Today (July 30th, 2009) the Dow Jones Industrials closed up 83.74 points, making July, so far, the best monthly gain in 23 years (since 1996). For the year, the Dow Jones Industrial Average is at a high. Of course, anything can happen, so it may not be the best monthly gain when the market closes tomorrow.

Regardless of what happens tomorrow we hope you weren’t like the typical investor who buys high and sells low. Many of these typical investors cashed in all their equities months ago when the outlook was bleak. In many cases these were the same people who jumped on the tech bandwagon in 1999 and 2000 to invest heavily in “dot com” stocks that had zero earnings.

Last fall for the Oakland Insider insert, we wrote an article titled “A Lesson from Warren Buffett”. We quoted one of our favorite Buffett quotes: “I will tell you the secret of getting rich on Wall Street. You try to be greedy when others are fearful, and you try to be very fearful when others are greedy.” We went on to point out what Warren was doing last fall when others were very, very fearful:

“While many contemplated pulling everything out of the market, Buffet invested $ 5 billion in Goldman Sachs. Amidst the market turmoil, Goldman Sachs’ stock had dropped a whopping 36% over a ten day period! Buffett drove a very hard bargain that bought him preferred shares in Goldman that can not be converted to equity and it pays a 10% dividend. The dividend is equivalent to $1.3 million a day to Berkshire Hathaway. At the time of this writing, it was just announced that Buffet had made a similar investment in General Electric.”

Today, G.E. stock was up 7%!

The point of all this is, that it is extremely difficult to time the market. In order to invest properly (buy low and sell high), you need to eliminate the emotions of investing. To do that, you need to choose a widely diversified portfolio with a level of risk (stock/bond ratio) that you can live with through all types of markets. If you then periodically rebalance that portfolio on a regular basis (at least annually), it will force you to buy low (the under-allocated asset classes) and sell high (the over-allocated asset classes).

To successfully time the market you need to know when to get out and when to get back in. You have to be right twice. Being right just once is tough to do. Since it’s impossible to consistently time the market, you need to always maintain a presence in the market. Avoiding a portfolio with too much risk makes it easier to stay in the market during difficult times.

We all are aware that the housing market in Metro Detroit is anything but a seller’s market. But, if you’re looking to sell and then buy something in the same area, it may not be all that bad. Of course, being able to sell has a lot to do with the equity position you have in your house and when you bought it. If you are able to sell, you can position yourself to get a really great deal on a new house. Selling at a price much lower than what you have invested in your home is very difficult to do. Just make sure you view the sale of your house as an investment and avoid getting hung up on all of the sweat equity you put into improving it and making it your own. The more emotional you get, the harder it will be to move on.

One thing for sure is that putting your house on the market is very expensive.
Consider the typical costs (Example: $150,000 house):

Hire a traditional real estate agent to list your house = $4,500
Pay the Selling Agent a commission for bringing you the buyer = $4,500
Pay the State regulated transfer tax of $8.60 per $1,000 = $1,290
Purchase Title Insurance = $600
Pay Home Warranty premium (if required by buyer) = approx. $375
TOTAL $11,265

To top it all off, it is not unusual for buyers to ask sellers to pay up to 3% of the buyers’ closing costs to obtain their mortgage! When it is all said and done, you could be looking at a $16,000 bill just to sell your $150,000 house.

Because of this, sellers are trying anything to lower their costs to sell. The only potentially negotiable costs listed above are agent commissions and paying the buyers’ closing costs. And, closing costs may not be negotiable with many buyers strapped for funds.

One thing to consider is what’s called a “flat-fee listing service”. These arrangements are quickly growing in popularity. Essentially, a flat-fee listing service provides you with the same online exposure as a traditional real estate agent at a much lower fee (usually $500 - $1,000 depending on the services you are interested in). It’s a huge step up from “For Sale By Owner” but without a huge cost. When you’re looking at paying an agent three percent to list your house, consider a flat fee broker and use the extra cash to save for your next house. Not only that, if you can somehow find a buyer that isn’t working with an agent, some flat fee broker arrangements allow you to sell your house on your own, avoiding the three percent fee on the other end. While the odds of finding your own buyer are slim, you just never know who has been eyeing your house for years.

