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.

Monday, September 28, 2009

Next Crisis May Be Sooner Than You Think!

As we recover from the current economic crisis it’s normal to wonder about how long it will be before we have another. Some economists believe that, in part, our current crisis was born in the aftermath of the tech stock bubble. Why do they believe that? They say that the low interest rates introduced by the Federal Reserve were kept in place too long and fueled the housing boom that led to the mortgage crisis, etc. etc., etc.

On top of that, we had banks and hedge funds investing in risky credit default swaps and other new exotic, highly volatile investments. Congress hesitated to introduce needed regulation and even prodded the mortgage industry, including Fannie Mae and Freddie Mac to give mortgages to low-income people who really couldn’t afford what they were buying.

Now, the Federal Reserve is faced with a balancing act similar to what they faced in 2000 and 2001. It needs to avoid keeping interest rates too low for too long while at the same time keeping rates low long enough to support the recovery. If they keep rates low too long, it could trigger high inflation and continued deterioration of the dollar.

Many have hoped that Congress would introduce new regulations to help avoid the problems of the past. In a Wall Street Journal article September 9, 2009 (“Finance Reform Falters as Shock of ’08 Fades”), it was noted that: “On the regulatory front, Democrats’ effort to rework the rules for finance reform have bogged down amid infighting between federal regulators, fury among bankers and opposition from many lawmakers who believe that further expanding the government’s reach will only create new problems.”

At the same time, the article said, “U.S. Banks have regained their footing, and some of their swagger.” Banks are using financial products similar to those that caused the current crisis. The article noted that in the second quarter of this year, “the nation’s top five banks stood to lose more than $1 billion on an average day, should their trading bets go sour, a record level.” This rate compared to a potential $0.52 billion a day loss in 2006, $0.59 billion a day in 2007 and $0.87 billion a day in 2008.

It seems as though we never learn. Last fall, one would have thought that banks would be much more careful going forward. Perhaps the government bailout allowed them to avoid learning an important lesson. As a result, the next crisis may be upon us sooner than we would like to think!

Thursday, September 24, 2009

We May Need to Re-Think Our Tolerance for Risk

An article I read recently in the Wall Street Journal discussed the traditional use of the “normal curve” for determining the risk of investing in stocks. If you aren’t sure what the “normal curve” is, think back to your high school days and how the teachers graded. If they graded on the “curve”, they were using the normal curve to distribute grades in a manner that would be consistent with what one would expect for a “typical” class. The graph of a “normal” distribution is the normal curve. Most grades are clustered around the mean (a C grade), fewer for B’s and D’s, and a very few for E’s and A’s.

Investment advisors have traditionally assumed that stock returns have the characteristics of a normal distribution over time. From a statistical standpoint, this allows them to predict a range of returns over time based on the long term return of stocks and the variability of those returns, which is called the standard deviation.

For stocks, the long term return has been around 10% and the standard deviation 21%. Using the normal curve, we can therefore predict that stock returns will fall in a range of 10% plus or minus 21%, approximately two-thirds of the time. In other words, about 67% of the time, stock returns will be between -11% and +31%. The other one-third of the time, the returns can be expected to be worse than -11% or better than +31%.

Clearly, the last couple of years we’ve seen the extreme case where stock returns have been below -11%. Some have said that the current economic crisis is a one-in-a-hundred year event. And when you consider that less than 10 years ago in 2000 and 2001, we also had an extreme downturn, you might begin to wonder if the statistical model we are using for stock returns may not accurately reflect the downside risk. It seems that economic crises are happening more often.

Regardless, it still makes sense to ensure you have a broadly diversified portfolio. And, we still think it’s crazy to try to time the market. In light of the extreme volatility we are now seeing, we think investors should make sure they are not taking on more risk than they need to in order to achieve their goals. And just in case more crises are coming down the road, you may want to rework your budget with the aim of increasing savings.
Additional savings allows you to increase your wealth without taking on unnecessary risk.

Tuesday, September 22, 2009

Getting Over the Financial Advisor Hurdles

In a recent post titled “Financial Planning Isn’t Just for People with Lots of Money” (August 11, 2009) we discussed the benefits a financial advisor could have for anyone, whether they are wealthy or of modest means. Unfortunately, many individuals are reluctant to seek professional advice for a variety of reasons, even though they realize the benefits could be significant. Below, we’ve listed some of the most common reasons and how you might get over each hurdle:

Overcoming emotions: Some people are ashamed of the state of their financial affairs or feel guilty about letting their finances deteriorate. They are embarrassed to share the details of their situation with a financial advisor. If you are in that position, you need to understand that financial advisors are in the business to help people resolve their financial problems. They don’t expect people to be perfect or to know everything about managing money. The majority of planners we know have a true desire to help people with their money problems and would never belittle or embarrass anyone about their financial situation.

