Blogs > Your Money

Dave Patterson and Erin Preston, a father-daughter team of Certified Financial Planner® licensees, provide thoughts and suggestions on a broad collection of personal finance topics.  Information provided in this BLOG is intended to be of a general nature and may not be appropriate for all situations.  Readers should consult with their own financial advisors before relying on any information contained herein.

Thursday, May 12, 2011

Our Final Blog!

We regret to announce that we have decided to discontinue our blogging activity with this final note. We would like to thank all of you who have spent time reading and commenting on our blogs and especially want to thank the Oakland Press for giving us the opportunity to share our thoughts and knowledge with its readers. We would especially like to thank Glenn Gilbert, Executive Editor of the Oakland Press and Rick Kessler, Good Life Editor, for their support.

It was a difficult decision to discontinue this effort. We have received a great deal of positive feedback during the nearly two years we have written well over two hundred articles covering all facets of personal finance. Writing two or three times a week is a bigger commitment than many might think and we have decided we can better serve our clients by focusing our efforts on other priorities.

We’d like to close with some investment advice we think best sums up the message we have been trying to get across these last two years:

(1)Diversify, diversify, diversify. Broad portfolio diversification will reduce risk and increase returns. It’s one of the best things you can do to improve your investment results.

(2)Higher returns mean higher risk – Don’t chase the latest hot investment you read about or hear about on TV. By the time you invest, it’s often too late.

(3)Find out how much you are paying – Make sure you understand exactly how your financial advisor is compensated. Find out what fees you’re paying for the various investments you own.

(4)Don’t forget Taxes – Pay attention to the tax efficiency of your portfolio and don’t let taxes get in the way of making the right changes to your portfolio.

(5)Establish a target portfolio - Determine the amount of risk you are comfortable with and allocate your assets across bond and stock assets accordingly. At least annually, review your allocation. Sell over-allocated asset classes and buy under-allocated asset classes. This forces you to do what is prudent and takes the emotion out of investing. It requires discipline, however.

(6)Focus on your spending – Determine what is most important to you and establish financial goals for your future. Then, align your spending with those goals and identify spending that doesn’t support what’s really important to you.

(7)Take advantage of employer retirement plans – Make sure you are contributing enough to take advantage of any employer match.

(8)Get professional help if you need it – Don’t be embarrassed to seek professional help if you’re unsure how to get your financial house in order. Yes, it will cost you money, but if you take care to select an advisor carefully, professional help can pay for itself many times over. We strongly suggest you consider a Certified Financial Planner® licensee.

We could go on and on with this list, but the items above represent some of the most important advice we’ve written about in our blog. Over time, we plan to publish selected past blogs on our website . We hope you will visit our website from time to time to see what we have added.

Thank you all again for your support and interest.

Friday, May 6, 2011

No Tree Grows to the Sky!

An old Wall Street Adage, “No Tree Grows to the Sky”, seems to be good advice once again. In the last few days we’ve seen commodity prices drop rather significantly after large recent price increases.

Silver has dropped 8 percent on Thursday alone, oil prices 8.6 percent and copper 3.3percent. As reported in Thursday’s Wall Street Journal (May 5th), silver had dropped 19 percent since the previous Friday.

Gold was down $34 an ounce yesterday, as well, to $1480.90 an ounce. Gold recently reached a high of more than $1540 an ounce. Gold has been on a tear for some time.
One can’t turn on the TV without seeing several ads to “Buy gold now”.

We have cautioned our readers for some time about buying gold, only to continue to watch it rise higher and higher. For those who limited their allocation to a modest amount and set a target price at which to take their profits, an investment in gold likely proved to be quite good.

Unfortunately many investors get greedy and continue to invest more and more as the price rises and peaks. Then when it drops quickly, they lose most, if not all of their gains.

Gold may continue its rise still further. We prefer broader allocations to commodities rather than investing in one metal alone. Even then, commodity investing isn’t for the faint of heart. You need to have a long-term orientation and avoid over-allocating too much to this one asset class.

We wouldn’t be surprised to see more downturns in commodities in the short run. Today’s Wall Street Journal’s feature article titled “Commodity Prices Plunge” by Liam Plevin notes: “But commodities investors and analysts say that the global appetite for natural resources remains robust, which is likely to keep prices from falling dramatically for long.”

We believe commodities should be included in most investors’ portfolios as a hedge against inflation. Commodities also have a low correlation to other more traditional asset classes. That helps reduce overall portfolio volatility and increase long-run portfolio returns. You just need to take care as to how you invest in commodities and how much you invest in them. If you are unsure of how to do so, we suggest you seek professional help.

Sunday, May 1, 2011

Additional Thoughts on Retirement Withdrawal Rates

Our recent blog titled “New Study Sheds Light on Retirement Withdrawal Rates” (Friday April 22, 2011) discussed a recent study published in the Journal of Financial Planning that seemed, on the surface at least, to indicate that under certain circumstances, portfolio withdrawal rates exceeding 4% annually (adjusted for inflation) may be sustainable for retirees.