If we assume you will have enough equity after the selling costs are accounted for to buy a bigger/better home, you still have three other hurdles to overcome once a buyer is found. The first is that your house must appraise at a high enough value to secure approval of the buyer’s mortgage. If the appraised value comes in too low, you will either have to renegotiate with the buyer, or risk losing the deal altogether.

The second hurdle is making it through the buyer’s inspection of your home. They may point out repairs that are necessary before they agree to buy the home. If you can’t do the repairs yourself, you may have to foot those bills too. The buyer could even back out of the purchase if there are too many things wrong.

Last, but not least, the buyer needs to qualify for their mortgage. In today’s volatile job market, just because someone is pre-qualified doesn’t necessarily mean it’s a done deal. What happens if the buyers lose their job at the last minute? Assuming they do qualify, try to arrange for a closing as soon as possible just in case something happens and they want to cancel the deal at the last minute.

Hopefully this hasn’t scared you off from making a move. There is still a nice $8,000 tax credit for first time homebuyers to take advantage of and don’t forget - it only takes one buyer to seal the deal. Good luck!

Our last post discussed the fact that nearly everyone has lost a significant amount during the recent market downturn and that we need to be careful to avoid chasing the latest “hot investments”. One way to recover some of the loss to our portfolio is to save more. And, one way to do that is to save more by creating and following a budget.

So what should you do to establish a budget? First and foremost, you need to sit down (with your spouse or significant other, if you have one) to define and prioritize your financial objectives. What is most important to you: early retirement, college for your kids, a new home, travel, a new boat? It is likely you have more wants than your income will support. That is why prioritizing and communicating with your spouse is very important. It helps make spending decisions much easier with clear goals in mind.

If you do not know where your money is currently going, keep track of it in detail for at least thirty days (three months would be even better). If you are relatively computer savvy, software packages such as Quicken® and Microsoft Money® can help with this task and ongoing budget management.

Next, identify all of your fixed monthly costs (mortgage payment, car loan, utilities food, taxes, social security, etc.). After the fixed costs have been identified, detail the variable costs such as dining out, entertainment, gifts, travel, hobbies, and so on. Next, review all of the fixed and variable expenses in detail to see what can be eliminated or reduced. Do you really need that latte every day on your way to work? Could you survive with a less costly cable package? What is more important, getting all the movie channels or helping fund your child’s college education?

If you subtract your monthly fixed and variable expenses from your monthly gross income, you are left with money to be used for discretionary items. Make sure you set aside enough for your top financial objectives. If there is not enough to make satisfactory progress on achieving those objectives, you need to re-examine your budget to see what can be cut out or find other ways to boost your income.

You will also find that there are some creative ways to reduce your spending. How about going to the library to get the latest novel you want to read or DVD you want to watch. “Free” is a lot cheaper than that $40+ movie cinema tab. What about finding some freelance work on the side? Try to turn your hobbies into a way to earn some more money. A creative budget does not have to limit your social life. It is highly probable that you have several friends or family members in the same situation; be creative together, you might even find that there is “fun” in being more frugal. It is a different era now; it is time to be more humble and realistic. It is time to take charge of your finances.


Even if you do not continue to follow your budget in detail, just going through the above process may be an eye-opener. We have only touched on the highpoints of budgeting but we hope you can see that a budget can be a useful tool to help you achieve your goals.

The current economic crisis is the worst most of have ever experienced. The market seems to have stopped its rapid decent, with a substantial recovery in the first half of this year. Lately, it seems to be going nowhere. We could even see another significant decline in the Dow before the end of the recession. Earlier in the year, many were predicting an end to the recession before year end. Now many think it may be well into 2010 before the recession ends. Regardless, it certainly seems that we may be in for a long, slow recovery.

Hopefully, you didn’t panic and liquidate your portfolio. Those who do so in a time like this, often find themselves sitting on the sideline when the market rallies. They struggle with when or if to get back in the market, only to miss the big upturn. In the end, they usually do far worse than those who sit tight during market downturns. We also hope you did not stop making your 401(K) contributions. You may never again have a chance to buy in to the market at the prices we are now seeing.

If you have a well-diversified portfolio and rebalance it at least annually, by buying the depressed asset classes and selling the over-allocated asset classes, your portfolio should do well over the long run. But what if we have an extended bear market? Bear markets have been known to last for many years. It may be tougher to achieve all of your goals.

