Your Money

Our Final Blog!

2011-05-12T08:55:00.000-04:00

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 www.pattersonadvisorsllc.com . 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.

No Tree Grows to the Sky!

2011-05-06T09:06:00.001-04:00

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.

Additional Thoughts on Retirement Withdrawal Rates

2011-05-01T10:58:00.000-04:00

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 Blogger.com 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).

What You Should Do Now

2011-04-27T16:13:00.001-04:00

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.

New Study Sheds Light on Retirement Withdrawal Rates

2011-04-22T14:21:00.001-04:00

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.

Will Money Motivate Your Children?

2011-04-19T09:58:00.001-04:00

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.

Notify Credit Card Companies Before Traveling

2011-04-14T09:18:00.002-04:00

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.

Some of Our Favorite Quotes

2011-04-11T10:50:00.002-04:00

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

Higher Returns with Lower Risk?

2011-04-07T21:32:00.001-04:00

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!

Why You May Need Help with Retirement Planning

2011-04-04T17:50:00.001-04:00

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.

Pay Attention to Your Healthcare Billings

2011-04-01T16:28:00.000-04:00

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!

Avoid These Basic Money Mistakes

2011-03-26T09:09:00.003-04:00

Note: We wrote this article a couple of years ago for the Oakland Press. We believe these common mistakes need to be re-iterated, again and again. We’ve updated it to reflect some of our current thinking.

If you’re a new college graduate, it’s easy to get so anxious about investing that you fail to take care of some simple basics. And it’s not just twenty-year olds that make basic mistakes. We often have clients in their forties and fifties, or even older, who have failed to address the some of the following basic pre-requisites to investing.

First and foremost, everyone needs to establish an emergency fund. Financial planners typically recommend that an emergency fund equal to three to six months of fixed and variable expenses be maintained in liquid assets (cash or cash equivalents). This is to avoid having to liquidate investments at a possible loss as a result of an emergency. You can also afford to increase your insurance deductibles if you have more than the deductibles set aside.

If you are single or married with only one bread-winner, we recommend at least a six month emergency fund. If your household has two solid incomes, then a three-month fund may be adequate. Lack of an emergency often leads to excessive credit card debt. (Note: as a result of the recent “Great Recession”, we now favor a six month to twelve month emergency fund for two-income families.)

When you do establish your emergency fund, don’t place it in a bank checking or savings account earning a paltry 1% or 2% (or lower) return. Instead, you should find a solid higher-returning money-market fund paying close to the one-year CD rate.

Eliminating credit card debt is another basic pre-requisite before starting to invest. Interest rates of 15% and 16%, or more, are common for credit cards. It makes no sense to invest in a stock and bond portfolio paying at best a single digit return while you are paying nearly double that rate in monthly credit card interest. And, to earn a solid portfolio return requires taking on the risk of the stock market. Think along the lines that paying down credit-card debt is equivalent to earning a high-return with no risk.

Another common mistake people make is to give investing priority over addressing the most basic everyday risks that can be minimized with adequate insurance policies. Good medical coverage, disability insurance, life insurance, home and auto insurance are a must to avoid large losses that could forever impact your ability to achieve your lifetime goals. You might also want to consider long-term care insurance and/or umbrella liability insurance. (Note: long-term care providers have significantly raised rates recently and some have withdrawn from the market, altogether. Selecting a provider who will be around, “long term”, is more difficult than ever.)

Often our clients have no disability insurance. Your chances of becoming disabled on a given day are actually greater than your chance of dying. A long-term disability can seriously hinder achievement of your financial goals.

Besides credit card debt, other high-interest-rate debts should also be paid off before investing. Just as with credit-card debt, paying off other high interest-rate loans is equivalent to earning the associated loan-interest rate without taking on the risk of the stock market.

Finally, make sure you take advantage of employer 401(k) plan-matching contributions and stock-purchase plan discounts before dedicating other funds to new investments. Then, once you’ve taken care of the basics, when you do begin investing, get some unbiased help from a financial professional who has your best interests at heart.

Want to Know More About Your Advisor?

2011-03-22T12:51:00.001-04:00

With all the financial scams going around (think Madoff), it’s more important than ever to carefully check out any financial advisor you may be considering or even the one you are currently using. We noted in our last blog that a new disclosure document will soon be available to investors, Form ADV Part 2A and 2B. See our last blog posted on Sunday, March 20th, titled “New Disclosure Document Will Help Investors”, for details.

Another document is also available to investors, for review, called Form ADV Part I. Part I is a basic registration document that has to be filed with either the states an advisor works in or with the Securities and Exchange Commission, depending on the amount of “assets under management”, the advisor has. Previously, advisors with more than $25 million in assets under management had to register with the SEC and each state in which they had more than five clients. Now, that hurdle is $100 million in assets under management.

The new form ADV Part 2A must be filed by March 31st. Once it is filed and approved, both parts of the ADV will be available for review by investors on the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov). If you go to this site you can then select “Investment Adviser Search” to find the adviser firm or representative you are interested in.

Disclosures regarding arbitration, bankruptcy filings and civil or criminal actions against the advisor are included. Details regarding the business services offered, how the adviser is compensated and any potential conflicts of interest are included.

You can’t be too careful when it comes to seeking help with your finances. Do your homework and you'll be able to sleep better at night.

New Disclosure Document Will Help Investors

2011-03-20T20:02:00.001-04:00

By the end of this month registered investment advisors will be required to begin using a new disclosure document that will help investors better evaluate and compare investment advisors.

The new documents will replace one of two forms investment advisors have to file with the Securities and Exchange Commission (SEC). The documents are called the ADV Part I and ADV Part 2. ADV Part I is filed online, primarily for review by the SEC and the States that investment advisors operate in. The ADV Part 2 is referred to as the “brochure” and must be provided to prospective clients for their review.

In the past, the ADV Part 2 was unavailable in an electronic format and was extremely cumbersome to change. The new version can be created in Microsoft Word and uploaded into Adobe Publisher, making copies available online via a PDF file.

The new ADV Part 2consists of two parts, Part 2A and Part 2B. Part 2A must be written in “plain English”. The SEC has even provided investment advisors with a plain English handbook with suggestion regarding how to simplify their ADV.

The ADV Parts 2A and 2B provide detailed information regarding who the investment advisors are, how they do business, how they are compensated and what, if any, conflicts of interest may exist. It also includes a detailed explanation of the strategies employed by the advisor and the risks involved in those strategies.

We found that it was quite time consuming creating the new ADV Part 2A but feel strongly that the new documents describe clearly who we are, what we do and how we are compensated. We believe our approach better supports the interests of our clients and believe that the new ADV Part 2 better makes that case to prospective clients. Investors will be able to make better decisions when hiring an advisor to help them manage their financial affairs.

It’s Not the Time to Panic

2011-03-17T14:38:00.000-04:00

We’ve seen the market drop significantly the last two days on fears the nuclear radiation problem in Japan may worsen. It’s certainly a concern to all. On top of that we have many other things to worry about, including our economy, rising U.S. Debt, problems in the Middle East and more.

Nevertheless, the Japanese are resourceful, resilient people. Trouble may remain in the short-term, but long term we can expect they will rise to the occasion and come back strong. The other issues we expect will work themselves out as well. We’ll continue to see ups and downs in the market. More problems will come and go.

There’s a lesson to learn, however, if you have been thinking about getting out of the market the last couple of days, either partially or entirely. If you have been thinking it’s time to sell, it may be an indication that you either should not be in the market at all or that you have too much invested in the market.

Smart investors look at market downturns as opportunities to buy. They buy low and sell high. What we call “typical investors”, tend to buy high and sell low, as they let their emotions drive their investing actions. We wouldn’t be surprised to see a big jump in the market in the next few days as investors look to the long-term and see the drop in prices as an opportunity to buy low.

We’re not recommending everyone go out and buy stocks right now. Whether an individual investor should consider doing that depends on many factors specific to that investor. We certainly could see a further decline in market prices during the coming days and weeks.

The point is, that if you’ve been having trouble sleeping at night because of the recent stock market gyrations, then you need to re-examine your investment strategy (assuming you have one). And, if you aren’t really sure of what you should do, you need to seek some professional help.

Words of Wisdom from Will Rogers

2011-03-13T21:00:00.000-04:00

It’s been a tough slog the last few years, economically speaking. The economy now appears to be moving in the right direction, yet many people are still hurting from the “Great Recession”. Their homes are worth less and their portfolios took a beating. Things are still not good on the “home front”, no pun intended. Home prices may still turn downward some more before hitting a bottom.

Investors’ portfolios, on the other hand, have, in most cases, made a nice recovery, unless you got out of the market and delayed too long getting back in. Even though many have recovered much of what they lost, they feel like they’ve lost precious time preparing for their retirement and are looking for the goose that laid the golden egg.

Some advice from a well-known celebrity of the 1920’s and 1930’s, William Penn Adair Rogers, better known as “Will” Rogers, is worth noting. He said: “Let advertisers spend the same amount of money improving their product that they do on advertising, and they wouldn’t have to advertise it.”

Every day, we hear commercial after commercial touting gold as the thing to buy. It may turn out that it is the best thing to buy right now. Yet the more people push something as the next best thing, the more dubious I become.

I had a couple of people ask me about a video presentation that’s making its way around the internet. It’s very long, and presents a doom and gloom picture of the American economy. If you break out the presentation, you have to re-start from the beginning. I finally figured out how to just view a written version of it. It talks about how to get free advice on this and that and in the end only gives the “free” information if you sign up for the writer’s investment newsletter. I decided to check on his background and discovered that he had been sued by the Securities and Exchange Commission. I noted today that he is advertising on Fox news. I hope the SEC is keeping an eye on him.

You often see advertisements for computer trading programs that will “surely help you beat the market”. If they are so good, why doesn’t the seller just concentrate on his portfolio instead of pushing his trading techniques. When everyone starts using the same trading strategy, that’s when they no longer work. So if you really had a “can’t miss” strategy, why would you sell it to anyone else?

The whole point of this blog is to remind everyone that there’s no silver bullet out there. There’s no free lunch. If you want to get rich, you must work hard, save your money, invest wisely and be wary of those who have the magic solution to getting rich. You need to do due diligence before investing with anyone. You need to find out how they get paid, what their credentials are and take what they say with a big grain of salt.

Half Full or Half Empty?

2011-03-09T18:15:00.000-05:00

We are basically optimistic people and tend to focus on the positive rather than the negative. We’ve had an “insider” (aka family member) mention that the blogs of late have had a pretty consistent cautionary tone. That’s due in part to our desire to help our readers address the issues that make them vulnerable when economic downturns occur.

Today, we’d like to report on some positive signs that things are getting better. A study by Charles Schwab and Company titled “Independent Advisor Outlook Study”, conducted between January 18th and January 28th, 2011shows that independent registered investment advisors (RIAs) are now quite optimistic about the economy. Schwab conducts its study every six months and the recent study shows a marked improvement in RIA optimism.

The survey included some 1300 RIAs with over $284 billion under management. The report stated that more than three-quarters of the RIAs surveyed (77 percent) expect the S&P 500 to rise in the next six months compared to 63 percent in the July 2010 study. According to the study, more than 50 percent classified themselves as “bulls” and less than 10 percent as “bears”.

Below are some of the findings included in the study:

• U.S. Treasury yields: Sixty-four percent think U.S. Treasury yields will increase in the next six months, while only eight percent think they will go down.

• Bush tax cuts: An overwhelming majority (85%) believe the extension of the Bush tax cuts will have a favorable impact on the stock market and economy overall.

• Quantitative easing: Fifty-five percent say the quantitative easing activities being conducted by the Federal Reserve will have a favorable impact on the stock market and economy overall.

• Inflation: Sixty-four percent of advisors think inflation will increase over the next six months, up significantly from just 28 percent six months ago.

• Cost basis reporting changes: Nearly half of RIAs’ clients (48%) are unaware of the impact the recent changes to cost basis reporting will have on their tax situation.

We hope the study portends a continued improvement in the economy. We live in turbulent times, which sometimes makes it difficult to see the glass as half full versus half-empty.

Don’t Take Your Eye off The Ball

2011-03-06T16:56:00.000-05:00

In the game of golf, it’s not uncommon for friends of a new golfer to repeatedly tell them to “keep their eye on the ball” or “keep their head down” after they dribble their fairway shot fifty or sixty yards up the fairway. Repeatedly hitting the long ball requires concentration and practice. If you don’t keep your eye on the ball, the results will be unpredictable. If you don’t spend some time at the driving range or get some lessons, you’ll likely not improve.

Success financially also requires concentration and focus on your goals. Help from a professional can be extremely beneficial. Many people fear that hiring some help will cost too much. Yet, if you hire the right advisor, the benefits can be huge. While taking the big step to get help from a financial advisor is, in many cases critical, it’s only a start. If you take your eye off the ball, you may find yourself in the rough or the sand trap with a sub-par financial future staring you in the face.

Periodic financial reviews can be instrumental in keeping you on track. It’s not unusual for us to see financial clients stray from their original plans. You might assume that in most cases, clients spend too much and face the prospect of running out of money. While that happens often, we also see the opposite case.

Some conservative clients are so worried about running out of money, that they are overly frugal. They have enough money to take an occasional overseas trip, eat out more often or buy a new car but hesitate to do so out of fear their money won’t last. They need a professional advisor to tell them it’s OK to spend.

We’ve also seen cases where we tell people they have sufficient funds, even encourage them to spend more and then later have to pull in the reins a bit as they go overboard.

As part of our investment services annual contracts, we provide our clients with phone/email financial consulting and an annual “mini-analysis” of their choice. They can request a “quick retirement” analysis, estate plan review, insurance review or other analysis of choice during each twelve-month contract year. These reviews are essential to keeping them on track to achieve their goals.

We are in some very dynamic times. It’s very difficult to predict the future. A one-time financial plan can be very beneficial. But things are constantly changing. To ensure ongoing success an occasional tune-up, a trip to the driving range or a quick lesson can help ensure long-term success and help you keep your eye on the ball.

Are You Managing Your 401(k) Account?

2011-03-03T09:19:00.000-05:00

Many Americans pay little attention to their 401(k) (or other similar type account such as a 403(b) or 457 account), let alone to their entire portfolio. A recent article in the Wall Street Journal titled “401(k) Advice – For a Hefty Fee”, by Karen Blumenthal (January 29, 2011), pointed out some interesting statistics regarding 401(k) accounts:

(1) The Employee Benefit Research Institute and the Investment Company Institute (a fund-industry trade group) reported that 17% of 401(k) account holders in their twenties owned little or no stock. Young investors should generally hold more stock in their portfolios than bonds, unless they are saving for a short-term goal.

(2) The article also reported that in those 401(k) accounts where company stock was a choice, 30 percent of those over forty years of age held more than 20 percent of their account in their company’s stock. When times are bad and a company has problems that force it to lay off employees, the company stock price is usually depressed as well. Holding too much of your company’s stock is a risky thing to do.

(3) A Schwab study reported that 53 percent of investors found that selecting 401(k) options was more difficult than selecting health benefit options.

Ms. Blumenthal’s article focused on new services being offered by Schwab, Fidelity, Vanguard and J.P. Morgan Chase to help investors manage their 401(k) accounts. In some cases, investors can quiz a financial planner and in other cases they can pay to have their account managed for $40 to $60 a year for every $10,000 managed (0.4% to 0.6% of the amount managed). Accounts over $100,000 pay less. Those fees are in addition to mutual fund fees.

Ms. Blumenthal notes that in many cases the management services are provided by outside third parties who act as a fiduciary for the investor. A fiduciary is required to act in the best interests of the client. Investors need to provide other information about their situation, such as how long they plan to work, other assets they have, etc.

One benefit of the approach is that those who sign up for these services generally tend to save more. A survey by Schwab showed that 70% of those receiving help nearly doubled their savings rate. Apparently, when one gets serious enough to pay for help they make more of an effort to save.

This new support can make a difference in your long-term financial success. It’s not cheap, however, and still leaves the need to manage other accounts outside your 401(k) as well as your other financial affairs. Another option is to consider working with a financial planner to develop a comprehensive financial plan that addresses your total financial well-being.

Make Sure You Read the Fine Print

2011-03-01T10:22:00.003-05:00

We have written several articles recently about significant changes in long-term care. Due to the high costs of providing long-term care, many companies have raised premiums substantially, in some case by as much as 40 percent. Others, such as Met-Life have stopped issuing new policies. For details see our past blogs titled: “Another Blow for Long-Term Care Insurance” (November 13, 2010) and “More News on Long-Term Care” (February 15, 2011).

A recent article in the Wall Street Journal, titled “The Latest Long-Term Care Snafu”, by Anne Tergesen, January 22, 2011 pointed out some additional issues you need to be aware of.

Many older, long-term care policies have provisions that can make it difficult to successfully make claims. The article points out that by taking care to read the policies in detail so that you understand the terms of the contract, you can, in many cases, avoid having a claim denied. Today’s policies generally are more liberal in their coverage than the policies written twenty years ago, according to the article.

Some of the rules to be aware of that the author pointed out in the article are:

(1) Some policies require a three-day hospital stay before benefits kick in. Therefore, patients with Alzheimer’s, who are physically in good shape, may not be able to receive benefits after satisfying the a 90 to 100 day waiting period. Family members may move Mom to a nursing home, pay for the first 100 days and then find out that mom can’t receive benefits because she didn’t spend three days in the hospital first.

(2) Make sure a health-care professional certifies that the disability will last 90 days or longer. Make sure the claim is documented adequately, as well. It may pay to seek help in preparing a claim from a geriatric care manager.

(3) Some insurers send assessors to verify disabilities. Some seniors, embarrassed by their disabilities, downplay their problems, only to have their claims denied.

(4) Some insurers have a 90 calendar-day waiting period before benefits can start. Others have a “service-day” waiting period where only days where care was paid to a licensed provider counts. In those cases, families can’t satisfy the waiting period requirements by taking care of Mom or Dad themselves.

(5) Some policies require that caregivers have specific licenses in order to be covered. Others require a certain number of beds in a facility (ruling out places like adult family homes).

As you can see, it’s very important to carefully understand the fine print in any long-term care policy you or your parents have or on any policy you are considering. Clearly, with the cost pressures on insurers, the recent increases in premiums and the companies getting out of the business, you can be sure that insurers will only honor future claims that meet all contract requirements.

Words of Wisdom for the Young

2011-02-27T08:01:00.000-05:00

As your children and grandchildren go off to college to start their careers, perhaps the best advice you could give them would be to seek their passion. Tell them not to focus on how much money they can make. Seek out a career doing what interests them the most.

John D. Rockefeller (1874-1960), an American oil magnate, once said: “I had no ambition to make a fortune. Mere money-making has never been my goal. I had an ambition to build.” And build he did. He founded Standard Oil Company and became the first American to be worth more than a billion dollars.

At a young age, Rockefeller tithed 10% of his earnings to his church. When he retired he founded a number of foundations focused on education, medicine and scientific research. He was the founder of the University of Chicago and Rockefeller University.

Those whose careers are in line with their passions, often seem to excel beyond their expectations. Even if they don’t make a lot of money, they are rewarded with the satisfaction they get from doing what they love.

And, they don’t necessarily have to accumulate a huge sum of money so that they can retire at age 65. Since they love what they do, they can continue on into “semi-retirement”, supplementing their savings, Social Security and pension earnings with income from the work they enjoy.

Surely other benefits abound from doing what you love. We have no evidence but expect that such careers are less stressful, more rewarding and likely promote better health.

And how often do we hear of someone who retires and turns their favorite hobby into a business that becomes successful beyond their wildest imagination?

Sure, money is great, but it’s only one means to achieving other goals. Those goals surely include doing things you enjoy, so why not choose a career focused on your passion?

Will Inflation Soon Be Rearing Its Ugly Head?

2011-02-25T11:10:00.000-05:00

Senior citizens have been complaining that they haven’t received an increase in their Social Security checks for two years now. The good news is that it may not be too long before they will see an increase. The bad news is it may not be too long before they’ll receive an increase. Keep reading to see why it’s also bad news.

As most people know, Social Security increases are tied to the rate of inflation. Inflation has been very low the last two years, so there haven’t been any bumps in Social Security benefits. However, many feel that the way inflation is calculated for Social Security purposes, doesn’t accurately reflect the true impact of inflation. For example, used car prices are used instead of new car prices. Rental costs are used for housing instead of actual house prices. Therefore, Social Security increases may well not be in line with the actual increase in prices.

If inflation goes up enough in the near future, seniors may again see an increase in their Social Security Benefits. At the same time however, the cost of living may go up more than the increased benefits.

With all the money the government has been dumping into the economy, we’ve been worried that inflation would soon begin to take off. The unrest in the Middle East has caused turmoil in the stock market and we are reading every day about rising food prices.

Yet even with these signs of renewed inflation, there are some who are saying that inflation will be modest going forward. At the time of this writing (February 24, 2011), an article by David Wessel was published in the Wall Street Journal titled ‘Tinker Bell’ Economics Colors Inflation Predictions . The article discussed the theory that inflation is caused in part by the expectations people have about inflation. The article stated that Ben Bernanke, Federal Reserve Chairman, ”says that it’s hard to sustain inflation with so many people out of work and so many offices, stores and factories empty.” It went on to say that Mr. Bernanke sees no big rise in inflation expectations.

We hope Mr. Bernanke is right. If not, you might want to consider including Treasury Inflation Protected Securities (TIPS) and some commodities in your portfolio.

Aim To Be a Creator

2011-02-23T10:01:00.000-05:00

We are hopefully coming out of one of the worst economic periods of all time. You’re feeling good. The stock market has rallied from its horrible lows. Your Social Security payments have been reduced by 2%. You’ve paid off your credit card debt and you’ve kept up on your house payments. What’s more, you didn’t get laid off during the crisis and you’ve even been working some overtime. You are confident your job is safe. After all, if you kept your job through the “Great Recession”, it must be safe. Right? Perhaps not.

