We’ve written more than once about the benefits of seeking help from a financial advisor (See our blog post “Getting Over the Financial Advisor Hurdles”, November 22, 2009. Unfortunately, for those of more modest means, affordability of help is a factor. For those with meager financial means, their biggest problem is a lack of basic financial knowledge.

A recent article in the Sarasota, Florida Herald Tribune by Humberto Cruz titled “Many Americans Get an ‘F’ in Financial Acumen”, January 16, 2010, Mr. Cruz reviews the results of a study by the Financial Industry Regulation Authority (FINRA). According to the article, seventy-five percent of Americans say they are good at dealing with day-to-day financial matters, seventy-seven percent think they are pretty good at math and seventy percent say they have a high level of financial knowledge.

The study by FINRA included five simple questions to test the respondents’ financial knowledge. The average number of correct answers by the respondents was 2.72 out of five.

Here is an example of one of the questions included in the article:

Suppose you have $100 in a savings account earning 2 percent interest a year. After five years would you have more than $102, exactly $102 or less than $102? The correct answer is: More then $102.

It is quite apparent, therefore, that the average American lacks the basic financial knowledge to make effective decisions about everyday financial matters. And, if they can’t afford professional help, what can they do?

The problem is that people must first see the need to get financial education and then take the initiative to actually do something. The good news is that there are many books available at the library or the local bookstore that can help address this issue. Many, however, may be hesitant to buy a book or go to the library. A better option for many may be self-education via the Internet.

There are a myriad of sites that offer tutorials on nearly every financial topic you can think of. Two in particular that include basic financial education are listed below:

(1) National Endowment for Financial Education (NEFE) offers a basic financial course titled “Smart About Money” where one can learn about getting out of debt and budgeting, setting financial goals and investing money to reach those goals.
(2) FINRA offers more than a dozen investor education modules and worksheets to help individual learn about budgeting, saving and investing.

The bottom line is that if you don’t feel you can afford to hire someone to help you with your finances, you can still educate yourself at little or no cost. Doing so will help you make better financial decisions and give you a feeling control over your financial destiny.

With the current economic crunch, many seniors are finding it harder and harder to make ends meet. One option we have written about before in our blog are reverse mortgages (Considering a Reverse Mortgage? Be VERY Careful, July 7, 2009). We recommended they be considered only as a last resort. Another relatively new option for some seniors to raise needed cash involves what are called “Life Settlements”.

A Life Settlement involves selling a cash value life insurance policy to someone other than the issuing insurance company. The party buying the policy is buying the right to your death benefits when you die. You can typically receive more than the cash value of the policy but less than the face value of the policy. Life Settlements typically are available to people who have life expectancies between two and ten years. The amount you can receive depends on your age, health and the terms of your life insurance policy.

While the promise of significant cash may be tempting, this new market has become quite intense with many participants, in some cases, vying to take advantage of seniors who may not be able to properly evaluate an offer. It is important, therefore for you to do your homework before selling a life insurance policy.

Here are some things you need to consider:

(1) Do you no longer need your policy? If you will need to replace your existing policy, you need to be sure you are still insurable and that purchase of a new policy will be cost effective. Life Settlements can trigger significant taxes if the amount you receive exceeds the total of premiums you paid. If you need to reduce the cost of your current policy, you may want to consider replacing it with another policy through what the IRS calls a 1035 exchange which can be done tax-free.
(2) Consider other, less costly alternatives, You may be able to borrow against your policy, or, depending on your policy’s terms and your health status, you may be able to receive accelerated death benefits. You may be able to downsize your home or possibly consider a reverse mortgage (not our favorite option).
(3) Shop around. It’s difficult to determine what a fair price is for your policy. What commissions will be received. Often, commissions can be as high as 30%.Get several quotes. If your state so requires it make sure the life settlement company or broker you are dealing with is properly registered. Check with your state insurance commissioner to see what regulations your state has and what information the state can provide.
(4) Ask the buyer how you can protect your privacy. What is their privacy policy and how will they protect your personal information.
(5) Review what your tax liability will be as a result of the sale. As we already noted, proceeds in excess of the total premiums you paid for your policy are taxable as ordinary income.

With the close of 2009 we can learn a very important lesson about investing. During the last 10 years, from 2000 through 2009, stock returns, as measured by the Standard and Poors 500 Stock Index (S&P 500), have lost 1.1%. Some have called it the “lost decade”. Some are questioning the wisdom of investing in stocks at all.

The lesson to be learned from the last ten years, however, is that we should continue to include stocks in our portfolios, but at the same time, we must ensure that our portfolios are well diversified and periodically rebalanced. In short, the lesson to learn is that diversification does indeed work.

It’s always dangerous to draw conclusions about investing from a single time period. The last ten years included some extraordinary events. We started off in 2000 with the internet stock craze and bubble followed shortly thereafter by the September 11th terror attack. Low interest rates introduced to counter the ensuing recession helped lead to the real estate crash of 2007 and 2008 and the current economic crisis. It was an extraordinary decade.