We had planned a follow-up blog with some additional thoughts. A few days ago, we received a comment from Wade Pfau, a former Oakland County resident, and now Associate Professor of Economics at the National Graduate Institute for Policy Studies (GRIPS) in Tokyo, Japan. Mr. Pfau has a stellar background, having obtained a Ph.D. in economics from Princeton University (2003). Mr. Pfau also writes a blog on titled “Pensions, Retirement Planning and Economics Blog”. In his blog bio, he states that his “main research interests are related to developing methods to better analyze issues related to retirement planning”.

Mr. Pfau had posted a blog titled “Trinity Study Updates” on April 1, 2011, discussing the same study we wrote about. We will leave it to our readers to read Mr. Pfau’s entire article and point out here just a few of the points he made. Mr. Pfau’s comments included the following:

(1) Mr. Pfau noted that the Trinity study did not consider mutual fund fees, which he noted could be anywhere from 1% to 2%, annually. Such fees could considerably impact the sustainable withdrawal rate.

(2) He also noted that the Trinity study considered withdrawal periods of up to 30 years. For those living to age 100 or more, lower withdrawal rates will be required in order to have a high probability of one’s funds being sufficient.

(3) Mr. Pfau noted that the Trinity study seems to indicate that higher portfolio stock percentages are needed for high success in retirement. He stated in his blog that “with U.S. data, the choice of stock allocations between 30% and 80% had very little impact on the worst-case sustainable withdrawal rates”.

(4) He commented that the Trinity study did not take into consideration retires who wanted to leave something for their beneficiaries.
He also pointed out some good news that we had planned to comment on. He stated : “On the other hand, there is some good news. Retirees who diversify their portfolios with international assets and TIPS many very well find an edge to keep the 4% rule alive.”

We would take his statement a bit further. We recommend our clients invest in eleven different asset classes, including TIPS and international assets as well as some commodity-related assets. Studies have shown that broad diversification can increase returns while lowering portfolio risk. We believe a focus on broad diversification and low fund fees (well below 1% for index funds) can do much to preserve the 4% rule and perhaps provide for a somewhat higher withdrawal rate. Further study is likely necessary to see whether our theory is justified. We appreciate Mr. Pfau’s comments and encourage our readers to read his blog in its entirety (just click on the link above).

Wednesday, April 27, 2011

What You Should Do Now

At the time of this writing the Dow Jones Industrial average sits at 12,636 points. That’s a far cry from its recent low of 6,547 on March 9, 2009. Most everyone’s portfolio has recovered nicely, assuming they stayed in the market.

The economy is still struggling, although it seems that slow progress is being made. Yet, there is still much to worry about. Oil prices have risen sharply. The Middle East is still of significant concern with Libya essentially in a civil war and Syria in serious turmoil. Today, we just heard of a bombing in Saudi Arabia that is disrupting oil flow to other Middle East countries. Oil prices are putting pressure on the world economy. Global food prices are also rising sharply.

Here in the U.S., the Federal Reserve has kept interest rates low. That’s fueled the stock market to some extent and caused the dollar to drop in value. The lower value of the dollar has contributed to our high oil prices. We expect that interest rates will begin to rise sooner rather than later. This will have a negative effect on the economy and the stock market but should be positive news for the dollar.

So what should you be doing with your portfolio? We’re sure there are many out there who are probably thinking they should put more in the stock market. After all, it’s been rising rapidly! If anything, however, just the opposite may be appropriate.

If your portfolio is broadly diversified and you have a target allocation for your stock holdings, you may want to consider trimming those holdings if your stock allocation significantly exceeds your target allocation and it’s been quite a while since you rebalanced your portfolio. We recommend that our clients rebalance at least annually.

If you have never established a target portfolio and are invested in just a few asset classes, we highly recommend you get professional help to diversify more broadly. Broad diversification can increase returns and lower risk over the long run. Rebalancing by selling those asset classes that are over-allocated and buying those assets that are under-allocated helps you buy low and sell high.

The temptation for many right now might be to buy stocks (buy high), when in reality the opposite may make more sense.

Friday, April 22, 2011

New Study Sheds Light on Retirement Withdrawal Rates

There have been many studies completed that examined what portfolio withdrawal rates are sustainable during retirement. A generally accepted rule of thumb is that you can withdraw 4 percent of your portfolio, adjusted for inflation, annually, and your funds will have a high probability of lasting for twenty-five to thirty years. The rule assumes your portfolio is invested in a roughly 60 percent stock, forty percent bond mix.

A new study in the April 2011 Journal of Financial Planning titled “Portfolio Success Rates: Where to Draw the Line” by Philip L. Cooley, Ph.D., Carl M. Hubbard, Ph.D., and Daniel T. Walz, Ph.D., provides new insight that somewhat higher withdrawal rates may be sustainable.

This new study uses a “rolling periods” approach to calculate end-of-period portfolio values from historical stock and bond returns from 1926 through 2009. It is considered to have some advantages over Monte Carlo simulation methodologies commonly used by financial planning practitioners.