A recent article in the Wall Street Journal provides reason for many to be concerned about the long-term viability of their jobs. The article, titled “Is Your Job an Endangered Species” by Andy Kessler (Thursday February 17, 2011) says that part of the reason we aren’t seeing the unemployment rate go down is a result of technology. He states: “Technology is eating jobs – and not just obvious ones like toll takers and phone operators. Lawyers and doctors are at risk, as well.”

That’s not to say that technology is the only reason for the lack of jobs. He notes that new regulations, payroll taxes and health-care costs make hiring people costly. However, new technology is rapidly replacing people. Among the professions with fewer jobs, Mr. Kessler noted were tellers, phone operators, stock brokers, stock traders and travel agents.

Mr. Kessler states that there are two types of workers in our economy: creators and servers. Creators, he says, are the ones who drive productivity. They are writing software, designing chips, doing research, inventing new products. Servers, service the creators. Many servers, he says will be replaced by machines and computers.

According to Mr. Kessler, even doctors and lawyers are at risk. Computer software that can scan legal documents and computer-aided diagnosis programs can do a lot of the work of lawyers and doctors much less expensively.

The bottom line is that unless you are a creator, your job may be at risk at some point down the road. You may want to give some thought to obtaining some new skills. We suggest you check out one of our past blogs titled: “Maybe It’s Time to Diversify Your Skills”, posted September 6th, 2010.

These days, it seems that nothing is a sure thing. The more you prepare for all contingencies, the better you’ll be able to sleep at night!

Saving Enough for Retirement?

2011-02-20T20:10:00.000-05:00

One of our recent blogs discussed how you could use the “Rule of 72” to get a better feeling about how much you’ll need for retirement (See “Rule of Thumb Puts Retirement Needs in Perspective”, February 4th, 2011).

At the present, inflation is fairly tame, but we are seeing signs of trouble ahead. Recent articles in the newspapers and on TV talk about rising food prices. The unrest in the Middle East raises the specter of higher gasoline prices. There were already predictions of $4.00 per gallon gas prices for this summer, prior to the upheaval in Egypt.

Our Rule of 72 shows that at 3% inflation, the cost of living will double in 24 years. If inflation is 4%, it will double in just 18 years. If you expect to live until your eighties and retire at 65, you can therefore expect to see a doubling in your cost of living during your retirement years.

It’s not surprising then that Saturday’s Wall Street Journal included an article about how tough it’s going to be for the Baby Boomers to have enough money for a comfortable retirement. In the article, titled “Retiring Boomers Find 401(k) Plans Fall Short” (E.S. Browning, Saturday/Sunday, February 19-20, 2011), Mr. Browning states: The median household headed by a person aged 60 to 62 with a 401(k) account, has less than one-quarter of what is needed in that account to maintain its standard of living in retirement, according to data compiled by the Federal Reserve…”

Mr. Browning went on to say that 60% of households nearing retirement age have 401(k) accounts. Those accounts he says: “represent the majority of most people’s savings”.

If you are like the typical person nearing retirement, you don’t have a lot of time to make up the difference. You may have to work longer, save more, spend less and plan on a more austere retirement budget. If you have a hobby that you can turn into a small business, you may be able to supplement your retirement income and perhaps make up for the likely shortfall. At the same tim,e you’ll be doing something you love, so it won’t really seem like work!

Most people, unfortunately, have no idea of what they will need to retire. If you haven’t done any planning, you should consider seeing a professional to help you make the most of what you have and the time left until retirement. One thing is quite certain. With the state of our economy and the prospect of higher prices, taxes and inflation, you need to increase your savings as much as possible to prepare for a comfortable retirement.

A More Fiscally Conservative Mortgage Market Ahead?

2011-02-17T13:46:00.001-05:00

There were a multitude of causes for the recent “Great Recession”. Many blame Wall Street and the big banks. They surely deserve some of the blame. One major contributor, however, was our Congress, seemingly bent on providing housing for low-income families. They pushed Fannie Mae and Freddie Mac to offer low-down-payment mortgages to people who really couldn’t afford the cost of a home. This helped fuel a runaway real estate market that was helped by low interest rates.

The new regulations passed last year by Congress were touted as a key to preventing another such crisis. Yet the issue of what to do about of Fannie and Freddie was glaringly unaddressed by the legislation. Taxpayers were on the hook to pay off the billions of dollars of debt the government had guaranteed for Fannie and Freddie.

We were delighted this last week to hear that the Obama administration was recommending that government support for Fannie and Freddie be discontinued. The administration recommended several alternatives that would take several years to complete.

We will likely see less government backing for mortgages, higher mortgage insurance premiums, tighter underwriting rules and higher equity requirements for borrowers. Thus, it will be more difficult to buy a home and we will see fewer homeowners in the future. While that may see like a bad thing, it’s better than the alternative of another recession and housing crisis.

We should also note that banks are already beginning to require that homeowners make larger down payments. An article by Mitra Kalita, titled “Banks Push Homebuyers to Put Down More Cash” (February 16th in the Wall Street Journal) pointed out that, as part of its recommended changes, the Obama administration has recommended a minimum 10% down payment for conventional loans. In the article, it was noted that last year the average down payment for conventional loans was actually 22%, more than double what it was three years ago.

The good news is that these changes will help prevent an over-zealous housing market in the future. The bad news, however, is that these changes will make it more costly and difficult to obtain a mortgage and will likely slow down the housing recovery that is so important to our economy.

More News on Long-Term Care Insurance

2011-02-15T08:50:00.001-05:00

We just received an email from Bob Gertie, CEO of Advisor Insurance Resource (Advisor Insurance Resource.com). In his email, Bob discusses the fact that another long-term care insurance provider (Berkshire) is dropping out of the market at the end of 2011.

We have written in previous blogs that significant changes are taking place in the long-term care insurance industry. (See our blog titled: “Another Blow for Long-Term Care Insurance”, November 13, 2010). In that article we noted how MetLife was dropping out of the long-term care (LTC) insurance market and that John Hancock had recently increased prices of up to 40 percent on its policies.

Mr. Gertie noted that Berkshire has a very low market share in the industry and typically charged premiums that were often 30 percent higher than other insurers.

Mr. Gertie went on to say: “Berkshire’s decision solidifies my view that we will end up with only a few companies offering long-term care insurance in the future. He noted in his email that the largest providers of long-term care insurance were currently Genworth with 1,072,111 policies, John Hancock with 881,622 policies and Transamerica with 217,119 at the end of 2008.

He noted that it doesn’t make sense for companies with a low sales volume to stay in business due to the high expenses to meet new regulatory requirements, sales and marketing costs and new business underwriting costs.

The bottom line: if you decide to purchase a long-term care policy, make sure you buy it from one of the large providers. The smaller companies likely won’t be able to compete in the long run.

More About the Risk of Bonds

2011-02-13T19:01:00.002-05:00

In a recent blog titled “So You Think Bonds Are Safe?” (Posted Saturday, January 22, 2011, we discussed many of the risks associated with investing in bonds. We won’t repeat the points we made in that article but we wanted to follow up on a concept we introduced to our readers: the concept of a bond’s “duration”.

In the article we discussed at length the how interest rates affect bond prices. If interest rates go up, bond prices come down and vice versa. If you hold a bond to maturity, and the company that issued the bond stays in business, you’ll receive the principle value of the bond and generally won’t lose any money (You could lose money, if you bought the bond for more than the face value of the bond. This could happen, if at the time of your purchase, interest rates are lower than when the bond was issued.)

If you have invested in a bond fund, you will likely be invested in hundreds of bonds and can’t just hold on until all the bonds mature. After all, the fund manager will be buying and selling bonds as he sees fit. Whether you make a profit and how much you make will be affected by a measure called the fund’s “duration”.

Duration is a measure of a bond funds’ sensitivity to interest rates. The shorter the duration the less sensitive the bond funds’ net asset value is to an increase in interest rates. The longer the duration, the more sensitive it would be. Generally, a bond fund with a duration of 5.0 years would drop 5 percent in value for every 1 percent increase in interest rates. Vice versa, the fund will gain 5 percent in value for every 1 percent drop in interest rates.

How one calculates the duration of a bond or bond fund is beyond the scope of our blog. You don’t really need to know how to calculate a bond fund’s duration, however, since Morningstar® provides it for you online. If you go to Morningstar.com, for example and look up JASBX, the Janus Short-Term Bond Fund and then click on the “Portfolio” tab, you will see its “Average Effective Duration,” listed on the right, is 1.8 years. Thus, if interest rates rise 1 percent, you can expect the net asset value of the fund to drop 1.8 percent.

With interest rates likely to increase in the coming years, an investor should be careful about buying bond funds with high durations.

Words of Wisdom from Mark Twain

2011-02-09T16:37:00.000-05:00

We all know Mark Twain from his wonderful novels: The Adventures of Huckleberry Finn and The Adventures of Tom Sawyer. According to Wikipedia, he started out as an apprentice to a printer. He also became a typesetter and while doing so, he contributed articles to his older brother Orion’s newspaper. Following that, he became a riverboat captain and then went out West to join his brother. He tried gold mining but failed at that and then turned to journalism. He wrote travelogues and became famous with his story- The Celebrated Jumping Frog of Calaveras County.

He made a lot of money as a speaker and writer but was not a good businessman. He was eventually forced to declare bankruptcy. It seems ironic therefore, that he was known for his quotes about money and the markets. Our book of financial quotes that gives us ideas for our “Words of Wisdom” blogs, has no less than seven quotes from Mark Twain.

One of his quotes seems appropriate for the current times. Indeed, it’s actually appropriate for all times. He said: “there are two times in a man’s life when he should not speculate: when can’t afford to and when he can”.

Lately, the stock market has been on a tear. It’s tempting for all to jump on the bandwagon. We don’t want to be left behind. We don’t want to miss the party. But whether we are wealthy or whether we are struggling to make ends meet, we should pay heed to Twain’s advice. When a “can’t fail” hot asset comes along, should you invest a bit? Maybe. Invest a lot? Probably not. The wise investor, buys low and sells high. Twain should know. He learned the hard way.

Market Back Over 12,000 --- Time to Relax?

2011-02-06T11:01:00.002-05:00

With the Dow Jones Industrial Average now over 12,000 and many talking about continued recovery, is it time to take a breather, relax and quit worrying about the economy and your children and grandchildren’s future?

We think not. While we are as hopeful as everyone else that the world economy will soon recover and the U.S. can get its arm around its debt, there are so many uncertainties, we think it’s best to continue to plan for tough times ahead.

We’ve written many times recently of the continued downward trend in home prices and the continuation of foreclosures at a rate higher than last year. Employers remain hesitant to hire and we’re a long way from getting our arms around our rising debt.

The unrest in the Middle East that surfaced this past week could have huge implications for the world economy. Gasoline prices were already projected to hit $4.00 a gallon this summer, prior to the crisis in Egypt. Commodity prices are on a rampage.

An article in the Wall Street Journal this last week titled “Emerging-World Fear: Inflation” by Tom Lauricella and Alex Frangos (Monday, January 31st, 2011) discusses the problem with rising inflation in emerging market countries. In the article, the authors quoted Michael Shaoul of Oscar Gruss & Son who wrote in a research note: We currently view overheating within the emerging-market complex as the greatest macro peril facing the global economy.”

Interest rates here in the U.S. have been at an all-time low for some time now and at some point will rise, along with inflation. Municipalities and state governments, with their rocky finances could likely see higher interest rates sooner, rather than later. And, it’s hard to imagine that we won’t see increased taxes in the not-too-distant future, as the government at all levels, tries to address the debt problem.

We are generally optimistic in nature. But, while there are some hopeful signs of an improving economy, there is still a lot to be concerned with. We believe it prudent to continue to focus on strengthening your balance sheet. Pay off credit card debt; pay down your mortgage and any other loans; cut discretionary spending and increase savings. There may still be some rough roads ahead.

"Rule of Thumb" Puts Retirement Needs in Perspective

2011-02-04T19:31:00.001-05:00

You may or may not have heard of a rule of thumb called the “Rule of 72”. It’s a handy rule you can use to estimate how long it will take you to double your money based on a particular interest rate. Most people use it to project how their portfolio will grow depending on the investment return they expect to realize. You can also use it to estimate the impact of inflation on your purchasing power.

First, a quick explanation of the rule. It’s really quite easy to apply. Let’s suppose you believe you can earn 7 percent over the long run on your investments, before tax, and 6% after tax. If you divide 72 by the after-tax return of 6, the result is 12. The result of this calculation, 12, is the number of years, approximately, that it will take for you to double your money, assuming an after-tax rate of return of 6 percent.

Thus, if you currently have a portfolio of $250,000 and believe you will need at least $1 million in order to retire, you will need to double your money twice, first to $ 500,000 and then again to achieve your $1 million. If you expect to receive an after-tax return of 6 percent it will therefore take you 24 years.

In planning for retirement, we believe too many people fail to consider the impact of inflation on the amount of money they will need in retirement. This is especially true for those in their sixties, who often use their current spending rate to estimate what they will need in retirement. Yet, they may live another twenty to thirty years. If inflation during their retirement years is 3 percent, according the rule of 72, their living expense budget will double in just 24 years, and in just 18 years, if inflation is 4 percent!

Applying this simple rule can open your eyes to the difficult task of saving for retirement. In most cases, the amount you’ll need is likely far more than what you’ve been thinking. We hope you’ll find this simple rule a helpful tool to bring things into perspective.

Continued Troubles for Real Estate

2011-02-02T19:09:00.000-05:00

Although there are signs the economy is improving, a significant roadblock appears likely to remain in place for sometime to come. Numerous articles we’ve read lately point to a continued downward trend in home prices. We wrote in a recent blog that you shouldn’t consider buying a new home unless you plan to stay for several years.

On Monday (January 31, 2011) two articles appeared, attesting to the further decline in home process. In an article in the Sarasota Herald Tribune by Jack McCabe, Chief Executive Officer of McCabe Research and Consulting LLC, Mr. McCabe stated that it will be sometime before we can declare that housing prices are going to start going up. He said: “We’re not there yet and won’t be in 2011 or, quite honestly, in the near future.”

While some areas of the country may be experiencing a rebound, Mr. McCabe was talking specifically about Florida. A primary reason for his doom and gloom, as stated in his article is: “According to the Mortgage Bankers Association, the largest wave of highly toxic, negative amortization junk loans to hit first-term rate adjustments occurs in 2011-12, portending an additional wave of distressed properties hitting the market for sale in addition to today’s current inventory.”

According to Mr. McCabe, the median price for a single-family home in Sarasota, Florida dropped from $322,700 in 2005 to $160,100 by the end on 2009. Prices dropped another 1.8 percent in 2010 and Mr. McCabe expects the price to drop another 2 to 3 percent in 2011, with median condominium prices to drop another 5 to 10 percent.

Another article, yesterday day in the Wall Street Journal by Nick Timiraos stated that “housing prices are falling at an accelerating rate in many U.S. cities. While Mr. Timiraos noted that the decline is not universal, he noted that a Wall Street Journal survey found that prices declined in the fourth quarter in all of 28 major metropolitan areas tracked.

What this tells us is that any significant economic recovery will likely be muted by real estate prices. Consumers need to continue to be conservative and concentrate on reducing debt, increasing cash reserves and spending cautiously.

Here We Go Again

2011-01-28T20:33:00.000-05:00

Today the Dow Jones Industrial Average dropped 166.13 points or 1.39 percent. The Nasdaq was down 68.39 points or 2.48 percent. The S&P 500 was down 1.79 percent. The reported reason: the unrest in Egypt and concern about interruption in the oil markets.

Just when everyone thinks things are getting better, some unexpected event occurs to create more uncertainty. I’m sure there are some out there who predicted the turmoil in Tunisia but most people didn’t see it coming. And even if they did, would they have also predicted what is now happening in Egypt? And would they have been so confident of what the world reaction would be that they would have adjusted their portfolios accordingly, in order to take advantage of what was about to happen?

If you assume there were some who were able to see this all coming and profit from it, did they also see the recent rise in the market that took us to nearly 12000 on the Dow this last week? Let’s suppose you were able to anticipate all of the above events. Are you also confident about what’s going to happen next? We sure aren’t. Things could easily get worse in the Mideast or they could quiet down and we could see a return to a slowly rising Dow as our economy makes a steady but slow recovery. Or, our economy might take a double-dip as interest rates and inflation rise as a result of our mounting debt.

Just about the time you think you know what’s best to do in the market to make a killing, a Tunisia-Egypt crisis, a BP oil spill, an Exxon Valdez accident, a tech-stock bubble, a housing crisis, natural disaster or what have you occurs unexpectedly. You can’t time the market. Stay broadly diversified and rebalance your portfolio regularly. You can’t time the market!

Increase Your Returns by Focusing on Taxes

2011-01-26T22:00:00.000-05:00

Too often, investors spend all their time focusing on their gross investment returns and ignore the tax efficiency of their investments. If you reduce the taxes paid on your investments by even a small amount it can have a big impact on your net, after-tax return.

An example will help illustrate what we’re talking about. Suppose your taxable investment accounts amount to $100,000, currently, and earn 7% annually, on average, over the next thirty years. Let’s assume your after tax return is 6%. Let’s further assume that through prudent placement of income-producing assets and selection of tax-efficient investment vehicles that you can increase your after-tax return to 6.5%. At a net return of 6% after tax, your $100,000 would grow to $574,349 after 30 years. With an improved 6.5% after-tax return, your $100,000 would grow to $661,436, a difference of $87,087!

Clearly, it pays to spend some time focusing on the tax efficiency of your portfolio. How do you do this, you ask? First, you need to pay attention to the assets you place in your taxable accounts versus the assets you place in your retirement accounts. IRAs and 401(k) accounts grow tax free. Therefore, it makes sense to place income-producing assets (i.e., those that pay interest and dividends) in your retirement accounts and place assets that don’t generate much income, such as non-dividend-paying stocks and growth funds, in your taxable accounts.

When selecting mutual funds, it also helps to pay attention to their tax efficiency. On the Morningstar® website, you can click on the “Tax” tab for mutual funds to see the pre-tax return, tax-adjusted return and tax-cost ratio for mutual funds. Morningstar also provides the Potential Capital Gains Exposure (PCGE) of a fund. Potential capital gain exposure (PCGE) is an estimate of the percent of a fund’s assets that represent gains. PCGE measures how much the fund’s assets have appreciated, and it can be an indicator of possible future capital gain distributions.

Selecting good investments is more involved than many people realize. Focusing on the tax characteristics of your investments can have a big impact on how much your portfolio grows.

Words of Wisdom from Wall Street

2011-01-23T21:33:00.001-05:00

Investors generally spend most of their time trying to figure out what stock to buy and at what price to buy, and then pay little or no attention to when to sell. An old Wall Street adage is good advice for investors to keep in mind: “No tree grows to the sky.”

In many cases, investors follow the herd, buying the latest hot asset for fear of missing the action. Even if they are lucky enough to buy before the frenzy starts, it’s not uncommon for them to buy some more as the asset approaches its peak, because they are just so sure the investment’s price will continue to rise. They can’t stand the thought that they might miss out on further gains.

Then the unexpected happens. Some news breaks that sends the asset price down ten, twenty, thirty percent or more, in a matter of days. Some, who now are underwater, buy more because they can’t stand the thought of losing.

Others hold on for sentimental reasons. They received a stock from their dad or their grandma. They can’t possibly sell a stock that was so good for all those years. Dad wouldn’t be happy.

We’ve written time and again about how important it is when you buy a stock, to set a price at which you will sell and then when it reaches that price – sell! And then, don’t look back. If you made a good profit, be happy that you did and begin looking for your next investment. Find something else that’s undervalued with good prospects. Surely there’s something else out there that is a better buy.

The event that causes the downturn in price is often quite unexpected (An oil spill, fraud, terrorism, a natural disaster, law suit, etc.). Others are more predictable. The price rises and rises with claims that it will still go higher. Often, we’re inundated with TV ads that tout the merits of the investment, seemingly hour after hour. It seems to us that the more ads there are on TV preaching the merits of an investment, the less likely the investment will continue to rise in price (think gold!).

A Wall Street Journal article this week by Carolyn Cui and Liam Pleven titled “From China, Signs That Gold’s Rally Isn’t Endless” (Friday, January 21) stated: “The precious- metals selloff accelerated on Thursday amid worries the rally of the past few years may be petering out and concerns that China will slam the breaks on its economy.” The article went on to say that on Thursday gold fell 1.7% and was down 5% for the year. Silver, the article noted, was down 11% for the year.

Just this last week, Steve Jobs announced he was taking a medical leave of absence from Apple. Apple stock dropped from $348 a share to $326 (a loss of 6.3% in just four days). It may not continue the downward trend, but who knows for sure?

Whatever you do, you need to avoid letting your emotions drive your investment decisions. You need to harvest that tree before it gets top heavy and falls to the earth; or before it gets diseased and begins to rot. Remember, no tree grows to the sky!

So You Think Bonds Are Safe?

2011-01-22T12:18:00.002-05:00

With interest rates so low the last few years and investors afraid to invest in stocks, there’s been a surge in bond buying. In more normal times, many people avoid bonds because bond returns are generally lower than stocks. Some view them as stodgy and have only turned to them recently because they are hungry for earnings of any kind.

Unfortunately, many investors don’t really understand the risks involved with investing in bonds. Many think bonds are safe investments. If you know what you’re doing they can be quite safe. But if you don’t know what you’re doing, you can lose much more than you might have ever thought. Following are some things to watch out for:

First of all, all bonds carry the risk of default, or credit risk. That’s the risk involved if the issuer of the bond defaults, typically due to bankruptcy. Do you recall how the bondholders of General Motors were recently left holding the bag when GM went through bankruptcy? Bonds are rated by various ratings agencies (e.g., Moody’s and Standard & Poor's) with somewhat differing ratings schemes. Moody’s uses the following ratings: Aaa, Aa, A, Baa, Ba, B, Caa, Ca, and C, with “Aaa” the best and “C” the worst. Standards and Poor’s ratings are similar, ranging from the best, “AAA” to the worst, “D”. Both services provide the ratings free on the Internet. Moody’s requires a log in, but it’s free to register.

