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.

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.

Monday, April 11, 2011

Some of Our Favorite Quotes

We thought our readers might enjoy some of our favorite investment-related quotes. In most cases, they contain a bit of wisdom or a lesson to be heeded. Enjoy:

• Rule number one: Never lose money. Rule number two: Never forget rule number one. (Warren Buffett)

• As some perspective person once said, if all the economists of the world were laid end to end, it wouldn’t be a bad thing. (Peter Lunch, One Up on Wall Street)

• Bulls make money. Bears make money. Pigs get slaughtered. (Wall Street Adage)

• We will never buy anything we don’t understand. (Warren Buffett)

• I have probably purchased fifty “hot tips” in my career, maybe even more. When I put them all together, I know I am a net loser. (Charles Schwab)

• If investments are keeping you awake at night, sell down to the sleeping point. (Wall Street Adage)

• No tree grows to the sky. (Wall Street Adage).

• Money won’t make you happy….but everyone has to find out for themselves. (ZigZiglar)

• Don’t try to buy at the bottom and sell at the top. It can’t be done except by liars. (Bernard Baruch, 1870-1965)

Note: All quotes are from “The Quotable Investor”, The Lyons Press, Copyright 2001

Thursday, April 7, 2011

Higher Returns with Lower Risk?

Note: We published this article in the Oakland Press back in 2007. The concepts detailed here are a key element of our client investment strategy. We updated it to reflect changes we’ve made since then. We felt a reminder about the role diversification plays in your investment strategy would be appreciated by our readers.

A basic principle of investing is that the higher return an investment pays, the higher the risk of the investment. And, if you want low risk, you must expect lower returns. We all expect stocks to return more than bonds over the long run but nearly everyone knows that higher returns bring higher volatility. Fixed income investments, with their lower returns than stocks are less volatile, hence less risky.

Whenever a client calls touting some great new investment that promises to pay 12%-14% or more, “guaranteed”, we are immediately suspicious. In every such situation we’ve experienced, there has been a significant risk associated with the investment.

The more risk you take on, the greater the chance of losing money. Warren Buffet, considered by many to be the greatest investor of all times, abhors losing money. His Rule # 1 is “Never lose money”. His rule # 2 is “Never Forget Rule # 1.” Consider that if you lose 50% of your principle, you must achieve a 100% return to recover your losses.

So how do you go about lowering risk and reducing the chances of losing money? And, is there a way to lower risk and increase returns at the same time, contrary to the basic principle discussed above? Fortunately, the answer is yes! It’s called diversification. Proper diversification of your portfolio can boost your portfolio’s returns and at the same time lower the risk (volatility) of the portfolio.

Clients often come to us with a portfolio made up of a large number of stocks and mutual funds and believe that they are well diversified. Often their portfolios may contain some cash, one or two bond funds, maybe one or two international funds and a number of large domestic stock funds. More often than not, the stock mutual funds overlap, (i.e. they each invest in many of the same individual stocks). It’s not unusual for clients to have 60%-80% of their total portfolio invested in large company U.S. stocks. That’s not what we consider proper diversification.

To be properly diversified, you need to be invested in several distinctly different asset classes. We include eleven different asset classes in our clients’ portfolios. These include cash or cash equivalents, short-term bonds, Treasury Inflation Protected Securities (TIPS), high-quality intermediate-term bonds, high yield bonds, international bonds, large domestic stocks, small domestic stocks, international stocks, commodities and real estate equities. We utilize broadly diversified no-load (no commission) mutual funds, Exchange Traded Funds (ETFs) and index funds.

You may be wondering: “Why does diversification increase returns and lower risk?” Warren Buffett might say that it’s due in part to the fact that diversification reduces investment losses (Remember Warren’s Rule #1?). The distinctly different asset classes noted above experience different up and down cycles. Thus, real estate equities may be in their up cycle while other stocks are in their down cycle. Bonds may be doing poorly while stocks are rallying. International stocks may be up while U.S. stocks are down. The returns of these various asset classes are not strongly correlated, meaning that they move somewhat independently of each other.

The next logical question is: How much of an effect does diversification have? Well known speaker and investment manager, Roger Gibson, in his book “Asset Allocation: Balancing Financial Risk”, Dow Jones-Irwin, Homewood, Illinois 1990, cites a study of the performance of what he describes as a “traditional portfolio” versus the performance of what he calls a “broadly diversified portfolio”. The “traditional portfolio” includes only Treasury Bills, corporate bonds and S&P 500 stocks. The “broadly diversified portfolio” includes the same asset classes as the “traditional portfolio” plus international bonds, small company stocks, international stocks and real estate equities.

