WHY LOSSES REALLY DO MATTER

Everybody who told us that the steep market drops earlier this month wouldn't last can rightly claim they're right. When the S&P 500 was down 7.4% during a two-week selloff, there was no way to know whether we'd have to endure more of the same. Staying the course turned out to be exactly the right strategy, but that doesn't mean that we shouldn't be concerned about downside risk. In fact, during the downturn, all of us should have been working hard to keep our portfolios from falling as far and as fast as the American indices.

Isn't this a contradiction? There is no contradiction between holding on during market downturns and building portfolios that are unlikely to keep pace with a bear market free-fall. You hold on because no living person knows when the stock markets will recover, but history tells us that they always do seem to recover and eventually deliver returns that are higher, on average, than the returns you get when the money is safely stored under your mattress.

But you also pay attention to downturns because the further your portfolio falls, the harder it is to recover. There's actually a rational reason why you tend to fear losses more than you enjoy your gains.

The mathematics show the asymmetrical effect of losses vs. gains. If your $1 million portfolio loses 10%, falling to $900,000, then it requires an 11.11% gain to get you back where you started. It doesn't seem fair, but that's how it is. A 20% loss requires a 25% gain, and if your portfolio were to drop 40%, you'd need a subsequent 66.67% gain to climb back to your original $1 million nest egg.

Chances are, you know how we fortify portfolios against losses: we include a variety of different types of assets--including bonds which, against every single market prediction at the start of the year, are actually delivering positive returns almost all the way across the maturity spectrum. We include foreign stocks, which haven't exactly been knocking the lights out this year, but which will, someday, offer strong gains when the U.S. markets are weakening. All of these different movements tend to have a calming effect on the portfolio's returns, not always in every circumstance, but fairly reliably over time.

The result? A smoother ride puts more money in your pocket. If an investor experienced returns of +20% and -10% in alternate years over the next 20 years, a $100,000 portfolio would grow to just under $216,000. If a more diversified investor experienced a smoother ride of 10% a year, her portfolio would grow to just under $673,000. The power of steady compounding is a marvelous thing to see. The drag of losses can be debilitating to a portfolio's growth.

You won't experience either of those trajectories, of course. But if you can somehow avoid the worst of the market's falls, even if it means never beating the market during the up-cycles, you raise your chances of long-term success. If you can do this and remain invested through a lot of uncertainty, like we experienced earlier this month, chances are you'll enjoy better long-term returns than a lot of the "experts" you see screaming at you to buy or sell on the cable finance channels.

Oh, and that 7.4% drop? The S&P 500 will have to go up 7.99% to recover the ground it lost in that two-week period.

Sincerely,
Bill Morrissey, CFP® and Tammy Prouty, CFP®
Sound Financial Planning, Inc.
Primary Office
425 Commercial St., Ste 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
info@soundfinancialplanning.net
Secondary Office
650 Mullis St., Ste 101
Friday Harbor, WA 98250
(360) 378-3022
www.soundfinancialplanning.net

PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.

HOW IS HEALTH CARE REFORM AFFECTING THE FEDERAL DEFICIT?

Some analysts think it is helping reduce the deficit; but others wholeheartedly disagree.

Has the Affordable Care Act actually cut Medicare spending? The numbers from the Congressional Budget Office make a pretty good argument for that, and suggest that the ACA has had a distinct hand in the recent drop in the federal deficit. Detractors of the ACA say that statistical argument doesn't tell the whole story.

Medicare has been a major factor in the deficit's expansion. Its cumulative cash flow deficits came to $1.5 trillion in the first decade of this century, according to the Congressional Budget Office; across the current decade, those cumulative cash flow deficits are projected to hit $6.2 trillion as more and more baby boomers become eligible.1

Admirers of the ACA contend that its technical changes (reductions in payments to some providers, simplified payment systems geared to holistic care, discouragement of hospital readmissions and greater use of generic drugs) are holding Medicare costs in check. These changes have led the CBO to hack 12% off its estimate for Medicare spending across 2011-20. In 2014 dollars, the federal government spent about $12,700 on Medicare per recipient in 2010; the CBO sees that declining to about $11,300 in 2019.2