Many are tempted to chase the latest “hot investments”. If you’re not careful, however, you may well get burned. About the time you jump on the bandwagon it’s often late in the cycle and the supposedly “sure thing” investment is already over priced. A recent Morningstar® article noted that the recent first-half rally was fueled primarily by investments in higher-risk stocks (over-valued). If your portfolio is well managed and you’re avoiding the latest hot investments, how can you make up for what you lost the last couple of years?

One way to make up for lost time may be to save more. That brings to mind the dreaded “B” word: budget. While most people do not like the idea of following a budget, having one can reap huge benefits. Few of the clients who come to us for advice have outlined their spending. If you do not know where your money is going, how do you know if you are spending it wisely? Our next post will discuss the steps in creating a budget.

A basic financial planning rule of thumb is to only insure against the large losses and self-insure against the small losses. What do we mean by self-insure? To self-insure means that we pay for small losses out of our own pocket. We make sure we have an adequate emergency fund that’s invested in an easily accessible money-market like account that we can tap quickly without loss of principle. (See our previous blog posts on establishing an emergency fund, Monday, June 8th and Wednesday, June 10th).

So what kind of losses do we self-insure? Let’s start with deductibles. Individuals often come to us with auto and home insurance policies containing $250 deductibles. You should seriously consider deductibles of $500 or even $ 1,000. The higher deductibles can significantly lower your premiums. Also, if you file a lot of small claims, many insurers will likely raise your premiums, so you’re better off paying for small claims yourself anyway.

If you’re healthy, consider a high deductible medical insurance policy that pays for the major medical expenses. Avoid buying insurance on new appliances or electronics. Over the long run it’s often better to avoid the cost of insurance and just replace the items. You’ll then have a brand new product and perhaps some new features, as well.

Be careful about purchasing travel insurance. Unless it’s a very expensive trip you may be better off just assuming the risk yourself. You also need to take care to make sure the travel insurance doesn’t overlap with other coverage. Your health insurance may cover you while you travel and your credit card company may cover medical emergencies, lost luggage or trips charged on their cards.

If you feel good because you often receive a small check from you insurance company for a small loss, you are costing yourself a considerable amount of money in high insurance premiums. With the proper coverage, you can save enough on your insurance premiums to pay for the occasional small loss.

Recently, one of our clients told to us about a close friend who claimed to be making a guaranteed 8% return with another advisor. We asked for some details about the high yielding investment. The best we could tell was that the friend had purchased b. Ford has issued bonds recently that yield around 8%.

You might think that the Ford bonds would be a safe investment now that Ford appears to have avoided bankruptcy (unlike GM and Chrysler). Regardless of what you might think, an 8% return of any sort, currently, must be considered a high return.

A basic investing concept you should never forget is that a high return for an investment means high risk. If you think about it, it makes perfect sense. If, for example, you wanted to raise some money through a bond offering, you would try to pay as little interest as possible. If long-term treasury bonds are paying only 4.3%, why would you sell bonds that promise an 8% return? The answer is that the bonds you are selling are perceived to be riskier than the Treasury bond and can’t be sold unless they promise a higher return; in this case, 8%.

Certainly, Ford seems to be doing better than GM and Chrysler, and the 8% bonds may well turn out to be a good investment. Nevertheless, they are still quite risky and a number of scenarios could render them a poor investment. Consider that even though Ford avoided bankruptcy, it currently has somewhere around $30 billion in debt. The national economy and car market are still struggling and it is still quite uncertain how long the recession will last. A terrorist attack, weather disaster, earthquake, Mideast crisis, Korean war breakout, etc., etc. could cause the recession to drag on and on. If that happens, Ford could be in serious trouble. The GM bankruptcy resulted in bondholders being paid only cents on the dollar for their investment.

Regardless of what the investment is, if it pays a much higher rate of return than other similar investment vehicles, you must assume that it is inherently more risky and you need to be sure you understand what those risks are. Don’t just ask the seller of the investment. He or she is biased by the prospect of their commission/fee for making the sale. Do your own research or find an independent knowledgeable third party.

In our March update to our investment advisory clients, we included an article titled “Did Asset Allocation Fail Investors in 2008?”. In that article we quoted Robert Arnott, Chairman and founder of Research Affiliates and manager of two PIMCO mutual funds. In a Morningstar® internet video, Mr. Arnott said that in market crashes, correlations between asset classes soar. He said “that you have a flight to quality, a flight to liquidity and a flight away from unfamiliarity.” That affects nearly all investments, with the exception of Treasury securities, which did well in 2008.

