The True Cost of Investing + Financial Market Update + 1.26.21

The True Cost of Investing + Financial Market Update + 1.26.21

FINANCIAL MARKET UPDATE 1.26.2021

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

THE TRUE COST OF INVESTING

Long-time readers of the Weekly Market Update may know I am a fan of Morgan Housel, as his blog is frequently among the links in the Hot Reads section. Last year, Morgan published a book titled The Psychology of Money, which I found to be an excellent read as well. One thing that I think sets him apart is his ability to explain abstract financial concepts through stories and metaphors that may be more relatable to people outside of the industry. A chapter of the book covering market volatility really resonated with me. It provided a unique perspective on market swings that, if embraced, can improve your chances for investment success.

Since 1927, the US stock market has returned just over 10% per year on average. At that rate, an investor with a diversified portfolio of stocks would have seen their money double every seven years or so. All you had to do was set it and forget it. Of course, doing so is much easier said than done. Morgan writes:

Like everything else worthwhile, successful investing demands a price, but its currency is not dollars and cents. Its volatility, fear, doubt, uncertainty, and regret. All of which are easy to overlook until you are dealing with them in real-time. The inability to recognize that investing has a price can tempt us to try to get something for nothing, which, like shoplifting, rarely ends well.

The stock market’s 10% average return was much higher than what could have been earned on a risk-free investment. Any investor that hoped to achieve that return had to pay the corresponding price. The period was fraught with wars, natural disasters, market peaks, market crashes, a global pandemic, and many other events that generated substantial volatility and fear. As a result, the price for pursuing that return was quite high, and many were likely unwilling to pay it. Morgan further describes the cost of investing through an analogy of purchasing a car:

Say you want a new car, it costs $30,000. You have three options:

  1. Pay $30,000 for it
  2. Find a cheaper, used one
  3. Steal it

Like the car, you have a few options (when investing). You can pay this price, accepting volatility and upheaval, or you can find an asset with less uncertainty and a lower payout – the equivalent of a used car. Or you can attempt the equivalent of grand theft auto and try to get the return while avoiding the volatility that comes along with it. Many people in investing choose the third option, like a car thief, though well-meaning and law-abiding, they form tricks and strategies to get the return without paying the price. They trade in and out. They attempt to sell before the next recession and buy before the next boom. Most investors with even a little experience know that volatility is real and common. Many then take what seems like the next logical step, trying to avoid it. But the money gods do not look highly on those that seek a reward without paying the price. Some car thieves will get away with it. Many more will get caught. 

The penalty for “getting caught” can be illustrated by the famous analysis conducted by Dalbar Inc. Their study showed that fund investors in aggregate tend to underperform the funds they invest in, a result of performance chasing and failed attempts to time the market.

Risk and return are bound together. Assets with the prospect of a higher return only exist because their payoffs are uncertain. If a risky stock had the same expected return as a risk-free government bond, nobody would buy the stock. Why take risk if you can earn the same return risk-free? In order to attract investors, assets with uncertain payoffs must be priced so that investors may be rewarded for taking the risk. The larger the uncertainty in the potential payoff, the larger the reward that is required to attract investors. This is an especially critical concept for investors to understand in today’s market environment, where interest earned on risk-free investments is effectively zero and negative after inflation. For most people, financial goals require a return that is not only positive but exceeds inflation. To obtain such a return, they must take risk.

I’ll let Morgan close this out with his thoughts on how investors should think about that risk:

The question is, why do so many people, who are willing to pay the price of cars, houses, food, and vacations, try so hard to avoid paying the price of good investment returns. The answer is simple, the price of investing success is not immediately obvious. It’s not a price tag you can see. So, when the bill comes due, it does not feel like a fee for getting something good. It feels like a fine for doing something wrong. While people are generally fine with paying fees, fines are supposed to be avoided. You are supposed to make decisions that preempt and avoid fines. Traffic fines and IRS fines mean you did something wrong and deserved to be punished. The natural response for anyone who watches their wealth decline and views that drop as a fine is to avoid future fines. It sounds trivial, but thinking of market volatility as a fee, rather than a fine, is an important part of developing the kind of mindset that lets you stick around long enough for investing gains to work in your favor.

WEEK IN REVIEW

  • The Federal Reserve’s FOMC began its two-day policy meeting today and will conclude tomorrow afternoon. The end of the meeting will be followed by Chair Powell’s 1 PM CT press conference, which can be streamed on Yahoo Finance. There seems to be a consensus in the market that the Fed will leave its policy rate at the zero bound for an extended period. Early signs of an uptick in inflation, however, are causing some speculation on when quantitative easing (QE) will be wound down. QE refers to the bond buying program the Fed implemented during the height of market volatility last year. Reducing these purchases would likely be one of the first ways the Federal Reserve begins to tighten, and the market will pay close attention to any guidance from Powell on the subject.
  • In the Spring of 2013, the Fed Chair at the time, Ben Bernanke, suggested the Fed may begin to “taper” its financial crisis era QE program. Following those comments, interest rate volatility spiked and long-term yields rose dramatically through the remainder of the year. The event was dubbed the “Taper Tantrum,” a repeat of which Powell will certainly seek to avoid.
  • From an economic data standpoint, look for durable goods orders tomorrow. On Thursday, we will get an update on Jobless claims, the first estimate of Q4 GDP, and the index of leading economic indicators (LEI). Finally, we will get inflation data and a reading on consumer sentiment on Friday.