One way to mitigate the credit risk, besides buying high quality bonds, is to spread the risk by buying a bond mutual fund or bond exchange traded fund (ETF). By investing in a bond fund you will own a share of a large number of different bonds, thereby providing diversification and reducing the risk, should any one bond default. You can check the average credit quality of the mutual fund or ETF by looking the fund up, online, via the Morningstar® website at Morningstar.com. A mutual fund with an “AAA” average credit quality will be much less risky than a fund with a “BB’ average credit quality.

The other significant risk with buying bonds is interest-rate risk. When interest rates go up, bond prices come down and vice versa. It makes sense if you think about it. A $1,000 bond with a 5% coupon (i.e., the bond pays 5%, or $50 in interest annually) will drop in price to $833.33 if interest rates go up to 6% ($50 divided by $833.33 = 6%). In other words, if interest rates rise to 6% for similar bonds (i.e. similar credit quality and maturity), no would buy your bond for $1,000, since it’s only paying 5%. They would only pay $833.33, since that’s the amount that would provide a yield equivalent to other similar bonds.

You can eliminate interest-rate risk, if you hold the bond to maturity. If interest rates rise or fall while you own the bond, the bond price will fall or rise, respectively. As your bond approaches its maturity date, the price will move towards the bond’s face value (typically $1,000). As a bond approaches its maturity, the default risk gets smaller and smaller, and the interest rate impact on price diminishes to zero. Therefore, if you buy a very high quality bond and hold it to maturity, you can minimize the chances of losing anything on your investment.

Another way to mitigate interest-rate risk is to buy shorter term bonds when there is reason to believe that interest rates will rise. The longer the maturity, the greater the interest rate risk of a bond. With interest rates extremely low right now, long-term bonds carry much more risk than short-term bonds. The same holds true for long-term mutual funds versus short-term mutual funds. Thus, in the current environment, short-term mutual funds are safer than long-term mutual funds.

One way to measure a bond funds’ sensitivity to interest-rate risk is to look at the fund’s “duration”. Shorter duration bond funds are less sensitive to increases in interest rates than loner duration funds. Morningstar® provides bond fund durations on its website. A discussion of the details of duration is a subject for a later blog.

In summary, bonds have risks just like other investments. Understanding those risks can help you avoid losses in your bond investments. Purchasing bonds can be relatively safe if you know what you’re doing.

How Much Money You Make Isn’t the Issue

2011-01-19T21:32:00.001-05:00

Sure, it’s nice to make a lot of money. Our years of experience, however, tell us that making a lot of money isn’t necessarily the key to a stress-free financial life or a successful, comfortable retirement.

What we have found is, that in most cases, the more people make, the more they spend and the more debt they take on. Often, people save too little and fail to anticipate what they will need in the future for their children’s college expenses or their retirement.

One rule of thumb suggests that you should save at least 5% to 10% of your gross income. These days, it may be prudent to save well in excess of that amount. With college costs increasing from 5% to 8% annually and concern about higher interest rates and higher inflation down the road, boosting your savings is clearly a smart thing to do.

With home prices still expected to fall further, paying down your mortgage may help you maintain positive equity in your home and will help prepare you for a retirement that is less stressful. Those who carry a mortgage into retirement have a much more difficult time making their resources last until life expectancy. And, with life expectancies increasing, longer retirements require increased savings.

When choosing a tag line for the Patterson Advisors’ logo, we wanted to emphasize that we help our clients balance their financial goals with their financial resources. Thus we chose the tag line “Helping Balance Your Means and Your Dreams”. For a stress-free life and retirement, we believe it’s more rewarding to live a more reserved lifestyle and have your finances in tune with your goals than to live a more aggressive lifestyle that stretches one’s resources beyond reason. People want a hassle-free retirement, most of all. More money is great, but it’s not everything.

Hopeful but Worried

2011-01-16T19:02:00.000-05:00

Economic indicators continue to point to a slowly improving economy, yet there are still many signs that tell us to be cautious. Unemployment continues to be high and few expect it to drop substantially, anytime soon. There were worries about commercial real estate problems as well but so far it hasn’t become a big issue. Foreclosures on residential homes are still very high and there are still some concerns that some homes may have been foreclosed upon improperly. There is continued downward pressure on residential real estate prices and the expectation of more foreclosures in 2011 than in 2010.

The high levels of debt and projected deficits of the U.S. Government continue to worry us about higher interest rates and inflation, long term. Many believe that inflation will not be an issue in the near term. While there were worries about deflation last year, those concerns seem to be dissapating. Concerns about debt in Europe continue to surface periodically.

There is still significant uncertainty as a result of the new healthcare legislation and the new finance regulation. However, with the tax-cut and estate tax issues now resolved (at least for two years) and a 2% cut in Social Security taxes now in affect, we believe there should be some improved confidence in the economy that we hope will bode well for 2011.

So while there is a lot to worry about, there are also signs of improvement in the economy that gives us hope for a better year ahead in 2011. Yet, just as we see some light peak out from behind the dark clouds, another dark cloud is gathering - the threat of state and local government bankruptcies. We certainly hope our federal government doesn’t decide to bail them out. We already have too much debt at the federal level. Yet, we worry that if California and other states declare bankruptcy, it would spill over into markets other than the municipal bond market and could send the economy into a second recession. Let’s keep our fingers crossed that a double-dip can be avoided.

Our 200th Blog – Whew!

2011-01-13T08:19:00.000-05:00

Our blog today marks the 200th time we’ve published in this space. When we started back in June of 2009, we worried about coming up with fresh ideas two to three times a week. While it can be taxing at times to decide on a topic, it’s probably been easier than we imagined.

Many of our blog topics stem from interactions with our clients. If our clients have a problem, many of our readers likely have the same or similar problems. Other topic ideas result from books we’ve read or articles in various magazines and newspapers including the Wall Street Journal and the Journal of Financial Planning.

We thought we’d take a moment today to first thank those of you who read what we have to say, particularly those who have given us positive feedback. We’d like to hear from those of you who read our blog, both its positive and negative aspects, so that we can hopefully continue with more of those things you like and change the things you don’t like. Please let us know via a comment or via an email to us. You can reach Erin at erin@pattersonadvisorsllc.com and Dave at dave@pattersonadvisorsllc.com.

If there are financial topics that you’d like to hear us talk about in general, please let us know. While we can’t promise we’ll answer everything of interest to you, we’ll do our best to meet your needs. Thanks again to all of you who have helped make our blog a success!

An Example of Why It’s Tough to Time the Market

2011-01-10T10:48:00.000-05:00

Many investors think they can time the general market or even specific sectors or asset classes. We’ve written time and time again about how difficult market timing is. You have to be right twice. You have to know when to get out of the market and then when to get back in. Being right in one of those instances is tough. Being right in both instances is really tough.

Over the last two years we’ve seen an exceptional drop in residential real estate prices, with nearly unprecedented numbers of foreclosures. Many predict more foreclosures in 2011 than in 2010. There has been some worry about commercial real estate, as well. While commercial real estate may not have been severely impacted in some parts of the country, in Michigan, wherever you go, you see empty offices, factories and stores.

It’s seems natural then, that investors should have shunned any type of investment related to real estate for the last two years. Many of our clients have, in fact, resisted investments in the real estate asset class and some have pushed us to sell their real estate holdings. We stood firm, however, and urged them to maintain their target portfolio real estate percentage, either buying or selling, depending on whether or not they were under-allocated or over-allocated, respectively, in the real estate asset class.

So what happened with real estate investments the last two years? A recent article in the Wall Street Journal titled “Real Estate Outruns the Stock Market Again” by A.D. Pruitt (Wednesday, December 29, 2010), noted that real estate stocks were “poised to end the year with gains that are twice as large as the broader stock market”.

The article went on to say: “REITs (Real Estate Investment Trusts), as measured by the Dow Jones All REIT index, were up 27% as of Tuesday’s close. While that is a smaller gain than last year, when REITS posted gains of 28.5%, the 2010 results handily beat the DOW Jones Industrial Averages….”

So why, contrary to logical thinking, did REITs perform so well? It was due to investors’ desire for income. According to the article, REITs were returning dividend yields of about 4% versus a return of 3.35% for Treasury bonds. If one looked at REIT prices alone, they might have thought they were over-bought in 2009 and due for a correction. Yet the yield for REITs, compared to Treasuries spurred investors on to continue buying REITs.

You might argue, therefore that astute investors should have anticipated the continued rise. That may well be, but sometimes asset classes continue rising for reasons not easily explained. Sometimes investors chase past returns. It may be that investors continue to buy more REITs in 2011 because they’ve done so well the last two years. Then again, there may be a correction in REIT prices in 2011.

The best approach, we believe, is to establish targets for all of your portfolio asset classes and then periodically (at least annually) rebalance them by selling if you are over-allocated and buying more if you are under-allocated. You won’t hit the peaks and valleys - but by doing so you remove your emotions from the process. Rebalancing, if done in a disciplined manner, forces you to buy lower and sell higher than the typical market timer.

Don’t Buy Unless You Plan to Stay

2011-01-07T20:34:00.000-05:00

It seems like a great time to buy a home and it is. Home prices are lower than anyone might have imagined two years ago and interest rates are way down, too. Property taxes have dropped significantly, as well. Yet, you need to keep one thing in mind before you rush out and buy a new home: In spite of all the positive things about buying now, you shouldn’t do so unless you plan to keep the home for some time.

Why is that, you ask? Although home prices have dropped substantially, they may not yet have bottomed out. A couple of recent articles in the Wall Street Journal support this view.

The first, titled “Housing Market Still Facing a Blizzard” by David Reilly (Wednesday, December 29, 2010). Mr. Reilly’s article discussed the fact that housing prices continued their downward trend for three straight months ending October, 2010 and prompted fears of a double-dip in housing prices. The article went on to say that while sales were up significantly in October, it was likely due to record-low mortgage rates which have since risen more than a half percentage point.

The other article we read was titled “Home Prices Are Still Too High” by Peter D. Schiff (Thursday, December 30, 2010). In his article, Mt Schiff makes a fairly strong case that home prices could easily decline another 20%. If they did, this would put them in sync with the long-term national trend line for home prices. Mr. Schiff argues that the long-term average annual increase in home prices has been 3.5%. If you compare the actual home price graph to the long term 3.5% increase-trend line, home prices are still 20% higher.

Mr. Schiff argues that housing fundamentals have not really improved. He says that government intervention is what has stopped the decline in house prices. Mr. Schiff believes that without government assistance (home-buyers tax credit, record low interest rates, government mortgage assistance, etc.) home prices would actually decline below the trend line.

Whether home prices continue to drop and by how much remains to be seen. It does seem that a further drop is likely in 2011 and perhaps even 2012. Even if the bottom is reached in 2011 or 2012, prices may remain low for several years. Buying now with a low down payment could put you underwater if prices drop 10% or more this year or next. Therefore, to be prudent, you may want to wait on buying a new home, if there’s any chance you may have to sell in the short term.

Some Latin Words of Wisdom

2011-01-04T21:55:00.001-05:00

We occasionally discuss a quote from someone well known, regarding some aspect of money or investing. We find that these “words of wisdom” can provide some great advice for investors to follow. Today’s quote is a Latin proverb: “Believe nothing and be on your guard against everything.” It’s sad that this advice is so often true, that we have to be suspicious of most everyone who tries to sell us something.

A recent example illustrates this point. Just last week we received an email from a friend with a link to an Internet audio presentation. Our friend wanted to know our opinion of the presenter’s opinions. The presentation was very long (an hour or so?) and once you started it you had to essentially listen to the whole thing. There was no way to restart it where you left off, if you closed your Internet connection.

The gist of the presentation was that our economy will soon to collapse when the dollar is no longer recognized as the world’s reserve currency. We must admit, the presenter pointed out many economic issues that we are concerned about. Yet the long-windedness of his message reminded us of Shakespeare’s quote: “The lady doth protest too much, methinks”. We began to suspect the motive behind the presentation.

When we finally figured out how to view the written text without having to listen to the whole thing, we scanned forward to the end. The presenter offered five recommendations to prepare for our future demise. Each recommendation included an offer for a free document detailing what one should do. In each case, the presenter said he would shortly tell the reader how they could receive the various documents free of charge. How was this to be accomplished? By signing up and paying for a newsletter!

We suspected a sales pitch fairly early on and weren’t surprised by what we found. We decided to go one step further and check on the presenter’s background. It didn’t take long to discover that he had been fined $1.5 million by the SEC back in 2007 for securities fraud.

As we often say: “If it sounds too good, it probably is”. Be suspicious of promised returns. Be careful of who you trust with your hard-earned money. Do your own due diligence. It may take some time and effort but it will be well worth it.

How About a Financial Checkup for the New Year?

2011-01-01T11:39:00.000-05:00

Yesterday’s Wall Street Journal had almost the entire back section devoted to the New Year’s resolutions of well-known people. At this time of the year, most people think about what they might do differently going forward. Thoughts of a new year give us hope that a fresh start will solve many of our problems. It seems like the majority of people focus on their weight or their health. As an alternative, why not get a financial physical for the New Year?

Certainly your financial health is just as important as your physical health. This is particularly true these days, with unemployment so high and the prospect of higher interest rates, inflation and taxes looming in the not-to-distant future.

Spending some time answering the following questions will give you some good insight to your financial health as well as whether or not you could use some professional help. If you can’t answer many of the questions, you need to either start hitting the books or seek out an advisor. Here are some of the most important questions to ask yourself:

(1)What’s your net worth? Add up the value of all your assets and subtract your liabilities (mortgage balance, auto loan balances, credit card debt, etc). The result is your net worth. If it’s negative, you need to take drastic action ASAP.
(2)Do you have an emergency fund invested in liquid assets that equals at least six months of living expenses (six to twelve months is probably better)?
(3)Are you carrying credit card balances forward each month or do you pay off what you’re charged each month?
(4)Are you saving enough for your children’s college education? Do you even know how much they will need?
(5)If you have an advisor, do you know exactly how he or she is compensated?
(6)Do you know how much the fund fees are for the mutual funds you own?
(7)Do you a strategy for investing?
(8)Do you know the extent of your portfolio’s diversification? We believe your investments should be spread over at least eight to ten distinct asset classes. Most people who come to us for help are over-weighted in U.S. stocks.
(9)Are you properly insured? Do you have disability insurance coverage and an umbrella liability policy?
(10)Have you done any estate planning? If you have children, have you planned for a guardian in case you and your spouse are tragically killed in an accident?
(11)Do you know where your money is going? If your miscellaneous expenses are more than 5% of your budget, you need to get a better handle on your spending.
(12)Do you have any idea of how much money you’ll need for retirement? Are you saving enough?

If you found you had trouble answering a number of these questions, you might better skip the New Year’s resolution focused on losing weight or exercising more. Your financial health may be in jeopardy. Make 2011 the year you did something about it!

Reduce Your Gas Bill and Save a Few Dollars

2010-12-29T21:20:00.001-05:00

With energy costs typically higher every year, it seems as though our gas and electric bills just get higher and higher each year. Recently, however, the price of natural gas has been dropping significantly as supplies have grown considerably. Consumers Energy gas price for residential customers was $7.3916 per MCF (thousand cubic feet) in December 2009. Currently the price is $6.9113 per MCF, a 6.5% decrease. Customers bills haven’t decreased that much because there are other fees that make up the total monthly gas bill.

So, if you don’t do anything and the weather in January and February is similar to last year’s weather, you can expect your bill to be a bit lower this winter. There’s a way, however, to lower it a bit more.

Residents in southeast Michigan who are customers of Consumers Energy (and perhaps other providers) have the option of receiving their natural gas from at least two other providers that we are aware of. One is IGS Energy and the other is Direct Energy. We assume that similar programs may be offered in other states.

We signed up with IGS Energy in September 2009 and received a guaranteed rate of $6.90 per MCF for the next twelve months. Although we didn’t keep my bills for the fall of 2009, in the last 12 months, there were only two months, in the summer, when Consumers Energy rate was less than the IGS rate. For the last 12 months, we have saved about $50 compared to what we would have paid for Consumers Energy gas.

We just renewed with IGS at a guaranteed rate of $6.19 for the next twelve months. Direct Energy is currently offering a guaranteed rate of $5.99. We don’t know much about Direct Energy, since we haven’t done business with them, so if you are interested in their offering, we suggest you check them out. Once you sign up with an alternative provider, you can cancel at any time. There are some rules with regards to cancelling and restarting, so we recommend you check them all out before committing.

We also recommend you keep a log of each month’s rate from Consumers Energy so that you can determine how much you are saving. You can find Consumers Energy current rate by clicking on the following link: Consumers Energy Gas Rate. While we had been comparing the rates, we weren’t diligent enough recently and only decided to check again when we received the offer from Direct Energy. We were able to switch to IGS’ lower rate over the telephone. We likely could have signed up for their lower rate a couple of months ago and saved even more.

You can contact IGS by calling 877-444-7427 and Direct Energy at 877-357-4675. We encourage you to ask lots of questions and make sure you are clear on all aspects of their programs before signing up. The new guaranteed rates for IGS and Direct Energy are 10.4% and 13.3% less, respectively, than the current Consumers Energy rate. Even if you only save $50 as we did, you can take your spouse out for a nice dinner. We think it’s worth a phone call.

The Best Investment You Will Ever Make

2010-12-25T07:43:00.000-05:00

It’s early on Christmas morning (very early) and I’m sitting here at my computer writing this blog. What am I doing? I hadn’t planned to write anything today. Where are my priorities? Yet, as it seems to happen more and more as I age, I woke up early with a thought in my mind that I couldn’t get rid of. My mind went into overdrive and I finally realized I wasn’t going back to sleep. So here I am sharing my thoughts with our readers.

Yesterday was a Christmas Eve day to remember. With our children now married, my wife and I are now often by ourselves on Christmas Eve. Yesterday, I helped my wife with some cooking in the morning and then we wrapped all the presents together. We planned a couple stops on the way to an early dinner out at one of our favorite restaurants.

We stopped to see two elderly acquaintances, one who lived alone and one recuperating from a recent accident. We were so happy we did, as they seemed to truly appreciate our visits.

A couple of years ago, in Florida just before Christmas, we decided to have a brunch for many of the people who lived in our condo. The association used to have a Christmas party but no longer sponsored one. So we decided to organize one. We were so happy we did, as many of the seniors really seemed to appreciate being able to get together.

The point of all this is that we write our three blogs every week focused on you and your money, your finances, your retirement, your insurance, and so on. Today, we wanted to write about “your time” instead of “Your Money” as this blog is titled. An investment of just a little bit of your time in others yields a huge return.

Christmas is a time of giving. It doesn’t matter what religion you practice. There’s a lesson for all from the example of the tradition of giving at Christmas. Everyone has been through a lot the last couple of years. People have lost their jobs or their homes. Yet, no matter how bad off one is there are others worse off. Many of you have likely already given of your time and resources to others in need. But if you haven’t, we hope that maybe you’ll take a moment to think of a lonely neighbor, someone in the hospital or someone unfortunate that you read about in the paper.

A small investment of a few minutes of your time will yield great benefits to you personally. It will be the best investment you ever made!

Give Your Children the Experience of Giving

2010-12-24T14:33:00.000-05:00

We’ve written more than once about a new way to give that maximizes your gift giving: “A Better Way to Give”, December 8, 2009. In that blog we discussed what are called Donor-advised funds. Many investment management firms such as Fidelity, Charles Schwab & Company, Inc. and The Vanguard Group offer such funds. In our blog, we explained what they are and how they work:

“Investors can open charitable gift fund accounts and easily transfer cash and securities to the accounts. Once transferred, the gifts are irrevocable and qualify for a tax deduction in the year of transfer (with some limitations). If a stock is transferred, it is immediately sold by the gift fund managers. Any gains on securities transferred avoid taxation. Therefore, assets with large capital gains tax liabilities allow individuals to give more by avoiding the potential capital gains taxes.

Donors decide how the assets they have gifted are to be invested. A number of investment “pools” are typically available in which to place the donated funds. Some are more aggressive than others; some focus on capital growth; some focus on income. The donor can decide how aggressive he or she wants to be. With professional management, donors have the possibility of seeing their accounts grow, providing the possibility of increasing the amount they can give to charities.

Accounts must first be funded with a minimum investment amount, which is usually between $5,000 and $10,000. After opening the account, gifts can be granted to the donee (This can be done online). Minimum grants are usually $50 to $100. Gifts must be made to IRS qualified public U.S. charities.”

We noted that a gift fund provides a way to reduce taxes in a year of unusually high-expected income. By bunching several years of gifts together, one can meet the gift fund minimum and receive a tax deduction for the total amount gifted in one year. The funds gifted can then grow tax free in the gift fund account and then be distributed to charities over the following years.

So what does all this have to do with giving your children the chance to experience giving? At least one gift fund allows you to give the gift of giving to others. The Fidelity Charitable Gift Fund, for example, allows you to give a “Gift4Giving” gift to whoever you please. Fidelity then sends them an email with a link to the gift fund website that allows them to designate the charity to receive the money you allocated to their “Gift4Giving”.

The Gift4Giving feature is a great way to help your children or grandchildren (or anyone else for that matter) experience the satisfaction of helping others when their resources are constrained. It’s a great way to set an example for your heirs that hopefully they will continue when you’re gone.

Your Emotions Can Cost You Plenty

2010-12-21T20:44:00.001-05:00

Note: This article was previously published in the Oakland Press about two years ago. The issues discussed need to be reiterated from time to time.

Have you ever made a big gain in a stock and then seen your gains evaporate because you held on to it too long? Have you ever stayed with a loser until it was worth virtually nothing? Or maybe you couldn’t part with a stock you inherited from your Dad that made up a substantial portion of your total investment portfolio and then saw it rapidly drop in value. People often hold on to a stock with big gains because they don’t want to pay the capital gains tax and then lose 20% to 30% when the stock tanks for any of a number of reasons.

