John Augustine: Since this past summer, one of our top recommendations to clients of the Huntington Private Bank has been the importance of having a personal balance sheet.
What’s a personal balance sheet? It’s an extension of your household budgeting. It gives you an overview of your investment portfolio and, best of all, helps you grow your assets while managing your liabilities -- and even reducing their cost. Personal balance sheets often don’t get the focus of household budgeting, but we believe it's just as important, especially now.
We saw a combination of positive events for one’s personal balance sheet this summer when the S&P 500 reached a new all-time high in August and the 10-year Treasury yield hit an all-time low in July. Home values also continued to rise in most parts of the country.
During this time, we began to form views for our clients on the asset side of the balance sheet around this question: How do you best diversify a stock portfolio when prices are at or near record highs? Then, on the liability side, we started to focus on how to manage and control liabilities in an environment where yields are at or near lows. An overall review of your personal balance sheet can help do this.
So that's how this concept of a personal balance sheet became an extension of the household budget for us. It’s no different than how a company tries to grow assets while limiting the cost of liabilities.
Wally Forbes: A very different approach.
Augustine: Let’s talk about the asset side of the personal balance sheet. A good place to start is your 401(k) plan, which is a major wealth accumulation vehicle for most Americans.
In our view, you can best use 401(k) plans by contributing 10% to 15% of your pre-tax salary and making sure you have a disciplined asset allocation. A good way to determine proper allocation is by age. Take the number 120 and subtract your age. The resulting number should be the minimum percentage you have in the equity side of that 401(k) plan.
We also encourage clients to consider rebalancing. There's a seasonality to markets, with stocks historically performing best from November through April. That coincides with the time changes twice a year. So in addition to changing the batteries in your smoke detector, you should use the rebalancing features on your 401(k) platforms around the time you change your clocks.
Second, we turn our attention to IRAs, which should be the next financial asset that investors focus on in their personal balance sheet. We encourage our clients to use IRAs as a tool with their partner or spouse to essentially pay themselves back. Here’s how: Take your five biggest household expenses -- excluding your mortgage -- and invest in those companies.
Chances are, they're paying dividends. So you're going to be paying yourself back, and you and your partner or spouse understand what you're invested in. And more than likely, those companies will continue to grow as long as our economy and consumer spending keep growing as well.
Forbes: Does that mean you're investing where you're spending your money? Like you're investing in stocks of clothing companies, oil companies and restaurant companies, etc.?
Augustine: Absolutely. You could be in travel stocks, energy stocks and some utilities stocks, such as your internet or mobile provider. As you mentioned, Wally, you could be in retail, grocery and other stocks, like Amazon if you’re a millennial. Exact allocations will vary depending on different lifestyles.
Forbes: Very interesting. So what does this lead you to at the moment?
Augustine: It leads us to a view that Americans need to pay attention to their financial asset portfolios as they maintain their real assets, such as their home.
We think it's as important for people to understand what they're invested in and why they're invested in it. A lack of understanding caused a lot of damage to investors in 2008 because they didn’t know what they were invested in and why their investments suffered.
Secondly, while U.S. large-cap stocks are near records, investors need to diversify to other portions of the stock market, like U.S. small- and mid-cap stocks as well as some exposure overseas, where we currently favor emerging markets.
Now our third item on the asset side of the personal balance sheet is the concept of a “portfolio inventory.” In addition to the 401(k) and IRA, Americans should holistically look at all the assets on their personal balance sheet and do an annual portfolio inventory.
Once a year, review all your holdings line by line and determine what you own and why you own it. If you don't understand something, sell it and buy something you do understand. In addition, have a feel for how these holdings fit together. Do they duplicate? How might they do in a recession? How might they do if inflation returns?
Also on the asset side of the personal balance sheet, ensure you have proper diversification, while understanding where your household cash flows come from versus what you are invested in. You don’t want to be overly invested in the same places as the industry where you draw your salary.
Lastly, consider balancing the mix of financial and real assets to complement each other -- that is, having some precious metals, real estate, art, collectables or other real assets in addition to financial assets.