HOT READS

Markets

  • November Home Prices Rose 9.5%, One of the Highest Gains on Record, Case-Shiller Says (CNBC)
  • GameStop Day Traders Won’t Sack Wall Street (WSJ)
  • Saved Stimulus Checks Expected to Help Spur Economic Recovery (WSJ)

Investing

  • Every Warren Buffett Needs a Charlie Munger (Jason Zweig)
  • A responsible Version of Market-Timing (Morningstar)

Other

  • Why You’re More Creative in Coffee Shops (BBC)
  • The Good Kind of Brain Drain (The Atlantic)
  • Coffee Tied to Lower Risk of Prostate Cancer (NYT)

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

ECONOMIC CALENDAR

Source: MarketWatch

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ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + CHIEF INVESTMENT OFFICER

Josh Jenkins is the Chief Investment Officer at Lutz Financial. With 10+ years of relevant experience, he specializes in assisting clients with portfolio construction, asset allocation, and investment risk management. In addition, he is responsible for portfolio trading, investment research and thought leadership for the division. He lives in Omaha, NE, with his wife Kirsten.

AREAS OF FOCUS
  • Asset Allocation
  • Portfolio Management
  • Research & Data Analytics
  • Trading System Operation & Execution
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst®
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

FORM CRS RELATIONSHIP SUMMARY

January Retirement Plan Newsletter 2021

January Retirement Plan Newsletter 2021

 

LUTZ BUSINESS INSIGHTS

 

PUBLISHED: JANUARY 13, 2021

January RETIREMENT PLAN NEWSLETTER

3(38) ADVISORY SERVICES - SHOULD FIDUCIARIES OUTSOURCE RETIREMENT PLAN INVESTMENT RESPONSIBILITY?

Department of Labor (DOL) enforcement recoveries are on the rise. A recent DOL report indicates that DOL recoveries have doubled since 2018 and tripled since 2016 (https://www.investmentnews.com/dol-retirement-plan-recoveries-198660).  As a result, fiduciary liability premiums have increased 35% since last year (https://www.investmentnews.com/fiduciary-insurance-costs-401k-litigation-198407).

Fiduciaries are personally responsible for participant losses resulting from a fiduciary breach. Plan sponsor fiduciaries who handle plan investments themselves, or use advisors who do not assume fiduciary status, face potential exposure for both investment performance and all plan fees.

The Employee Retirement Income Security Act of 1974 (ERISA) specifies that any plan fiduciary level decision must be informed by expertise. Most plans do not have a credentialed investment expert on committee (if they do, that individual is typically not amenable to accepting the responsibility and liability involved). Plan sponsors who are wont to mitigate this liability for investment decisions (investment menu structure, selecting and monitoring plan investment options) have specific options available under ERISA.

 

ERISA 3(21) Investment Advisor

The most utilized mitigation option and perhaps most suitable for many plans is hiring an ERISA 3(21) investment advisor. An advisor acting in a 3(21) capacity is responsible for delivering unbiased prudent investment recommendations regarding the selection, and ongoing monitoring of plan investments. The DOL has made clear that it is the responsibility of the plan investment fiduciaries that the final selection be commensurate with their participants’ needs. Your advisor has access to a Qualified Default Investment Alternative (QDIA) selection tool. This tool is used to determine and document the participant demographic investment appropriateness for a QDIA, thus eligible for a fiduciary “QDIA safe harbor”. This same tool can also aid in making an appropriateness determination for individual investments as well.

 

ERISA 3(38) Investment Advisor

Section 402 of ERISA allows plan fiduciaries to delegate investment responsibilities to, what ERISA calls, a “named fiduciary.” This named fiduciary is a 3(38) investment advisor who assumes all responsibilities for selection, monitoring, and participant demographic appropriateness for plan investments. The company is then left with only monitoring that the advisor retains a prudent analytic process (e.g., their analytic process does not deteriorate substantially from its original prudent level). The 3(38) advisor needs to work with the client to determine investment appropriateness on issues such as risk, expense, and style appropriateness, but once accomplished, substantially more meeting time is available for other important topics like fiduciary education, plan success, participant retirement readiness, and more.

FORMER EMPLOYEES WITH PLAN ASSETS ARE STILL PLAN PARTICIPANTS

Plan Sponsors should understand that terminated employees who left their account balance in your plan, are still considered participants under ERISA. As such, they have the same rights as current employees. They cannot contribute to their account under the plan but otherwise they have the same ERISA protected rights as plan participants.

One protected right is to receive all ERISA required notices that current participants receive. The distribution of notices to former employees can be challenging. With online notice distributions now allowed, it may ease this problem a bit, but losing track of former employees through undeliverable mail or emails can be troubling.

Participant direction of investments and notice of investment changes is another obligation that is more difficult with terminated employees. A fundamental fiduciary responsibility is to provide sufficient investment information such that participants can make consistently informed investment decisions. In the event the stock market goes through a bear market cycle, former employees may become disgruntled if they did not receive proper and required investment information based on which they may have prevented financial losses.

Small account balances belonging to former employees can be problematic for plan providers as well as plan fiduciaries. This can lead to greater administrative recordkeeper costs. In addition, having terminated employees in your plan may cause your plan to be subject to an annual plan audit at a potential cost of around $15,000.

One step many plans take to mitigate this exposure to some extent is to adopt a cash-out limit (usually $1,000 or $5,000). With a cash-out limit, terminated participant accounts may be distributed after communicating that they need to take a distribution directly or a rollover to an Individual Retirement Account or another qualified plan. For participant accounts in excess of $5,000 you must obtain consent from employees requesting to take their account balances out of the plan. It is advantageous for plan sponsors to persistently reach out to former employees to request they take their money out.

The Department of Labor (DOL) has been focused on missing participants with dormant accounts. As with any fiduciary task as part of your annual request that former employees take their money it is advisable that all correspondence (both sent and returned) be documented to evidence your communication efforts. Internet searches can be helpful to find those who leave no forwarding address.

