October, 2013
By Darren Nyce, CFA
Senior Research Analyst, Castle Investment Advisors®, LLC

As the summer of 2013 fades into history and fall begins, it ushers with it a return to school, apple picking, football season, breaking out sweatshirts, pumpkin flavored everything and this year we also get the shutdown of the U.S. government. As politicians try to navigate through this quagmire, many investors are wondering what actions they should be taking in this current environment.

I’m not much of a soccer guy, but I do find the penalty kick aspect of the game intriguing. Because of the speed of the ball, goalkeepers (at least at the highest levels of competition) must try to predict which direction the kick will come and they almost always commit to jumping to the left or right before the ball is struck; but should they? A few years ago, a researcher at Ben-Gurion University in Israel performed a study that indicated if professional goalkeepers would remain stationary in the center of the goal, they would increase their chances of stopping a penalty kick from about 13% to 33%. Sometimes the best action to take is to take no action.

But, we live in a culture that values action. I’m guessing that most goalkeepers would be more highly criticized for “doing nothing” than they are for trying something, even though that activity is less likely to be successful.

Investors often feel the same way; when the headlines stir up an emotional reaction, we feel the need to do something. But in a case like the government shutdown, in order for investors to profit from taking action, they would have to correctly predict what decisions the politicians will make as well as then correctly predict how the markets will react to those decisions and do both of those things with perfect timing.

We at Castle believe that successful long term investing involves maintaining diversified portfolios that consist of stocks, bonds, and other diversifying assets. As a result, in times like this we won’t push to make drastic changes to portfolios as long as the allocation continues to fit the client’s personal situation.

We will however make adjustments to allocation percentages as conditions warrant. Imagine the folly of a goalkeeper not moving to block a ball that is clearly kicked to his right. For instance, we have made adjustments to many accounts this year to help reduce interest rate sensitivity. When the stock market becomes cheaper, we will use that as an opportunity to increase equity exposure. These adjustments get made on longer term economic themes rather than volatile headlines.

Another aspect of portfolio construction that is important to us involves the area of fees and expenses. The expenses a client incurs to have their investment portfolio professionally managed come from 3 sources.

  • The management fee paid to the advisor
  • The transaction fees to buy and sell the investments
  • The expenses fund companies charge

At Castle, our management fees are based solely on the value of the accounts we manage and they remain below the industry average.

The custodian of our clients’ accounts, Charles Schwab sets the transaction fee schedule. Stock trades cost $8.95, while many mutual funds can be purchased without a transaction fee, some will cost $25. These rates are very competitive within the industry. Clients who elect to receive paper statements instead of the electronic version pay higher transaction costs, so we encourage all of our clients to sign up for e-delivery whenever possible.

Fund company expenses vary greatly depending on the type of investment strategy. These expenses are tricky because the investor doesn’t see the charges flow from the investment; they only see the after-fee return. To discover the expense ratio, one has to either read through the fine print of a prospectus, or look it up on a website (through the fund company or a third party provider).

The tendency is to lump all fund fees together and declare that since Fund XYZ has a higher expense ratio than Fund ABC, we should only use ABC. But just like someone who cleans your carpets will charge a different rate than someone who cleans your air ducts and someone else who cleans your chimney has a completely different rate altogether, differing investment strategies will also have different expenses. Just like the cheapest carpet cleaner may not be the one you want, the cheapest fund may not be the one you want either.

When we filter through funds, ETF’s, individual stocks and bonds to evaluate which funds to use in our client’s accounts we want the costs to be low, but more importantly we want the best combination of assets for each individual client. We will also look at things like, Risk Adjusted Returns over 3, 5, and 10 years, a fund’s performance ranking compared to others with a similar strategy, the ability to participate in up markets and protect in down markets, Sharp Ratios, Information Ratios, Manager Tenure, to name a few.

In some cases, a fund will be available in multiple share classes, one that requires a transaction fee and one that does not. This requires some additional evaluation as well, because funds that require a transaction fee usually come with a lower expense ratio (typically .2% - .3% lower) than funds that can be traded for “free.”

In most cases we intend to hold the fund for several years, so it often makes sense to pay the $25 transaction fee because we will save approximately $25 every year for every $10,000 invested. While for smaller amounts the no transaction fee version makes more sense.

It also makes sense, whenever the account size and the client’s profile permit, to include individual stocks and bonds which do not charge an ongoing fee. In areas where a manager’s specific expertise in an investment strategy is required, we will use a mutual fund. If we can get the exposure we are looking for in a lower cost vehicle such as an index fund or an ETF (Exchange Traded Fund), then we will utilize those tools. In an effort to gain a high level of diversification and reduced costs to our clients, the typical portfolio will include individual investments as well as funds. In all cases, we are cognizant of our fiduciary duty to always do what is in the best interest of the client.

Recapping the third quarter of 2013, here is a look at how the major indexes fared followed by a few other items that caught our attention:

Index 3rd Qtr
1 Year Return 3 Year
Annualized Return
5 Year
Annualized Return
S&P 500 5.2% 19.3% 16.3% 10%
Dow Jones Industrial Average 2.1% 15.6% 14.9% 9.9%
Nasdaq Composite 11.2% 22.8% 18.2% 13.8%
Russell 2000 – Smaller Companies 10.2% 30.1% 18.3% 11.2%
MSCI EAFE – International 11.6% 23.8% 8.5% 6.4%
Barclays US Aggregate Bond 0.6% -1.7% 2.9% 5.4%
  • In Q3 growth stocks outperformed value stocks
  • Materials and Industrials were the best performing sectors, while Telecom and Utilities were the worst
  • Profit margins remain near all time highs as profits are 10% of GDP – 50 year average is 6.3%
  • Most recent GDP reading shows a modest 2.5% growth – 20 year average is 2.6%
  • The most cyclical elements of the consumer economy, Vehicle Sales and Housing Starts, both continue to show improvement
  • Household debt as a percentage of personal income is 10.4% - down from 14% in Q3 2007
  • Unemployment rate drops to 7.3% but the Labor Force Participation rate also drops
    • For college grads unemployment is 3.5%, for high school grads with no college it is 7.6%
  • Average Hourly Earnings Growth is up 2.2%
  • Inflation stays tame at 1.8% - 50 year average is 4.1%
  • In the fixed income realm, High Yield bonds were the best performers, while Treasuries were the worst
  • The 10 year Treasury rate finished the quarter at 2.61% - in September 1981 it was 15.84%
  • The average 10 year municipal bond is currently yielding 108% of a U.S. Treasury bond
  • The U.S. Dollar has appreciated 26.1% vs. the Japanese yen in the past year while depreciating 5.2% vs. the Euro

On behalf of all of us at Castle, thank you for your confidence in us and what we do. Have a great fall! For some additional reading if you are interested, PIMCO just put out a white paper on the importance of Staying the Course: https://investments.pimco.com/MarketingPrograms/External%20Documents/PIMCO_Stay_ the_Course_PT024.pdf

The Castle Investment Advisors®, LLC Investment Team

Tax, legal, and estate planning advice contained in this article is general in nature. Always consult an attorney or tax professional regarding your specific legal or tax situation.
This article was prepared for informational purposes only and does not constitute an offer to buy or sell, or a solicitation of any offer to buy or sell the securities mentioned herein. Information presented does not involve the rendering of personalized investment advice, but is limited to the dissemination of general information regarding products and services. It should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. 
Any strategy discussed herein may not be suitable for all investors. Before implementing any strategy, investors should confer with their financial advisor. No current or prospective client should assume that the future performance of any specific investment, investment strategy or product made reference to directly or indirectly, will be profitable or equal to past performance levels.