History tells us there have been 10-year periods in the past with similar poor stock returns relative to fixed income assets. When we meet with clients to discuss the risks of investing, we review the historical returns of equities and fixed income assets. In the book Asset Allocation by Roger C. Gibson, Mr. Gibson includes historical data on stock and bond returns. A review of all the rolling 10-year periods from 1926 through 2004 shows that in a bit more than 21 % of those periods, fixed income assets performed better than stocks. We can therefore see that the returns of the last decade were not that unusual.

Money Magazine’s January/February Investor’s Guide 2010 shows how investing regularly, diversifying and rebalancing improved returns over the last 10 years. A lump sum invested in the S&P 500, followed by $1,000 a month investments, lost 0.3% over the last ten years compared to the 1.1% loss for the same lump sum investment with no periodic additional investments. The article also showed that a lump sum invested in a diversified 80% stock/20% bond portfolio would have returned 2.9% over the last decade, while a similar portfolio with additional monthly investments of $1,000 would have returned 3.7%. Annual rebalancing further increased returns of the 80/20 portfolio to 3.8%. Three similar portfolios with a 60% stock/40% bond mix returned 3.6%, 3.9% and 4.3%, respectively.

Clearly, the returns of these diversified portfolios were nothing to rave about – but, they were positive returns during one of the most difficult economic decades ever. We are sure there are many investors out there who would have loved to have achieved similar results.

There is no guarantee that we will experience similar results in the future but unless someone can convince us of a better approach, we will continue to recommend broadly diversified stock/bond portfolios with periodic rebalancing. Don’t give up on stocks yet, but don’t shun bonds either.

As we begin the New Year, our thoughts turn to the preparation of our tax returns. We ask ourselves: “I wonder if I will get a refund this year?”, or “How much am I going to owe the IRS?” Every year it seems more difficult to prepare our returns. Thank goodness we have software programs like Turbo-Tax® and accounting professionals to help us. Every time Congress tries to tweak the economy by changing the tax code, they add more complexity to an already complex task.

To make matters worse, according to a recent article in the Wall Street Journal, we can look forward to “some 70 new taxes on the middle class and small businesses” that went into effect with the New Year, in some cases “thanks to Congress’s failure to prevent the expiration of popular and economically vital tax breaks on time.” (The New Year Brings Tax Chaos by Stephen Moore, January 8, 2010)

Most notable, perhaps are the alternative minimum tax (AMT) and the estate tax. According to Mr. Moore, some 25 million middle class American families with incomes as low as $75,000, could get hit with the AMT. Mr. Moore further points out that the AMT was originally designed to hit only the richest 100 Americans.

The estate tax expired, effective January 1st, making 2010 a good year to die, if you have a large estate. Previous changes to the estate tax that increased the estate tax exemption to $3.5 million per person in 2009, called for the complete elimination of the estate tax in 2010. However, if Congress does nothing this year, the estate tax will be reinstated at a 55% rate in 2011.

Members of Congress have indicated that they will reinstate the estate tax and possibly address the other tax changes retroactively to January 1st. Unfortunately, it makes it very difficult for tax and estate planning professionals to help their clients effectively do tax planning. In a few somewhat extreme cases, seniors even changed their living wills in 2009 to allow their heirs to extend their life into 2010, if necessary, to take advantage of the situation.

Other changes for 2010 include the expiration of the new homebuyer tax credit, the elimination of the deduction for state sales tax and local taxes, tax deduction for college tuition, and the research tax credit for businesses, to name a few.

With spending by Congress at record levels, the focus will turn to lowering the deficit. While one would hope Congress will work hard to reduce spending, it seems likely that we will see numerous increases in taxes along with more complexity and more uncertainty in 2010 and beyond.

While many people have the skills and motivation to manage their own money, they are probably in the minority. Normally, our clients come to us either because they need our expertise or they don’t have the time or desire to manage their own financial affairs. Nevertheless, we are amazed when clients meet with us, express an interest in having us help them and then put off gathering their financial information so that we can prepare a customized proposal for their review.

There are numerous reasons people do this. In a recent blog post titled “Getting Over the Financial Advisor Hurdles”, we noted that: “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.” They also worry about getting bad advice or are unsure of how to evaluate an advisor. And, in some cases, the concern about the cost stops them in their tracks even before receiving a specific quote. The aforementioned blog post addressed those concerns.

What we want to focus on here is the cost of doing nothing or putting off getting help. Time is money and letting your financial affairs continue to be poorly managed can cost you significantly.

Financial advisors often point to the “Rule of 72”. Simply stated, the “Rule of 72” can be used to estimate how long it will take to double your money if it’s invested at a particular rate of return. Let’s suppose, for example, that you can invest your money at 6% annually. Dividing 72 by 6 yields 12, which according to the Rule of 72 means that you can roughly double your money in 12 years if it is invested at 6%, annually. If you have 36 years until retirement, every dollar you invest now that earns 6% annually will be worth eight times as much upon retirement, since it will double in value three times in 36 years. So a thousand dollars invested now at six percent will be worth $8,000, roughly, in 36 years.