SHOULD YOU ADOPT A PLAN COMMITTEE CHARTER?

Yes!

The primary purpose of a committee charter is to document overall plan governance. It is not dissimilar to how your Investment Policy Statement (IPS) acts as a “roadmap” for managing your plan investments. The charter also documents delegation of fiduciary responsibilities from the plan’s “named fiduciary” to
co-fiduciaries. Even small plans with a single fiduciary who makes all plan management decisions can benefit from having a plan governance document.

But simply having a committee is not sufficient. Per ERISA, a retirement plan governance committee charter sets out the committee’s goals and responsibilities. It should include certain specific fiduciary principles, such as managing the plan for the exclusive benefit of participants; practicing ERISA’s procedural prudence; adhering to the plan document; and ensuring proper diversification of investment options.

Committee members should sign the charter initially stating that they understand and accept responsibilities as a plan fiduciary, and resign when retiring from the committee if they remain with your company.

 

What is a Named Fiduciary?

Every plan document is required to identify the plan’s “named fiduciary”. This can be a specific individual, an entity, or most frequently, “the company” can be the named fiduciary. “The company” as the named fiduciary denotes the main decision-making person or entity (e.g., the party with authority to adopt the plan). For a “C Corporation” this would be the board of directors. The board of directors, as the named fiduciary, can never delegate all its fiduciary responsibility, but via committee charter it can delegate nearly all plan fiduciary responsibilities (except the responsibility of prudently selecting and monitoring the plan’s committee members, who serve as fiduciaries) to co-fiduciaries (e.g., committee). As a result of this monitoring requirement, the committee needs to keep the board (named fiduciary) informed of its activities and to approve its recommendations on key items which may not have been delegated.

 

Who, What, When and Why of the Committee

Given the high level of the committee’s responsibility, a representative of top management should play a key role on the committee.

The number of committee members varies, but one should consider having an uneven number of committee members to avoid any voting ties. Typically, medium, and larger plans committees will have 3, 5, or 7 members. Some plans will have a separate investment committee if in-house investment knowledge is available in house. It is important that committee members can make a contribution, and are agreeable, to participating in committee activities.

Most medium and larger plan committees will meet with their plan advisor on a quarterly basis discussing and documenting topics covered such as: investments, participant behavior/retirement readiness, funding, administration, plan goals/objectives, plan administrative processes and general plan management. Committees may occasionally invite a third party to a meeting who represents a specific plan function (plan administration, representing a specific employee group, CEO, etc.).

It is expected that all committee members attend meetings regularly. Those that do not, or otherwise demonstrate a lack of commitment to their role, should be considered for potential removal and or replacement. If a member with specific expertise important to the plan leaves the committee, they need to be replaced by someone with the same expertise.

All committee topics and decisions should be thoroughly and carefully, in accordance with ERISA procedural prudence, and then documented in committee meeting minutes. If the decisions have an ongoing impact on the plan those decisions should be reviewed periodically to insure their continued prudence.

All committee members should receive training on their fiduciary responsibilities under ERISA, their liabilities (and mitigation strategies), plan operations and plan administration. During an annual plan audit (required for plans with 100+ participants) or a DOL investigation, it is typical for evidence of the frequency of fiduciary training for committee members be requested.

ERISA requires retirement plan fiduciaries to exercise their authority “with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.” This standard of “…a prudent person acting in a like capacity and familiar with such matter…” means having or obtaining expertise pertaining to each matter under consideration. As an example, when considering an investment decision, credentialed investment expertise is a best practice whether in-house or with a credentialed fiduciary plan investment advisor.

 

Personal Financial Fiduciary Liability Mitigation

As a plan fiduciary you may become personally financially liable for any breach of duty that causes financial detriment to your plan participants. Retirement plans that operate without a coherent governance structure are susceptible to mismanagement potentially incurring personal financial legal liability for imprudent or ill-informed decisions. There are effective strategies for mitigation this potential liability. Understanding your ERISA fiduciary responsibilities, liabilities, clearly and administering your plan document accurately are most important.

Obtaining ERISA fiduciary liability insurance and/or company indemnification should be considered.

By creating an effective plan governance committee, including ongoing fiduciary education, your plan management can operate effectively for the benefit of plan fiduciaries and plan participants.

PARTICIPANT CORNER: RETIREMENT PLAN FACTS

Your employer provides you with a retirement plan for you to save money in, tax-deferred, for the day you bid your career farewell and enter into retirement. It’s important for you to know the facts about your plan, so you can maximize its saving potential. Here are essentials to know about your retirement plan:

 

What is it?

A defined contribution plan designed to help you finance your retirement. As a participant in the plan, you own an individual account within the plan that you contribute money to for your retirement.

 

What are the limits?

For the year 2021, you can contribute a total of $19,500 towards your retirement plan. Individuals age 50 and over can contribute an additional $6,500.

 

Salary deferral advantages.

By participating in the plan you receive the benefit of saving via payroll deduction on a tax-deferred basis. Tax deferral on both savings and asset growth via payroll deduction helps you save more money and pay less tax upon distribution at retirement.

 

Tax-deferred growth.

Not being taxed on the growth of your assets helps accumulations during your working years. With your qualified retirement savings plan, you not only defer taxes on the amount you save, but earnings on your savings is also tax deferred until distribution.

 

Employer contributions.

If offered, they help you accumulate assets for retirement and can add considerably to your retirement account balance. You are also not taxed on your employer’s contributions until distribution.

 

Portability.

If you change employers at some point in your career, you typically can keep your assets in the current plan, roll your assets over to your new employer’s plan or roll your assets into an IRA.