We have a lot of psychological hang-ups that impact not only our investment portfolios but many other areas of our financial well-being. A relatively new scientific study called behavioral economics, looks at how investors think, the mistakes they make and how they can benefit from understanding those mistakes. The book titled Why Smart People Make Big Money Mistakes – and How to Correct Them: Lessons from the New Science of Behavioral Economics by Gary Belsky and Thomas Gilovich (Simon & Schuster) is a very easy read that’s difficult to put down.

Behavioral economics attempts to understand the links between psychology and economics. By doing so, people can potentially enhance their enjoyment of life by understanding, and changing the way they make money decisions.

One example discussed in the book is the concept of “mental accounting”. The book presents two scenarios:

“Imagine that you’re at the racetrack for a day of gambling or at your favorite store shopping for a suit. Yesterday you won $ 1000 from your state’s instant lottery game. Will you bet more tonight than you would otherwise, or will you buy a more expensive suit?

“Now imagine that you’re once again at the racetrack for a day of gambling or at your favorite store shopping for a suit. Yesterday you realized that you had $1,000 in a savings account that you had forgotten about. Will you bet more tonight than you would otherwise, or will you buy a more expensive suit?"

The authors point out that “if you answered yes to the first question and no to the second –-- as most people would--- you’re prone to mental accounting.” Mental accounting involves putting different values on the same dollars just because they came from a different source. Why should lottery winnings be valued any differently that your hard-earned salary or savings? Nearly all of us do this.

Another of the basic principles of behavioral science discussed in the book is that people are “loss averse”. According to the authors- “the pain people feel from losing $100 is much greater than the pleasure they receive from gaining the same amount. This helps to explain why people behave inconsistently when taking risks. For example, the same person can act conservatively when protecting gains (by selling successful investments to guarantee profits) but recklessly when seeking to avoid losses (by holding on to losing investments in the hope that they’ll become profitable.)”

There are a number of psychological obstacles that keep us from acting in our best interest, financially. Just being aware of them can help. We highly recommend that everyone read Belsky and Gilovich’s book. If you don’t have the time, below are a few of the steps they recommend to improve your financial well-being:

(1) Raise your insurance deductibles to $ 500 or even $ 1000. You may be able to cut premiums by 10% or more.

(2) Pay off credit card debt with emergency funds. It makes sense to pay off 16% credit card debt with funds earning perhaps only 3% to 5% in a savings account.

(3) Switch to index funds in your investment portfolio. It’s very tough to beat the market. Mutual fund expenses and taxes eat away at your returns. Index funds are low-cost and tax efficient.

(4) Diversify your investments. Holding a diversified portfolio will reduce the volatility in your returns and help you avoid over-reacting to the market’s gyrations.

(5) Track your spending Understanding where your money is going will help you feel more in control of your finances and better understand the behavioral-economic factors that affect how you manage your money.

In summary, understanding a bit about behavioral economics can have a significant impact on your financial well-being.

You May Want to Consider a New Credit Card

2010-12-19T18:30:00.000-05:00

If you are like many Americans who like to earn points towards purchases or air travel, it may behoove you to take a look at some other credit cards. While the Capital One ads on TV annoy many people, they recently caught my attention with their double miles offer. I had intended on checking it out in more detail when I came across an article in the Wall Street Journal just this week that addresses the issue.

Titled “More Ways to Earn Miles Using Plastic” by Scott McCartney (Thursday December 16, 2010), the article points out that competition and changes in promotional partnerships due to airline mergers have resulted in better benefits than previously.

The article points out that there are basically two kinds of reward programs. Those tied to the airline’s frequent flier program typically pay one mile for every dollar charged. Usually, a $400 ticket can be earned with 25,000 miles flown. There are usually blackout dates and other restrictions. The other programs offered by credit card companies award miles usually varying from one to two miles per dollar charged and often have no blackout dates or airline restrictions. A $400 ticket for those programs often costs as much as 40,000 miles.

Some new programs (mainly bank-issued cards), according to the article, are offering perks such as baggage fees, change fees, pet fees, access to airport lounges, on-board food and special early boarding or security-line access. These types of cards, according to the article, are good for elite-level frequent fliers who get lots of free tickets but don’t have those types of awards.

The article includes a table of eight different credit card offerings, comparing the features. Two cards (Escape by Discover and Capital One Venture Rewards) offer double miles with a domestic flight awarded for $20,000 of charges (i.e. 40,000 miles) with no blackout dates or airline restrictions. The Capital One Venture card also charges no foreign currency transaction fees.

With competition stiff, many companies are offering big sign-up bonuses to attract customers. American Express Platinum, for example offers 50,000 bonus points with $1,000 spent in the first three months. But watch out because the platinum card costs $450 a year!

At the least, it may pay you to do a detailed comparison of the cards you use to the others that are available. If you travel a lot, it may very well be worthwhile.

Paychecks May Still Be Impacted

2010-12-17T21:10:00.000-05:00

Well it’s over. Congress finally quit playing games and passed the extension of the Bush tax cuts, along with a number of other significant measures. Most everyone has probably already heard about the changes, so we won’t discuss them in detail hear.

Most people likely assume that the only change they’ll see in their first January paycheck is the 2% of-their-pay reduction in Social Security taxes. For some, that change may not take place for a few weeks. Fortunately, the delay shouldn’t result in the increases people would have experienced had the tax-cuts not been extended. Nevertheless, some may not see the Social Security tax reduction right away.

In an article in the Wall Street Journal Thursday, December 16 by Laura Sanders titled “Pay Won’t Reflect Tax-Code Changes for Several Weeks, Ms. Sanders noted that some payroll providers will require several weeks to make the required changes and adequately test them. Of particular concern for some processors is the 2% reduction in the payroll tax.

The article points out that: “a worker earning $106,800 or more – the maximum that Social Security tax applies to – will save $2,136 or about $82 for every two-week period”. That’s enough for a decent dinner out for two at a moderately-priced restaurant. If that applies to you, you’re fortunate. Just don’t make a dinner reservation yet. You may not see that $82 for a few weeks.

A Mixed Bag for the Economy

2010-12-15T17:55:00.001-05:00

There are signs the economy is improving, yet there are just as many signs that we still have a tough slog ahead of us. Yesterday the stock market closed at 11,476, up 13.04% for the year. The Wall Street Journal’s front page headline today reads: “Shopping Spree Fuels Surge”. If that was all you looked at, you’d think the economy was on a roll. Yet, if you dig a little deeper, we clearly have continued economic problems that will haunt us well into next year or longer.

Unemployment continues at near 10%. The real estate market continues to struggle. Yesterday, we received a “SmartBrief” from the Financial Planning Association. It included the following report from the Wall Street Journal regarding the projected increase in foreclosures for 2011:

“The housing market reported 1.2 million repossessions in 2010, up from 900,000 in 2009, and some analysts say 2011 could be even worse because problems with the foreclosure process prevented many from being completed in 2010. High unemployment and interest-rate resets on adjustable-rate mortgages that will increase monthly payments on some mortgages will also exacerbate the problem.”

The FPA brief also noted that investors have increased their cash holdings by $1.0 trillion in the last three years. The yield on 9-month certificates of deposits is now less than liquid money market accounts. Some turned to bonds for safety not realizing that bonds will drop in value when interest rates rise. Muni-bond prices are currently dropping as investors worry about the end of the subsidized Build America Bond (BAB) program. Long-term bond yields are rising.

Municipalities and state governments are struggling. New concerns are now arising about the financial stability of Spain.

We are hopeful that the tax legislation now being considered in Congress will provide some level of certainty for businesses to help then begin to invest and create jobs. Nevertheless, the added stimulus elements of the bill worry us that Congress hasn’t yet gotten the message about our rising national debt. And just yesterday we heard about a new $1.1 trillion omnibus spending bill submitted that includes billions in questionable earmarks. It’s hard to imagine a future without higher taxes and higher interest rates. Will that lead us into the next recession?

We suggest you hunker down, cut whatever discretionary spending you can, beef up your emergency funds and make sure your portfolio is very broadly diversified. Pay off whatever debt you have and avoid chasing the latest hot assets. It’s time to be fiscally conservative and prepare for more tough times ahead.

Words of Wisdom on Taxes

2010-12-12T22:23:00.001-05:00

Ronald Reagan once said “The taxpayer – that’s someone who works for the federal government but doesn’t have to take the civil service examination”. How true it is. Each year we seem to work more and more for the federal government and less and less for the benefit of ourselves.

It now seems as though Congress may pass the legislation agreed to by President Obama and the Republicans, yet with Congress, nothing would surprise us. It seems as though everyone has some problem with the agreement, as do we, but some certainty regarding taxes is needed to get the economy moving.

We’ve written previously that we felt one of the big problems with the slow economic recovery was the lack of confidence resulting from so many unknowns: What would happen to taxes January 1st?; How would the estate tax mess be resolved?; What will the impact of the new healthcare legislation be on businesses and individuals?; What impact will new federal regulations have on the economy?

Now, it appears that two of these questions may soon be answered. Income tax rates and estate tax rates will be clearly defined for at least for a couple of years if Congress approves the President’s deal. It would certainly be better if the agreement provided longer-term certainty, but at least businesses and individuals can make some intelligent short-term decisions.

There’s also now talk of trying to simplify the taxes to eliminate loopholes and increase revenues. The tax code is so complex now that it’s tough for honest taxpayers to prepare an accurate return. In many cases, we expect that the IRS employees themselves don’t know how to accurately calculate what’s due, let alone ferret out the cheaters. As Will Rogers once said: “Income tax has made more liars out of the American people than golf has.” You might want to start early on your 2010 return, if you can figure out what the latest rules are.

Quotes from “The Quotable Investor”, published by The Lyons Press.

Don’t Depend on the Regulators

2010-12-10T20:57:00.001-05:00

Financial advisors must register either with the states in which they do business or with the federal Securities and Exchange Commission (SEC). Currently, those advisors with $25 million or less of “assets under management” are regulated by the states in which they conduct business and those with more than $25 million of assets are regulated by the SEC. Starting next year, state regulators will manage advisors with up to $ 100 million of assets under management. Should you care?

We wrote in our blog just last week about the continuing problem of dishonest advisors who continue to fraudulently abscond with investors funds (There’s a Sucker Born Every Minute, Sunday, December 5, 2010). It would be nice if the state and federal regulators could better protect investors. Their resources, however, are severely limited.

Some think that state regulators can do a better job than the federal government since they typically audit advisors every three to five years, whereas the SEC typically audits ten percent of the advisors it regulates every year, according to a recent article in the Wall Street Journal by Jason Zweig titled “Will Shaking Up the Watchdog Take the Bite Out of Crime?". This means an SEC regulated advisor can expect to be audited only once every ten years.

Perhaps changing some advisors to be regulated by the states will free up resources at the SEC so they can audit advisors more often. But what about the smaller advisors regulated by the states? The recent economic crisis has created an economic crisis for state governments as well. Most states are faced with cutting services and are unlikely to be able to increase regulatory staff to address the coming increased workload. It seems likely, therefore, that state regulatory agencies may very well have to reduce the frequency with which they audit state-regulated advisors.

So it seems that the problem of regulating financial advisors won’t get better anytime soon. The larger advisors may be audited more often, the smaller ones, less often. The Ponzi schemers are both state regulated and SEC regulated. If you want to avoid being scammed, you have to do your own due diligence. Perhaps the best thing you can do is remember that “if it sounds too good, it likely is”. There’s no silver bullet.

Are You Saving Enough for College?

2010-12-07T15:42:00.001-05:00

Although we often have clients with college-bound children and help them plan for their college savings, we are still amazed ourselves at how much college costs. Everyone knows that college is getting more expensive every year. Nevertheless, many are surprised when they see the projected future costs.

State governments are in a money crunch and therefore are not contributing as much as they did in the past to the public colleges in their states. College costs have been increasing anywhere from 5% to 8% annually. It seems like every day you pick up the newspaper and see that a college is increasing its next year costs by eight or ten percent.

Saving early is the key. Our example that follows will illustrate this. The current cost for a freshman at Michigan State University currently is approximately $19,924 for tuition, room and board and books. The total cost for four years, starting eighteen years from now is estimated to be $247,784. This assumes a six percent annual increase in the costs going forward.

For a couple with a baby just born, who start saving this year and save the same amount monthly until the second semester of their child’s senior year at MSU, the required monthly savings would be $ 575, assuming a 5.19% average return in a moderate-age-based portfolio in a Vanguard 529 college savings plan. This rate of savings would provide for the payments to be made at the beginning of each semester for the four years.

If the couples’ child is currently five years old and they start saving now, they’ll have to save $651 a month. If the child is currently ten years old and they begin saving now, the savings amount jumps to $806 a month! Or, the parents of a newborn could invest a lump sum now of $89,278 and have enough for the four years’ expense.

If you have children or grandchildren and want to provide for their college education, hopefully you’ve already started saving for their college. Maybe you’ll be lucky and they’ll get an academic or sports scholarship. For those who aren’t so lucky, the key will be to start saving early or be prepared to sacrifice significantly, later. Whatever the case, it’s never too late to start saving. Whatever the amount, every little bit helps!

There’s a Sucker Born Every Minute

2010-12-05T17:51:00.002-05:00

P.T. Barnum’s quote, “There’s a sucker born every minute”, provides a great lesson for all investors, yet few people seem to learn. Barnum was an American showman, businessman, and entertainer, known for promoting celebrated hoaxes. He founded the circus that eventually became the Ringling Bros. and Barnum & Bailey Circus. It’s somewhat ironic that, according to Wikipedia, the quote was not actually attributable to Barnum, himself.

Just last week, The Sarasota Herald Tribune carried an article discussing the fourth Ponzi scheme arrest in the Sarasota, Florida area in recent times. Ponzi schemes typically provide the promise of uncommonly high returns to investors. Early investors receive “returns” funded by the contributions of newer investors. The scheme is usually uncovered when one or more large investors ask to liquidate their accounts (often in a down market). When they don’t get paid, a red flag goes up and investigators step in.

This recent alleged scheme drew hundreds of people to seminars, which according to the Tribune’s article, “were run like religious revivals”. The article went on to say that “they (the alleged perpetrators) used religion to make people feel, No.1- Safe, and No. 2 - To exploit them emotionally”.

According to the article, one of the attendees stated: “Not only did I pay for the seminar; I paid an extra 25 bucks for a lousy breakfast, so I could meet the guy. Quite honestly, he sounded like a creep, but I invested anyway, because it sounded too good.”

We often tell our readers and clients that if it sounds too good, it most likely is. Keep in mind that higher returns virtually always bring with them higher risk. In the case of Ponzi schemes, the risk is ultra high. A French proverb states “Skeptics are never deceived.” And Charles Dickens once said in his novel “The Old Curiosity Shop” (1841), “It was a maxim with Foxey – our revered father, gentlemen – ‘Always suspect everybody’”.

The lesson here is that when you hear of higher, guaranteed returns, you need to get suspicious. You need to be skeptical and do some serious due diligence. If you don’t, you’ll run the risk of being the next sucker to get taken by the latest, flashiest Ponzi scheme.

You Might Want to Set Aside Some Extra Money for January

2010-12-02T20:55:00.000-05:00

If you are like many Americans out there, you don’t have any extra money floating around for unforeseen expenses. We’ve written time and again about how important it is to have an emergency fund, yet many Americans don’t. They are living from paycheck to paycheck and in many cases have high credit card debt.

If that sounds familiar to you, you may want to make an extra effort to set aside some extra cash for what may be a tough January. Why is that you ask? You may have heard on the news or read in the paper that Congress has yet to make a decision on whether or not to let the Bush tax cuts expire on December 31st. The big issue between the Democrats and Republicans is whether to renew the Bush tax cuts for those making more than $ 250,000 a year. Most Republicans and some Democrats believe that it is best for the economy to avoid raising taxes for anyone, including the “rich”.

The problem is, there is little time for Congress to come to an agreement. One would think that after the election and the message sent by the American people that the two parties could get together and agree on the tax rates for 2011. Yet, it wouldn’t surprise us if they adjourned for the holidays without resolving the issue.

If there’s no resolution, the IRS will be forced to issue tax tables to employers that require larger amounts withheld for taxes. If Congress settles the issue late, the Treasury Department may be forced to issue higher withholding rates to employers. If that happens, your first paycheck may be significantly smaller than usual, putting you in a bind to pay all your Christmas bills or even your normal monthly bills.

The new Congress will likely reinstate the Bush tax cuts if it doesn’t get done before Christmas and President Obama is seen by many as likely to approve such a measure if passed in January. Nevertheless, it may take some time for payroll systems and the IRS to make proper adjustments. So, as tough as it may be, you might want to set aside a little extra cash if you can find a way to do so.

Who Can You Trust? – Part II

2010-11-30T21:09:00.000-05:00

Our last blog was titled “Who Can You Trust?” (Saturday, November 27, 2010). We discussed the myriad of designations for financial advisors and why you need to check their credentials carefully. We had written before about the problem with many financial advisor credentials but decided to raise the issue again after reading an article in the Wall Street Journal titled “The Credentials Racket” by Jason Zweig and Mary Pilon, (Saturday/Sunday, October 16-17). Recently, a follow-up article by the same authors points out more problems with advisors’ credentials (“Who’s Advising Your Advisers?”, The Wall Street Journal, Saturday/Sunday November 20-21, 2010).

The follow-up article discusses the problems with the training provided by the groups who grant the credentials. According to the article, some of the groups have lower standards and people with questionable backgrounds leading their training programs. An example given was the Society of Certified Retirement Financial Advisors, which appointed an education chairman who had lost his state securities and insurance licenses.

Another example given was the National Association of Financial and Estate Planning (NAFEP), whose seven-person “advisory board” included an individual who had been barred from the insurance and securities industries for two years in Tennessee.

The article also pointed out that some of the groups have also been accused of teaching their students questionable sales methods.

We noted in our last blog that it’s possible that many people who need financial help shy away from hiring an advisor because they are unsure of how to find one they can trust. With over 200 financial designations out their, some with shady characters doing the training, it’s no wonder consumers are hesitant to hire an advisor.

If you need help, we recommend you start your search with those who are Certified Financial Planner® licensees (i.e., those who use the CFP® designation). Follow that with a check with state security regulators: Go to www.nasaa.org and click on “Check Your Broker or Adviso”r. Next, interview the advisor in depth. Make sure you understand clearly how he or she will be compensated.

Be wary of asking for references. Unless you know someone personally, a reference is probably not worth much. Some state regulatory organizations frown on advisors giving references unless the advisor discloses his entire client list. And, they can’t disclose their client list without their clients’ approvals. So, if an advisor gives you a reference, be very skeptical.

With proper due diligence, you can find a good advisor you can trust. Just be sure you take the time to do it thoroughly.

Who Can You Trust?

2010-11-27T19:42:00.000-05:00

Many Americans lack the skills to effectively manage their money and would like some help. It is likely that they don’t seek it for two reasons: (1) They view the costs as prohibitive and (2) They are unsure about how to find an advisor they can trust. Both concerns are understandable. We focus here on the second one: How can you find an advisor you can trust?

To find a qualified accountant most people rely on credentials and look for a Certified Public Accountant (CPA). Finding a qualified financial advisor isn’t as easy. We’ve written about this before, yet we were surprised by a recent Wall Street Journal article (“The Credentials Racket” by Jason Zweig and Mary Pilon, Saturday/Sunday, October 16-17) that noted there were now 95 different “professional” credentials for financial advisors compared to 48, back in 2005.

The most commonly recommended certification, without question, is the Certified Financial Planner (CFP®) designation. Other well-known designations often cited along with the CFP designation are the CPA and CFA (Chartered Financial Analyst) designations. The latter two, however, do not require the multiple-discipline study required of the CFP program.

The Wall Street Journal article points out that the CFP, CPA and CFA credentials require a much more rigorous program in order to become certified. Certificants of the CFP program are required to take the equivalent of fifteen credit hours of undergraduate study followed by a 10 hour, two day exam. Ongoing CFPs must complete 30 credits of continuing education every two years, including a two credit course on ethics.

In contrast, the article discusses the less-rigorous requirements for certification as a Certified Retirement Financial Adviser (CRFA), which requires a 100 question exam requiring only forty to seventy-five hours of preparation.

Finding an advisor with the CFP certification is just the start. We recommend you find someone who has worked previously with the advisor and check with state regulatory authorities to make sure the advisor is properly registered and has not been disciplined for unauthorized activities. Ask for a copy of their SEC Form ADV Part II which all financial advisors are required to provide prospective clients.

Find out how they charge for their services. Those who charge fixed or hourly fees are usually preferred. Next, would be fee-based advisors, who charge a percentage of assets managed. With those who charge commissions, there is always the question of whether a recommendation is being made solely because of the commission that the advisor will receive. Be sure to ask also about the fees charged by the funds that the advisor recommends.

In summary, don’t be impressed by a long string of designations following an advisors name. And, don’t stop your due diligence just because a friend recommended someone with a CFP designation. Dig deeper into their background and how they charge for their services.

“CFP is a federally registered trademark of the Certified Financial Planner Board of Standards, Inc.”

Some Thanksgiving Thoughts

2010-11-24T07:43:00.000-05:00

Our blog is primarily focused on how you can improve your financial situation. Last year, during the holidays, we received an email card from a client that put things in perspective. We wrote about the need to think of others and thought it appropriate to repeat that message as we all give thanks this Thanksgiving.

It doesn’t matter what religion you practice or even if you practice a religion, the email we received was a good reminder that there are many others much worse off than we are who can use our help.

While we can’t vouch for the numbers quoted in the email, we’d like to share a few of the messages as a reminder that we need to help others with our gifts, not only now, during the holiday season, but throughout the year.

Hear are a few of the thoughts that made us take special note:

“If you have food in the refrigerator, clothes on your back, a roof overhead and a place to sleep, you are richer than 75% of the people in the world.”

“If you have money in the bank, in your wallet and spare change in a dish some place, you are among the top 8% of the world’s wealthy.”

“If you woke up this morning with more health than illness, you are more blessed than the million who will not survive this week.