In the big picture, the savings projects to $95 billion in Medicare's 2019 budget. That is more than the projected 2019 federal outlay for welfare, unemployment insurance and Amtrak combined. It also means Medicare's trust fund will now last until at least 2030 according to the Medicare Trustees.1,3

Does the ACA deserve all the credit? Not really, say its detractors. They argue that while health care spending and Medicare spending have slowed in the past few years, it isn't because of the ACA's changes. The counterargument posits that Medicare spending lessened as a consequence of the recession (and the shallow recovery that followed) and higher-deductible health plans that meant greater out-of-pocket costs for consumers.1

Another contention: lawmakers could have done much more to reduce Medicare spending all along, but backed off of that opportunity. When Congress passed the Balanced Budget Agreement in 1997, it authorized cuts in federal payments to doctors who treat Medicare patients. These cuts (which would have significantly reduced Medicare spending) were supposed to occur in 2003, but Congress has postponed them 17 times since that date.1

Hasn't the federal deficit declined anyway? It has, and it is also about to grow again. By the CBO's estimate, the federal deficit for the current fiscal year will be $506 billion, equivalent to 2.9% of U.S. gross domestic product. At the turn of the decade, the deficit was above $1 trillion, corresponding to 9.8% of GDP. The CBO thinks that the deficit will rise again in two years, however, as an effect of increasing federal spending. As for the federal debt held by the public, it has risen 103% during the current administration.4

The deficit aside, the self-insured may pay cheaper premiums in 2015. Preliminary research from the non-profit Kaiser Family Foundation estimates that the mean premium on "silver" plans (the popular and second-cheapest choice among standard plans) will decline 0.8% next year. The KFF's per-city projections vary greatly, though. For example, it forecasts "silver" plan premiums dropping 15.6% in Denver next year and rising 8.7% in Nashville.4

Bottom line, the CBO sees less Medicare spending ahead. That will contribute to a reduction in the federal deficit, and whether the projected decline is attributable to economic or demographic factors or the changes stemming from the ACA, that is a good thing.

Citations.
1 - forbes.com/sites/gracemarieturner/2014/10/07/its-time-to-end-the-doc-fix-dance-and-move-on-to-real-reform/ [10/7/14]
2 - nytimes.com/2014/08/28/upshot/medicare-not-such-a-budget-buster-anymore.html [8/28/14]
3 - washingtonpost.com/blogs/plum-line/wp/2014/08/27/yes-obamacare-is-cutting-the-deficit/ [8/27/14]
4 - msn.com/en-us/news/politics/obama%E2%80%99s-numbers-october-2014-update/ar-BB7PQFw [10/6/14]

Sincerely,
Bill Morrissey, CFP® and Tammy Prouty, CFP®
Sound Financial Planning, Inc.
Primary Office
425 Commercial St., Ste 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
info@soundfinancialplanning.net
Secondary Office
650 Mullis St., Ste 101
Friday Harbor, WA 98250
(360) 378-3022
www.soundfinancialplanning.net

PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO MARKETING PRO INC.

THE MARKET'S WILD SWINGS

A hugely volatile week concludes. What's next as earnings season gets underway?

During this past trading week, volatility ruled Wall Street. In fact, stocks either fell or rose 1.5% or more on three consecutive trading days. That had happened only 54 times since 1928.1

What prompted these ups & downs? Several factors. The International Monetary Fund just cut its global and Asia growth forecasts for 2015 and stated that the eurozone could soon slide into another recession. European Central Bank president Mario Draghi wants easing to stimulate the eurozone economy, yet German finance minister Wolfgang Schäuble doesn't. The DAX and CAC 40 (the benchmark indices of Germany and France) have both corrected since spring.2

So has the Russell 2000, which wrapped up last week down 13% from its peak in early March. Oil entered a bear market Thursday. Finally, the end of the month will presumably see the end of the Federal Reserve's quantitative easing effort - which has played a big role in the market's bull run. The S&P 500 ended Friday down more than 5% from its September 18 record close, and Friday actually saw a rare 100-point drop for the Nasdaq Composite (102.10, to be precise).2,3

Where might things go from here? Stocks could fall further - keep in mind that the S&P has gone more than two years without a correction, definitely an abnormality. On the other hand, fall earnings seasons have tended to give stocks a lift throughout history, so let's hope history repeats. Bespoke Investments cites some encouraging data: in instances where the market sees 1.5% or greater swings on three straight trading days, the S&P has averaged a gain of 0.55% on the next trading day and 1.13% during the following trading week.1