DISCLOSURE INFORMATION

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Lutz Financial (“Lutz”), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Lutz.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  Lutz is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.  A copy of the Lutz’s current written disclosure Brochure discussing our advisory services and fees is available upon request. Please Note: If you are a Lutz client, please remember to contact Lutz, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. Lutz shall continue to rely on the accuracy of information that you have provided.

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The True Cost of Investing + Financial Market Update + 1.26.21

Growth Trounced Value in 2020 + Financial Market Update + 1.12.21

FINANCIAL MARKET UPDATE 1.12.2021

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

GROWTH TROUNCED VALUE IN 2020

For the fourth consecutive year, growth stocks have outperformed their value counterparts. The degree of outperformance in 2020, however, was on a different level. Small and mid-cap value stocks trailed by the largest amount since the technology bubble of the late 1990s, while large-cap value stocks trailed by the largest amount ever. Factors including low interest rates and the strong relative performance of the so-called work-from-home (WFH) stocks likely contributed to growth’s dominance.  

Now that we have entered 2021, what is the outlook for growth versus value stocks moving forward? There are a number of reasons to believe the performance of value stocks may be poised to rebound. The biggest support for this happening is the relative valuation between growth and value, as the two charts below illustrate.

Investors typically pay a premium relative to the market for companies that demonstrate rapid growth. The size of the premium that investors pay ebbs and flows with market conditions but tends to return to its long-term average level. Today, investors are paying the highest premium for growth in nearly twenty years!

 

Source: Morningstar Direct. Valuations are based on an equally weighted composite of price/book value, price/earnings, price/sales, and price/cash flow of each value index relative to the broad market. Large cap growth is represented by the S&P 500 growth Index. The broad market was represented by the Russell 3000 index. Data from 1/2001 to 12/2020.

Value stocks, on the other hand, typically trade at a discount relative to the broad market. As these companies fell further out of favor with investors over much of 2020, the discount continued to widen. By the end of the year, investors had the ability to purchase smaller, value-oriented companies at the largest relative discount in decades. For investors concerned about owning stocks while the market appears to be so expensive, small-cap and value-oriented companies offer an attractive opportunity.

Source: Morningstar Direct. Valuations are based on an equally weighted composite of price/book value, price/earnings, price/sales, and price/cash flow of each value index relative to the broad market. Small cap value is represented by the S&P 600 Value Index. The broad market was represented by the Russell 3000 index. Data from 1/2001 to 12/2020.

The last time the dispersion in performance and valuation, between growth and value, was this wide (1999), value stocks went on to outperform dramatically for several years. Of course, that does not mean the same will happen this time. It is possible that growth stocks will continue their dominance. Recently, small and value tilted companies have staged a small comeback, though we have seen multiple false starts over the past several years. Still, valuations have a tendency to revert to their long-term averages. Growth stocks are trading well above average, while value stocks are trading well below. A reversion would suggest strong relative performance for value.

WEEK IN REVIEW

  • Data published by the Bureau of Labor Statistics (BLS) last week showed the US economy shed 140,000 jobs, compared to forecasts of a 50,000 job gain. Job losses were concentrated in the virus-sensitive hospitality industry, including bars and restaurants, as accelerating Covid cases caused governments to intensify restrictions. The unemployment rate held steady at 6.7%.
  • This week kicks off the earnings season for Q4 2020, with many of the big Wall Street banks reporting. According to Factset, YoY earnings are expected to be -8.8%, which represents an improvement from the original estimate of -12.7%, made at the beginning of the quarter. Typically the pattern is for companies to guide earnings expectations lower throughout the quarter, which lowers the bar making them easier to beat. This is the second consecutive quarter where estimates have increased during the quarter. With valuations stretched, strong results are needed to justify more gains. One positive is that YoY growth rates are going to get a tailwind as the weak Q1 2020 quarter becomes the comparison for Q1 2021.
  • On Wednesday, look for an update on inflation. Jobless claims will be published on Thursday. Finally, retail sales and industrial production will be published on Friday.

HOT READS

Markets

  • Economy Sees Job Loss in December For The First Time in Eight Months as Surging Virus Takes Toll (CNBC)
  • Two Worlds: So Much Prosperity, So Much Skepticism (Morgan Housel)
  • Cash in Circulation is Soaring, and that Usually Means Good Things for the Economy (CNBC)

Investing

  • Unrelated Stock Sees Massive Gains Days After Elon Musk Said People Should ‘use Signal’ (CNBC)
  • The Stock Market is Causing the Bubbles (Michael Batnick)

Other

  • Former US Air Force Fighter Pilot Breaks Down 12 Fighter Pilot Scenes From Film & TV (Wired)
  • ‘The Browns Is The Browns’ (Sports Illustrated)
  • We are What we Remember (Farnam Street)

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

ECONOMIC CALENDAR

Source: MarketWatch

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ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + CHIEF INVESTMENT OFFICER

Josh Jenkins is the Chief Investment Officer at Lutz Financial. With 10+ years of relevant experience, he specializes in assisting clients with portfolio construction, asset allocation, and investment risk management. In addition, he is responsible for portfolio trading, investment research and thought leadership for the division. He lives in Omaha, NE, with his wife Kirsten.

AREAS OF FOCUS
  • Asset Allocation
  • Portfolio Management
  • Research & Data Analytics
  • Trading System Operation & Execution
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst®
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

FORM CRS RELATIONSHIP SUMMARY

The True Cost of Investing + Financial Market Update + 1.26.21

2020: Year In Review + Financial Market Update + 1.5.2021

FINANCIAL MARKET UPDATE 1.5.2021

GUEST AUTHOR: JUSTIN VOSSEN, CFP®, NAPFA

STORY OF THE WEEK

2020: YEAR IN REVIEW

There are decades when nothing happens, and there are weeks where decades happen. As I sit with clients and reflect on the year that was, I am struck by all that can happen in a short amount of time. The last year brought about a large array of things that were unfathomable just 12 short months ago. The most difficult part for a middle-aged person like me is to digest a lifetime’s worth of changes so rapidly.