“If you have never experienced the danger of battle, the loneliness of imprisonment, the agony of torture or the pangs of starvation, you are ahead of 500 million people in the world”.

“If you can attend a church meeting without fear of harassment, arrest, torture or death, you are more blessed than 3 billion people in the world.”

So while we write of how to increase your investments, lower taxes, save for college, plan for retirement and a myriad of other financial topics, we urge you now and throughout the year to share some of your wealth with others less fortunate. Even a little can go a long way.

Sure, the last couple of years have been tough, but if you’ve been reading our blog, it’s highly likely that you are far better off than a very large number of other people in the world. And, we believe strongly that any funds you give to others in need during these difficult economic times will provide a return to you that far exceeds any you might have received by investing the money for your own benefit.

Note: In a previous blog article posted December 8, 2009, titled “A Better Way to Give”, we discussed a way to better stretch your limited gifting dollars.

Words of Wisdom on Economists

2010-11-22T06:21:00.002-05:00

Like lawyers and politicians, economists are often the brunt of jokes, wisecracks and famous quotes. Peter Lynch, famed mutual fund manager for Fidelity, once noted: “As some perceptive person once said, if all the economists of the world were laid end to end, it wouldn’t be a bad thing.” (1) And, even John Kenneth Galbraith, a famed economist himself, once said: “Economics is extremely useful as a form of employment for economists.” (2)

Why is it that people like to pick on economists? And is there a lesson here for the average investor?

Economics is a very complex field. There are so many variables that it seems that no two economists can ever agree on where the economy is headed. And, if economists can’t agree on the direction of the economy, why would one expect that investment gurus could successfully predict the short-term direction of the markets?

We believe that the seeming inability of economists to agree on where the economy is headed lends support to many a financial advisor’s belief that it’s futile to try to time the market. The lesson from economics, therefore, is to adopt a broadly-diversified portfolio tuned to your individual risk tolerance and objectives and then rebalance that portfolio on a regular basis. You may not beat the market but we expect you’ll do quite well over the long run.

(1), (2) both quotes taken from “The Quotable Investor”, The Lyons Press

Are You Prepared for an Emergency?

2010-11-18T15:59:00.001-05:00

We’ve written several times about the basic steps to take before even thinking about investing money for retirement or college for your children. Having basic insurance coverage on your auto, home and life, plus an adequate emergency fund are critical.

We were shocked by a statistic published in a recent Journal of Financial Planning (October, 2010). Forty-five percent of Americans believe that they could meet their financial obligations for less than a month if they lost their job.

A basic rule of thumb for most financial planners is that you should set aside in cash or cash equivalents at least three to six months of your fixed and variable expenses. In many cases we now lean toward having six months to a year’s worth of funds set aside.

The last two years have been tough for everyone, and for many just having enough to meet everyday needs is difficult. Nevertheless, you can be sure another tough recession lies ahead, and probably sooner than we might expect. Now is the time to do all you can to establish a rainy day fund for the next economic crisis.

Budget Strained by New Needs?

2010-11-16T09:37:00.001-05:00

We've written before regarding what appears to be some new trends to live a simpler life. The economic crisis of the last couple of years has had a big impact on many Americans. Many have lost their jobs; many have lost their house due to foreclosure and few have received pay increases. They worry about higher taxes and rising national debt.

It seems that many are cutting back, at least on the little things. A recent poll by Harris Interactive, dated November 11, 2010, documents some of the ways people have cut back. According to the Harris poll, some 37% are going to the hairstylist or barber less often, over a quarter of adults have cancelled magazine subscriptions and one in five Americans have stopped purchasing coffee in the morning. Twenty-two percent have cut back on cable TV and seventeen percent have cut or cancelled cell phone service.

Clearly, cutting back on the little things will help a strained budget, however, we believe Americans need to give serious thought to what can and what can’t be cut. In an article by Humberto Cruz titled “Are boomers’ ‘necessities’ grounded in reality?” (Sarasota Herald Tribune, August 28, 2010), Mr. Cruz discussed the results of another Harris poll commissioned by Mainstay Investments. The “Retirement Lifestyle” study examined what were considered the ’needs” of boomers who had $100,000 or more in investments.

It used to be that food, clothing and shelter were the basic needs. The study found that new “needs” have surfaced. Some of the new needs identified in the study were healthcare, internet connections, shopping for birthdays and special occasions, family vacations and getaways, lawn care, housekeepers, club memberships, professional haircuts, and funding children’s education.

We often see client budgets that include $ 100 or more for pet care and $100 to $150 a month for cable and cell phone bills. Clearly, cases can be made for all of the above new needs, in special circumstances. Nevertheless, we believe Americans need to re-examine their life goals and in light of what is really important to them, re-assess how they are spending their money. They might find that mowing the lawn provides some exercise that promotes better health and saves $20 to $ 25 a month for their poorly funded retirement.

Another Blow for Long-Term Care Insurance

2010-11-13T09:03:00.000-05:00

In one of our recent blogs titled “Long-Term Care Insurance Getting Tougher to Buy” (Thursday, October 21, 2010), we noted that insurers were significantly raising the premiums on long-term care policies.

Buying long-term care insurance has always been a difficult decision for many people. To begin with, no one wants to think about losing their independence and having to move into a nursing home. On top of that, with few Americans saving sufficiently for retirement, budgets have little room for the cost of long-term care insurance.

At the time of this writing, an article in the Wall Street Journal (“MetLife Steps Back from Long-Term Care Market” by Erik Holm and Anne Tergesen, November 12, 2010) makes us wonder about the viability of long-term care insurance. The article notes that MetLife, one of the bigger sellers of the coverage has just announced that they will no longer offer long-term care insurance to their customers.

Insurers have found it more difficult to make money on long-term care policies due to several factors. One is that with interest rates so low, they are unable to make enough by investing premium dollars to cover the cost of the benefits. The article also noted that people are hanging on to their policies longer than expected. Assumptions regarding the number of purchasers who will let their policies lapse (i.e., quit paying premiums and forego the policies) have proved to be higher than expected. And, with people living longer than in the past, the cost of benefits is rising significantly.

In our previous blog we noted that John Hancock had announced price increases up to 40% for its policyholders. Other companies have ceased selling the product. Yet still others are holding their ground. The Wall Street Journal article notes that “New York Life, which has sold the product since 1988, said it has never raised rates for customers once they have purchased a long-term care policy.” While this is encouraging, the increases in prices and decision to stop selling the product altogether by some insurers, gives one little confidence a policy will be viable, long-term. Will long-term care insurance be a short-term product?

More Words of Wisdom from “Anonymous”

2010-11-11T13:49:00.000-05:00

Our last “Words of Wisdom” blog was attributed to that unknown person “anonymous”. Today’s quote from anonymous is “a rising tide raises all ships”. We suspect that most investors are feeling a bit better now about their investments with the market’s recent rally. At the time of this writing, the Dow Jones Industrial Average is up 11.89% for the year.

Some are probably patting themselves on the back for their good judgment and investing prowess. “Anonymous” says, however, that we should not get too overconfident about our investment skills, for everyone’s portfolio has risen along with the market. Nevertheless, you can at least take credit for being “in the market”. If you remained in the market throughout the last two-year crisis, you are to be commended.

We often talk about the “typical investor” who buys high and sells low. They follow the crowd, buying the latest hot assets and then panic and sell when the market crashes. They need to do just the opposite. Even if you stayed in the market, you may have some of the bad characteristics of our typical investor.

So what should you do now? You might want to take a look at your portfolio and trim your winners back to your target allocations, if you have target allocations. If you don’t have target allocations for the various asset classes in your portfolio, you might want to spend some time establishing targets. If you’re not sure how to do this, we recommend you seek professional help.

If you stayed in the market but are not broadly diversified, you should consider diversifying your portfolio as soon as possible. Again, we suggest you seek professional help if you don’t know how to do this.

If you pulled everything out of the market and are still sitting on the sidelines, we really recommend that you seek professional help. You need to establish a broadly diversified portfolio tuned to your individual risk tolerance so that you can avoid panicking the next time there is a serious market crash.

If we assume your risk tolerance is low, you may need to dollar-cost average back into the market in order to sleep at night. If you are a long-term investor, however, and have confidence that over the long run the market will rise, putting your entire portfolio back into the market now is the best approach. (This assumes you have an adequate emergency fund and funds needed for short-term goals are invested more conservatively.)

Whatever your situation, don’t get overconfident just because the market has risen nicely in the last few months.

Another Twist to Harvesting Losses

2010-11-09T20:07:00.000-05:00

In our last blog titled “It’s That Time of Year Again”, we pointed out that dumping your losses at year end (“harvesting them”) can allow you to recover some of the losses by writing them off on your tax return and reducing your taxes. Doing so also allows you to replace poor investments with investments that have better prospects. In some cases you may want to buy back a loser if you believe it has good prospects.

Unfortunately, your timing with respect to harvesting can make a big difference in the end result. A recent article in the Wall Street Journal titled “Facing Your Failures” by James B. Stewart (Saturday/Sunday, October 30-31, 2010) discussed the problem. Mr. Stewart noted the problem with harvesting late in the year:

“The problem is that is when everyone else is doing it. Year after year, I end up selling a losing position, only to watch it bounce back in January when the tax-loss selling is over and bargain hunters swoop in.”

Mr. Stewart notes that if you want to re-establish a position in an asset you harvested, there’s no reason you can’t sell it now, before the majority of other investors do so, wait the required thirty days to avoid a “wash sale” (see our previous blog for an explanation if you don’t know about the wash sale rules) and buy the asset bask at year end after everyone else has sold. Doing so can allow you to capture your losses for tax purposes and gain back some of your losses as others buy the asset back and drive up the price.

Of course, if everyone catches on to this technique, it won’t really be effective. That’s often the case with investment strategies. When everyone adopts the approach, it no longer works as effectively.

It’s That Time of Year Again

2010-11-07T20:23:00.002-05:00

Halloween was just here; the cold of winter is approaching and farmers are all clearing their fields, harvesting the last of the year’s crops to prepare for next year’s planting. Between now and year-end, we need to consider some harvesting of our own, to take advantage of the last two years’ tumultuous markets and minimize any losses remaining in our portfolio. Losses in taxable accounts can be “harvested”, resulting in significant income tax savings that will mitigate any losses we may have in our portfolios.

All too often, investors have a tendency to hold on to their winners and losers too long. They don’t want to part with losers because they’re sure that as soon as they do, the losing investment will rebound. They can’t stand the thought of selling and then missing out on a miraculous recovery. They overlook the fact that if they sold the loser, they could mitigate their loss by writing off the loss on their tax return and then replace the poor-performing asset with one that has a better probability of providing a good solid return going forward.

As for holding on to winners too long, investors have similar fears; what if they sell a winner and then lose out on future gains? Or, they hold on to winners to avoid having to pay taxes on their gains. Letting taxes get in the way of doing what’s right from an investment standpoint, is a common mistake. You need to establish a target selling price when you purchase a stock. When it reaches that price, you should sell the stock unless you can make a sound argument as to why that stock remains undervalued. Keep in mind too, that a significant increase in the capital gains tax is likely going forward, although no one knows when.

So, with the 2010 tax year coming to an end, it’s time to “harvest” your winners and plow up your losers. Even though the market has risen significantly in recent months, you may still have significant losses in your taxable accounts. And, if you haven’t rebalanced your portfolio recently, trimming over-allocated asset classes could reduce your portfolio risk, significantly. With the economy still facing high unemployment and more real estate foreclosures looming, some worry that we might still have a double-dip recession. Selling some winners may be a wise move.

If you focus on the tax savings from selling losers and the current low capital gains rate, it will help motivate you to take action. Often the losses will offset the gains of selling winners and eliminate the potential capital gains liability.

Review your portfolio and look for assets with significant losses. It may be that the asset is worth keeping but has a significant loss that can be used to offset the gains of a winner that needs to be sold. Due to what’s called the “wash-sale rule”, you can’t just sell the asset and then re-purchase it. IRS rules require you to wait 30 days before re-buying else you lose the right to write off the loss. There may be a way around this rule, however.

For example, let’s suppose you have a substantial holding in the Fidelity Spartan 500 Index fund that is still down significantly from your purchase price. You’d like to sell the fund but want to maintain your position in large domestic stocks, in case the market continues its upward swing. You can sell the Fidelity fund and immediately buy a somewhat similar fund (such as the Vanguard Total Stock Market Index Fund). You may want to check with your tax advisor to be sure the new fund is not essentially the same as the one you sold. IRS rules are unclear as to what they consider to be essentially the same fund. This is a gray area that you need to be pay attention to. In the case where the holding is a stock, you may be able to find a similar stock in the same industry in order to maintain your position in the market.

You also need to analyze your winners to determine those that have reached their target selling price and should be sold. You should also look for stocks that have done so well that they now represent more than 5% to 10% of your total portfolio’s value. Often these holdings are in stock of the company you work for or for which you have strong emotional ties (e.g. inherited from your parent). Nevertheless, a stock holding of more than 5% to 10% of your portfolio adds significant risk that should be avoided. Having too much stock in the company you work for is a big mistake. When times get bad, companies lay off people or give early retirements. At the same time, your company’s stock price will likely be low, just when you may need it the most. ”Harvest” time is a good time to trim those holdings too, since losses from losers can help mitigate the taxes from possible gains.

So, as we point out every year to our clients at this time, let the falling leaves be a reminder to take a look at your portfolio and do some “harvesting”!

A Budget Category Often Overlooked in Retirement Planning

2010-11-05T11:56:00.000-04:00

My wife and I have one grandchild, a grandson now age four. We love him dearly and cherish the moments we have with him. We take care of him one day a week and it’s always a high point for us.

I distinctly remember talking to a couple we know, just prior to our grandson’s birth. The husband told me, that every time his wife passed a toy store, book store or children’s clothing outlet, his wife was drawn inside as if by a human magnet of some sort. He said his wife was constantly buying something for their grandchildren and I’d better prepare myself for the hit on our finances.

I never even gave it a second thought when I was contemplating my semi-retirement. Sure, I knew we’d be spoiling our grandchildren like everyone else, but I truly underestimated what our friend was talking about. Everyone wants their grandchildren to have the best of everything. It’s tough to pass up all the toys, books and clothes that many of us didn’t have when we were children.

If you’re in the planning stage for retirement, you might want to at least include a budget item for spending on your grandchildren. Consider doing so, if you will likely contribute to one or more of the following: their college fund, clothing needs, entertainment (movies, sporting events and special shows), toys, games and books. You also may buy car seats, game tables and sporting equipment. Perhaps you’ll help with swimming lessons, dance class and maybe even fees for little league. And, if you spend the winter in a warm climate, you may even want to set aside some money for plane tickets to help your kids come visit.

A recent article in the Wall Street Journal titled “Grand Times” by Glenn Ruffenach, (October 25, 2010) provides data from a recent study by Grandparents.com, a website that focuses on family relationships. According to the article, grandparents spent an estimated $52 billion on goods and services for their grandchildren in 2009. In 2005, according to the article there were 62.4 million grandparents, and in 2010, an estimated 69.6 million. No data was provided for 2009, but we can estimate that there were , somewhere around 68 million grandparents that year. That means, that on the average, they spent around $765 each on their grandchildren, that year. For a married couple, that comes to $1,529 per couple, per year.

So, what would you spend if you had several grandchildren? One thing is for sure - you’ll likely spend more than you think. Of course, they’re worth every penny. Just don’t forget to include the category in your planning!

Be Careful With Reinvesting

2010-11-02T15:01:00.001-04:00

We are often asked the question regarding whether or not it’s advisable to reinvest the dividends or capital gains distributed by mutual funds. In non-taxable accounts such as IRAs, there’s really no problem with reinvesting, since distributions are taxed as ordinary income when withdrawn. And while you may have some cost basis as a result of post-tax contributions, the distributions of dividends and capital gains have no affect on the cost basis in tax-deferred accounts.

There’s no problem in taxable accounts, either, if you keep good records. Often, however, people make the mistake of not adjusting their cost basis by adding to the cost of purchases, the value of the reinvested dividends and capital gains that have been distributed. If this is not taken into consideration, you will end up paying tax twice on the dividends and capital gains.

Why is that, you ask? Dividends and capital gains are reported annually to the IRS on Form 1099. You must include the distributions on your tax return, annually and pay the tax due. If you don’t adjust your cost basis when the holding is sold, you’ll pay tax again on the distributions you’ve received.

Reinvesting dividends and capital gains in taxable accounts can make record keeping a bit more difficult when you sell taxable assets. It’s not really a problem if you sell the entire holding, including all the reinvested shares. If, however, you sell part of a holding, then you must determine which lot, lots or partial lots were sold. This can be a bit more involved, even if you have good records. Therefore, you may want to avoid reinvesting dividends and capital gains in your taxable accounts.

Our recent blog titled “Good News for Some, Bad News for Others” (October 26, 2010), discussed the fact that brokers will be required to keep track of the cost basis information for you going forward. Nevertheless, you will still have to specify what lots you are selling when you sell part of a holding. If you don’t reinvest in taxable accounts, specifying lots will be easier.

It’s not as “Scary” as it Sounds

2010-10-31T10:15:00.000-04:00

With Halloween upon us, there are lots of scary bats, witches and monsters about. And with the election just a couple of days away, we once again see the issue of the privatization of Social Security surface in the election ads. We don’t like to take sides politically in our blog and won’t debate issues around how such a concept would actually be implemented, but we do think it’s important for people to know that it’s not as scary and radical as it’s often made out to be.

We’d like to discuss here, the basic idea and show that it could have merit, if it’s implemented in a common sense way that considers the concerns of all of the Social Security stakeholders, future and present.

At the heart of the issue is whether one could earn more by investing in “the market”, a portion of what is now going into the Social Security system. Part of the controversy involves what one means by “the market”. If “the market” means just investing in U.S. common stocks, then we would be concerned about such a concept. If “the market” means a broadly diversified portfolio which becomes more conservative as the owner ages, that becomes a more agreeable concept.

Even so, a recent article in the Wall Street Journal titled “Private Social Security Accounts: Still a Good Idea” by William G. Shipman and Peter Ferrara, showed how investing in stocks alone over a long period would provide far better returns than Social Security. The article cites the following example:

“Suppose a senior citizen ‘Joe the Plumber’ –who retired at the end of 2009, at age 66, had been able to set up a personal account when he entered the work force in 1965, at the age of 21. Suppose that, paying into his personal account what he and his employer would have paid into Social Security, Joe was foolish enough to invest his entire portfolio in the stock market for all 45 years of his working career. How would he have faired in the recent financial crisis?”

The article goes on to say that if you assume Joe and his wife invested in a portfolio consisting of 90 percent large-cap stocks and 10 percent small-cap stocks, they would have accumulated $855,175, even taking into consideration a 37% loss in 2008. According to the article, this was equivalent to a 6.75% return, annually from 1965 until 2009. Note also that their portfolio would have been severely impacted by the tech stock bubble and the 9/11 terror attack fallout. Their return would be 75% greater than what they would have earned, had their funds been invested in the Social Security system.

A large number of Americans are invested in the market in their 401(k) plans and outside of those plans. If they could invest part of their Social Security contributions in “the market” in an intelligent manner (yes, that may be the problem!), stay broadly diversified, rebalance frequently and take a more conservative stance as they approach retirement, it is highly probable that they can beat the returns of Social Security. If not done properly, it could be very scary. If done right, it could be very rewarding.

Words of Wisdom from Anonymous

2010-10-29T10:43:00.000-04:00

Our first two “Words of Wisdom” posts were quotes from the famous investor, Warren Buffet. This time we thought you’d like to here from that famous person “Anonymous”. He/she is often quoted regarding all sorts of topics. Sometimes it is more than one person, the oft-referred to experts, “they”. Everyone wants to know who “they” are. No one seems to know.

In this case “Anonymous” is credited for an old Wall Street adage: “No tree grows to the sky.” This is an important fact for all investors to remember. Too often we let our emotions get the best of us. We often buy investments we don’t really know that much about, and then hold on to them longer than is prudent.

While we don’t recommend individual stocks to clients (we utilize low-cost, no load mutual funds, primarily), our clients often like to dabble in this or that stock they heard about over the backyard fence or at the cocktail party last week. We advise them to set a target price at which to sell. They seldom do. Often the stock they buy is one that’s been on a meteoric rise for some time. Surely it will continue? What’s to stop it?

They hang on and hang on until suddenly there’s a market correction or the company’s earnings fall short of over-zealous expectations and the stock drops ten or twenty percent, overnight. The tree they thought would grow to the sky, suddenly was blown over by an unexpected storm. To make matters worse, they often continue to hold on while their stock continues to plummet in price. Surely it will bounce back, they think!

Unfortunately, too often, investors let their emotions drive their investment decisions. We can learn a lot from “Anonymous”. He or she is really quite smart.

Good News for Some, Bad News for Others

2010-10-26T08:45:00.001-04:00

For those who have struggled while preparing their tax returns to determine the cost basis of investments sold during the tax year, there’s good news on the way. For those who cheat on their returns, it will soon be more difficult to fudge on the gains they’ve received.

In 2008, new rules were passed by Congress that will require investment companies to track the cost basis of their customers’ assets and report them to the IRS on form 1099, when those assets are sold. The new rules will be phased in starting this coming January.

Many investors have difficulty determining the cost basis of investments they have sold, in part because they have not kept good records. In some cases they have the data but don’t understand how to accurately calculate the cost basis.

Cost basis is generally not an issue in retirement accounts such as IRAs and 401(k)s, since distributions from those accounts are typically all taxable at ordinary income tax rates. (Note that after-tax contributions to 401(k) accounts and non-deductible contributions to IRAs require special handling when taking distributions).

Gains from the sale of taxable assets must be classified based on how long the asset has been held as either a long-term or short-term capital gain. Long-term capital gains are currently taxable at the maximum rate of fifteen percent. Short-term gains are taxable as ordinary income.

