Beyond California: States in Fiscal Peril

The Pew Center on the States recently released a report entitled “Beyond California: States in Fiscal Peril”. The report examined the impact of the recession on the finances of the states, highlighting nine other states facing similar stresses to California. This report received
widespread press coverage, including both the Inquirer and the Wall St Journal. Below are brief comments regarding several states where we have client concentrations.

The full report can be found at http://www.pewcenteronthestates.org/

Pennsylvania: We have previously distributed positive comments regarding PA’s relative position among the states. It is gratifying to see the Pew Center list PA among the 10 states “least like California”. PA’s revenue decline of only 5.5% is well below the national average of 11.7%. The budget deficit of 18% of the general fund is close to the national average of 17.7%. The increase in unemployment has been 3%, compared to the average of 4.4%. PA was particularly cited for having established and funded its rainy day funds. Several states had set up such funds but never really deposited any money into them.

Maryland: MD’s revenue decline of only 1.2% was among the smallest drop of any state. Despite that, its budget gap is 18.7%, above both PA and the average. Similarly to PA, its real estate market had neither run up nor collapsed as much as the national averages. General financial management and employment levels are also above average. MD scored just outside the 10 best states.

Delaware: DE also had a modest drop in revenues of only 3%, well better than average. Its budget gap at 17.6% was close to the national average. The 3.6% increase in unemployment was better than the national average but worse than its regional peers. The financial management was scored very high. DE’s overall score was slightly behind MD.

New Jersey: NJ scored as one of the 10 worst states, most like California. Pressured by several factors, its revenue declined 15.8%, well above the average. The budget gap at 29.9% was among the worst. The 3.7% increase in unemployment was not as bad as the average. However, only 2 states scored worse than NJ regarding financial management and practices. We continue to believe that NJ residents should diversify some of their municipal holdings outside the state in order to lessen risk.

Virginia: VA scored very highly regarding its financial practices. Unemployment has only risen 3.2%, well better than average. The budget gap of only 10.9% also reflects well. A revenue decline of 19% is probably the only reason VA scores just outside the 10 best states and even with MD’s score.

Florida: FL’s ranking among the 10 states most affected by the recession should not be a surprise as its real estate difficulties have been well documented. The foreclosure rate of 2.72% is effectively twice the national average of 1.37%. The revenue drop of 11.5% is better than might have been expected. The unemployment increase of 4.4% is at the national average. The state has mixed scores on political and financial management issues. FL does not have a state income tax, so client portfolios are national portfolios, already diversified outside the state.

Ohio: Perhaps surprisingly, OH fares better than many of its Midwestern neighbors. Unemployment has increased at the national average of 4.4%. Despite that, revenues fell a less than average 9%. The budget gap is a better than average 12.3%. OH also scores well regarding financial practices. Its overall score is equal to DE.

Top 10 Investing Mistakes

Once you've made it... Mistakes can still take it!

We all know the formula for investment success is to invest early, invest often and invest broadly. These are the core principles of achieving wealth through saving and investing. Do this diligently over an entire working career and you are virtually assured of a lifetime of financial security. But, for those who have already done this, or who for any other reason find themselves responsible for a substantial sum of money, the rules are a little different. The focus must change from accumulating assets to protecting wealth and preserving purchasing power. And, the mentality of the investor must change. Investing “right” still matters, but the greater concern must be not investing “wrong.” At this stage, mistakes can be lethal to your financial security, largely because the time needed for recovery from any setbacks is limited.

So, what are the most common miscues investors make in this wealth preservation stage?

1. Maintaining insufficient liquidity
This is the big one. You must never have to sell an investment to raise needed spending money. All spending should come from stable value investments and accounts – like short-term fixed income securities and checking, savings, or money market accounts. You want to sell investments (stocks, bonds, real estate, commodities, etc.) to fund the stable accounts only when the investments are trading at favorable prices. Second best (and more practical for most of us) is to liquidate investments only on a regular, periodic basis – the opposite of dollar cost averaging in. Neither approach can be achieved if your checking account is empty and bills are due.

2. Ignoring inflation
The end of the accumulation phase of an investment program is not the end of the investment program. Tempting as it may be to seek the “safety” of stable investments with all of your investment dollars, this safety comes only at the expense of significant risk to your purchasing power. If your future spending needs extend five or more years into the future, it is simply not prudent to expect to fund those future needs with current dollars. This is especially true with today’s rampant Federal spending, which almost assures significant inflation in the years ahead.

