On the news side, One Day In July won some national recognition. See our press release here.
Warren Buffett had his annual "Woodstock of Capitalism" shareholders meeting last weekend. Today I want to look at four concepts from Berkshire Hathaway, and how they are applicable to you.
1. Performance. The annual meeting is fun to listen to, but the performance of Berkshire over the past 20 years has been average. Exactly average, to be precise. Like to the hundredths of a percent average. This is something Warren predicted 20 years ago when I attended some of the annual meetings, and it came true. From 1/1/2002 to 12/31/2022, the S&P 500 returned 9.70% annually. Berkshire Hathaway returned 9.70% annually. Berkshire is so big it essentially is an index at this point. (Credit to Frank Koster's team in Shelburne, VT for pointing this out.).
You're likely better off to own the index than Berkshire. One reason is Buffett is 92 years old, and it's a big risk that successor Greg Abel is going to be able to run the firm at the same level. With the S&P 500 you have 500 CEOs working for you to mitigate this risk. In other words, if Buffett couldn't beat the index, it's likely that Abel is at best going to match, and there's no reason to take that risk. Should a shareholder of Berkshire tire of an underperformance situation, he or she could then face a tax bill in a brokerage account.
2. Share ownership. At one point in the meeting, and it got a little unclear so I want to explain it, Warren was talking about how he was organically owning more and more of Apple. One Day In July clients here do too, via an index. We often talk to clients about the importance of increasing share ownership. The flip side of that coin is you can own the same number of shares, and if the corporation reduces its share count, your claim on the overall earnings of the corporation goes up. But either way, this is the objective as the investor: to acquire more claims on larger amounts of future earnings.
Often business will announce share buybacks, and then quietly they will issue excessive stock to executives and employees. This does not help the shareholder. In Apple's case, while they may be doing this to some degree, they are reducing their share count overall. Here, in billions, is the number of outstanding shares from January 2010 to today:
3. Taxes. Berkshire is not particularly efficient from an internal tax perspective. Berkshire alone paid 1.5% of all U.S. corporate taxes in 2019 and 2020 (this figure was once higher than 3%). Beyond its businesses being largely U.S.-based, two effects drive this. 1. The subsidiaries are expected to be profitable and send significant, and taxable, cash to Omaha. This arguably Warren has pushed too hard, as long-term it may have starved his own subsidiaries of capital. 2. This one relates a lot to you: he recognizes capital gains fairly regularly, to keep assets optimized.
While we try hard to reduce or zero capital gains taxes for clients, often when people arrive they are in sub-optimal investments, like annuities, that require a tax to liquidate. If you are in this situation, remember that Warren doesn't mind paying some taxes to make things optimal in the future.
4. Treasuries. This one is straightforward. You don't see Berkshire holding money in cash or CDs. You don't see him sweating because Silicon Valley Bank is failing. Berkshire holds its cash-related obligations in U.S. Treasuries. Over 95% of the bond obligations of One Day In July clients are in U.S. Treasuries.
Dan Cunningham
1. Graph source: Macrotrends.com, Berkshire Tax Rate: Yahoo Finance 2/22/20.
Vermont Business Magazine this week named One Day In July the 2023 Best Investment Firm in the State of Vermont. While we now have clients in 31 states, it's fun to take the hometown honors. More on our awards page here...
You have, are, or should be wrapping up your taxes now. One of the benefits to public market investing is that in certain cases we can recognize tax losses, reducing your tax bills and improving your total return. When we do it for clients we do not give up exposure to the asset class for even a short period of time, and the transaction costs are zero or close to zero. Private investments do not allow this.
On the subject of private investments, today I'm going to talk about all of the reasons I don't like private real estate as an investment by a casual investor. It's popular - we get the question all the time, and many Americans participate in it. If you're buying it for enjoyment, that's one thing. If you're a professional real estate investor and you really focus on the comparative advantage you can bring, that's a different story. But I don't see many cases in which people buying second homes for fun or to lease outperform the index. Here are the issues:
1. Transaction costs are high. Getting into and out of properties is not a zero-cost trade the way it is with a public security. These costs can run 5% to 10% of the proceeds of a transaction, even before capital gains taxes.
2. Geographic risk. In a single property you have geographic concentration risk. It's impossible to know what real estate markets will have the highest performance going forward. While the index by definition also buys the worst performing markets, on balance this diversification reduces risk.