How big a drag will Europe continue to exert on the market? Agreement between EU finance ministers would give domestic and foreign stocks a lift. If that isn't there, perhaps earnings - the "mother's milk" of stocks - will help guide the market back to equilibrium and gains.2

Perhaps the wisest words came from Cornerstone Wealth Management CIO Alan Skrainka, who told USA TODAY Friday: "The market was overdue for a correction. Not every correction develops into a bear market. Every economic slowdown is not a recession. Look for opportunities and maintain a long-term perspective."3

Citations.
1 - tinyurl.com/k9nfbxc [10/10/14]
2 - bloomberg.com/news/2014-10-09/index-futures-slip-as-stocks-slump-while-oil-extends-drop.html [10/10/14]
3 - usatoday.com/story/money/markets/2014/10/10/stocks-friday/17022819/ [10/10/14]

Sincerely,
Bill Morrissey, CFP® and Tammy Prouty, CFP®
Sound Financial Planning, Inc.
Primary Office
425 Commercial St., Ste 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
info@soundfinancialplanning.net
www.soundfinancialplanning.net
Secondary Office
650 Mullis St., Ste 101
Friday Harbor, WA 98250
(360) 378-3022

PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO MARKETING PRO INC.

THE NEWEST LARGEST IPO IN HISTORY

Last fall it was Twitter. Before that, it was Facebook. Now it's Alibaba, the huge Chinese e-commerce company that just became the largest tech IPO in history, after raising $21.8 billion in its initial public offering on September 18.

As it turns out, Facebook and Twitter turned out to be decent investments at their IPO price. Post-IPO buyers purchased Twitter shares at roughly $45 a share, and over the nearly 12 months since, the stock has climbed to around $50--an 11% return that is below what the market as a whole has delivered, but above the negative returns most investors experience in the first year after a public offering. Facebook has done better, starting life at $38 a share in May of 2012, following a very bumpy path that saw investors deeply under water for months, and then recovering so that shares are now trading around $75.

Will Alibaba continue the streak? Amid all the hype, one voice to listen to is veteran emerging markets analyst/manager Mark Mobius, of Franklin Templeton Investments. Mobius acknowledges that Alibaba has some interesting fundamentals--including a return on equity of 24%, operating margins of 26% and revenue of $1.02 billion, making it by far the biggest e-commerce engine in China.

But he also notes that the company has an unusual corporate structure that could lead to problems for investors down the road. He warns that the company's ownership team controls the board of directors, which means that if shareholders are concerned about the direction of the company, or if the owners decide to loot the assets and put the money in their own pockets, well, there isn't much shareholders could do about it.

What, exactly, did investors buy in this IPO? In most cases, IPO investors are purchasing direct ownership shares of the company. But Alibaba is listed as a variable interest entity, which creates a somewhat more complicated ownership structure. The bottom line is that shareholders, in this public offering, are actually buying a stake in a company registered in the Cayman Islands, which has a contract to share in Alibaba's profits. If shareholders ever became concerned about Alibaba's management decisions, they would have to go to a Chinese court to get redress. It is hard to imagine a positive outcome for American investors.

Along this line, it is interesting to note that the original plan was for Alibaba to go public on the Hong Kong stock exchange, but the Hong Kong regulators declined to allow it, citing concerns about (you guessed it!) the ownership structure and fairness to Hong Kong investors. The New York Stock Exchange may have been more focused on a big payday than on consumer protection when it allowed the company to list in the U.S.

Sources:
http://money.cnn.com/2014/09/17/investing/mark-mobius-alibaba-ipo/index.html?iid=SF_INV_River
http://www.marketwatch.com/story/alibabas-structure-is-dangerous-mark-mobius-2014-09-18
http://www.macroaxis.com/invest/market/1688.HK--fundamentals--Alibabacom_Limited

Sincerely,
Bill Morrissey, CFP® and Tammy Prouty, CFP®
Sound Financial Planning, Inc.
Primary Office
425 Commercial St., Ste 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
info@soundfinancialplanning.net
www.soundfinancialplanning.net
Secondary Office
650 Mullis St., Ste 101
Friday Harbor, WA 98250
(360) 378-3022

PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.