3. Forgetting your legacy
Investors with the good fortune to have assets well in excess of their personal or immediate family needs may be able to ignore inflation. They have virtually no risk of running out of money. But, based on our many years of experience working with such people, even those who start out with a strong preservation focus often begin to see their role not as owner, but as temporary custodian of their assets. They come to realize that they have the ability to favorably influence the lives of others, now and well beyond the end of their own lives. This sometimes encourages immediate gifting and donations. Or, it may introduce a much longer investment time horizon within their own portfolio, which warrants a much different investment approach with that portion of their net worth that exceeds their personal lifetime financial needs.

4. Carelessly selecting an advisor
The Bernard Madoff scandal provides a vivid warning to all investors not to pick their advisor based on image, reputation, or social standing. Some homework is required. Visit the CoreStates website at www.corestates.us and see our “Qualifications of a Financial Advisor” and “Commitment to Fiduciary Responsibility” (both located under the “Learning” tab) for our list of the key criteria that every investor can and should look for before entrusting assets to any financial advisor.

5. Settling for hazy investment objectives
Risk tolerance, time horizon, return objectives – these are important concepts. But, they are only concepts. It is important for you and your advisor to have a clear, mutual understanding of your current and anticipated financial resources, expected additions to your investment account, expected needs to be funded from your investment account, and how much flexibility you have in how and when these needs are met. And then, keep your advisor updated. Only by discussing your particular situation in these very tangible terms can you maximize your chances of long-term financial security.

6. Pursuing investment fads and fashions
Besides their financial aspects, investments can serve a valuable recreational purpose. Investing can be fun and exciting, and can convey intellectual and emotional prestige. To capitalize on this, financial product marketers provide a constant flow of new investment ideas. Most are merely the old standards repackaged, but many are much more insidious, and some, as we just learned, are downright toxic. All investments differ in only two meaningful respects – the expected amount and timing of cash returns to be provided, and the certainty (or potential variability) of those future cash returns. If you don’t understand how these two variables compare to more straightforward investments like CDs, bonds, and stocks, don’t buy them. And, if you do understand the differences, make sure they add value. In most cases, they won’t.

7. Obsessing over the parts while ignoring the whole
An investment’s price really matters at only two times – when you buy it and when you sell it. If that investment is part of a well-constructed portfolio, your manager will have the discretion to buy it and sell it whenever the price is deemed to be favorable. And, a well diversified portfolio will at all times have some investments at favorable prices and some . . . not so much. That’s how portfolio diversification works. So, if you see some investments that currently “aren’t working,” they may signify only that the portfolio is effectively diversified, and is behaving exactly as it should.

8. Confusing a Net Worth Statement with Cash Flow Analysis
While the net worth statement is a great way of assessing your financial well being, it captures only a single frame of your financial picture at one point in time.
Unlike your net worth statement, the cash flow analysis tracks your income/expense ratios over an extended period of time. That is like comparing the features of a picture camera and video camera.
For an individual investor, no diagnostic approach is more important than the Cash Flow Analysis. Not only will you become acutely aware of how expenses, taxes and inflation affect your lifestyle, you and your advisor will also have the proper basis for making investment decisions.
And because you are recording all your transactions, coming in or going out, this makes your cash flow analysis dynamic, allowing you to review your financial decisions from time to time.
There are many approaches to control expenses and spending habits. But the critical starting point is to generate and maintain your own Cash Flow Analysis.

9. Losing faith in your investment program
Investors must play a continuous game of emotional “chicken” with the market. Don’t let it scare you to the sidelines, or hype you into a high-risk investment position. A sound investment program will respond to the market cycles in a prudent way at the manager/investment selection level. Major revamping of the overall portfolio in response to market swings is almost always detrimental to your long-term wealth. It may help to remind your self that, by definition, the market is at its low when investor fear is greatest, and at its high when enthusiasm peaks. Acting on your emotions will almost guarantee buying high and selling low.