During a 10-year period ending 1988, the ‘traditional portfolio” returned 13.9% versus 15.3% for the “broadly diversified portfolio”. And, the higher return of the more diversified portfolio was accompanied by 0.8% lower risk as measured by the portfolios’ standard deviations (a statistical measurement generally equated to investment risk). Over 16 years ending 1988, the “broadly diversified portfolio” returned 12.3% versus 9.9% for the “traditional portfolio” with 0.9% lower risk.

So, if you want to pursue Warren Buffet’s Rule # 1, make sure your portfolio is broadly diversified. You can improve your portfolio’s return and at the same time lower your risk!

Monday, April 4, 2011

Why You May Need Help with Retirement Planning

We keep a folder of old articles and ideas for blog topics. While reviewing it recently, we came across a quiz that appeared in the Wall Street Journal way back in June of 2008 titled “Measuring Your Retirement IQ” by Glenn Ruffenach. The quiz was based on a number of different surveys. The results were not surprising.
Here are a few of the questions:

(1) What percentage of the workers surveyed reported that either they or their spouses had tried to calculate how much money they would need for retirement? Answer: Just 47%

(2) What method did they most often say they used to determine how much money they would need for retirement? Answer: They guessed

(3) When asked how much money they would need for retirement, how much did they say they needed? Answer: Most workers said they would need less than $250,000

(4) What percentage of the workers surveyed, whose employers offered 401(k) plans, were saving the maximum amount? Answer: only 7%

What conclusions can one draw from these results? Clearly, few workers are giving any thought to what they will need for a comfortable retirement. Most either haven’t paid any attention to it or have addressed the issue in a very casual manner.

Those not contributing the maximum to their employer’s 401(k) plan are leaving a lot of money on the table, particularly if they are not getting the full employer match. The employer match is essentially a risk-free return. What can be better than that? Those not contributing the maximum are also missing out on the tax-free growth of contributions they are not making.

The average couple receiving Social Security payments, according to the article, receives just $ 2,100 a month ($25,200 a year). If you have less than $ 250,000 saved, according to a commonly used financial planning rule of thumb, you can only plan to safely withdraw 4 percent of your portfolio, adjusted for inflation, each year during retirement. Four percent of $250,000 is $10,000. That would provide a total of just over $ 35,000 a year for retirement, with moderate inflation protection. We expect that many retirees would not be comfortable with only $ 35,000in annual retirement income.

The bottom line is that it appears that many American workers could use some professional advice to help them better prepare for their retirement. Are you one of them? If so, you need to give serious thought to getting some help.

Friday, April 1, 2011

Pay Attention to Your Healthcare Billings

Having just turned 65 last year, I’ve had a tough time getting things straightened out between our Medicare statements and our Blue Cross supplemental coverage. I’ve always paid close attention to our insurance claims to make sure I didn’t pay a bill I wasn’t responsible for. But with two organizations involved, it requires even more attention to detail.

Medicare covers some of the costs and then our Blue Cross coverage picks up where Medicare left off. There’s a Medicare deductible to pay attention to as well as Blue Cross deductibles and co-pays.

Our first problem was that the doctors and hospitals weren’t all sending their bills to Medicare for processing. Then, I discovered that in some cases the bills went to Medicare but were not then forwarded to Blue Cross for processing.

You should never pay a doctor or hospital’s invoice without making sure that your insurance company processed the claim. If you have both Medicare and a supplemental plan, you need to make sure they both have processed the claims. Cross-reference all statements to be sure the claims have been properly reviewed. Read your policies to make sure you’re not being billed for a procedure that should have been covered. Make sure you’re not being billed for a procedure that was not provided to you.

If you have a question, call your doctor, hospital, clinic or lab to get your questions answered. Call your insurance company if something doesn’t seem right.

We can’t help but wonder how the elderly can ever make heads or tails of their medical bills and insurance statements. If your parents are on Medicare, we highly suggest you inquire as to whether they need some help deciphering their medical bills and statements.

Whatever you do, don’t just assume a medical bill is right and send in your check. Take the time to read your policy, understand your coverage and check to make sure you’ve been billed properly.

We expect things may even get more complicated when the new healthcare plan is implemented. Now is a good time to establish good habits with respect to reviewing your healthcare billings. It may even save you some money!