Worry about the cost: Many people are concerned about how much it might cost to seek professional help. Costs vary significantly. This is an area you need to pay special attention to. Some advisors “charge nothing” for financial advice. Beware of this type of arrangement. These advisors make their money on other fees or commissions and may or may not be qualified to give comprehensive financial advice. Others charge fixed fees or hourly fees. Whatever the fee arrangement, make sure it is clearly defined and get it in writing.

Let’s suppose an advisor wants $ 2,500 for a comprehensive plan. Are the financial savings likely to justify such a fee? Often a good advisor can significantly reduce taxes or expenses on one’s portfolio. Even a small reduction in taxes and expenses can result in thousands of dollars in just a few years. A review of your insurance policies can also be a potential way to save money. Advisors often help clients reduce their tax liabilities. Not to mention the cost savings you can attribute to your peace of mind in planning for your financial future. These are but a few ways a comprehensive financial plan can reap significant savings.

Procrastination: Some people just keep putting things off. If you are one of them, remember that each day you wait can be costing you significant savings in taxes, investment expenses, better investment returns as well as a number of other possible savings. A portfolio invested in holdings that carry high management fees can be costing you hundreds, if not thousands of dollars and you may not even realize it. Aristotle once said: “Well begun is half done.”

Afraid of getting bad advice: Some of you are perhaps worried about getting bad advice, being taken advantage of or just don’t know where to look to find a financial advisor. To start with, seek out a Certified Financial Planner®. The Financial Planning Association website has a “Planner Search” function that can help you identify planners in your area ( You can also visit the Certified Financial Planner Board of Standards website for information on how to choose a planner ( Both sites include interview questions you can ask as you search for a qualified planner. We recommend that you interview several planners before making a selection. Don’t be afraid to ask questions!

Keep in mind also, some of the other benefits of seeking help. A financial advisor can help you take control of your financial affairs and give you a feeling of empowerment. They can help you clarify your goals and give you a detailed plan to accomplish them. Hopefully, the information above will help those of you who need some financial advice get over the hurdles that are currently getting in your way.

Friday, September 18, 2009

Avoiding Risk May Be Costly!

In our August 21st post titled “Avoid Complex Investments”, we noted that “when investments are more complex, they often contain hidden fees or in some cases, carry higher risk.”

While we believe low-cost fixed annuities can be very beneficial, we have never been big fans of variable annuities or more recent annuity products called “indexed annuities”.

Indexed annuities come in many different flavors. In general, however, they guarantee a minimum rate of return and the possibility of returns tied to the stock market if stocks return more. Investors who are very risk averse are attracted to indexed annuities as a means of avoiding losses. In times such as we have experienced the last couple of years, products that guarantee a return can be quite attractive.

In our opinion, indexed annuities are somewhat complex products. So much so, that it can be very difficult to understand them or compare one to another. And, if you can’t easily understand the product, how do you know whether the guaranteed return is sufficient for the cost involved? New York Life Insurance Company, in fact, doesn’t sell indexed annuities, in part because they are too difficult to understand.

An article in the Wall Street Journal titled “How Well Do You Know… Indexed Annuities?” (September 2, 2009), noted some of the typical features. Below are some of the more interesting facts about indexed annuities included in the article:

(1) They return the higher of a fixed interest rate or an amount tied to a market index, such as the S&P 500 Index.
(2) They contain restrictions on how much of the index’s gain you get to keep. It could be a fixed percentage (e.g. 80%), a cap such as a maximum of 8%, or an amount less than the index’s return ( e.g. 3% less than the index)
(3) They often include steep surrender charges (sometimes as much as 10% to 15% in the first year).
(4) Many of the products allow insurers to change the contract rules after purchase.
(5) Usually, equity dividends are not included in the index portion of the return. Dividends have historically been a significant part of total equity returns.
(6) Some contracts guarantee the minimum return on only a portion of the amount invested (e.g. 90% or 85% of what you invested).
(7) Commissions generally range from 6% to 10% of the amount invested. You don’t pay the commission (the insurance company does) but it affects your total return and can incent the sales agent to sell you something that is not appropriate for you.

As you can see from the above facts, the devil is in the details. We believe that unless investors are extremely risk averse, they will be better served over the long run with a well-diversified portfolio that utilizes low-cost no load mutual funds, index funds and exchange-traded funds (ETFs).

Tuesday, September 15, 2009

The Best of Times and the Worst of Times

We often mention how difficult it is to time the market and recommend that you should stay invested when the market tanks. That advice, of course, assumes you have a well diversified portfolio tuned to your risk tolerance and that you are invested in low-cost high quality investment vehicles. If not, some adjustment may well be warranted.