So, I think it is worth some time to look back at all that happened. Sometimes we learn more about events and ourselves reflecting after the fact. Because of all that was happening around us, it was hard to absorb everything in the moment. I will try to limit the virus statistics and political events as much as possible and try to focus on the financial changes that have occurred over the last year. 2020 was more than a decade’s worth of changes, and they will impact us all for many years to come.

  • January 4th – WHO announces unknown pneumonia case in Wuhan, China
  • January 20th – First confirmed case of Covid-19 in the United States
  • February 19th – S&P 500 closes at a record high of 3,386
  • February 28th – S&P 500 falls into correction territory (-10%) due to Covid-19 fears
  • March 3rd – The Fed announced an emergency rate cut of 0.50%
  • March 6th – Ten states report their first case of coronavirus, including Nebraska
  • March 9th – The Dow Jones loses more than 2,000 points in a day
    • The 10-year Treasury Note falls to 0.40%
    • Oil prices fell 22%
  • March 12th – Total U.S. Cases passed 1,500
    • The S&P 500 fell 9.4% in a day, effectively shaving more than 27% off the index over 16 trading days
    • The NBA, NCAA, NHL, MLB, PGA suspend or cancel their seasons
  • March 15th – The Fed lowers the fed funds target rate effectively to 0%
  • March 16th – The S&P 500 falls 7% at open to again halt trading in U.S. equities
    • The Dow suffers its worst daily point drop in history, closing down nearly 3,000 points or 12.9%
  • March 17th – The Federal Reserve announces establishment of new initiatives:
    • Commercial Paper Funding Facility (CPFF) to help money markets
    • Primary Dealer Credit Facility (PDCF) to help banks and credit
    • Money Market Liquidity Facility (MMLF) to assist money market funds
  • March 18th – The IRS announces that tax filers can defer personal income taxes until July 15th
  • March 19th – California announces the U.S.’s first “stay at home order”
  • March 20th – Bond spreads widen to recent records over Treasuries
    • Investment-grade corporates nearly 4%
    • High yield bonds more than 10%
  • March 23rd – Federal Reserve begins to buy Treasury securities and agency mortgage-backed securities in “whatever amount is needed to support market functions.”  Also, the Fed expands money market purchases to municipal bonds
  • March 23rd – The S&P 500 index hits lowest point. Peak-to-trough losses(1):
    • S&P 500 fell 34%
    • Small caps (S&P 600) fell 41%
    • High yield corporate bonds fell 22%
    • REITs fell 41%
    • Municipal bonds fell 9%
  • March 25th – The Dow rises 2,113 points or 11.4%
  • March 27th – CARES Act is passed, and the government starts sending checks to taxpayers
  • March 30th – For the month of March, the S&P 500’s average daily swing was 5.3%
    • The prior record for any month was November 1929 of 3.9%
  • April 2nd – Covid-19 cases top a million worldwide
  • April 3rd – The SBA announces “Paycheck Protection Program” loans to businesses
    • The SBA processes 14 years’ worth of loans in 14 days to 1.66 million small businesses
  • April 8th – The S&P 500 index has a 12-day streak of 1% moves up or down
  • April 9th – Federal Reserve to provide up to $2.3 Trillion of loans to support the economy as well as purchase high yield bonds and other low rated debt
  • April 20th – Crude oil prices turn negative as producers paid buyers to take the commodity off their hands as fears that storage capacity could run out in May
  • April 22nd – AAII publishes investor sentiment survey that shows the lowest levels of the year
  • April 29th – Real GDP falls 4.8% in the first quarter of 2020
  • April 30th – The S&P 500 rises 12.7% for the month of April
    • This is the best April for stocks since 1938
  • May 8th – BLS reports payrolls fell by 20.5 million and the unemployment rate rose to 14.7%
  • May 11th – Federal Reserve announces the Secondary Market Corporate Credit Facility will begin the purchase of exchange-traded funds
  • May 18th – Moderna reports positive results from its vaccine candidate in human trials
  • May 20th – CDC provides guidance as states begin to reopen
  • May 21st – Covid-19 cases eclipse 5 million worldwide
  • May 26th – NYSE reopens the trading floor
  • June 5th – BLS reports 2.5 million of job gains in May and a decline in the unemployment rate to 13.3%
  • June 8th – The National Bureau of Economic Research declared a recession began in February of 2020, ending the 128th month of expansion, the longest in the history of U.S. business cycles
    • The S&P 500 turns positive on the year after losing nearly 34% during the 21 trading days between February 20th and March 23rd
  • June 30th – The S&P 500 moves higher by 18.7% in the second quarter ended 6/30/2020
    • This is the best quarterly return for the market since December of 1998
  • July 21st – European Union leaders pass $857 billion stimulus package
  • July 28th – Gold rises to a level not seen since 2011, up 27% for the year
  • August 8th – The unemployment rate falls to 10.2% in July from 14.7% in April
  • August 27th – Fed Chairman Jerome Powell announced policy shift toward “average inflation targeting” to maintain maximum employment and price stability
  • September 23rd – The S&P 500 closed lower, falling 9.6% for the month of September
  • September 30th – Global equity markets experience first down month since March
  • October – Global Covid-19 infections rise dramatically
  • October 29th – U.S. GDP Booms at 33.1% annualized increase for the quarter but still down in raw percentage 9% from the level in Q3 2019
  • October 31st – The S&P 500 has its second consecutive negative month, falling 2.7%
  • November 8th – The U.S. surpassed 10 million infections
  • November 9th – The S&P 500 gains 7.3% week after the election
  • November 10th – Unemployment for October falls to 6.9%
  • December 11th – The FDA approves the first vaccine for emergency use from Pfizer
  • December 24th – 30-year mortgage rates fall to a low of 2.66% according to Freddie Mac
  • December 31st – The S&P 500 rises 12.2% for the fourth quarter of 2020
    • S&P 500 rises 16.2% on the year
    • 10-Year Treasury Note ends the year at 0.91%

