Business Update

After a very busy December due to the tax law changes, January will also be very busy month for D3. We are focused on the following activities:

Portfolio Performance: We look to reconcile all client accounts by January 10th. Once all accounts are reconciled we will review your portfolio performance reports and look to have them on your client portal or mailed to you by January 19th.

Asset Allocation Model Changes: We have reviewed our asset allocation models with the perspective of improving portfolio performance based on our highest convictions regarding potential future market conditions. We have made some minor changes to our models and the details of these changes are described below in the “Investment Strategy” section.

Tax Law Change Impact on Client Considerations: Due to the elimination of miscellaneous itemized deductions, we recommend that clients with traditional IRAs consider having a proportionate amount of D3 fees deducted from their traditional IRA account. Clients following this strategy will effectively be getting a tax-free distribution from their IRA to pay their D3 fees. Because of the economic benefit to all clients with IRAs at Fidelity, if you have granted us fee deduct authorization, the standard D3 policy will be to deduct our fees proportionately from each Fidelity account (except for Roth IRAs and 401k accounts, which will continue to be paid out of your taxable account).  Please call if you have any questions.

Also, because of the tax law change increasing the standard deduction, it may make sense for charitably inclined clients over age 70.5 to donate their required minimum distributions directly from their IRAs. This strategy is effectively a tax-free distribution to a charity which in some cases clients may not have previously been able to deduct. We will incorporate this analysis in our annual financial plan updates for Affordable Family Office clients (AFO). Give us a call if you want us to analyze this strategy for you before then.

Contract Update: Sharon will be calling all clients who have not returned signed contracts. We need these returned by January 15th.

New D3 Employee: Tim Stuart, CPA (and has passed level 2 of  the CFA Program) has joined D3 from Crowe Horwath LLP. Tim will be managing the tax processes for our Affordable Family Office clients and will participate in our Financial Planning Management Development Program. Please welcome Tim when you talk to him.

D3 20 Year Client Appreciation Event: We look forward to seeing all of you who can attend our 20-year client appreciation event. Please respond to Patty’s email regarding your dinner preference by January 10th.

Market Insight

From a return standpoint, 2017 ended the year as the second highest (second to 2013) of the 8-year equity bull market that started in March of 2009. Some observations regarding 2017 are listed below.

  • Returns for the 3 major indices that we use in our performance reports were as follows:
    • U.S. Bond (AGG) index up 3.59%
    • U.S. Large Cap Stock/S&P 500 (IVV) index up 21.79%
    • International Large Cap Stocks (EAFE) index up 24.94%
  • During 2017, the S&P 500 index had a positive return every month. This was the first time in the history of the index that it did not have at least one negative monthly return in a calendar year.  We believe this unusual lack of market volatility is not sustainable over the long term.
  • From a historic valuation standpoint, the U.S. bond and stock markets have less attractive valuations relative to long term averages of international stocks.
    • As of 12/31/17 the U.S. large cap stock index (S&P 500) has a forward price to earnings ratio (P/E ratio) of 18.2x.  The 25-year P/E average is 16.0x.
    • As of 12/31/17 the International stock index (ACWI-Ex US) has a forward P/E ratio of 14.3x.  The 20-year P/E average is 14.5x.
    • As of 12/31/17, nominal 10-year treasury bond yields were 2.4%. The average yield over the last 60 years was 6.09%.
  • The U.S. appears to be at or near full employment (4.1% unemployment rate). We believe this will be a catalyst for inflation, rising interest rates, and could pose a threat to economic growth in the U.S.
  • We believe tax reform should at a minimum provide short-term support for equity prices if companies use tax cuts to buy back stock and increase dividends. For tax reform to be truly successful, companies will use tax savings to increase capital expenditures, leading to productivity growth and thereby boosting U.S. economic growth. However, we are not yet convinced that this will be the case, as businesses have had the cash and access to credit to invest in property, plant, and equipment over the last few years, but have not done so.
  • Taking into account the current and projected economic environment (from numerous institutional sources), valuations across asset classes, projected increases in discount rates, and the above average returns for 2017, we have a modified our 10-year projected average annual return and volatility assumptions.  Generally, we reduced our 10-year expected return for equities and kept similar our 10 year expected returns for income assets classes. For financial planning purposes, we have also made downward revisions to our healthcare and education inflation assumptions.

Investment Strategy

As we do at least annually, we have made changes to our asset allocation models based on our current long term economic view and valuations across asset classes.  Click here to see our updated asset allocation models. Note that a red number indicates a 5% decrease to an asset class relative to 2017, and a green number indicates a 5% increase relative to 2017.

Broadly speaking, we are reducing fixed income and increasing alternative income for our more conservative models. This reflects our conviction that short term interest rates will increase and could potentially have a negative impact on longer duration fixed income holdings. In our more aggressive models we are reducing equity income and U.S. large cap exposure, and increasing international developed and emerging markets exposure. This primarily reflects our perspective that international equities are more attractively valued. These economies also have more room to grow because they are not in a full employment situation like the U.S. (other than Japan and Germany).

We will begin implementing these asset allocation model changes in late January and early February. If your portfolio has a custom override, we will retain the primary focus of the override while integrating these model changes. If you want to discuss these model changes, please give us a call. Additionally, if you are unsure of the asset allocation model you are invested in and want to discuss, please give us a call.

Final Thoughts

We look forward to celebrating our 20 years of Helping Smart People Make Smarter Financial Decisions™ with you on January 13, 2018. Additionally, we hope you, your family, and your friends have a healthy, happy, and prosperous New Year. We look forward to serving your financial planning and investment management needs in 2018.