Re-investment of dividends and capital gains are often handled incorrectly by investors when preparing their tax returns. Re-investments add to the original cost basis of an asset and are taxed in the year received. If the cost basis is not adjusted upward for the amount of re-investment, an investor will end up paying taxes twice on the re-invested amounts. The new rules will help investors avoid this problem.

Many investment companies have been keeping track of investors’ cost basis for some years now. Starting in January, they will all have to do so, when they will have to keep track of the cost basis data for newly acquired stocks (both domestic and international) and real estate investment trusts (REITs). Mutual funds will have to start keeping track of the data, starting in January of 2012.

While the new rules make things easier for investors, they will still have to pay close attention to cost basis issues. Assets acquired prior to January 2011, that are not held in an account at a firm that has been tracking cost basis, will still require that you do your own calculations. And, assets for which you have multiple lots will require you to specify which lot or lots you are selling. Those bought at lower prices will generate higher capital gains taxes. You may need to specify which shares you are selling if you want to minimize the taxes.

In summary, it will eventually be easier to determine your cost basis for asset you acquire in the future. For those you already own, the burden still falls on you.

More Bailouts to Come

2010-10-24T20:53:00.001-04:00

As everyone hopes for a turnaround in the economy, few people probably realize that more bailouts have been promised by the government and will continue to increase the country’s already huge debt.

Who’s going to get the bailouts you ask? None other than Fannie Mae and Freddie Mac, who, as of 2008, owned or guaranteed 56.8% of the U.S.'s $12 trillion mortgage market. Neither Fannie Mae nor Freddie Mac was included in the massive new package of regulations passed by Congress a few months ago. Many felt that Fannie and Freddie bore much of the blame for the “Great Recession” we found ourselves in, and were dismayed that Congress refused to include them in the legislation.

An article in the Wall Street Journal titled “Fannie, Freddie Elicit a Grim Forecast” (Saturday, Sunday October 23 -24) by Nick Timiraos, reported that “propping up Fannie Mae and Freddie Mac will cost taxpayers $154 billion under the most likely scenario for home prices, the mortgage giant’s regulator said Thursday.” The article went on to say that the cost may be higher, “nearly double the $135 billion already spent – if grimmer projections prove true and the economy slides back into recession”.

In 2008, the government took over Fannie and Freddie and promised to provide unlimited funds to keep them solvent, in turn for 10% dividends to the government. According to the article, the dividend expense itself will likely be from $67 billion to $91 billion and “will likely keep them from ever returning a profit”. And if home prices continue to drop, the government will have to cough up much more to keep Fannie and Freddie afloat.

It’s hard to imagine how Congress could ignore the inclusion of Fannie and Freddie in the new regulations recently introduced. We can only hope the economy turns around soon. If not, we’ll all be paying substantially more to bailout Fannie and Freddie.

Long-Term-Care Insurance Getting Tougher to Buy

2010-10-21T20:40:00.001-04:00

For many people, buying long-term care insurance is a difficult decision to make. It gets about the same level of attention as planning for one’s funeral. Few like to even think about going to a nursing home. Many just rationalize that they will never need it, putting off what they know is an important decision that could severely impact their financial future.

With people living longer and longer, the odds of needing long-term care are increasing. We provide in-depth information about long-term care insurance to all of our clients who contract for a comprehensive financial plan.

Long-term care should not be considered by those who are either too poor or too wealthy. If you are struggling to just get by in meeting your expenses, you likely can’t afford long-term care insurance. If your net worth is two or three million dollars, you possibly can cover the cost of long-term care yourself (i.e. self insure). If your net worth is somewhere in between, you may be a candidate for long-term care insurance.

Unfortunately, recent news has made the decision even tougher. In the last few months, a number of large insurance companies have either significantly raised premiums for many of their existing policy holders or are planning to (from 10% to as high as 40%). John Hancock Financial has also stopped selling long-term care plans to employer-benefits programs.

According to an article in the Wall Street Journal titled “Long-Term-Care Premiums Soar” (October 16 -17, 2010), the increases are the result of people living longer, generating higher cost claims and canceling fewer policies. The article states that low interest rates have also resulted in less income on investments used to fund the long-term-care policies.

As a result, a decision that’s always been a tough sell is now even tougher. The only option to combat the higher prices seems to be to reduce coverage or increase the waiting period before benefits kick in (i.e. assume more of the cost yourself). What ever you do, be wary of low-cost providers who may not be large enough to be around for the long-term. The way things are going, we worry that even the large companies will stop selling long-term care policies.

Now You’ll be Able to Check Out Your 401(k)

2010-10-19T08:34:00.000-04:00

On more than one occasion, we’ve worked with clients who had 401(k) plans that were hard to evaluate. Often, the real costs were not easily discerned. In many cases, we discovered that clients were paying very high fees that ate away at employees’ annual returns. Now, it will be easier for everyone to evaluate just how much they are really paying for their 401(k) plans.

Recent articles by both the Wall Street Journal (“Investors in 401(k)s to get More Details”, October 15, 2010) and the Associated Press (“Labor Dept. Releases New 401(k) Fee Disclosure Rules”), discussed new rules just released by the U.S. Labor department.

Often, investors have overlooked the impact that taxes and investment expenses have on their investments. With 401(k) plans, the data has been generally difficult to ferret out, even if one made an effort to find out what they were paying. According to the Wall Street Journal article, companies will be required to provide details about their 401(k) plans’ performance, fees and expenses starting in 2011.

According to the Journal article, “the fees and expenses associated with the funds that a worker chooses must be explained as a percentage of assets held, and also represented as a dollar amount for each $1,000 invested.” An easy-to-understand glossary of terms must also be available to help workers understand the fees, expenses and other information about their plans.

The two articles contained conflicting information about when the new disclosure rules will take affect. The Wall Street Journal said the new data will be available in 2011, while the AP article mentioned both July 2011 and January 2012 as effective dates for the new disclosures.

Get Ready for a Possible Cut in Pay

2010-10-17T11:16:00.001-04:00

We wrote recently about avoiding large tax refunds (see our post titled “Are Your Tax Refunds Too Large” (October 6, 2010). Any planning you might try to do in that regard will be difficult due to Congress’ inability to finalize the tax rates for 2011.

According to an article in the Wall Street Journal titled “Delays to Tax Tables May Dent Paychecks” (October 7, 2010), workers may pay significantly more for withholding, starting with their first paycheck in January, if Congress doesn’t act quickly following the November 2nd election.

As most people know, Congress adjourned recently without addressing the issue and won’t return to Washington until November 15th. According to the Journal article, the Senate plans to address some non-tax issues first, when they re-convene. It’s possible they won’t be able to address the tax issues before they adjourn for the Thanksgiving recess. That would push the decision on the Bush tax cuts to early December.

Such a late decision on the taxes creates a real problem for the Treasury Department, which normally releases the tax-withholding tables for the upcoming year in mid November. Employers and payroll processing companies may find it difficult to change and test their systems prior to the first January paychecks being issued.

The Treasury Department has a couple of options. They can just tell employers to continue to use the current tables. In that case, taxpayers may end up being significantly under-withheld for the year. Another option is to provide a one or two-month grace period for the implementation of the new rates. A third option would be to assume Congress will extend the Bush tax cuts for those joint filers making less than $ 250,000 ($200,000 for single filers). However, they have never published tax tables based on assumptions before.

Whatever happens, we recommend you stay tuned to our blog for an update on how the issue is resolved and what you should do.

More Words of Wisdom from Warren

2010-10-14T20:17:00.001-04:00

We recently posted a blog titled “Words of Wisdom from Warren”. We like financial quotes of all types, especially those from famous investors or well-known people. Warren Buffet, known as one of the savviest investors of all time, is often quoted for his thoughtful words of wisdom.

This is the second of our “Words of Wisdom from ……..”. that we will post from time to time. It’s unlikely the quotes will focus on something we haven’t written about previously. Many however, will give us the opportunity to re-emphasize an important concept.

Warren’s quote today is attributed to his “oft-repeated response when asked why he doesn’t invest in high-tech stocks”, as noted in The Quotable Investor (The Lyons Press, 2001). Prior to the tech-stock bubble, Warren’s Berkshire Hathaway stock was avoided by many investors because he hadn’t participated in the tech-stock buying frenzy. His response as to why he hadn’t was: “We will never buy anything we don’t understand.”

Because of his views on tech stocks, Warren’s Berkshire Hathaway stock price was significantly depressed at the time. Some were saying that he had lost his touch. Like everything else, Berkshire Hathaway stock dropped in price when the tech-stock bubble burst, yet it proved to be a great buy at the time, since its price drop was small when compared to many of the tech-related investments. We’re sure a great many investors wish they’d bought Berkshire Hathaway stock back then.

The lesson is simple: To be a successful investor, you have to do your homework. Don’t be taken in by hype, flashy commercials or promises of inordinately–high yields. And if you don’t have the skills to ask the right questions, take the time to find a trustworthy, qualified professional who can do it for you. It will be well worth the time and money.

Have You Thought About Commodities for Your Portfolio?

2010-10-12T09:28:00.001-04:00

We are constantly talking about the importance of diversification in your portfolio because good diversification can actually increase your returns and at the same time, lower risk. How is that possible you may ask, when normally, higher returns bring with them higher risk? It’s due to the fact that effective diversification is achieved by including asset classes in your portfolio that have low correlation to one another.

The correlation between two investments measures how closely the prices of the two investments move in tandem with each other. If two types of investments have high correlation, their prices will move up and down together. With low correlation, their price movements are unrelated. If they are strongly negatively correlated, they will move in opposite directions.

Investments that have low correlation tend to achieve their highs and lows at different times. Thus, some will be down in bad markets while others may be up in value.

It turns out that commodities (oil, precious metals, corn, soybeans, etc.) exhibit low correlation to many of the traditional asset classes people own in their portfolios (stocks and bonds). Because they have low correlation, adding commodities to your investment portfolio can improve your portfolio’s diversification. As noted above, improving diversification can increase your portfolio’s return and lower its risk (volatility).

In addition, many investment advisors believe that commodities are a good hedge against inflation. At the present, inflation is quite low and many economists expect it to remain that way in the near term. Others, however, worry that our high national debt will lead to high inflation in the long run. Including a small amount of commodities in your portfolio can help protect you from increasing prices.

We all know that our natural resources are limited. As we use more and more of them and they become scarcer, their prices will rise dramatically. This is another reason to consider owning commodities. The problem is, there are limited ways to invest in commodities and commodity prices can be very volatile. If you are interested in investing in commodities, we highly recommend that you seek professional advice on the best way to invest. We’ll talk more about ways to invest in commodities in the future.

Your Power of Attorney Isn’t Enough

2010-10-09T11:39:00.002-04:00

We’ve written before about powers of attorney (POAs) being ineffective. If you don’t take some action with respect to your POA, your designated representative may have great difficulty helping you with your investment accounts, should you become incapacitated. We decided it would be beneficial to our readers to review this subject, once again. In addition, we conducted a short survey with three mutual fund companies to determine their policies with respect to POAs.

In a previous series of articles we have covered the basics of estate planning. The articles are no longer available on the Oakland Press website but may be viewed on our website by going to our “In the News” web page and clicking on the “Estate Planning” topic.

In those articles we pointed out that at a minimum, everyone needs a will, patient advocate form and power of attorney. Should you become incapacitated, and unable to conduct your own business affairs, a durable power of attorney gives authority to another individual or individuals to act on your behalf. Or does it?

A phone survey of Fidelity, Schwab and Vanguard discovered different procedures regarding POAs:

Fidelity: Your POA may be affective but you need to complete an Affidavit and Indemnification form and then send your POA to Fidelity along with the Affidavit form for their review. If approved, your POA will provide the authority you desire.

Schwab: With Schwab, you just need to send a copy a copy of your POA along with a list of the non-retirement accounts to which the POA pertains, to Schwab Operations Center, P.O. Box 628291, Orlando Florida 32862. Schwab will review your POA to determine if it meets their requirements and notify you if the POA is approved.

Vanguard: Vanguard has its own POA form that you must complete.

If you’ve invested with other financial institutions we recommend that you call them to see what their policies are.

We suspect that all three firms will honor existing POAs, should a customer become disabled without previously taking the steps noted above, but probably not without having to jump through several hoops. We believe it’s wise to make sure you have taken the necessary steps in advance of needing a POA. Few people know of these requirements. If you haven’t done so, make this a priority on your “To Do” list. While you’re at it, it’s probably a good idea to check to see if your bank will honor your POA too.

Are Your Tax Refunds Too Large?

2010-10-06T17:39:00.000-04:00

If you receive a large tax refund each year, you are in effect loaning money tax free to the Federal government. People with irregular income: sales people, people earning bonuses, and those with large tax deductions such as rental losses, capital losses, large itemized deductions, etc., often receive large tax refunds.

Often the large tax refunds are caused by a common misconception regarding payroll tax withholding. The number of allowances you claim on your payroll withholding form W-4 does not have to match the number of exemptions you are legally required to claim on your tax return. What you put on your W-4 is only a guide to let your payroll department know how much to withhold from your paycheck.

Consider a specific example, a married couple with two children who have been getting refunds between $7,000 to $10,000 each year. They are feeling very pinched each month. But since they have large deductions and/or credits such as a rental property at a loss and a college lifetime learning credit, they are getting large tax refunds each year. Instead of each of them claiming “Married with four allowances”, they should change their withholding to seven allowances in order to get more money paid to them each payday.

How do you determine how many allowances to claim? Prepare a tax plan to determine the estimated refund you will get if you don’t change your current withholding (Note: if you use Turbo Tax or some other tax preparation software, you can create a pro-forma tax return for the current year by estimating the same types of income, deductions, etc that you included the year before).

Take that refund number and divide it by the number of paychecks remaining in the tax year. Don’t forget that if you are paid every two weeks, you receive 26 pay periods per year instead of 24 (paychecks twice every month). Then obtain the IRS Circular E (Publication 15). Find the chart that corresponds with your filing status (single, married, etc.) and the frequency of your paychecks. Find the amount of gross income from each paycheck and match it with the corresponding row in the chart. Then, in the columns to the right of that row, find the dollar amount of withholding you want to change your withholding to. The number at the top of that column is the number of allowances you need to claim. Remember, the higher the number of allowances, the less withholding from each paycheck. If your income is higher than the charts show, follow the formula included in the Publication.

For many, the method above may be a bit complicated. Here’s an alternative method. It’s also possible to tell your payroll department to withhold a flat dollar amount from each paycheck. You’ll need to check with your payroll department first, but generally they recommend that you claim 9 allowances (the equivalent of $0 withholding) and then an added dollar amount equal to the total withholding you want per paycheck. This can be a much easier way to control your withholding without having to follow the IRS payroll withholding charts. Again, make sure you contact your payroll department first to make sure they can accommodate these types of requests.

Many people find themselves spending their big tax refund every year instead of saving it. The above approach is a good way to force yourself to save. You’ll find that automatically investing the increased amount of your paycheck each pay period will prove to be an easy way to set aside funds for retirement, college, or your next car. And, don’t forget to change your withholding back to an appropriate level when the New Year comes.

Be Careful of Your Bond Holdings

2010-10-03T10:18:00.000-04:00

Many have been pulling their money out of the low-paying money market funds and buying into bond funds in order to increase their income. With the market downturn in 2008, many investors have shied away from equities and are searching for yield. Money market funds and savings accounts are paying next to nothing.

What investors need to understand, however, is that bond funds are not without risk. Two types of risk are particularly important: credit risk and interest-rate risk. Credit risk involves the risk of the issuer defaulting on the debt. If you buy high-quality bonds (AAA or AA) you can minimize the credit risk.

Interest rate risk involves the risk of rising interest rates. The prices of bonds decline when interest rates rise,. You can measure the interest rate risk by taking note of what is called a bond’s “duration”. A bond with a duration of 3 years will lose approximately 3 percent when interest rates rise one percent (e.g. one percent loss for each year of duration). Obviously, if you hold a bond until it matures, you can eliminate interest-rate risk. With bond funds, however, you are subject to interest-rate risk because you can’t control the maturity of the bonds they purchase or whether or not the fund manager holds the bonds until maturity. You need to take care to note the duration of a bond fund before purchasing. That information is readily available on Morningstar.com.

We just attended the Financial Planning Association of Michigan’s Fall Symposium this last week. There seemed to be a general consensus of the speakers that interest rates will stay fairly low for the near term. Nevertheless, you need to take care to ensure you are not taking on too much risk with your bond investments. You can lose principle when you invest in bonds!

Tempted by Gold?

2010-09-30T21:44:00.000-04:00

On Tuesday gold jumped above $1,300 an ounce for the first time. On the surface, it seems as if gold will continue skyrocketing upward with no end in sight. Many are tempted to buy now, afraid to miss out on this “sure thing”.

In our blog article back in June (Differing Views on Gold, June 2, 2010 ), we quoted a Wall Street Journal article by author Jason Zwieg titled “Why One Legendary Investor Is More Worried Than Ever”. Mr. Zweig explained how Seth Klarman (president of Baupost Group, a firm in Boston that manages $22 billion of investors’ money) views the current market situation. Mr. Zweig stated in the article that:

“Mr. Klarman specializes in buying securities that nauseate other investors….” Mr. Zweig pointed out how worried Seth is about the world economy, in general. And how does Seth feel about gold as a hedge against the problems of the future? According to Mr. Zweig, Seth believes that all the obvious hedges are already extremely expensive, including gold. Seth was quoted as saying that gold is “Near its all-time high, it’s a very hard moment to recommend gold.”

At that time the price graph of gold’s rise reminded us of the typical graph of an asset bubble. The further it rises, the more so it looks like a bubble waiting to burst. If you must buy, limit your exposure to a small percentage of your portfolio and set a price at which to sell. Then, don’t hesitate to sell if gold reaches that price.

We believe it’s still a hard moment to buy gold. In fact, for us it’s even harder. Sure, gold may well continue its meteoric rise. And if it does, you can rightly say we were wrong. On the other hand, if it crashes, we can say we told you so. Remember our blog post from last week “Words of Wisdom from Warren”, in which we quoted one of Warren Buffet’s famous quotes: Rule # 1: Never Lose Money. Rule # 2: Don’t forget Rule # 1.

Do You Really Know Where Your Money is Going?

2010-09-28T21:41:00.000-04:00

We often do comprehensive plans for our clients. We emphasize to them that besides establishing meaningful objectives, the most important factor in creating a meaningful plan is to properly document how they are currently spending their money and then projecting what their expenses will be in retirement (in today’s dollars).

This sounds pretty straightforward, right? In turns out that this is the biggest problem we have in doing comprehensive plans. If we don’t have an accurate assessment of where a client’s money is going and what they will need in retirement, we can’t complete a meaningful plan.

The typical scenario we run into is this: After signing up for a plan, our clients fill out a detailed questionnaire that includes detailed spending information. Invariably it seems, when we enter the data into our software, we find that when we compare what the client says they are currently spending to their current income, our software indicates a surplus of hundreds or even a thousand dollars, or more. They just don’t know where their money is going.

We strongly believe that the vast majority of our readers also don’t really know how much they are spending on many of their budget items. Yet they worry constantly about their investment returns. If they have given serious thought to their financial objectives (and many have not), there is no way that they can be spending in an optimal way to achieve their goals, if they can’t even document where their money is going.

If you are like many out there, who have not made it a point to track where they are spending their money, we strongly suggest you make it a priority. Software packages such as Quicken® or the website mint.com can help you manage your money. If you don’t think you can do it yourself, seek professional help.

Will the Market Rally Following the Election?

2010-09-26T08:51:00.000-04:00

We wrote back in July in a blog titled “Don’t Miss the Party” that a substantial amount of cash was on the sidelines waiting for the right moment to invest. We wrote:

“An article in the July 12 –July 18, 2010 issue of Bloomberg Businessweek titled When Cash Takes a Vacation by Roben Farzad, reported that ‘American Households are sitting on nearly $8 trillion in cash – money that’s earning virtually no return because people are so wary of additional losses.’ The article also reports that non-financial U.S. corporations had $1.4 trillion of cash on hand in the 1st quarter of this year. That was a 27% increase over 2007. At some point, the low returns this cash is receiving will motivate corporations and individuals to deploy it elsewhere.”

In our blog, we noted that being out of the market when a big rally takes place can be detrimental to your financial future.

In our opinion, the current problem with the economy seems to be more a problem of uncertainty and lack of confidence than anything else. Businessmen, bankers and investors are afraid to invest because they are uncertain about taxes, new regulations and the new healthcare plan. Banks are afraid to lend and businessmen are afraid to borrow. Providing them more money to invest doesn’t seem to be the answer. They need a reason to feel confident. A considerable number of people are unhappy with their government.

It seems probable that a substantial number of incumbents will find themselves without a job following the upcoming election. It may be that a significant change in Washington across both parties could spark a market rally.

An article in this weekend’s Wall Street Journal titled “Will Post-Election Bounce Happen This Year?” by Ben Levisohn, notes that historically markets rally after mid-term elections. The article quotes an average gain of 17.1% in the Dow Jones Industrial Average following mid-term elections.

The article explains that sitting presidents typically try to stimulate the economy in their third year in an effort to help their prospects of re-election. In many cases, the article says, the Federal Reserve has often lowered interest rates in the third year by an average 0.3%. With interest rates currently so low and all the controversy about the administration’s stimulus plans to date, it seems unlikely that the administration can utilize those tools. Therefore, the article states, a post-election bounce may not happen this time around.

Yet, for the reasons noted above, we believe the election may give confidence to bankers and investors alike, that the issues they are concerned about may soon be resolved. This could result in a market rally. The Journal article states that some believe the recent run-up in the market is in fact due to anticipation of a Republican takeover of the House of Representatives. Whether or not a rally occurs following the November elections remains to be seen. Timing the market is tough. We don’t recommend placing a big bet on such a speculative outcome. Never the less, it’s interesting to think about.

Words of Wisdom from Warren

2010-09-24T19:24:00.000-04:00

We like money quotes from famous people and often include them in our client newsletters. Most people know who Warren Buffett is and we often quote one of many of his quotes: Rule # 1 is: Never lose money and Rule # 2 is: Don’t Forget Rule # 1.