3. Taxes. Professional REIT managers work to classify distributions as return of capital whenever possible, therefore reducing dividend taxes to zero for that portion of the dividend. In contract, rents from private houses are taxed as ordinary income. Additionally, public REITs can be held in an IRA, shielding more taxes, at least in the near term. While this can be done with private real estate, it is difficult.
4. Tax-loss harvesting. As mentioned above, because the indexes are public and liquid, tax-loss harvesting can occur, which can raise your overall returns over time.
5. Interest rates. Until last year, real estate benefited from a forty-year decline in interest rates. This provided a boost to both private and public holdings. Should this trend reverse the capital value of the asset class will now face a headwind. The point here is that the returns many people made on houses were at least partially a function of interest rates being lowered, not the house being an unusually productive investment.
6. Financial leverage. Similar to #5, much of the return made in real estate is due to the financial leverage from the loan. While public REITs are internally leveraged as well, if you had applied the same leverage to the S&P 500 in the past 15 to 30 years as people applied to their houses, the returns would have been significantly higher.
7. Capital and maintenance improvements. To calculate the real return on a private house sale, you have to consider all property taxes, improvements, and maintenance that were paid into the house over time. If you owned a railroad you could not ignore bridge repair. In a similar way, you must calculate the time value of cash you put into a house.
Dan Cunningham
Charles Schwab, both the firm and the eponymous founder, have put out a statement regarding Schwab's financial position. I encourage you to read it here.
A week ago Silicon Valley Bank (SVB) went down in spectacular fashion.
First, they had "Bank" in their name, but everyone in the Valley knew they were a pseudo-bank. 25 years ago I was in their offices in California trying to get a loan from them, and I was dumbfounded at their model: little asset backing requested, they'll take some warrants in the firm, if things go well they'll piggyback along. This sounded like some sort of hybrid VC-firm-bank-thing, and I could see it had a role! But it didn't feel like a traditional bank.
Tech firms are often unprofitable, especially when young, and as the venture capital spigot dried up last year, SVB customers withdrew funds. With a lopsided Treasury portfolio of long-dated bonds, SVB had a mismatch between a short-term demand for funds and a long time horizon on its investments. At some point the CEO actually realized this novice mistake and started dumping his own shares in the bank. As the bank had to sell its Treasuries to meet redemptions, they had to report the loss on those positions, and the tide went out.
Let's look at three things that relate to you, using SVB as a backdrop:
1. Your portfolio is marked-to-market in real time. The values you see are extremely close to the actual cash value of the portfolio were we to sell it all today. There are some rare exceptions in the firm, all of which are due to positions brought in from other firms. These are general private REITs and other complex investment products that are not marked-to-market daily.
So, unlike universities fudging their investment results with the help of private equity shops and venture capital outfits, you know what you own. And unlike Silicon Valley Bank, there is no complex accounting obscuring that fact.
2. Holding a substantial amount of cash above the $250,000 is an error and shouldn't happen. This only occurs at One Day In July for brief periods of time while cash is in a position to move, or at client request. Otherwise short-term Treasury bills serve as a safer short-term store of value.
3. You don't want to create the same time-dating error in your retirement that SVB created in its bond portfolio. SVB was long-dated and had short demand. The risk today is that with interest rates higher in the short duration sector of the bond market, people are shifting assets to shorter positions to meet a need, retirement, that is fundamentally long. Although they don't perceive it as such, this is a risky move, as declining rates could leave them short on cash years from now.
Related to the item above, in terms of matching assets to needs, is the impact inflation will have on a retirement portfolio. As people today shift money from equities to short-term bonds or cash, they are ignoring the inflation-fighting characteristics of businesses. And inflation is a big deal for a retirement portfolio. If inflation stays at a long-term average of 2.5% over 25 years, in real dollars $1,000 drops to $545. But if inflation stays at 4.5% over the same 25 years, that $1,000 drops to $331. This erosion of buying power could affect many Americans facing retirement, and their short-term bonds and cash will exacerbate the issue.
Dan Cunningham
Chesterbrook, PA 19087
Burlington, VT Financial Advisor
Burlington, VT 05401
Rochester, VT Financial Advisor
Available for meetings in Rochester, VT and surrounding areas.
Bennington, VT Financial Advisor
Available for meetings in Bennington, VT and surrounding areas.
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