Since our last newsletter much has changed and yet nothing has changed. Interest rates have increased dramatically (as we projected 13 months ago) and are exactly at the level where we had projected: 5.25%. The S&P 500 stock market has produced a zero return over the last 24 months. From our timely forecast we were able to transition out of long-dated bonds (5 years or longer maturities) in our fixed income allocation. We used these funds to invest in higher interest paying short term treasuries (3 months to 2 years) As a result of these actions, we find ourselves in the best possible scenario and are comfortably able to continue rolling into higher yielding short term bonds as the Federal Reserve continues to raise rates.
Based on our rate forecasting models, we do not foresee any interest rate cuts for the next 12 months. This presents us with the opportunity to lock in current and potentially higher rates over the next two years as our shorter term treasuries mature.
Fed Funds Rate
Today, the new rate environment is a blessing for savers and investors. For the first time in more than two decades every $1 million dollars in short-term fixed income will produce $52,500 in annual interest income. And if you are invested with a taxable account at Quantum, you are generating an additional 3% in option premium for a total of 8% on cash equivalents. That is an estimated $80,000 in annual income!
We may also be assigned great companies at lower prices on those overlay options with the potential to see them climb back to new highs similar to Facebook, Google, and Amazon. This can further turbo-boost total returns on cash and cash equivalents. That perfect scenario actually did occur as we were assigned Facebook (META) under $125 on our options overlay strategy accounts for an additional boost in total return. Passive income is now a very real thing!
Just how good do we really have it today? The historical rate of return of a portfolio fully invested into stocks (equities) ranges from 6.5% to 9% annually depending on the decade. Some decades are good, some are great. What is important is that you stay invested or are invested according to your actual psychological risk profile.
If you say you are “Aggressive” and lose sleep when your portfolio is down only 15%, then you are only aggressive on paper. The average drawdown of the S&P 500 in a bear market since 1955 is minus -31.5%. So if you say you are aggressive and flinch, sweat, panic, or decide to move money around when your $1 million dollar portfolio dips down to $600K, well then you are not aggressive at all. Always invest according to your psychological makeup so that you can stick to a long term strategy that will build wealth over time. At Quantum we customize client portfolios based on their actual risk tolerance by having open, honest and continued conversations to discover a client's ideal portfolio allocation and strategy.
The good news is that as a result of curbing inflation, the Federal Reserve has given us a wonderful fixed income environment where the faint of heart and risk averse can now capture greater return without incurring more risk. So yes, go ahead and celebrate the current rate environment where we have the ability to capture stock-like returns but with less volatility and risk due to current interest rates levels and elevated option premiums. We would have to go all the way back to the early 2000s to find anything close to the current rate-friendly environment for cash equivalent investments.
So, you may ask, when were interest rates the highest in our modern lifetime? Back in 1979 you could have purchased a 30-year treasury at a yield of over 8% risk free! Alternatively, you could have also put the money into the stock market and made a whole lot more money too! However, you would have needed an iron stomach to withstand the massive stock portfolio dips that made even Warren Buffet nervous such as the 1987 stock market crash and the internet boom and bust of the late 90s and into early 2000s.
The latter produced a -55% drawdown! This was followed up by another stock portfolio beating during the financial crisis just 5 years later. So, before you start claiming 100% “Aggressive” on your risk profile questionnaire, look inward and try to invoke the feeling of temporarily having your portfolio be down -55% with the possibility that it may take 10 years to recover (think 2000 to 2010s). Long story short, invest according to your actual psychological fortitude and not based on your idea of what that should be. Following this simple rule will allow you to build wealth and pay less attention to the noise of the market.
One final note, while we are not likely to ever see 8% on a 30 year treasury, we most certainly will be positioned perfectly if and when that happens. And of course we won't stop there….we will continue to overlay our options strategy in taxable accounts for another 3%!
If you have other accounts not managed by our firm, please determine the yield on your portfolios (dividends plus bond coupon payments). If it is not at least 4% (the risk-free yield on the 10-year US treasury), you may be set up for unnecessary future volatility. Part of our current strategy is finding high-cash flow companies that pay us to hold them and are strong enough to withstand any economy. Also, check your outside portfolios for hidden fees that can be a drag on your investments during sideways markets (like the last 24 months) . Please call John Henek to discuss these ideas or if you have other questions or concerns at 708-267-0627.
All written content is for information purposes only. Opinions expressed herein are solely those of “Quantum Capital Investments” and our editorial staff. Material presented is believed to be from reliable sources; however, we make no representations as to its accuracy or completeness. Fee-based financial planning and investment advisory services are offered by “Quantum Capital Investments” a Registered Investment Advisor. Insurance products and services are offered through “HST Insurance brokerage and JDS Life insurance brokerage.” “Quantum Capital Investments” and "HST and JDS insurance brokerage” are affiliated companies. The presence of this web site shall in no way be construed or interpreted as a solicitation to sell or offer to sell investment advisory services.
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