Adapted from my letter sent to my private wealth management clients on August 17, 2023.

Harry Markowitz

A great mind in the investment world, Harry Markowitz, Nobel Laureate in Economics, passed away earlier this year at age 95.

As a young PhD student at the University of Chicago in the early 1950s, Markowitz was considering thesis options when he had a chance encounter in a waiting room with a stockbroker who suggested researching stock selection. Markowitz took the broker's recommendation, proceeded down this path of inquiry—where little academic work had been completed—and developed research so groundbreaking that even today, Markowitz's work carries the title, “Modern Portfolio Theory” (MPT), and I view his “Efficient Frontier” model as one of the most important concepts I learned early in my finance studies. Markowitz's work has since provided the underpinnings of numerous subsequent advances and research-based evolutions in portfolio management theory and practice.

“Before Modern Portfolio Theory, the decision about whether to include a security in a portfolio was based principally upon fundamental analysis of the firm, its financial statements and its dividend policy. Finance professor, Harry Markowitz, began a revolution by suggesting that the value of a security to an investor might best be evaluated by its mean, its standard deviation, and its correlation to other securities in the portfolio. This audacious suggestion amounted to ignoring a lot of information about the firm—its earnings, its dividend policy, its capital structure, its market, its competitors—and calculating a few simple statistics.”
~An Introduction to Investment Theory, William N. Goetzmann

Still, many eschew, ignore, or are unaware of Markowitz’s MPT and choose to primarily focus on returns and deal with volatility extremes. We thank Professor Markowitz for his contributions to our financial security—his concepts are fundamental to our approach—and our thoughts are with him as he moves on to the great final efficient frontier.

Markets & Economy

Bank failures. Widespread predictions of recession. Federal debt ceiling battle and ratings downgrade. Peaking interest rates. Persistent inflation. Wars. Political scandals. Poor market returns in 2022.

Did you expect stocks to be up strongly for the quarter?

If you have been pleasantly surprised by the stock market’s 2023 upward run, you’re not alone. One of the most widely followed investment analysts, working for one of the world’s largest investment firms, recently admitted, “We were wrong” in regard to his pessimistic 2023 outlook.

Earlier this year, I offered my thoughts on air regarding market forecast and the dangers of short-term thinking in investing.

Resilient economic numbers have offered hope that the desired economic "soft landing" is unfolding. Indications of a slowing increase in the rate of inflation have investors anticipating an end to central bank interest rate hikes. Technology stocks, which broadly took a serious beating in 2022 are again delivering big gains, in particular a handful of technology stocks tied to the potential of artificial intelligence (AI.) This outperformance of the technology sector over the broader stock market is reminiscent of the dot com era, and, in my opinion, warrants a risk-measured exposure, Harry Markowitz-style approach with diversifying investments in areas with less tech concentration and an expected lower correlation of returns, such as value-oriented stocks, international stocks, and bonds.

The chart below is from First Trust and shows the historically high level of market concentration in the five largest S&P 500 companies (blue line on graph).

It’s interesting to also note for historical context the peak and current weighting of the top 5 stocks in 2000, at the top of that era’s “Tech Bubble.”

Leading economic indicators are still concerning. Core inflation has proven to be persistent. Corporate earnings headwinds are likely to intensify, which could lead to additional job losses and a decline in consumer spending and labor market activity, which could then trigger the arrival of a widely anticipated recession.

Wealth Planning Strategies

We have a lot to share on the financial planning and wealth management front! While I’m very excited about being able to offer advice via radio, webinar, and blog on a broad-based communication formats, there are limits to generalized commentary and the application of these wealth topics are best considered in your personal planning sessions with our team.

The information below may not fully address the complexities and constraints of your unique situation, so if you have questions about any of the following, please contact us to schedule a time to discuss!

Developing Intelligence: College & 529 Plans

529 plans have long been a favorite college funding tool, and they have become even more attractive over the past few years due to regulatory changes. In this webinar, our Wealth Strategy Team offers an overview of financial planning for college and a focused discussion on updated strategies using 529 plans.

In this recent episode of Money Matters, I also talk about the college financial planning process, including deciding whether college is the right choice, setting financial boundaries for students, and 529 college savings plans.

I also really enjoyed this earlier conversation with Cozy Wittman of College Inside Track, where we focused on making smart higher education purchase decisions.

New 529 Plan Preference: Utah

We’ve recently reviewed available 529 college savings plans and have chosen the Utah “my529” college savings plan as our top recommendation. This choice is based on the excellent low-cost investment selection, which includes several of our most frequently used fund companies (e.g., DFA, Vanguard, Pimco), the ability to construct custom-built portfolios, and the ability for us, as your investment advisors, to link to these plans and provide investment direction to maximize your 529 plans based on your short- and long-term goals.

For many years, the Virginia VEST plan was our top recommendation, and while we still think it is a fine plan, it lacks the portfolio customization option and the ability for us to receive a direct data feed from the plan.

I Bonds

With soaring inflation and U.S. Treasury inflation-linked "I Bonds" offering a 9.62% yield last year, we strongly recommended buying them with reserve funds that you could afford to lock up for a one year holding period. Happily, inflation has cooled, but along with this cooling, the I Bond inflation return component has fallen significantly and is now below 4%.

Do we still like I Bonds in the 4% range?

On the one hand, there are now many alternative fixed-income investments, such as bond and bank offerings with yields at or above 4%—and many without complexities like I Bond holding period requirements and maximum purchase limits, and easy purchase options without having to deal with the Federal Reserve's glitchy website.

On the other hand, while the I Bonds inflation return component has fallen, the bond now actually pays a fixed interest rate component (.90%) in addition to the inflation adjustment for a 4.30% total yield. While not the attention-grabbing returns of a year ago, this does make I Bonds a reasonable long-term “safer money” holding. Morningstar’s John Rekenthaler provides further analysis in this piece.

Healthcare Cost in Retirement

I recently discussed healthcare costs in retirement, health savings accounts (“HSA”), extended care insurance, and other health-related costs that commonly occur in the golden years. I also offered financial strategies designed to prepare for such costs, so your retirement savings aren’t hurt by unexpected healthcare costs.

Sequence of Return Risk

In this episode of Money Matters, I explain sequence of return risk, and why it is critical to include in your retirement financial planning process.

Financial Independence

In this Money Matters episode, recorded while still recovering from July 4th festivities, I discuss the concept and measures of financial independence.

Let’s be Smart About This!

“I can calculate the motions of the heavenly bodies, but not the madness of people.”

— Isaac Newton

Harry Markowitz’s great intellect gave us a valuable model for combining financial assets into a portfolio that aims to blend the risk and return characteristics of the individual holdings into an optimal mix. Will artificial intelligence have a comparable effect on the investment world? Currently, it seems there will be advances in the speed and scope of research using AI. Access to markets and information have made incredible advances over the course of my career and simultaneously, investment expenses and transaction friction in have decreased.

While the mechanics of investing have advanced, in terms of investor mindset, many still wrestle with the same core human impulses that have been with us since the dawn of time.

“Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ. Success in investing doesn’t correlate with IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”

— Warren Buffett

We’ll happily take this year’s big gains—unexpected by many and lopsided and overly concentrated—but we will also be prepared for the market’s next setback. Whether that setback is related to a widely anticipated recession, or, as so many times in the past, due to completely unexpected circumstances. We do not need to try to outsmart the market to be successful investors, but rather, to smartly manage our exposure to the markets and know that a steady hand and even investment temperament will allow us to benefit from the market’s continued upward compounding.

Please let me know if you’d like to discuss anything in more detail.