It’s a long list, and there are valid arguments for adding a dozen or more events. While an army of forecasters offered their predictions for what 2020 would bring, it’s unlikely anyone anticipated anything near the above timeline. So, it is oftentimes better to reflect than try to guess what will happen in the future. However, this certainly won’t stop them from trying again in 2021!

1. Source: Morningstar Direct. Peak-to-trough return calculated as the period between 2/20/20 and 3/23/2020. Asset classes were represented by the following ETFs: S&P 500 (VOO), S&P 600 (IJR), high-yield bonds (HYG), REITs (VNQ), municipals (MUB)

WEEK IN REVIEW

  • According to a report by the Wall Street Journal,  Saudi Arabia and Russia reached an agreement this morning that would maintain reduced oil production levels until March. Last year, OPEC and nearly a dozen other oil producers led by Russia, agreed to cut production to support prices as the pandemic response crushed oil demand. The initial reduction amounted to about 9.7 million barrels a day, roughly a quarter of which has already been restored. West Texas Intermediate (WTI), the US benchmark for oil prices, rallied nearly 5% on the news and briefly touched $50/barrel for the first time since last February. The group, referred to as OPEC-plus, decided to pause the production increase due to fears about more lockdowns and the slow rollout of Covid Vaccines.
  • The Institute for Supply Management (ISM) published its December Index of Manufacturing Activity, which showed an increase to a two-year high of 60.7 from last month’s 57.5 (anything over 50 signals expansion). Prior to Covid, the services sector was doing better than the manufacturing sector, but that has since reversed as a result of social distancing and government restrictions.
  • It’s a big week for economic data. Later this week, look for the minutes from the last FOMC meeting, an update on services sector activity, and jobless claims. Headlining the week of data releases will be the jobs report published on Friday.

ECONOMIC CALENDAR

Source: MarketWatch

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

HOT READS

Markets

  • Why the Fed’s Inflation Push Could Turn From Friend to Foe For the Market This Year (CNBC)
  • China’s Economic Data: A Guide for the Dazed and Confused (WSJ)
  • Home Prices are Rising Faster in the Middle of the U.S. as Covid Drives People Away from Coasts (CNBC)

Investing

Other

  • German Automakers Are Charged Up and Ready to Take on Tesla (NYT)
  • A monster Wind Turbine is Upending an Industry (NYT)
  • Bowl Season Dropouts’ Economic Worries Trump Pandemic Concerns (Sportico)

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ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + CHIEF INVESTMENT OFFICER

Josh Jenkins is the Chief Investment Officer at Lutz Financial. With 10+ years of relevant experience, he specializes in assisting clients with portfolio construction, asset allocation, and investment risk management. In addition, he is responsible for portfolio trading, investment research and thought leadership for the division. He lives in Omaha, NE, with his wife Kirsten.

AREAS OF FOCUS
  • Asset Allocation
  • Portfolio Management
  • Research & Data Analytics
  • Trading System Operation & Execution
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst®
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

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bitcoin back in the spotlight + Financial market Update + 12.29.20

bitcoin back in the spotlight + Financial market Update + 12.29.20

FINANCIAL MARKET UPDATE 12.29.2020

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

BITCOIN BACK IN THE SPOTLIGHT

Over the last few months, Bitcoin has recaptured the imagination of investors. While risk assets, in general, have had a strong quarter, Bitcoin has been on another level entirely. Since the start of October, the price of the popular cryptocurrency has increased 154%. In the last two weeks alone, the price has increased by nearly $10,000, rocketing to a new all-time high. The previous peak, achieved in December of 2017, came courtesy of a similarly explosive rally. In the twelve months that followed, Bitcoin experienced a devastating selloff that reduced its value by 83%(1).

The recent rally has been propelled by several factors. There has been increased institutional backing for Bitcoin. Prominent Hedge Fund managers, including Stanley Druckenmiller and Paul Tudor Jones, have publicly indicated they have made purchases. A few corporations, including software company MicroStrategy and insurance giant MassMutual, have also made headlines after announcing they purchased Bitcoin into their corporate treasuries. Finally, fintech companies have made it considerably easier to purchase Bitcoin. Popular services, including those operated by PayPal, Square, and Robinhood, allow individuals to make a purchase with a few quick taps of their smartphone.

Another factor that has likely supported the rise in Bitcoin has been inflation. Global central banks have aggressively eased monetary policy in response to the pandemic induced economic slowdown. This has generated fears that a sharp rise in inflation will degrade the purchasing power of the US Dollar and other major currencies. The code that underpins Bitcoin, meanwhile, caps its total supply at 21 million. This feature is a cornerstone of the belief that Bitcoin offers a strong hedge against inflation, but more on that later.