As we pointed out in our past blog, a good advisor can significantly reduce taxes or expenses on one’s portfolio. They can often help you reduce insurance premiums and increase portfolio returns while minimizing risk. They can help you better manage spending and increase your savings. They can help you avoid the emotional hang-ups that so often damage investment returns: holding on to winners too long, holding on to losers too long, letting taxes get in the way of wise investment decisions, chasing the “hot” asset classes, and so on.

The bottom line is that if you know you need help, take action now to get help. Every day you delay will cost you money. You work hard to earn your money. Shouldn’t you make an investment in managing what you have? To get you started, we like to quote Aristotle, who once said: “Well begun is half done.” Get started now and you’ll be well on your way to letting time work its magic.

We’ve talked many times about the “typical investor” who buys high and sells low. Think back to the tech stock bubble in 2000. What was everyone doing? They were chasing the tech stocks off a cliff. They didn’t want to miss out. It didn’t matter that prices were already bloated. They told themselves: “Surely tech stocks will go higher! Won’t they?”

At the time, all we heard on television, in the newspapers and in magazines was what was happening with all the tech stocks. At cocktail parties, everyone bragged about their big gains. They were stroking their own egos. They bought at high prices with no thought about when to sell. Most people couldn’t even imagine an end to the upturn.

Of course the party ended suddenly and the huge gains evaporated overnight. Those who bet big by moving substantial portions of their portfolio into the hot assets experienced significant losses. As the market dropped and dropped, some sold out near the bottom, making things worse. They bought high and sold low.

What lessons can be learned? Clearly, there were warning signs, signs that tend to be there again and again: the TV hype, the bragging at cocktail parties, the relentless newspaper and magazine ads touting the huge returns of the newest “hot asset” to invest in. Relentless media and social focus on the latest hot asset should be red flag to every investor. We’re not saying that there couldn’t be some opportunity to take advantage of. In many cases, however, it is likely that the opportunity already passed you by.

Ask yourself this: “What investment is currently being promoted heavily on television and on a daily basis by several different investment companies? What have you heard at social gatherings or from family members as the asset to invest in now? Our answer: GOLD. Is it too late to invest in gold? It may well be. And then again, it may not. There is a lot of concern about the declining dollar, future inflation and high interest rates. Many worry about a continue decline in the U.S. economy. Nevertheless, we suspect that gold prices could easily become a bubble that once again catches investors looking for a silver bullet.

If you just can’t resist the gold temptation, keep your investment to no more than 5% of your total portfolio value and set high and low prices at which to sell. Then, stick to those prices no matter what. That will help protect you from a bubble.

The red flags are there. Don’t ignore them. They may well save you from some big losses down the road.

A recent article in the Wall Street Journal, “Investors Hope the ‘10s Beat the ‘00s” by Tom Lauricella, showed a graph of the stock market returns by decade since the 1830s. As it stood on December 21, 2009 the decade from 2000 to 2009 was set to be the worst decade ever for stocks. So what can we expect in the next decade?

We should first note that the stock returns for the decade following each of the previous worst three decades since 1830 (1830s, 1910s, 1930s), all proved to be quite good for stocks (12.8% return in the 1840s, 13.3% in the 1920s, 9.6% in the 1940s). Keep in mind, however, that the 1920s were followed by the great depression of the 1930s. Can we be sure the 2010 decade will be better than the 2000 decade?

Another article in the Journal by Gerard Baker titled “A Gloomy Crystal Ball, With Glimmers” for the most part is not all that optimistic about the next decade. Mr. Baker states: “Just because one year, one decade, is forgettable doesn’t mean the next one won’t be even worse.” Mr. Baker states that the immediate outlook “warrants pessimism”.

Consumers are trying to reduce their excessive debt, trying to save more and will likely consume less than in recent times. The government is facing huge deficits as a result of its recent unparalleled spending spree. Current low interest rates could trigger continued decline in the dollar and high inflation. Future interest rates will likely rise substantially as a corrective measure by the Federal Reserve. We still have many residential foreclosures to come in 2010 and the commercial real estate market is a serious concern. Mr. Baker notes that “it took 25 years for the Dow Jones Industrial Average to return to its inflation-adjusted 1929 peak.”

But all is not gloomy. Americans are very resilient. We’ve recovered before and can do so again. As Mr. Baker states, “Americans are rather good at learning quickly from their mistakes.”

So what should you do to prepare for a worrisome 2010 and beyond. A lesson from 2009 will help. At the beginning of the 2009, would you have expected high yield bonds to return more than 45% this year? Would you have expected real estate mutual fund returns to top large domestic stock returns. The point is, it’s tough to know which asset classes will do the best in any given year. Therefore, the first thing you need to do to prepare for 2010 and beyond is to make sure your portfolio is broadly diversified and tuned to your risk tolerance.

In addition to that, we suggest you rebalance your portfolio at least annually, eliminate credit card debt, make sure you have an adequate emergency fund, step up your savings program, eliminate unnecessary spending to the extent possible and minimize investment expenses and taxes. Finally, we suggest you review all of your insurance policies to make sure your coverage is adequate.

While no one can predict what will happen in the next decade, taking the steps above will help prepare you for whatever may come your way.