Portfolio Issues - Budgeting
The new year is a time when people set goals and reflect on the past twelve months. With that in mind, we thought it would be a fine time to bring up a useful topic: budgeting.
You’ve probably heard of the 4% rule for retirement spending. In brief, you withdraw 4% of your savings in the first year of retirement and adjust that dollar amount for inflation. That theoretically gives you 30 years until you run out of money.
The 4% rule is a useful guideline, but that’s it. Everyone has a unique situation that is easier to evaluate when you track where your money goes. We hear questions about spending with some frequency. But once we discuss further, it’s often about the amount of discretionary spending someone can afford. Items like vacations or renovations to their house. You know, the fun stuff.
Questions like those mostly refer back to a budget. How much money is coming in and how much money needs to go out for living expenses like mortgages, property taxes, utilities, etc.
Now, if you find yourself already enjoying retirement, there is a pretty good chance you know where your money is going. No longer receiving a paycheck tends to put a focus on spending. However, large expenses still come up. If it is on the discretionary side, we think it’s useful to break it out over twelve months. Say it’s a $12,000 cost, so $1,000 per month. What does that look like as a percentage of your savings and your current monthly spending?
Being informed makes the discretionary spending feel like it should: fun.
“You’re talking about 1999?! You really are a dinosaur.”
Market View - Time To Be Careful
Markets are generally efficient. But there are times when market prices seem to be out of whack with the available information, either because investors are overly optimistic or overly gloomy. We think this is one of those times.
The US economy looks strong. Indeed, it’s the envy of the world. The stock market is reaching new highs. But in many places where we look, we see signs of excessive optimism.
Nvidia is priced such that someone has to be making a mistake. Nvidia currently has about 18% of the semiconductor market, and probably 70-80% of the market for high-performance semiconductors. Analysts estimate that Nvidia’s revenue and earnings will grow at about 40% per year for the next five years or so. On the other hand, the semiconductor market as a whole is estimated to grow at 14-15%. If you do the arithmetic, that means Nvidia will have 50% market share in five years, and 100% market share in eight years (if that 40% growth rate extends for three more years). Is that really possible?
Bitcoin is now at about $100,000 per coin. We still don’t know what Bitcoin is, other than a way for criminals to hide income. We haven’t heard any reasonable explanation for what a Bitcoin is worth, yet it continues to go up in price. Our guess is that someday everyone will suddenly realize that the emperor has no clothes, and the price will crash. But we don’t know when that is.
The excitement about artificial intelligence is frighteningly similar to the excitement about the internet 25 years ago. Any company with the whiff of artificial intelligence about it is seeing its stock price go up, including electric utilities. But so far, how anyone will make money from artificial intelligence is not clear, as it wasn’t for the internet. If you look back now, the internet has had a tremendous impact on businesses and societies, but often not in the way people were talking about 25 years ago.
The top ten stocks in the S&P 500 index now account for more than 30% of the index, more concentrated than it’s been in decades. That means the index isn’t very diversified. And guess what? Twenty-five years ago technology comprised 42% of the index—also not diversified.
Standard and Poors, a research and data firm, points out that momentum has been the single most important factor for stock performance in 2024. This means that investors don’t care how much they are paying for a dollar of earnings or cash flow. What they care about is whether the price of a stock is going up, and if it is, they will buy more. Again, we heard this sort of sentiment in 1999. The problem is people don’t care about whether they’re receiving good value for their investment dollars, until suddenly they do.
The only place we continue to see good value is in dividend-paying stocks. Why they’re being ignored right now is a mystery to us. We like the cash flow of the dividends, but we also like the financial discipline that dividends impose upon a company’s management.
Bonds are providing a decent amount of interest—the 10-year US Treasury yields about 4.6%. At that rate, we think Treasurys are reasonable. Not great, but reasonable. The curious part of the bond market is junk bonds, politely called high yield in some circles. They’re riskier than US Treasurys, so they should pay a higher rate; and they do, but it’s not much higher, which means that investors have a very rosy view of the future for junk bonds and the companies that issue them. So we think sticking with safer, investment-grade bonds is more prudent than stretching for a slightly higher yield from junk bonds.
When many other investors are so obviously optimistic in several different markets, the rest of us should take a step back and exercise caution.
Sources: Economist, Wall Street Journal, Value Line, Vanguard, Applied Finance Group, Schwab
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