One easy lesson to draw from 2008, Mr. Arnott said, is to assume that you should not count on diversification, that you should take less risk. “That’s the wrong lesson to take” he said because what we saw in 2008 was probably a “once in a career” event and that structuring our investment strategy on an event that we will likely never experience again is dangerous. Mr. Arnott said “that the correct lesson to take form this experience is to step up your risk if you weren’t already taking too much risk”.

At the time of this writing, the Wall Street Journal had just published an article discussing this same issue titled: “Failure of Fail-Safe Strategy Sends Investors Scrambling” (July 10, 2009). The article noted that the financial crisis has caused many financial advisors to rethink their asset allocation strategy. Some argue that asset-allocation strategies are inherently flawed. The article noted that Fidelity Investments disagreed: “ Diversification didn’t fail in the recent market downturn. It worked – just to a lesser degree.”

Our view is that in extreme market downturns such as we have just experienced, asset allocation will not be as effective. Nevertheless, all asset classes did not experience the same level of losses. Bond funds, in general, suffered less. Therefore, we believe, a diversified portfolio made up of a broad collection of diverse asset classes will help minimize losses.

An obvious question is: What’s the alternative? If you try to pick one or two asset classes that will do the best, it’s very tough to do. Besides, we believe that in more normal markets, asset allocation still works. Many asset class returns are not highly correlated in up markets. And even though U.S. and international returns seem to be more closely correlated, investing in both markets helps reduce currency risk.

Market returns so far this year are proof that various asset returns are uncorrelated. Small stocks have outperformed large stocks, international stocks are doing better than U.S. stocks and bonds in general are doing much better than stocks. In the 2000 tech stock debacle, small stocks and REITs performed very well while U.S and international stocks crashed.

So what’s the bottom line? While it does appear that the world is getting smaller and the various asset class returns are somewhat more closely correlated, we still have confidence that asset allocation makes sense for the average investor.

Starting January 1, 2010, it will be easier to convert regular IRAs to Roth IRAs. Currently, individuals whose Modified Adjusted Gross Income (MAGI) is more than $120,000 or couples whose MAGI is greater than $176,000 can’t contribute to a Roth IRA. You also can’t convert a regular IRA to a Roth IRA if your household MAGI is greater than $ 100,000 for the year.

Roth IRAs are desirable because distributions are tax free as long as you’ve had the Roth for at least 5 years. This can be particularly beneficial if you think tax rates will be higher in the future. With our current economic crisis and announced government spending plans, higher rates seem inevitable. Unlike regular IRAs that require minimum distributions to be taken when you reach age 70 and ½, Roth IRAs do not require you to take minimum distributions. This allows you to let your Roth grow tax-free for as long as you want.

Starting January 1, 2010, as a result of the Tax Increase Prevention and Reconciliation Act of 2006, the government is eliminating the $100,000 income limit for conversions to Roth IRAs. You’ll still have to pay the income taxes on the pre-tax amounts converted but will be able to spread the amount converted equally across your 2011 and 2012 tax returns, paying any resulting tax in those years. Lastly, whatever you do, don’t convert unless you can pay the taxes due with funds from outside the IRA you plan to convert.

"The Little Book of Main Street Money" by Jonathan Clements (John Wiley and Sons, Inc. 2009) provides a common sense, easy-to-understand guide for main street Americans about all aspects of managing their financial affairs.

Mr. Clements is currently Director of Financial Guidance for myFi (www.myFi.com) a new financial service from banking giant Citicorp. Previously, Mr. Clements was the Wall Street Journal’s award-winning personal finance editor for eighteen years. We looked forward to his weekly columns and often quoted him in our newsletters and articles.

The book’s subtitle: “21 Simple Truths that Help Real People Make Real Money”, sums up the book quite well. Mr. Clements summarizes all the keys to financial success he has written about for all those years while at the Wall Street Journal and does it in a clear, easy to understand way that even the novice can understand.

Jonathan’s “21 Simple Truths” cover all aspects of your finances from basic money management, investing and taxes to behavioral finance issues, wills and insurance. He sums up each chapter with key points he calls “Street Smarts”. In our opinion, there’s no one better than Jonathan Clements when it comes to explaining to the layman what one must do to be successful financially. If you’ve tried other financial books and been turned off with their technical jargon, this is likely the book for you. If you follow Jonathan’s straightforward advice, you can’t help but achieve financial success. This book’s a quick read that you’ll have trouble putting down.