Overall, our goal at the Huntington Private Bank is to help clients think about the asset side of their balance sheet in different ways and bring it all together once a year with an inventory.
Forbes: Very, very interesting and very different than I've ever run across before.
Augustine: Now, let’s take a look at the liability side on the personal balance sheet, which is the loans we all have. This year, interest rates hit another low in July and provided the best time to refinance since mid-2012. Since that summer low, bond yields have drifted higher but are still not even to levels at the beginning of this year. That’s why the refinancing window is still open.
Another interesting approach to debt right now is that borrowers with ample cash flows and a stock portfolio can manage to something called a “positive spread.” In other words, it’s when the dividend yield on many blue-chip stocks exceeds the interest cost of some collateralized debt. That’s a circ*mstance that doesn’t occur very often.
Forbes: That’s for sure.
Augustine: Well, Wally, that's what we're thinking of from a personal balance sheet point of view. Understanding both sides of it -- and trying to maximize the effectiveness on both sides -- is a critical part of personal financial responsibility.
Forbes: Very fascinating. So, John, why don't you get into a few investments that you like or don't like under the circ*mstances.
Augustine: Here are some 2017 themes on our minds for investors.
First, there are relatively low expectations right now around economic growth, interest rates and inflation. That makes us as fiduciary investors think of this question: What if the consensus is not right? That’s why investors may want a little inflation or more economically sensitive investments as we move into the new year.
However, there are high expectations next year for earnings and earnings growth. The expectation is we’ll get out of this profits recession in the second half of this year, and these big S&P 500 companies will see double-digit earnings growth next year.
With this prediction, our minds now turn to where the most optimistic earnings growth is and how realistic it is. There are four sectors in which earnings growth is double digits, or in one case, triple digits.
I bet you can guess which one is triple digits: energy. The others are financials, technology and materials. So we're thinking of rising earnings for these sectors and how to invest in stocks within each.
So in energy, we'd look at which big multinational we like best. Our picks are Exxon (NYSE: XOM) or Chevron (NYSE: CVX). Second, we ask which producers do we like best. We use Pioneer Natural Resources (NYSE: PXD) and EOG Resources (NYSE: EOG). And third, we decide which services companies in the energy space we like best. It’s either Schlumberger (NYSE: SLB), the largest company, or Halliburton (NYSE: HAL).
Then with financials, the strategy is to essentially pick your favorite banks -- large and mid-sized. Right now, from a large bank perspective, the market favors JPMorgan Chase (NYSE: JPM). From a regional bank perspective, pick your favorite part of the country and where you see the best performance coming from the regional banks.
In the tech sector, the big mover this year has been arguably the chip stocks and chip-related stocks or semiconductors. What's lagged this year is the big service companies, such as IBM (NYSE: IBM), Salesforce.com (NYSE: CRM), Oracle (NASDAQ: ORCL), Microsoft (NASDAQ: MSFT), Automatic Data Processing (NASDAQ: ADP) or their equivalents. However, we see a shift beginning to occur. In our view, we will transition from a semiconductor-focused tech sector to a services focus next year as those semiconductors begin to be used in the service arena.
For the materials space, what's very noticeable to us this year are the farmers and agricultural prices, which were generally down except for soybeans. That has caused a big downward hit to the agricultural stocks. So moving into next year, our focus is on industry groups within agriculture that could rebound from a tough year this year. As examples, large fertilizer stocks, such as the Mosaic (NYSE: MOS) and the CF Industries (NYSE: CF), have seen big share price declines this year. Monsanto (NYSE: MON) has been running around trying to find a partner all year to merge with and seems to have found one in the German company Bayer. That leads us to think about DuPont (NYSE: DD), which is trying to merge with Dow Chemical (NYSE: DOW). That could be a profitable combination when agriculture recovers.
Forbes: Well, this is a very fascinating way of going about it, and you've come up with certainly a large group to choose from. Much appreciate your taking the time to share your very unique thinking with us.
Augustine: Thanks, Wally.
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