Unsurprisingly, the soaring value of cryptocurrencies has once again piqued the interest of many individual investors. In order to assess whether Bitcoin is suitable as an investment, it would be informative to compare it to other traditional investments. In a paper published just days before the 2017 Bitcoin peak, Dimensional Fund Advisors (DFA) went through such an exercise(2). The excerpt below summarizes the comparison:

When a company issues stock, it offers investors a residual claim on its future profits. When a company issues a bond, it offers investors a promised stream of future cash flows, including the repayment of principal when the bond matures. The price of a stock or bond reflects the return investors demand to exchange their cash today for an uncertain but greater amount of expected cash in the future. One important role these securities play in a portfolio is to provide positive expected returns by allowing investors to share in the future profits earned by corporations globally. By investing in stocks and bonds today, you expect to grow your wealth and enable greater consumption tomorrow.    

Holding cash does not provide an expected stream of future cash flow. One US dollar in your wallet today does not entitle you to more dollars in the future. The same logic applies to holding other fiat currencies — and holding Bitcoins in a digital wallet.

The fact that stocks and bonds generally produce a positive cash flow is the critical differentiator. Similar to gold, Beanie Babies, and tulips, Bitcoin does not generate any cash flow. The entire investment thesis for Bitcoin revolves around the belief (hope) that someone will be willing to pay you more than your initial purchase price on some date in the future. Unfortunately, an investment strategy based on hope is merely speculation. This simple but powerful reason for avoiding cryptocurrencies will likely not be heeded by everyone. The allure of a potential rapid increase in wealth can elicit emotions that are difficult to suppress.

If you are determined to purchase Bitcoin, there are a few additional things you should consider:

  • Determine an appropriate position size. A widely accepted practice for doing this is to hold assets in proportion to their total market value. This idea is the basis for popular market cap indices, including the S&P 500. The total market value of Bitcoin is about $493 billion(3), compared to the global stock market value of $95 trillion(4) and the global bond market value of $106 trillion(4). This would suggest an appropriate position size for Bitcoin of no more than 0.25% of an investor’s portfolio.
  • The idea that bitcoin has a finite supply is a common thesis for its use as a hedge against inflation. This logic fails to consider that Bitcoin is just one among thousands of different cryptocurrencies, the supply of which is essentially limitless. Additionally, the US has not experienced high inflation since the creation of Bitcoin, so the jury is still out. Also, there are some studies that question whether Bitcoin will prove an effective hedge(5).
  • There is risk associated with Bitcoin storage. Some estimates suggest that as much as 4 million Bitcoin have been permanently lost due to broken computers, lost private keys, or otherwise inaccessible wallets(6).
  • There is risk of regulation. While no one entity controls Bitcoin or the underlying blockchain, the government has power over many of the gatekeepers that are helping to make it mainstream. This includes the exchanges and other apps like PayPal, Robinhood, and Cash App.
  • Transacting in Bitcoin can be accompanied by high fees, wide spreads, and potential tax consequences. In 2014, the IRS issued IRS Notice 2014-21, which established “virtual currencies” as property for Federal income tax purposes. Among other things, this means that sellers of Bitcoin must recognize a capital gain or loss on the sale.  

After spending a few years in relative obscurity (an 83% loss of value will do that to you), Bitcoin’s blistering rally has it once again dominating the headlines. Our view is that there is no basis for an expected return because Bitcoin does not produce any cashflows. The ability to make money rests solely on the hope that another buyer will come along and be willing to pay a higher price in the future. While this is certainly possible, this represents a gamble rather than an investment.

1.. Source: Koyfin. Bitcoin price and return data represented by BTCUSD.

2. “To Bit or Not to Bit: What Should Investors Make of Bitcoin Mania?” Dimensional Fund Advisors, 14 Dec. 2017, https://www.mydimensional.com/to-bit-or-not-to-bit

3. Source: Coinmarketcap.com

4. Source: SIFMA Capital Markets Factbook 2020

5. Erb, Claude B., Bitcoin is Exactly Like Gold Except When it Isn’t (December 14, 2020). Available at SSRN:  https://ssrn.com/abstract=

6. Source: Chainalysis

WEEK IN REVIEW

  • It has been an excellent quarter for the equity markets, with major US stock indices at or near record highs as of the close on Monday. There are only three more trading days left in 2020 including today, although the market is down slightly as of this writing.
  • President Trump signed the Pandemic Relief Bill on Sunday, which will provide $900 billion of aid and fund the government through September. The House subsequently passed a bill that would increase the stimulus checks for individuals from $600 to $2,000 on Monday. On Tuesday an attempt in the Senate to call a vote on an increase to the stimulus amount was blocked.  
  • The final week of the year is light in terms of economic data releases. This morning the S&P Case-Shiller Home Price Index showed the fastest rate of home price appreciation in six years. Tomorrow we will get an update on pending home sales. On Thursday, look for an update on jobless claims. The market will be closed on Friday for New Year’s Day, and there will be no economic data published that day.

HOT READS

Markets

  • U.S. Home Prices Rise at Fastest Pace in More than 6 Years (CNBC)
  • How the 2020 QE Boom Might Trip Up Central Bankers (WSJ)
  • Pandemic Reshapes U.S. Employment, Speeding Changes Across Industries (WSJ)

Investing

Other

  • The Best Books I read in 2020 (Ben Carlson)
  • You Got a New iPhone 12 For The Holidays – Here Are The First Things You Should Do (CNBC)

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

ECONOMIC CALENDAR

Source: MarketWatch

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ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + CHIEF INVESTMENT OFFICER

Josh Jenkins is the Chief Investment Officer at Lutz Financial. With 10+ years of relevant experience, he specializes in assisting clients with portfolio construction, asset allocation, and investment risk management. In addition, he is responsible for portfolio trading, investment research and thought leadership for the division. He lives in Omaha, NE, with his wife Kirsten.