Advisors often talk of the importance of being “in the market” when it rallies and how just a few good market days can make a big difference. A recent Morningstar® article by Invesco Aim (“Rethinking Risk: The Tale of 10 Days”, 07-16-09) looked at the best and worst days of the last 81 years to see how important it is to be “in the market”.

According to the article, “the S&P 500 Index’s 10 best performing days over 81 years (from Jan. 3, 1928, to March 31st, 2009) – yielded an average daily return of
11.68%.” The worst 10 performing days over the same period yielded an average daily return of -10.84%.

On the surface, it appears that since the average return for the best 10 days is better than the average decline for the 10 worst days, staying “in the market” would automatically make you a winner.

However, the article goes on to say that a buy and hold strategy for the entire 81 years would turn a $1 investment into $45.18 (i.e., being in the market during both the 10 best and 10 worst days). If you happened to miss just the 10 best days over the 81 years, your $1 investment would have returned just $14.99. If you had missed just the 10 worst days, you would have earned $143.47 on your $1 investments. And, if you missed the 10 best and 10 worst days, your $1 would have grown to $47.59.

Since it’s very difficult, if not impossible, to identify in advance either a “best” or a “worst” day, it’s basically unrealistic to try to avoid all the worst days in order to maximize your return. There is evidence, however, that the “best” and “worst” days often happen close to each other.

Therefore, although the article didn’t say so, one could argue, that it makes sense to stay the course during market crashes. Why so? It usually takes severe market downturns (“worst” days) to motivate investors to sell all their equities. Since the “best” and “worst” days are often bunched together, pulling out after one or two really bad (possibly “worst”) days could likely cause you to miss a coming “best” day.

The article notes the futility of trying to time the best and worst days and the impact losses can have on your portfolio. A 10% loss requires and 11% gain to break even. A 25% loss requires a 34% gain to break even and a 50% loss requires a 100% gain to break even.

If a market crash happens at the wrong time, you may not be able to achieve your goals. Therefore, the article says, you need to: “Approach your investments with an aim to reduce risk, not maximize returns.” You need to be sure that you take on no more risk than necessary to achieve your objectives. Doing that is no easy task. We strongly suggest you seek out professional help, so that you improve your odds of achieving the “best of times”.

Thursday, September 10, 2009

The Next Problem We Will Face

An article in the Wall Street Journal earlier this summer (Get Ready for Inflation and Higher Interest Rates”, June 10th, 2009) warns that once we get through the current economic crisis, we can expect high inflation and high interest rates.

The article was written by Arthur B. Laffer, chairman of Laffer Associates and co-author of “The End of Prosperity: How Higher Taxes Will Doom the Economy – If We Let It Happen” (Threshold, 2008).

Mr. Laffer wrote: “With the crisis, the ill-conceived government reactions, and the ensuing downturn, the unfunded liabilities of federal programs –such as Social Security, civil-service and military pensions, the Pension Benefit Guarantee Corporation, Medicare and Medicaid – are over the $100 trillion mark. With U. S. GDP (gross domestic product) and federal tax receipts at about $14 trillion and $2.4 trillion, respectively, such a debt all but guarantees higher interest rates, massive tax increases and partial default on government promises.”

If cap and trade and healthcare reform legislation are also passed and call for even more government spending and taxes, it can only make matters worse. Higher interest rates and high inflation could likely trigger another recession, shortly after we’ve recovered from the current crisis.

So what can you do to prepare? Make sure your portfolio is broadly diversified and contains more than just fixed income assets. You’ll need equities for the long haul to keep up with inflation. You might include some treasury inflation-protected securities (TIPS) and possibly even a small amount of commodities via a well-diversified no load mutual fund. We would recommend dollar-cost averaging if you invest in commodities.

One way to help combat inflation is to reduce spending and increase savings. The less you spend, the less inflation will impact you and the more you’ll be able to add to your portfolio.

Consider learning a new trade to improve your marketability. You might also consider developing a hobby into a side business to help boost your income.

Finally, make sure you minimize investment expenses and optimize your portfolio’s tax efficiency.

In short, if you prepare now, you can mitigate the affects of the possibility of high inflation and higher interest rates down the road.

Monday, September 7, 2009

Don’t Overlook Liquidity in Your Portfolio

We’ve dedicated a couple of past posts to the need to have an adequate emergency fund. Emergency funds need to be invested in assets that can be quickly converted to cash with no loss of principle. In other words they need to be liquid and safe. Therefore, emergency funds need to be invested in cash, money markets funds or very-short-term CDs.

In addition to being important for your emergency fund, liquidity can be important for other assets in your investment portfolio.