If you’ve purchased a whole-life, variable-life or universal life policy, you may have a problem in the not-too-distant future. If your life insurance policies are all through your employer or are all “term” life policies, you can rest easy.

Often, when whole-life, universal-life and variable-life policies are sold, illustrations (projections) are provided to show how the policy will grow in value and in many, if not all cases, how the policy will be able at some point in the future to self-pay all ongoing premiums. In many cases, the investment return and/or interest-rate assumptions used in the illustrations are too rosy.

A recent Wall Street Journal article (May 26, 2009) discussed how the strategy of using life insurance to pay for estate taxes was causing some estate plans to self destruct. The problem, however, is not limited to life insurance in estate plans. If the policy can’t generate enough earnings to pay premiums, it’s possible for the policy to lapse. This is true whether the policy is used in an estate plan or to provide for a surviving spouse.

The Wall Street Journal article quotes Bill Boersma, president of Opportunity Concepts in Grand Rapids, Michigan, who said he has worked with many “troubled policies” lately and predicts a “tsunami” of lapses over the next few years.

If the underlying policy assumptions about interest rates and investment returns are too optimistic, the policy may begin generating internal loans to pay the premium payments. You need to keep a close eye on your life insurance policy statements to avoid an unpleasant surprise. You may want to contact your insurance agent and ask for some new policy illustrations that use more conservative future return assumptions. If you’re considering buying a new policy, check out the investment return and interest rate assumptions carefully.

The recent economic crisis has hit retirees hard, reducing the value of their investments by 25% to 30% or more. The ability to downsize their homes to reduce expenses has been made more difficult by the severe downturn in real estate prices. As a result, many are turning to reverse mortgages as a way to eliminate their mortgage payments and tap into existing home equity.

A recent Wall Street Journal article (“Seniors Drawn to Mortgages That Give Back”, May 10, 2009) stated that in March and April, the number of reverse mortgages by the government increased nearly 20% from the same period a year ago. In April there were 11,660 reverse mortgages insured by the government, the highest number for a month since the program began in 1990.

With a reverse mortgage, the bank makes payments to the homeowner instead of the homeowner paying the bank. To qualify for a reverse mortgage, you must be at least 62 years of age and have a significant amount of equity in your home. Reverse mortgages may allow a senior to pay off their mortgage and/or receive a lump sum payment or line of credit. The bank gets paid back when the homeowner dies or sells the home.

For some seniors, a reverse mortgage allows them to continue a comfortable retirement while staying in their home. Due to the high fees charged for reverse mortgages, however, we believe taking out a reverse mortgage should be a last resort for retirees. They need to take care also to watch out for unscrupulous investment advisors pushing high-fee insurance and annuity products for seniors to invest in with their reverse mortgage proceeds.

In our recent post titled “There’s No Silver Bullet in Investing”, we talked about how typical it is for investors to want to buy a stock just because its price is low. Surely a low price must mean it’s a good buy! And, you don’t have to invest very much to make a killing! That’s what they’re thinking.

A low price by itself means nothing. Just because a stock once sold for $100 a share and now sells for $15, provides no basis for buying the stock. You need to do some research to determine what the outlook is for the company’s earnings. What’s the competition doing? The price is often low because the company has some problems. Can they overcome those problems? A high-priced stock might have significantly better potential.

A recent report by Turner Investment Partners discussed its analysis of the recent market rally. Their analysis showed that the smallest and cheapest stocks have gained the most since the rally started in March of this year. Their report stated:

“To us, the spectacular rally by small-cap stocks represented the investing equivalent of Newton’s Third Law of Motion: any action produces an equal and opposite reaction. For example, one-quarter of the small-cap stocks in the Russell 2000 Value Index lost 65.5% or more in the 12 months prior to the rally, then rebounded with a vengeance.”

In other words, a substantial portion of the recent rally has been the result of investors buying low priced stocks. What do you suppose is the chance that the majority of those buyers did any significant research before buying? Certainly there were many that did. And a good portion of the rally included large and mid-cap stocks, as well. But many likely were looking for bargains. And with prices so low, how could they possibly go wrong? I guess investors will just never learn!