In case you aren’t quite sure of who Warren is; he is one of the wealthiest people in the world who learned about investing and started investing at a very early age. In college, he studied under the famed investor Benjamin Graham who wrote the classic book on investing titled “The Intelligent Investor”. Using what he learned from Graham, Warren started his own investment firm, now known as Berkshire Hathaway.

Warren is now worth billions of dollars and plans to leave the vast majority of his assets to charity, when he passes on. He has become close friends with Bill Gates and made headline news in June, 2006, when he announced that he would join forces with Gates by leaving the majority of his fortune to the Bill and Melinda Gates Foundation... Recently Warren and Bill Gates secured the pledges of numerous other billionaires to leave at least 50% of their fortunes to charity.

Warren’s quote reminds us of the importance of protecting our principle when investing. Too often, investors look only for investment return, often chasing the latest hot investments. They overlook the fact that high returns bring high risk. Steady growth over time is what is really important. Losses are difficult to make up. A 10% loss requires and 11% gain to get back to where you were. A 25 percent loss requires a 33 percent gain and a 50% loss requires a 100% gain, just to break even.

We believe that many of these money quotes help teach a lesson often overlooked by investors. We plan to include more of these “Words of Wisdom” in our blog and hope you enjoy them.

The Biggest Mistakes People Make

2010-09-22T21:20:00.000-04:00

Our last blog talked about the best money advice people have received. It caused us to think about the mistakes we’ve seen our clients make. We thought a summary of some of the common mistakes people make would be beneficial to our readers. Here’s a list of some we believe to be most detrimental to your financial well being:

(1) Running up too much credit card debt – Nearly everyone is aware of this problem. It’s so easy to pull out that credit card and buy whatever you want. If you’re not paying off your balances each month, you’ve got a problem. Seek help if you don’t know how to eliminate it.

(2) Lack of financial goals – Everyone’s budget is limited. Therefore you need to sit down and decide what’s important to you. Take time to analyze where you are currently spending your money and then re-align your spending to address what’s really important to you.

(3) Lack of an emergency fund – We used to recommend three to six months of living expenses set aside in liquid assets. With the recent volatility in our economy, we now believe that nine months to a year of living expenses might be more prudent.

(4) Lack of saving - Too many people focus too much on investment returns, when the best way to increase their net worth is to reduce their spending and save more. Benjamin Franklin’s saying “A penny saved is a penny earned” is just as valid today as it was back then. And, there’s no tax on the dollars you save. That’s a big benefit!

(5) Lack of portfolio diversification – We recommend eleven different asset classes for clients to invest in. Having five different large stock mutual funds provides large stock diversification but not true portfolio diversification. And having five large stock mutual funds most assuredly results in significant overlapping of the same holdings. True diversification across a variety of uncorrelated asset classes can increase your portfolio returns and lower your portfolio risk. If you don’t know how to do this correctly, seek professional help.

(6) Lack of basic insurance protection – An accident, sickness, death, disability, fire or lawsuit could wreak financial havoc. You need adequate medical, home, auto, disability, life and umbrella liability policies to protect you and your family. You want adequate coverage with deductibles designed to protect you against the large loss. Assuming the cost of small losses keeps your premiums down and will save you in the long run.

(7) Lack of focus on investment fees and taxes - Too many investors focus only on investment return. They forget that with high promised returns comes higher risk. Don’t ignore investment management fees, fund expenses and taxes which often significantly reduce returns. Investors frequently have no real idea of what fees they are being charged. Make it a point to find out what you are really paying.

(8) Letting emotions or taxes drive investment decisions - Investors are loss averse. They hold on to their losers too long and hold on to their winners too long. They are always “just sure” their poor investment will return to its former value. When an investment has a poor outlook you are better off selling it, write off the loss on your tax return and invest in something else with good prospects. When you buy a stock, set a target price at which to sell and then sell when it reaches that price. And don’t let taxes get in the way of selling. You will ultimately have to pay them anyway, so if it makes sense to sell, do so and pay the taxes. Many bad things can happen if you delay just because of taxes.

(9) Lack of estate planning – many people have not taken the time to even create a basic will. If you die without a will (intestate), state laws will determine the distribution of you assets. You may not like how the state does it. And if you have children, who will have custody if something happens to you and your spouse? Many clients come to us with detailed estate plans that include revocable living trusts. It’s very common for the trusts to be unfunded (e.g. the trusts contain no assets because the client failed to re-title their assets.) It’s also common for beneficiary designations to be incorrect. If you have no estate documents or it has been some time since they have been reviewed, we highly recommend you seek professional help.

Keep these in mind and you will be well on your way to personal financial freedom.

My Best Advice

2010-09-19T21:51:00.001-04:00

The October issue of Real Simple magazine included readers’ thoughts on what is the smartest money advice they had ever received (“This Month’s Question” in the Your Words section). The advice people had received was very diverse and caused me (Dave Patterson) to ask myself the same question. In my case, it was probably not some specific piece of advice someone gave me but rather the example set by my parents in how they managed the family’s finances. Clearly, they had been affected, like many, by the experience of the great depression.

I can still remember vividly, the little black notebook that my mother kept to log all of their expenses. I remember the stories my dad told of working in the potato fields for 15 cents a day and how they had only a dollar or so for gasoline each week, when they were first married.

I began saving at an early age. Someone gave me a “piggy” bank that took only quarters, inserted one at a time. As each quarter was placed in a slot in the bank, I had to pull a lever that inserted the money and registered the current total in a small window on the front of the bank. It held a total of $25.00. What was really cool was that the bank had a key that opened a little door on the bottom to empty the bank of its precious contents. I became almost obsessed with the bank. I couldn’t wait to earn another quarter, so I could see my savings rise. I asked for jobs to do and eventually delivered papers to earn money.

When I finished college, married and started working, I made it a point to direct nearly all of any net pay increase I received to savings. As a result our retirement savings grew rapidly.

If you were to ask me what my “best” money advice would be, I’d probably tell you to make saving the highest priority. Once you are making ends meet, direct any raises and bonuses to savings. After all, if you’re getting by on what you make and get a raise, you don’t really need that extra money to live on. If you want to really get ahead, take the opportunity to direct the extra cash to savings. Sure, it’s OK to spend a bit of it on yourself or to help you achieve a goal that was previously unattainable. Saving the majority of it, however, may be the only way you’ll truly get ahead in this tough world we now live in.

There are lots of people making big bucks who spend everything they make. They have the fancy cars, big homes and all the toys. What they often don’t have, is any significant savings. They may appear to be wealthy but aren’t saving for the future.

My best advice to you is to make saving a top priority. If you do, you’ll be making a wise investment in your future.

When Should You Start Taking Social Security - Part II

2010-09-17T12:49:00.001-04:00

Our last blog (Part I) discussed the various issues involved in deciding when to start taking your Social Security benefits. This blog discusses how those who already started to receive Social Security can potentially increase their lifetime benefits by “resetting” those benefits.

We believe that most people have never heard about resetting Social Security benefits. So what’s involved? To reset your Social Security benefits, you basically pay back the government all the benefits you’ve received as of a certain point in time. This is called a “Withdrawal of Application”.

To initiate this process, you must file form SSA-521. You can obtain a form online. The instructions on the form state: “This procedure is intended to be used only when your decision to file has resulted, or will result, in a disadvantage to you”. It’s not clear what criteria the Social Security Administration applies in approving a Withdrawal of Application, but if a withdrawal results in potentially increasing your lifetime benefits, it seems like that should be reason enough. At some point in the future, you would then re-apply for Social Security and begin receiving larger benefits based on your then current age. Obviously, the longer the period since you originally applied, the greater the benefits will be.

Once the request is approved, you are required to pay back all benefits previously received. No interest is charged on the repaid amount and your Medicare status is unaffected. You will receive a form SSA- 1099 that indicates a negative net benefit amount. You can either deduct the back taxes or receive them as a credit on your current year’s tax return.

An obvious question is: under what circumstances does a reset of Social Security benefits result in greater lifetime benefits? We noted in our last blog that actuarially, the present value of the stream of benefits you receive should be the same regardless of when you start taking payments, assuming you live to your projected life expectancy.

Those who believe that they may live substantially longer than their expected life expectancy because of their health and family longevity history, may well benefit from a reset. Additionally, married couples where the lower-income spouse is significantly younger (or healthier) than the other major wage earner of the household, may find a reset to be of value since the increased benefit can continue as a larger survivor benefit through to the life expectancy of the younger/healthier spouse.

In an article in the Journal of Financial Planning titled “Social Security Reset: When Does it Make Sense?”, by Charles Ryan, CFP® (June 2010), Mr. Ryan also points out that: “After repaying benefits, time must elapse before the retiree breaks even on the transaction.” If the retiree dies earlier than expected, the benefit of the reset may be lost.

Mr. Ryan also points out in his article that retirees who are considering the purchase of an immediate annuity may find that they will receive a much greater benefit amount if they use the cash they have on hand to fund a reset of their Social Security benefit.

If you think a Social Security reset may benefit you, we strongly urge you to seek professional advice before filing out an application.

When You Should Start Taking Social Security - Part I

2010-09-15T21:32:00.000-04:00

We assume that many of our readers are already retired and collecting Social Security payments, or soon will be. Our clients often ask us when they should start taking their benefits. What few people know, however, is that after you have started receiving Social Security payments, you can still change your mind. It’s called Social Security “reset”. In some cases it may make sense. We’ll discuss that in our next blog – Part II of this series.

First, let’s talk about when you should start taking your Social Security payments. Obviously, the longer you wait the greater your monthly payments will be. If you start receiving payments at age 62, you will receive an amount that is less than what you would receive if you wait until your full retirement age (FRA). If you outlive your life expectancy, then waiting till FRA could be very valuable. On the other hand, if you wait until your FRA and then die soon after, you may come out on the short end.

The Social Security system is set up so that from an economic standpoint, it should make no difference when you start receiving your Social Security benefits. Actuarially, the present value of the stream of benefits you receive should be the same regardless of when you start taking payments, assuming you live to your projected life expectancy.

To start with, you should consider your health and family history. If everyone has lived well into their 90’s and you are in top notch health, you should consider waiting until you reach FRA. On the other hand, if you are not very healthy and your family has no history of longevity, you might want to consider starting your benefits at age 62.

Also, if you plan to work full time until FRA in order to have enough funds for retirement, you would be best to wait on starting benefits, since they would be reduced by one dollar for each two dollars you earn above the current limit of $14,160. Once you reach FRA, there is no reduction in benefits received. If you work part time while receiving benefits, there is no reduction as long as you earn less than $14,160.

Obviously, if you are forced into an early retirement and need the Social Security benefits just to survive, you may have no alternative but to start receiving benefits at age 62. If your health outlook and longevity are good, and you have other sources of income you can rely on (including the possibility of part-time income), you should wait as long as possible in order to maximize the amount of your benefits.

If you are married and one spouse is significantly younger than the other major wage earner of the household, it likely makes sense for the major wage earner to wait until FRA or longer before starting benefits. Assuming the older spouse dies first, the lower-earning surviving spouse will receive a significantly higher spousal survivor benefit over the remainder of his/her life expectancy. Health and longevity outlook of both spouses still need to be considered.

One final consideration that is difficult to evaluate, is how legislation may affect the decision of when to start taking benefits. With Social Security System funding in question, future benefits could be cut, FRA’s extended and Social Security taxes increased by coming legislation. While it’s unknown what the impact might be, one could argue that taking benefits earlier rather than later might be advisable.

If you are unsure of what to do, we recommend you discuss the issue with a financial advisor.

When Should You Take Your Annual IRA Distribution ?

2010-09-12T21:15:00.001-04:00

In a recent meeting with a client we were asked whether it was better for them to take their IRA required minimum distributions early in the year or towards the end of the year. Seniors who have reached the age of 70 and ½ must take their first IRA distribution by April 1st of the year following the year they reach age 70 and ½. For the years thereafter, they must take their minimum distributions by December 31st of each year.

The required minimum distribution (RMD) each year is based on the IRA balance on December 31st of the previous year and the life expectancy the IRA owner reaches in the year of distribution.

Obviously if funds are needed to live on, the distribution should be taken whenever it’s needed. Generally, however, it makes sense to leave assets in an IRA for as long as possible, so that they can continue to grow tax free. That assumes, of course, that over the long run, the value of the assets will grow.

On the surface, for the distributions required in a given year, it seems that it probably doesn’t make that much difference whether the distribution is taken early in the year or later, unless the distribution is reasonably sizable. Even then, it would be better to take it earlier, if the market dropped significantly during the year, and better to take it later, if the market rose during the year. But who can predict what will happen at the beginning of any given year?

Given that over a very long time horizon, market values have increased, it probably does make sense to take distributions later in the year rather than earlier. While any yearly gain from waiting may be minimal, and some years may result in losses, over a retirement of twenty or more years, there should be some benefit to taking the distributions later in the year.

Confused yet? To make matters more complex, a recent MorningstarAdvisor online article titled “IRS Stepping Up IRA Enforcement” (9-10-10) by Natalie Choate, considered the “guru” of retirement benefit distribution planning, warned that the IRS is going after those who fail to take their required minimum distributions. The penalty for insufficient withdrawals is 50%. In order to minimize the chance of an audit, Natalie’s article concludes that those reaching the age of 70 and ½ are best to take their first distribution in the year they turn 70 and ½, rather than delaying to the year following (prior to April 1st). She also points out that those nearing their expected life expectancy (who can be sure of that?) can minimize audit possibilities by taking their distributions early each year.

Clearly, if you take care to withdraw the proper amount, you have no fear of an audit (unless you’ve stretched other IRS rules). In any case, if you are unsure of how much to withdraw or when, seek professional help.

Naming a Trust as Beneficiary of Your IRA

2010-09-09T15:21:00.001-04:00

In December 2009 we wrote a blog titled “Don’t Overlook Beneficiary Designations”. We noted in that article that it if you are married and have established revocable living trusts, with your spouse as primary beneficiary, it may make sense to name your trust as a contingent beneficiary. Doing so may allow your spouse to disclaim (refuse) all or a part of the IRA distributions in order to “fund” your trust, should pre-decease your spouse. (Note: “Funding” a trust involves re-titling assets in the name of the trust and or designating the trust as a beneficiary of insurance policies or retirement accounts).

Revocable living trusts can be set up for many reasons, but commonly are used to avoid costly estate taxes. At the present time (2010) there are no estate taxes, since Congress let the estate tax expire at the end of 2009. It is expected that Congress will enact a new estate tax by year-end. If not, estate tax law will revert back to a one million dollar exemption per person with the highest estate tax rate exceeding 50%. We can be quite sure, therefore, that there will be an estate tax in our immediate future.

With properly executed revocable trusts and proper titling of assets, a couple can protect two times the estate tax exemption from estate taxes. With a one million dollar exemption, that would mean a married couple could therefore shelter two million dollars from estate taxes. If, however, the majority of your assets are held in IRA accounts with your spouse as beneficiary, those assets would not be included in the trust. The trust might therefore not be fully funded, resulting in an estate tax liability.

By specifying the trust as a contingent beneficiary, the spouse can disclaim some or all of the IRA funds, if necessary, to fund the trust. While distributions from the IRA might be taxable at the trust’s higher tax rate, estate tax rates are typically much higher than income tax rates. Therefore, significant taxes may be saved by diverting some or all of the IRA to the trust. We highly recommend discussing the tax issues with a CPA prior to disclaiming any benefits.

If an estate tax liability is unlikely and you have children you want to be contingent beneficiaries, it is generally better to actually name them as contingent beneficiaries, even if they are the beneficiaries of the trust. Naming the children as contingent beneficiaries of the IRA will allow the IRA to be split into separate IRAs upon your death so that each child can take distributions over their individual life expectancy. Separate IRAs also provide more individual flexibility with respect to distributions for the children.

If the IRA is paid to the trust as contingent beneficiary, with your children beneficiaries of the trust and certain conditions are met, the distributions may be paid out over the life expectancy of the eldest child. If the trust does not meet those conditions, the IRA will have to be distributed within five years, thereby eliminating the ability to allow the IRA to continue to grow tax-free.

The tax rules involving retirement plans and trusts can be quite complex. We highly recommend you seek the professional advice of a CPA, tax attorney, estate planner or financial advisor, if you have any questions.

Maybe It’s Time to Diversify Your Skills

2010-09-06T11:29:00.000-04:00

We are always emphasizing that investors need to make sure their portfolios are adequately diversified. Proper diversification can help increase returns and lower the volatility of your portfolio.

With Labor Day upon us once again, we couldn’t help but think about the fact that another type of diversification could serve investors well. Acquiring new skills can position you to weather tough economic times like we are now experiencing. Unemployment is currently at 9.6 percent. Well in excess of fourteen million people are unemployed in the United States.

Having a diverse skill set can help mitigate that unexpected pink slip. You may even find a job that you find more enjoyable, even though it may not pay as much as your old job. A part-time job can supplement your emergency fund (You do have an emergency fund, don’t you?) to help you bridge the unemployment gap.

Consider pursuing your passion. It’s not unusual for people to work their entire life at a job they don’t really enjoy. They are stuck in a rut and afraid to try anything else. Take a hobby to the next step by starting a part-time business. Take a course or two at your local community college. Go back to school to get an advanced degree or finish that degree you never completed.

Even if you never lose your job, you will be positioning yourself to make a job change that might just change your life for the better. You may be preparing yourself to pursue your passion in retirement, doing what you love and at the same time supplementing your retirement income. With the Social Security system stretched and high inflation likely down the road, it will be tougher and tougher for people to save an adequate amount for retirement. Having the skills to supplement your limited retirement funds may make all the difference to what otherwise might be a stressful time.

While working at Pontiac Motor Division I (Dave) went back to school at nights
to obtain a business degree. There’s no doubt in my mind that doing that helped me advance my career and helped me obtain a better job when I needed a change. More importantly, during my business classes, I took a course on investing that led to my interest in financial planning. Little did I know that seeking new job skills would lead to a new career that has made it possible for me to work part-time well into my retirement years.

Diversifying your skill set will give you added flexibility to weather whatever storm comes your way while at the same time enriching your life experiences. It might be just as important as having a diversified portfolio.

So You Think You’re Diversified?

2010-09-05T08:21:00.000-04:00

Probably the most important thing to remember about investing is that high returns generally involve higher risk and taking on lower risk generally results in lower returns. That raises the question: Is there a way to increase returns without increasing risk? The answer is: Yes, there is. It’s called diversification.

Properly done, diversification can increase the returns of your portfolio and at the same time, lower risk. In his book, Asset Allocation: Balancing Financial Risk (Dow Jones- Irwin, 1990), author Roger Gibson gives examples of the returns of what he calls traditional portfolios (consisting only of T-Bills, long-term corporate bonds, and stocks in the S&P 500) versus more broadly diversified portfolios (that additionally include international bonds, small domestic stocks, international stocks and real estate investment trusts).

Over 10-year periods ending in 1985, the traditional portfolios returned 13.9 percent while the more broadly diversified portfolios returned 15.3 percent with significantly less risk, as calculated by the statistical measure known as standard deviation. Over the sixteen-year period ending in 1985, the return of the more broadly diversified portfolio was even better, with lower risk.

Obviously, there are limits to how much you can increase returns while at the same time lowering risk and there is no guarantee that in the short term every approach to diversification will result in higher returns with lower risk. Never the less, broader diversification over the long run, if done properly, will likely yield positive results. It is important, therefore, to make an effort to effectively diversify your portfolio.

Effective diversification requires that your portfolio include a number of distinct asset classes. Our client portfolios, for example, include eleven asset classes, including cash equivalents, short-term bonds, high-yield bonds, large-cap domestic stocks, international stocks, to name a few.

We often hear people say: “I don’t invest in mutual funds, I only invest in stocks”. Many financial advisors generally consider eight to ten large-cap stocks to provide adequate diversification for that asset class. However, in order to include small cap domestic stocks and international stocks requires that you research twenty-four to thirty stocks in total, to be broadly diversified in just three asset classes. That’s a lot of work and requires skills that the average investor lacks. Exchange traded funds (ETFs) and mutual funds can provide a way for the average investor to achieve diversification.

In order to include eight to ten diversified asset classes in your portfolio without using mutual funds or ETFs, you would have to research eighty to a hundred different individual investments. For the do-it-yourself investor, this can be quite a daunting task.

When clients come to us, they often have a rather large number of mutual funds in their portfolio. Often there are multiple large company domestic stock funds, multiple international stock funds and so on. They believe they are broadly diversified but in reality may only have three or four distinct asset classes in their portfolio. Certainly, this is better than just a couple dozen stocks and a few bonds, but it doesn’t constitute broad diversification. Multiple large stock funds often include many of the same stocks. This can lead to higher-than-desired concentrations of several stocks and can add significant risk to your portfolio.

In summary, broad diversification across multiple asset classes can help increase your returns and lower risk. To do so however, it must be done properly. If you are unsure of how to do this, we recommend you see a competent professional advisor.

It’s Only a Star-t!

2010-08-31T21:20:00.002-04:00

If you are like many investors who invest in mutual funds you may put too much emphasis on Morningstar®’s star rating for funds. But is having a portfolio of all five-star funds really the most important thing in constructing a portfolio? Is it the magic potion for a successful portfolio? Do you even need a financial planner to recommend investments for you?

First of all, it’s pretty easy to pick a five-star fund. Just go to Morningstar’s website, click on “Tools”, then “mutual fund” under the “Basic Screener” heading, click the five-star box in the “Ratings and Risk” section and then select whatever other search criteria is of interest to you and voila!, you have yourself a list of five star funds.

Is that all you need to do to be a successful investor? We think not. Surely, it’s better to pick good funds than bad funds, but picking funds is only part of creating a solid portfolio.
You need a portfolio that is broadly diversified across a number of distinct asset classes that are not highly correlated with each other (i.e., their returns don’t move in lock step with each other. - one will be up when another is down, and so on). Picking several five-star funds that are all of the same type doesn’t do much for your portfolio.