A recent Wall Street Journal article (“Ivy League Schools Learn a Lesson in Liquidity”, Wednesday, August 19th) noted that Harvard University and Yale University’s endowment funds were expected to report losses of 30% and 25% for their fiscal year, respectively. Both endowment funds have been leaders for many years.

So what went wrong at Harvard and Yale? Both endowment funds invested in private equity investments and hedge funds that don’t provide the liquidity of publicly traded stocks, bonds and mutual funds. The article stated: “ …in the midst of unprecedented market turmoil, many endowment managers learned the true meaning of ‘illiquid’. The exits for most private equity and venture-capital funds slammed shut.” The endowment managers couldn’t sell the illiquid investments and saw their asset allocations get “wildly out of balance”. The illiquid investments continued to drop in value, and they couldn’t do anything about it.

Individual investors need to keep the issue of liquidity in mind when they choose investments. Some investors like to invest in real estate. While real estate used to be a great investment and likely will be again in the future, the lack of liquidity can really hurt you in times like now.

Thinly-traded exchange-traded funds (ETF) sometimes have wide spreads between the buy and sell prices. Wide spreads can have a big impact of your returns. Limited partnerships often boast of high returns but can be difficult to sell if you need cash.

The bottom line? Make sure you consider the liquidity of any investment before buying. Not being able to sell an investment when you want or need to can offset most, if not all, of the good features of the investment in bad economic times.

Saturday, September 5, 2009

You Won’t Get Rich But You’ll Feel Better

We just came back from a trip to Royal Oak Recycling’s new facility in White Lake Township at 10320 Highland Road. Residents in neighboring communities can recycle a variety of items including: newspapers, magazines, office paper, soft and hard cover books, plastic bottles and jugs, cans of all sorts, shredded paper, cardboard, metals, computers, TVs, computer monitors, printers and appliances.

You can visit their website at . Or, you can call them at 248-387-5555.

For most items, Royal Oak Recycling (ROR) currently pays 1 and ½ cents per pound. There is a charge for computer monitors and TVs of $ 0.30 per pound. Ferrous metals such as iron and steel have no value but can be recycled. For non-ferrous metals, you can ask the sales representative for the current price per pound.

ROR does not accept glass of any kind, Styrofoam, batteries or any chemicals or paints.

When you arrive at their facility, drive onto the scale and tell the agent what you have to recycle. They will then direct you to the proper unloading dock. When finished, return to the scale where the agent will pay you for the items you brought.

We cleaned out our garage of newspapers, shredded documents, plastic containers and cans as well as an old printer.

We made a total of $ 1.50! It wasn’t much, but our house is less cluttered and we feel good about doing our part for the environment!

Wednesday, September 2, 2009

Are We In The Middle of a “W”?

With yesterday’s drop in the Dow Jones Industrial Average after many weeks of rallies, it is reasonable to question what’s ahead. Economists have been speculating about the recovery and whether it would be a “V”, a “W” or perhaps a “U” shaped recovery.

A Morningstar® article titled “The Alphabet Soup of Economic Recovery” (James Levin, 08-28-09) explains in layman terms, the differences between “V”, “W” and “U” -shaped economic recoveries. (Note: the article also discusses an “L” shaped recovery which is unlikely to happen.)

With a “V” shaped recovery, according to the article, “the economy sees a sharp decline, hits a pronounced bottom, and quickly turns upward, cancelling much or all of the losses that investors experienced on the way down.” The article made an argument that a “V”-shaped recovery was unlikely since “consumer spending remains soft, and the over-indebted consumer continues to feel the sting of depreciation of his greatest appreciable asset, his home.”

A “W” recovery starts out like a “V” but the upside of the “V” is followed by another market correction, a new bottom and then another upturn to finish out the “W”. The “W” can be a bonus or a bust for investors. For some, it brings a second chance to buy stocks at bargain prices. For many, however, of what we describe as “typical” investors, it provides a second emotional panic and selling at the bottom followed by buying as prices again rise higher (the wrong thing to do)!

A “U” shaped recovery according to the article: “is similar to the “V” differing only in that the upturn is not as defined, as the economy waffles at its lows for a lengthier period before steadily climbing to higher ground.”

The author expressed his belief that a “V’ was now unlikely, a “W” was a possibility but seemed to favor a “U” -shaped recovery the most.

Yesterday’s drop in the DOW could well be the start of the second “W” correction. Then again, we’re not economists, and even if we were, our advice would be questionable since few economists agree on much of anything. We are concerned, however, about the impact of future foreclosures and the possibility of a commercial real estate meltdown that many people fear may happen.

However, we’re pretty confident about one thing; we will see a recovery. But only time will tell whether it’s a “V” a “W’ or a “U” –shaped recovery. Who knows, it may even be something different!