AREAS OF FOCUS
  • Asset Allocation
  • Portfolio Management
  • Research & Data Analytics
  • Trading System Operation & Execution
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst®
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

FORM CRS RELATIONSHIP SUMMARY

My Values or My Investments… Why Not Both? Implementing ESG

My Values or My Investments… Why Not Both? Implementing ESG

 

LUTZ BUSINESS INSIGHTS

 

MY VALUES OR MY INVESTMENTS… WHY NOT BOTH? IMPLEMENTING ESG

my values or my investments… why not both? implementing esg

joe carlson, financial planner

 

Most investors are familiar with the terms ESG, socially responsible, and sustainable investing. However, these investment philosophies can mean very different things to different investors. Over the past ten years, investors have flocked toward responsible investing. ESG has blazed a new path into the mainstream investment community. Whether it’s institutional investors or individual investors, assets have steadily moved into ESG funds.

In fact, nearly one in four dollars under professional management in the U.S. are currently in ESG oriented investments. 2020 marks the year that ESG related funds have reached $1 trillion in assets[1]. The recent surge of investors to the ESG landscape has attracted many players to specialize in this field. This has led to an abundance of data that requires particular expertise to filter through and apply to focused strategies.

At Lutz Financial, we partner with Dimensional Fund Advisors (DFA) to offer ESG investment solutions to our clients. We have written about the different options we can provide to implement an ESG strategy in your portfolio (here). This blog aims to further break down ESG investing and help you understand the different ways it can be implemented into a portfolio.

 

Understanding ESG

ESG stands for Environmental, Social, and Governance. People have come to realize that these factors aren’t just about improving the world, but they can also help manage risk within portfolios. It is safe to assume that the Environmental and Social aspects are more commonly known throughout the industry. DFA tailors to investors whose values align specifically with sustainable or social investing by offering exclusive options for both. I will touch more on these later.

However, ESG is also broadly implemented throughout all of their equity and fixed income strategies. Many wonder if ESG is a standalone factor that leads to higher expected returns, similar to commonly known factors like small capitalization and value companies. Extensive research has not found a reliable relationship between higher expected returns and ESG factors, like emissions intensity, for example.

Our belief is that material information, financial or non-financial, is priced into the market by investors. ESG does encompass material aspects about companies, and therefore allows the market to incorporate this information into prices quickly. Even though ESG factors may be priced into the market, there are still ways to use it to add value to portfolios.

 

Broadly Integrating ESG

DFA broadly implements ESG in all their portfolios through risk management. This is where the governance aspect of ESG comes into play. Risk can be managed by looking at elements of governance to prevent investors from situations where owning a particular stock may not be beneficial. One example of this is excluding companies that are closely held. These are companies that have a large percentage of their outstanding stock owned by insiders. This can put investors in a situation where insiders can take advantage of minority shareholders.

Another example is monitoring companies that are listed on exchanges. To be listed on an exchange, companies have to meet specific requirements. Companies must be listed on approved exchanges to be considered for ownership.

The third example is running daily news checks. These news checks look for companies that are involved in controversies, whether it involves ESG or not. This may be a reason to put a halt on buying any more of a company’s stock.

Governance has a direct impact on a company’s valuation and expected return. Companies with a track record of poor governance & oversight practices tend to be considered riskier by investors. To combat this, DFA looks to engage with companies to help manage risks with the goal of improving future returns. They have largely expanded their stewardship and proxy voting methods to reach as many companies as possible in an efficient manner.

 

Sustainable and Social Investing

At Lutz Financial, we recognize some clients have specific ESG goals, and we offer solutions that can accommodate them. From an environmental standpoint, we can construct portfolios using DFA sustainability funds that pursue lower exposure to companies with high greenhouse gas emissions or potential emissions from fossil fuel reserves, companies involved in toxic spills or factory farming, in addition to other factors important to investors. On the other hand, the DFA social funds seek to exclude individual companies involved in controversial activities, like abortion, gambling, adult entertainment, etc.

We believe that the choice to adopt a value-driven approach should not have to come at the expense of sound investment principles. The common misconception is that you must give up some return to pursue responsible investing. By integrating sustainability and social considerations with an investment solution that focuses on broad diversification and tilting towards sources of higher returns, that does not necessarily have to be the case.

Many investors around the world are increasingly aware of the effect that harmful business practices can have on the world. As a result, the ESG investment landscape has become dynamic and will continue to innovate. It is important to understand all of the ways it can be implemented in an investment strategy.

Investors are prone to flocking to “the next big thing” regarding investment trends. However, ESG isn’t just a popular trend that is currently hot. Its sheer size and asset growth rates tell us that it is a sustainable trend. If you would like to learn more about how we can incorporate it into your plan, please reach out to your advisor or contact us

 

[1] US SIF. (2018). Report on US Sustainable, Responsible and Impact Investing Trends 2018. https://www.ussif.org/trends.

ABOUT THE AUTHOR

402.778.7976

jcarlson@lutz.us

LINKEDIN

JOE CARLSON + FINANCIAL PLANNER

 Joe Carlson is a Financial Planner at Lutz Financial. With 1+ years of relevant experience, he specializes in collaborating with advisers to provide detailed financial planning solutions and wealth management services for high net-worth individuals, families and businesses. In addition, he works closely with the Sr. Portfolio Manager to monitor client portfolios and implement trade requests. He lives in Omaha, NE.

AREAS OF FOCUS
  • Comprehensive Financial Planning
  • Client Relationship & Account Management
  • Trading Support
AFFILIATIONS AND CREDENTIALS
  • Financial Planning Association, Member
  • Bloomberg Certified
EDUCATIONAL BACKGROUND
  • BSBA in Finance, University of Nebraska, Lincoln, NE

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