The study showed that withdrawal rates as high as 7 percent, adjusted for inflation, are sustainable for fifteen years with a high probability, if 100% of the portfolio was invested in large-company common stocks. Six percent withdrawal rates were also sustainable for 20 to 25 years with a high probability, with a 100 percent stock allocation.

A 50 percent stock/50 percent bond portfolio with a 7 percent withdrawal rate had an 84 percent chance of the funds lasting for 15 years. With a 6 percent withdrawal rate the 50 percent stock/50 percent bond portfolio had an 80 percent chance of the funds lasting 20 years and with a 5 percent withdrawal, an 83 percent chance of lasting 25 years.

The study seems to indicate that a better than 4 percent withdrawal rate can be maintained with a high probability over a 20 to 25 year period with a 50 percent equity, 50 percent bond portfolio.

This is good news for retirees who are struggling to make their money last, particularly with worries of high inflation down the road.

Tuesday, April 19, 2011

Will Money Motivate Your Children?

It’s not uncommon for most everyone to try to use money to motivate their children in one way or another. How much allowance to give and guidelines for its use, are of interest to most parents.

Two recent articles in the Journal of Financial Planning shed some light on using your money as a motivator. The articles, titled “Not Your Typical Incentive Trust: The Rote and FST, Part I & II”, by Eileen Gallo, Ph.D., Jon Gallo, Ph.D., and James Grubman, Ph.D. (April 2011), discuss the use of various trusts in estate planning to try to motivate beneficiary behavior.

The first article points out that money is often a disincentive rather than an incentive. The authors explain that a 1908 study produced what is known as the Yates-Dodson Law. According to the authors, the Yates-Dodson Law says that we are motivated by activities that are interesting and challenging and turned off by activities that we view as work. When we attach money to activities, we tend to view those activities as work and are therefore dis-incentivized to do them.

Based on the above study, therefore, it seems that we need to be careful about our expectations to achieve certain behaviors as a result of giving our children an allowance. Allowances may help motivate our children to clean their rooms, do the dishes or take out the garbage (i.e., work). Giving money for improving your children’s grades in school may be marginally successful, since achieving good grades may be more dependent on your children’s interest in school and the degree they feel challenged. If they view school as merely “work” for which they might receive some compensation, they are less likely to be motivated to the extent required to improve their grades.

We believe with some thought and creativity, allowances can be used to motivate activities that are not work-related. We have written previously of an approach to giving allowances that requires a child’s allowance to be used in three specific ways. One part of the allowance is designated for current, immediate gratification (fast food, a movie, toys, etc.).

A second part is designated to be used for longer-term goals. Longer term goals would focus of larger expenses that require good savings habits (purchase of an IPOD or expensive sports equipment, for example). Children will hopefully learn the benefit of saving for important goals and the greater satisfaction that can come from waiting for something of greater importance.

The remaining part of the allowance would be set aside for philanthropic purposes, to teach the importance of helping others and help your children experience the satisfaction of helping those in need.

If presented properly, children may experience a heightened sense of interest and the challenge involved with saving for important purchases or with helping others in need.

The bottom line – money is often not the answer to achieving the behavior you desire in your children. You often have to work hard to find ways to make things interesting and challenging in order to achieve desired results.

Thursday, April 14, 2011

Notify Credit Card Companies Before Traveling

When preparing for a trip, it’s always a good idea to notify your credit card companies as to where you’ll be traveling. Recently, my wife and I took a one week cruise and I was pleased to see that two of our credit card companies provided an easy way to enter travel details online, via the Internet. A third card company required that we call them to notify them of where we were going and when.

Unfortunately, notifying your credit card companies does not ensure your cards won’t be blocked when you try to use them. A few years ago, we took a cruise to Costa Rica and the first time we tried to use one card, its use was blocked, even though we had notified our card company of the trip in advance.

We suggest you take two or three cards with you, to avoid the inconvenience and possible embarrassment of one or more of them not working. It’s possible a card may work for a while and then be shut down, if someone tries to use your card fraudulently. If a card won’t work you can call the company via the 800 number on the back of the card and they may be able to resolve the problem.

It is also suggested that you take some cash or traveler’s checks along with you to help minimize your credit card transactions. Not only will this help avoid fraudulent use of your card but it will help you avoid the added fees tacked on by the banks issuing the credit cards. Most banks now typically charge an additional 3%for credit and debit card purchases. Many fear that the fees may go even higher in the not-too-distant future.

Capital One, as far as we know, is the only major credit card issuer that does not charge foreign transaction fees. Others companies have lowered their fees for select groups but an annual fee is typically required.

Another reason for taking some cash is that many European countries have adopted what is called “Chip and pin” technology, which requires credit cards to have an embedded chip and personal identification number in order to work. If you don’t have one of these new types of cards, you’ll need to have some cash on hand. You should check with your card companies to see if your cards include the new technology.