Fourth Quarter 2023 – The fourth quarter of 2023 had spectacular results, albeit a catch-up quarter which accelerated the annual gains. Equities, real estate, and bonds had outsized returns. The blended portfolio model (DGSIX) is 60% equities/40% bonds. The annual return was 14.53% and the three-year 4.56%. The ‘ultra-conservative’ 25/75 model (DGTSX) had 8.9% one-year returns and 1.88% for the three-year period. The 60/40 blend outperformed the 25/75 for all periods.
Statistics are from Morningstar Advisor Workstation which are considered reliable.
While the closing quarter and the 2023-year performance were impressive, looking at the three-year annual performance is significant. It emphasizes taking a long-term approach, and equities are important to add to portfolios as part of the allocation. The ultra-conservative portfolio model (DGTSX) did not keep pace with inflation with a 1.88% annual return for the three-year period.
Returns will vary from the models due to the mix of investments. Our portfolios tend to make a smaller allocation to international investments, and don’t include a comprehensive commodities investment. We add utilities and health care above the market weight which tend to be more stable and exceed the pace of inflation over the long-term. Preferred stocks have been added to the interest and dividend allocation and have provided some capital gain opportunities as shown below. Bonds had attractive yields this year and individual bonds were added to larger portfolios.
Utilities and Health Care – Utilities (VPU) and Health Care (VHT) are core components in most of your portfolios. Total returns are as follows:
These are considered defensive positions, less prone to volatility, and highly likely for returns better than inflation. Utilities are also considered a dividend proxy. The poor returns for 2023 affected portfolio performance, but will remain core positions for the long term.
Preferred Stocks – Many of your portfolios have individual investment grade preferred stocks added to your interest and dividend allocation. Below are some frequently added preferred stocks.
The securities are purchased based upon investment grade, yield and yield to call. Preferred stocks do not generally have a maturity date. Most preferred stocks are called on their call date giving you a long-term gain opportunity. If BAC-Q for example is called on 11/1/2026, you get $25 for each share of stock, for a capital gain of $6.48 per share ($25 par - $18.52). If held for a year or more, this is a long-term capital gain. Any capital losses can be offset against this gain.
If the preferred stock is not called, you continue to receive the yield based upon your purchase date. For a 12/29/23 purchase of BAC-Q, your dividend yield would continue to be 5.46%. The dividends on these preferred stocks are subject to capital gains rates. Interest on bonds by contrast is subject to your regular tax rates.
Capital Loss Harvesting – For your taxable brokerage portfolios, we regularly go through and sell some securities to create capital losses. Capital losses can offset capital gains with a ($3,000) annual limit to offset against your other income.
Here is how it works. To keep you invested, as a simple example, a sale of KO, (Coke) at a loss, can be offset with a purchase of PEP (Pepsi). After 31 days, the KO can be repurchased. In the case of preferred stocks, BAC-Q can be sold and WFC-A can be purchased. The risk for the shares are identical, and a capital loss can be harvested. Capital losses can be carried over indefinitely and can also be used to offset gains on other investments like real estate or business sales.
With mutual funds or stocks with dividends reinvested, some shares will be trading at a loss. Stocks like AMZN, for example, may be purchased on different dates. We use our performance software to list those shares at a loss and identify them as the shares being sold. The goal is to keep you invested in similar securities, and harvest the losses to offset against capital gains.
Mutual funds, for example, have annual capital gains dividends which are paid on shares. Capital losses can be used to offset these capital gains dividends. Research from Barron’s and other sources shows that using the loss harvesting technique can increase annual returns between .8% and 1.5%.
Interest rates – The general consensus is the Fed is done raising interest rates and will begin cutting interest rates in 2024, likely .25% at a time.
Mortgages – 30-year mortgage rates continue at 7%, twice the 2.96% rate in 2021. New home buyers purchase based upon monthly payment. The 4% differential on a $300k loan is an increase of $1,000 per month. The housing market has limited all-cash buyers. Those with 3.0% loans on their homes are reluctant to move and take on a 7% mortgage in a new home.
Other interest rates – Interest rates for most of you have surged upward. Bank line of credit loans and equipment loans have increased. Credit cards, auto, and RV loans are higher.
Labor – Unemployment continues at a low 3.7%, and the labor participation rate is 63%, lower than prior years due to the aging US population and long term Covid affects. The ‘cure’ to these trends will be immigration of young, productive people looking for the opportunity to become citizens.
EV’s – Electric vehicle sales have reached a stalling point. A major factor is prospective inconvenience. As commercial vehicles for local travel and individuals commuting to jobs, electric vehicles work well recharging at home base every night. (Like golf carts for the last fifty years!)
For a trip, getting recharged poses concerns, like where to get recharged at a convenient time and place. Waiting in line at a recharging station is not like a gas station stop, and there are not always charging stations in “middle of nowhere” areas.
Batteries do not work as well in cold temperatures, and older drivers dread getting stuck without power. Hybrid vehicles are increasing in popularity, using a combination of gasoline and battery power. As an investment, EV auto companies and vendors present a challenge.
Richly valued markets at year end – The market is richly valued at year end, powered to the finish by large technology companies. A couple of readings showed 70% of the market performed below the S&P 500 for 2023, so not a ‘rising tide lifts all boats’ market. The gains for 2024 may be muted. A lot is riding on artificial intelligence. This seems to be a continuation of internet growth and companies like GOOGL.
As always, the future of the market is unknown and unknowable. The best strategy continues to be a broadly diversified portfolio across many different asset classes. DFA, Vanguard, and Pimco institutional investments will continue as the core of your portfolios.