10. Forgetting that wealth is the means, not the end
In a capitalist economy and a culture focused on continually improving living standards, money becomes a measure of success. But, that’s not all it is. It is also a means to less tangible ends. It can support favored causes, facilitate desired change, and promote higher principles. It can allow you to accept the challenge of the great religious leader, Mahatma Gandhi: “You must be the change you want to see in the world.” Let it help you to be the person you want to be, in the country where you want to live, and in the world you want to leave to succeeding generations.

Take Off Your Blindfolds! It's NOT Pin the tail on the Donkey!

Never before in the post-war era have U. S. investors had to deal with a crippled financial system, such monumental depth and breadth of change, and a pervasive uncertainty about the future. And, never in any modern era have we had to do so while also experiencing the waning of our nation’s global economic power, international prestige, and internal potential for future growth.

Even more importantly, never before have U. S. investors had to deal with the kind of investment markets produced by this new economic environment – investment markets that lack the underpinnings of a consistently growing and increasingly productive economic base. In this previously unknown environment, most investors will be essentially investing blind.


The reasons behind the gradual dissipation of the foundational substance of our nation and economy are many, varied, and controversial. So, I will leave the explanations and evaluations of the causes (e. g., the opinions) to the political pundits and economic editorialists.

The more important issue is this: What can investors do to protect their lifestyles and preserve their economic legacies in this extremely hostile financial environment?

At CoreStates Capital Advisors, we have been pondering this question since well before the severe market erosion began. Our approaches will continue to develop and evolve, of course, but the following are some of the key concepts, strategies and tactics we have been implementing for our clients in our pursuit of investment success in this new environment.

21st Century Diversification
The four-cylinder portfolios (stocks, bonds real estate and cash) of the 1980s gave way to the eight cylinders (adding energy, precious metals, commodities and currencies) of the 1990s, but success in the 21st century will require all of this, plus the ability to be long or short in each category, and with manager discretion within each of the categories to move among style boxes, or even to abandon the style box concept for a more opportunistic approach.

Emphasis on Liquidity
An investment’s returns become “real” only when the investment is sold. Until then, they are only on paper. But, when sold, the return is locked in. So, it is critically important never to be forced to sell an investment, especially a highly priced volatile investment, at an inopportune time. The only way to achieve this is by maintaining enough liquidity in price-stable form or in truly uncorrelated assets to meet any scheduled or unscheduled cash needs.

Dynamic Allocations
The days of fixed allocations . . . never really existed. Going forward, dynamic allocations will become even more important as most markets see their historically upward bias diminish or even reverse, making all markets into trading markets and generously rewarding those investors able to capitalize on their inherently higher volatility.

End of Indexing
The days of buy-and-hold investing are also over. Active security selection will be more important than ever as increasing global competition as well as the mounting geopolitical challenges make the generation of corporate earnings increasingly difficult. In a flat-to-declining overall economy, “par” corporate performance will be insufficient to provide attractive returns to shareholders or even to maintain long-term credit quality. We must invest accordingly.

Focus on quality and valuation
The easy investment approach for the coming years will be to focus on quality . . . and settle for near-zero nominal returns in a potentially high-inflation environment. True growth of purchasing power will be achieved only by correctly evaluating investment quality and being willing to trade among quality levels based on their current relative valuations.

Polar Portfolio Positioning
Implement all of the above points and you are likely to find yourself with a “polar” portfolio – one consisting primarily of some very high quality, liquid assets and some very cheap, but rather speculative, exposures. Middling opportunities are likely to provide piddling returns as most investors seek to improve on low risk, low return investments by edging up the risk spectrum, thereby bidding up prices and diminishing their returns.

Importance of Judgment
Investing driven by historically based, “black box” models becomes less and less effective as the future becomes less and less like the past. The sea change in our worldwide investment landscape is rendering not only past models ineffective, but weakens the very concept of historically based investment models. The next generation of quantitative market analysis will require a higher level of investor behavior-based sophistication, as well as a very influential overlay of superior investment judgment.

Commitment to Patience
A more volatile, changeable market demands a more resolute, patient investor. Returns are certain to be erratic. Extreme market moves will be more common. Directionless markets will become the norm. Periods of steady, positive returns will be extremely rare.

We at CoreStates have no legacy investment styles that we must maintain. Our product is building client portfolios in whatever way we believe will be most effective in the years ahead. This gives us the freedom to truly serve our clients’ needs as those needs, and the market’s nature, change over time.

To us, this is the only way to do business.