Morningstar typically says that the mutual fund rating should just be the start of your search for a good fund. We look at ten to fifteen different factors, depending on the asset class, when we research our recommended funds. In two previous blogs, we outlined a number of factors investors should consider when searching for good solid funds in which to invest (Tips on Picking a Mutual Fund, Parts I and II, February 22 and February 25, respectively).

Can you expect five-star funds to do better than a three-star or four–star fund? In a June 1st, 2010 article in the Wall Street Journal titled “Investors Have Stars in Their Eyes”, by Sam Mamudi, Mr. Mamudi writes: “ The trouble is that investors seem to forget that star ratings are backward-looking, based on a fund’s past performance, and studies have shown the ratings have no predictive value.” It’s not unusual for a fund rated five stars this year, to be rated just one or two stars next year and vice versa.

The article discusses a study that showed during a ten-year period, starting December 31st, 1999, of the 248 funds with a five-star rating at the start of the period, only four retained their five star rating at the end of the period. Morningstar points out that they changed their methodology in 2002 to 48 categories instead of just the four categories they previously used.

Regardless of the criticism of the star ratings, we believe considering funds’ star ratings are a good place to start. In the article, Morningstar points out that higher rated funds typically have lower expenses and lower turnover, factors that bode well for fund performance. Whatever you do, don’t just focus on fund ratings. There are some great three-star and four-star funds out there that have served investors very well over the years.

Too Young for an Estate Plan?

2010-08-29T18:17:00.001-04:00

We’ve all been exposed to a young person who can’t imagine anything bad ever happening to them. They don’t use sunscreen until they have been badly burned. Only old people get skin cancer, right? They drive up behind you with the music from their CD player so loud that your car shakes. Hearing aides are for old fogies, they say! They drive in and out of traffic with reckless abandon. They drive motorcycles without wearing a helmet. They view themselves as impervious to any type of harm.

It’s understandable then, that they would never think of writing a will, let alone consider other estate planning documents. Those are for old people. Yet it may very well make sense for anyone over 18 years old to consider at least some basic estate planning: a will, a healthcare directive and power of attorney, at a minimum.

If one dies without a will (intestate), their estate will be distributed based on the law their state of domicile (jointly held assets, if any, would pass to the joint owner). Most young people have minimal assets to distribute, perhaps only a highly-valued collection of baseball cards, a pet or their car. Some may have some assets they inherited from a grandparent when he or she passed on. Nevertheless, without a will, they may not be happy with how those prized possessions may be doled out, since state laws differ on how those assets should be distributed.

It is particularly important for a young person who is married to have a will. In an article by Daisy Maxey titled “Planning for the Unthinkable” (Wall Street Journal, June 14, 2010), Ms Maxey points out that when one spouse dies without a will, in most states the property goes to the surviving spouse. However, in South Carolina, half the property goes to the surviving spouse and half to children of the deceased. Minor children must go to court to establish conservatorship. If the surviving spouse wants to refinance the house, they would have to seek court approval.

Another aspect of estate planning for the young that was not addressed in the Journal article, is that of the healthcare directive, sometimes called a power of attorney for health care. Several years ago a young woman named Terri Schiavo in Florida was in coma-like state for fifteen years while relatives and friends argued whether or not to cease life support. Had she thought to prepare for such an event, it would have eliminated the undue stress her situation caused her family. With the young so oblivious to risk, just having a healthcare directive, is reason enough to do some basic estate planning.

While it seems on the surface that the young would be difficult to motivate regarding the creation of estate planning documents, the Journal article put a different light on the subject, as the article quoted Peter Bielagus, a former financial adviser, who gives speeches to young people about managing their money: “Broaching the subject of a will is not as difficult as some parents think. Young adults are generally excited about anything that solidifies their recent adulthood, so parents can bury the topic of wills among other financial tasks…, it’s playing to the idea of being an adult.” The bottom line is that basic estate planning for a young adult gets them started on a solid financial foot and gets them thinking about their future and the assets they will acquire throughout their careers.

Are Your Parents Prepared?

2010-08-25T19:03:00.003-04:00

We recently had a conversation with a married couple regarding the wife’s elderly mother. The wife had attended a meeting with her mother’s financial advisor. Only recently had the mother begun to involve the daughter in the mother’s financial affairs.

The advisor had served as the mother’s financial advisor for years and was recommending some significant changes for the mother’s portfolio that after just a few minutes of questioning on our part, seemed ill-advised, at best. The advisor had not addressed his client’s financial needs or tax situation. It appeared to me that the advisor was not acting in his client’s best interest but rather was motivated by the potential fee he would earn if the mother accepted his recommendation.

The daughter and husband asked questions about the mother’s trusts. It was clear to me that they had little knowledge of the mother’s estate plans.

The point of all this is that as your parents age, it’s important for you to have a heart-to-heart talk with them about their estate plans. This is a difficult topic to bring up, but we believe, is a necessary one.

Some of the questions you need to ask include:

(1) Have your parents done any estate planning?
(2) Do they have wills, trusts, powers of attorney, patient advocate forms?
(3) Where are their documents located?
(4) How long has it been since they have been reviewed?
(5) Are their assets titled properly?
(6) Have they considered sitting down with all of their children to review their
estate plans? (Such a meeting can help to avoid disagreements among siblings
once the parents pass on).
(7) Who are the parents' advisors (attorney, financial advisor. accountant)?
(8) How do they wish to distribute their financial assets and personal assets?
(9) Have they made plans for their funerals? If not, what are their wishes?

Once you break the ice and get them sharing information, it may make sense to offer to go with them to update or review their plans with their advisors. This will allow you to assess whether or not the advisors are really acting in your parents’ best interest. Often we hear people describe their advisor in the following manner: “Oh, my advisor is so nice!” That may well be but is he/she acting in their best interest or their own best interest?

Not All Interest Rates are Low

2010-08-24T15:43:00.001-04:00

Just when you think interest rates are really low, it was reported yesterday in Monday’s Wall Street Journal that credit card interest rates have hit a nine-year high. Mortgage rates are currently below 4.5 percent and savings account and CD’s are paying next to nothing, yet according to the article, the average credit card rate in the second quarter of this year was 14.7 percent, compared to 13.1 percent in the previous year.

Why the difference you ask? According to the Journal article, “New credit-card rules that took place Sunday limit banks’ ability to charge penalty fees. They come on top of rule changes earlier this year restricting issuers’ ability to adjust rates on the fly.”

The latest rule changes are a result of the Credit Card Accountability Responsibility and Disclosure Act of 2009 (also called the Card Act). These rules have resulted in less flexibility for credit card issuers and essentially forced them to focus more on the risk profile of cardholders. This has made it more difficult for Americans to obtain new credit cards and impacted small businesses, since they use credit cards, in many cases, to fund their operations.

With many cards charging variable rates and interest rates eventually headed higher, credit card rates will only rise higher, down the road.

It’s clear that financial institutions will always find a way to get around regulations to avoid a decrease in their revenue. Representative Carolyn Maloney (D-NY) sponsored the Card Act. In the Journal article, she explains how the Act benefits consumers regardless of the rising rates: “Better that consumers should know up-front what the interest rate is, even if it’s higher, than to be soaked on the back-end by tricks and hidden fees.”

If you are like many Americans, who are carrying high credit card debt, it has become even more imperative that you focus on paying it down as soon as possible. The Journal article reported, for example, that Capital One Financial Corporation increased the rate on its Classic Platinum for Young Adults card by 2.9 percentage points just prior to the Card Act limits taking effect. The old rate was 16.9 percent! If you are carrying an ongoing credit card balance and paying that kind of interest, you need to do everything possible to cut discretionary spending and reduce your credit card balances.

Happiness Requires More Than Money

2010-08-20T07:45:00.000-04:00

Note: We originally wrote this article in April 2008. With the current, continuing economic crisis, many are now adopting a simpler lifestyle reminiscent of years past. We felt this article, updated to reflect some changes since we wrote it, might be of interest to our readers who may be considering a return to the “simpler life”.

Everyone seems to think that having more money will make them happier. Clearly, everyone needs a sufficient amount of money for food, shelter, health care, education of their children and so on, but do they need to be rich to be happy?

To the contrary, Sophocles, the Greek philosopher warned of the perils of money: “Of evils current upon earth, the worst is money. Money ‘tis that sacks cities, and drives men forth from hearth and home; wraps and seduces native innocence, and breeds a habit of dishonesty.”

In his book Your Money and Your Brain (Simon and Schuster, 2007) Jason Zweig, currently a weekly writer for The Wall Street Journal, quoted the results of a survey of 800 people with a net worth of at least $500,000: 19% agreed with the statement that “Having enough money is a constant worry in my life.” Zweig went on to say that among those worth at least $10 million, 33% still worried about money. He stated: “Somehow, as wealth grows, worry grows even faster.” Fewer than half of those with a net worth of $10 million felt that as they accumulated more money they became happier.

Working people always want a raise but studies show that the satisfaction we get from a raise is very short lived. After all, in most cases people feel they deserve more than they are being paid. Therefore, when they finally get a raise they often still have a feeling that they’ve been short-changed, since raises are seldom, if ever, retroactive.

One of our favorite columnists, Jonathan Clements, previously wrote a weekly column for the Wall Street Journal. In his final article, he focused on the reason people save and invest. He said: “You save now so you can spend later.” He went on to say: “People dream of endless leisure and bountiful possessions. Unfortunately, after a few months, endless leisure seems like endless tedium.” And, people quickly tire of the material things that money can buy. Jonathan went on to say: “The ’rich life’ of popular imagination is no great shakes.”

So what does money do for you? Clements points to what he believes are three key benefits. The first is that if you have money you don’t have to worry about it. The second is that money can make it possible for you to pursue your passions. And the third is that having money allows you to spend more time with friends and family.

What is somewhat ironic (and Clements pointed this out), is that the second and third benefit of having money don’t really require money to achieve. As we noted in our past article titled “Rethinking Retirement” (available on our website in the “In The News” section), if we pursue a profession that we truly love, then how much we make is less of a concern. If we truly love what we do, we can continue to work beyond the common retirement age of 62 to 65. Doing so reduces the amount of money we will need for retirement by reducing the number of years in retirement and at the same time increasing the amount we will receive from Social Security. With less stress in our work life and less need to work long hours, we can spend more time with friends and family.

Regardless of the evidence that there’s more to happiness than being rich. People will still continue to be slaves of the mighty dollar. Perhaps Sylvia Porter, famed economist and journalist (1913 - 1991), summed up best the dichotomy of views about money: “Money never remains just coins and pieces of paper. Money can be translated into the beauty of living, a support of misfortune, an education, or future security. It can also be translated into a source of bitterness.”

Should You Consider Refinancing Now?

2010-08-19T17:13:00.000-04:00

Today, interest rates on fixed-rate 30-year mortgages were reported to be 4.42 percent, the lowest rate we’ve seen in years. So, this begs the question: “Should you consider refinancing your home mortgage loan?” Before even analyzing this, in general, you have to have at least a 90% loan to value (current market value) ratio in order to qualify for a refinance. For many people, especially those who bought their houses in the last 10 or so years with little money down, refinancing is not an option, unless they have somehow increased their equity position by making extra payments or by improving the property.

In the past, when mortgages were not as large as they are today, the rule of thumb for refinancing was that you needed to be able to obtain a new mortgage with at least a two percent lower rate of interest. Now, with mortgages typically larger (although in many cases not as large as a couple of years ago, due to the decrease in home prices), many advisers say that a one percent lower interest rate can justify a refinance.

The bottom line is: How long will it take for you to recoup the cost of obtaining the new mortgage (i.e., cover the closing costs: points, appraisal costs, etc.). If it will take only a year or two, it’s probably worth considering. If it will take more than a few years, it may not be appropriate. Also, if you only plan to be in your home for only a few more years, refinancing is not likely justified.

There are many reasons that might motivate you to refinance besides obtaining a lower interest rate:

(1) If you’ve had your mortgage for some time and the payment is constraining your budget, refinancing for another 30 years could lower you payments significantly and give you some breathing room.
(2) You may currently have an adjustable-rate mortgage (ARM) and are concerned about the real possibility of rising interest rates. A fixed-rate mortgage at today’s low rates could protect you from the threat of rising interest rates many worry are not far down the road.
(3) You may have improved your credit rating significantly. Refinancing could give you a significantly lower rate than you currently are paying due to both the current lower rates available and the fact that you have improved your credit worthiness.
(4) If your income has increased significantly, (you received a raise or your spouse went back to work), you may want to refinance to take advantage of the lower rates and to take out a shorter mortgage (15 years instead of 30 years). The total cost of a fifteen-year mortgage is substantially less than the total cost of a 30-year mortgage even though the payments may be higher.
(5) If you are currently paying for private mortgage insurance (PMI) because you couldn’t put 20% down when you took out your mortgage but have since made major improvements to your home or prices have increased such that your equity is now more than 20%, you should seek to have the PMI coverage eliminated. A current appraisal will be required. If your lender won’t eliminate the PMI, you can consider refinancing with another lender.
(6) If you have significant other debt, you may want to refinance to consolidate your debt and take advantage of the fact that home mortgage interest is deductible while other personal loan interest is not. This may be OK to do if you are a very disciplined person and can avoid racking up new debt. In many cases, however, people have a lot of personal debt because they are in fact not disciplined. We do not generally recommend refinancing to consolidate debt.

If you do decide to look into refinancing, get quotes from several lenders. Check out each lender with your state financial regulator and Better Business Bureau. Ask for a good faith estimate, which shows what all the costs of closing are and how much the lender will make. If there are no closing costs, the loan will typically have a higher interest rate. Determine what you will have to pay at closing. If closing costs are rolled into the mortgage principal, it will reduce your equity and take you longer to pay off the loan. Request a re-issue rate on your title insurance.

Your monthly savings will be equal to your new payment (Principal, Interest plus PMI, if any) minus your current payment. The payback period is obtained by dividing your total closing costs by the monthly savings. The longer the payback period, the less desirable it would be to refinance.

You also need to consider the total cost of refinancing. If the cost of the new mortgage plus what you’ve already paid on the current mortgage is more than the total cost of the original mortgage, then refinancing is generally not advisable. Whatever you do, don’t let just one lender talk you into refinancing based on monthly payment alone. You need to look at the whole picture and get quotes from at least three providers.

No Road Will Take You There

2010-08-17T08:13:00.000-04:00

There’s an old saying that “If you don’t know where you are going, any road will take you there.” With your finances, it’s more like: “If you don’t know where you’re going, you’ll likely get nowhere.”

It seems to us that more than a few Americans plod along day to day, without any real plan in mind regarding how to achieve their goals. In many cases, they don’t really have any defined goals, let alone plans to achieve them. They are just living paycheck to paycheck, paying their monthly bills, saving little, running up credit card debt, buying the latest toy or new electronic gismo, while running up cell phone and cable bills of $100 to $150 a month.

To get ahead, one has to have some specific financial goals that guide their spending and saving. There are so many “nice to have things” out there that if one doesn’t have their spending prioritized and use goals to guide their spending, they will likely end up with lots of nice things that provide short-term satisfaction and many regrets regarding their unfulfilled life.

One of the first things we do with clients is to ask them to fill out our Life Planning Questionnaire, to help them sort out what they really want out of life and what they really value. For married couples, we ask each one to separately fill out a copy and then get together to discuss each other’s responses. This helps them to better understand what is important to their partner and lays the foundation for establishing and prioritizing their financial goals. One question we ask really gets at the heart of what’s important in their lives: “If you only had two days to live, what would be your biggest regret?”

Once you’ve spent the time to define what’s really important to you, the next step is to track your spending to see where your money is currently going. You’ll probably find a number of expenses that have no relation to your goals and can easily be cut out. Is that morning latte really necessary? Perhaps a “staycation” (stay-at home vacation) could save you a bundle. Or maybe you don’t really need that fancy cell phone with the expensive digital service plan.

Take a moment to think about how you’re spending your money and what’s really important to you and your family. You may find that you’re just spinning your wheels and aren’t really going anywhere. Having established and prioritized your financial goals can help you find the right road to a more meaningful life.

A Risk Often Overlooked

2010-08-14T07:50:00.000-04:00

Often, when we work with new clients, we find that their portfolios include stock holdings that constitute 10 percent or more of an individual stock. Why does this happen and what added risks does it create for their investment portfolio?

Excessive holdings of a particular stock can happen for a variety of reasons. In many cases, the stock is that of the company the client works for. They may have a generous stock plan that allows them to purchase company stock at a discount (often 15 percent). They may be required to invest a portion of their 401(k) account in the company stock. They may have received and executed stock options for their company’s stock or they may have just purchased the stock because they were confident in the direction the company was going and believed the stock would do well.

When times get tough, your company may be forced to lay you off or offer an early retirement. At such times the company stock is likely depressed in value just when you may need it most.

In other cases, clients may have inherited a chunk of stock from their grandparents or perhaps from Aunt Lillie. The stock may have been in the family for years and they have an emotional attachment to it. Aunt Lillie did well by it. How could it possibly drop in value?

In other cases, clients have purchased the stock themselves and held it for many years. The stock may have split several times, pays good dividends and they are sure it will continue it meteoric rise. They can’t stand the thought of missing out on it’s continued growth.

Whatever the reason, all of these situations can lead to added risk for your portfolio. We recommend clients keep their holdings of individual stocks below 10 percent, and preferably 5 percent of their total portfolio’s value. Doing so can protect them from unanticipated risks.

A case in point is Hewlett-Packard Company’s stock which has fell 8 percent in just one day (August 9th), following the news of the resignation (firing?) of their CEO, Mark Hurd. Mr. Hurd was reportedly “fired” by the H-P’s Board for ethical issues involving improper expense reports discovered when a female contractor filed a sexual harassment suit. Mr. Hurd had improved H-P’s operating margin from 6 percent when he took over to 12 percent as of last quarter.

It seems likely that the stock will recover once a suitable replacement is named. Yet in the interim, it’s unclear what the stock will do, especially if the economy continues to struggle. If someone was over-weighted in H-P stock, they may be emotionally driven to sell out of fear of losing more or perhaps can’t wait for a recovery because of an urgent need for cash.

Who could have anticipated such an event? Yet, history tells us that stocks tumble unexpectedly more often than we might think (Think BP, for example). It’s easy for a stock over-weighting to creep up on you. So take some time periodically to check out your portfolio to see if you are exposed to this often-overlooked risk.

Expect More Days Like Yesterday

2010-08-12T10:49:00.001-04:00

Yesterday, the Dow Jones Industrial Average (DOW) dropped 265 points, 2.5 percent, to 10,378.83. It is now negative for the year. This is naturally unsettling for investors, yet not at all surprising with all the uncertainty both in the U.S. and abroad. The market has been up and down all year. It seems that just when the market starts to make a move upward, some news comes out that sends it right back down.

Yesterday, the Euro dropped 2.3 percent, the S&P 500 dropped 2.82 percent, the Dow Jones Transportation Index dropped 4.27 percent and the Russell 2000 Index of small cap companies dropped 4.02 percent. All thirty components of the DOW were down, yesterday.

The media, of course, always has an explanation for the daily ups and downs for the market. Yesterday, it was a continuing concern about a global economic slowdown. While we sometimes roll our eyes at some of these daily pronouncements, it seems clear that few investors have any confidence that our economy will return to better days, anytime soon.

We expect to see continued high volatility such as we saw yesterday, with the market jumping on signs of good news and pulling back hard on signs of bad news. We worry about a double-dip recession but remain convinced that the best thing for investors to do is stay broadly diversified.

If the market swings keep you awake at night, you need to consider reducing your equity exposure, so that you don’t panic during a market downturn. Being out of the market when it rallies can be just as damaging as being in it when it crashes. In some respects, being out of the market is worse, because the fearful investor often doesn’t buy back in until the market has recovered much of its losses. Such a sell low, buy high reaction is very harmful to one’s portfolio.

So make sure your portfolio isn’t overly aggressive, so that you can ride out the volatility. There are many more bumps in the road ahead.

Inflation, Deflation, Double Dip?

2010-08-07T16:10:00.000-04:00

If you’ve read the papers, watched the TV or listened to the radio lately in hopes of getting a clue as to where the economy is going, we expect you are confused. We hear concerns about inflation, deflation and a double-dip recession. Unemployment is steady at 9.5% with some 131,000 jobs lost last month alone. At the same time, the President says the economy is recovering slowly but surely.

A recent report we heard, predicted that housing prices won’t bottom out until the middle of 2011. Foreclosures are expected to be as high or higher this year than last. The new financial regulations bill just passed by Congress will clearly increase business costs for many but in ways that have yet to be determined. The bill was quite general in nature and some 240 rules need to be defined before the regulations can be fully implemented.

While it seems likely that taxes will increase, it’s not one hundred percent clear for whom the Bush tax cuts will be extended. The new healthcare legislation also raises a significant amount of uncertainty for businesses, since it creates a significant number of new government organizations that must define their role and span of control.

We’ve written before that all the uncertainty in the economy could certainly be the reason that small businesses are not hiring. Many are struggling to make ends meet. Expanding businesses requires confidence that the economy is on the mend.

It would be nice if we could turn to the economists for a definitive projection about what the future holds. Unfortunately, many of them disagree. Laurence Peter, the author associated most famously with The Peter Principle, said of economists: “An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today.”

Edgar Fiedler, former Chief Economist at The Conference Board once said: “Ask five economists and you’ll get five different answers (six if one went to Harvard).”

We can’t remember when there’s been this much uncertainty about the economy. It doesn’t seem that anyone can convince anyone else what’s going to happen. So what are we to do? What lesson can we learn from all of this?

The lesson to be learned is that if you ever thought you could time the market or pick the next hot asset class, you clearly have your work cut out for you (We don’t believe in trying to time the market.). Avoid looking for the silver bullet. Make sure you are broadly diversified. Pay down your debt. Build up your emergency fund. Increase your savings. Do all the things you should do in a normal market and don’t panic. If you do those things you should do all right no matter which way the economy turns.