9 Simple Steps to Financial Planning

Book: The Behavior Gap by Carl Richards

2012-01-11T18:49:00.004-05:00

I recently read a good book entitled "The Behavior Gap" by Carl Richards and encourage you to read it. He writes that "...financial plans are useless...". Basically the author means that the "process" is vital but the "product" can be stagnant if it is based on a range of variables (no one knows for sure) combined with a long time period (that just compounds the inability to guess inflation rates, investment returns, etc.).

He uses cute "back of the napkin" simple charts that you can find at his website: http://www.behaviorgap.com

Here is an example quote from the book, "...decisions should be made on principles not on our feelings about what's going to happen...". The example he gives is someone who is unwilling to give up an investment that makes up too much of their portfolio. The principle: "...it is always a bad idea to have too much of your net worth wrapped up in a single investment..."

Behavior Gap

2012-01-03T17:41:00.003-05:00

Thanks to Chuck Rylant (www.chuckrylant.com) who introduced Carl Richards book and sketches on his blog:

http://www.behaviorgap.com/sketches/

Another effective perspective on financial planning.

Planning to wait until 60, 66 or later to retire?

2011-12-28T11:09:00.005-05:00

In a December 2011 article in the Financial-Planning magazine (I do not recall the author of this particular article), based on 2006 data, "...40% of adults between 51 and 55 who were employed full-time lost their jobs because of a layoff or shuttered business. When they find new employment, older workers earn less. The median wage of older career changers fell by 57% for those who had been laid off, and 5% for those who left their jobs..."

The time to plan is now. The time to save and invest is now.

What Does a Loss Really Mean to You?

2011-09-29T17:19:00.002-04:00

This quote really puts investment performance into perspective if you have 10, 20 or more years of future earnings to add to your retirement assets. Your "human capital" (what you make) can be very important to your overall financial health.

From Nobel Laureate Robert Merton (Morningstar video clip created in 2011):

“…If we only focus on the financial piece and we say we put a 100% of that in equities, when you just look at what happens to that, it looks very risky. We say to ourselves, "We had a decline of 30%; equities have lost 30%."

But if we look at it more holistically and say, "Really it’s not that bad. They only have 10% of their retirement assets in this, because the other 90% is future contributions," then saying a decline of 30% is really only 3%....”

Management of Assets

2011-08-24T12:29:00.001-04:00

It is rare that an advisor who only manages your investable assets can secure your retirement income.

Tax planning, cash flow analysis, careful spending, reduced/minimized debts, insuring risks and reasonable withdrawal rates are just as important (if not more so) than the asset management portion.

Has your advisor asked about these other areas of your financial life?

Bond Investing Comparisons

2011-08-23T07:25:00.001-04:00

Alternative I: Bond ETF's

Many larger, more popular funds can be tax efficient, easy to trade during the day (marketable) and inexpensive but the value you "buy at" may be more expensive (premium) than its underlying value and when you sell the value may be less (discount) than its underlying value. It is difficult for ETF companies to create a sampling strategy that matches the broader bond indices, therefore, the investor must scrutinize how diverisifed they are within size, sectors, etc.

Alternative II: Bond Mutual Funds (indexed or actively managed)

Diversified for the investor though you must pay attention to this (size, quality, sector) as well as to duration and cost when selecting funds.

Alternative III: Individual Bonds

Difficult to adequately diversify and manage on your own (professional management is important). This method can be tax efficient and you can trade bonds during the day, unlike bond mutual funds.

Managing duration and having enough bonds to create an allocated portfolio requires more funds than many investors are willing to allocate to this strategy.

Production and Utilization

2011-08-22T12:12:00.004-04:00

"...At 94.2 percent of its 2007 average, total industrial production for July (2011) was 3.7 percentage points above its year-earlier level. The capacity utilization rate for total industry climbed to 77.5 percent, a rate 2.2 percentage points above the rate from a year earlier but 2.9 percentage points below its long-run (1972--2010) average..."

This information was obtained from the www.FederalReserve.gov site 8/21/11 and, in the midst of all of the recent bad news and stock market lows, helps to bring a little perspective. The U.S. is making more than last year and using plant capacity at a slightly higher rate than last year.

These are longer-term positive trends to focus on during short-term volatility. It is not all bad in the economy and these numbers are certainly better than last year. Hope. Perspective. Hard things to find through the media onslaught.

Foreign Corporate Bonds - Another Alternative

2011-08-20T07:15:00.000-04:00

If investing in foreign currencies as an alternative investment is too difficult to understand and implement, then investing in foreign coporate bonds may be another method to diversify a portfolio.

The disadvantages are many: political risk, interest rate risk, higher volatility, lack of standard reporting from companies, etc. and so selecting the appropriate vehicle and minimizing exposure are essential.

Commodities - An Uncorrelated Alternative or Are They?

2011-08-19T07:00:00.002-04:00

Commodities may have been less correlated with stocks in the past (1970's and 1980's) because there was a lot of spare capacity. This allowed for price gyrations independent of stock returns. In the past, large positive returns were compacted into only a few years making the long-term averages higher. Those few high years of commodity returns offset many years of returns that were below the stock averages.

Is is possible that, as Virginia Munger Kahn writes in the August 2011 issue of Financial Advisor magazine, that, "...while supply shocks can still send commodities soaring and equities reeling, commodities and equities now march to the same drummer - global economic growth..."?

If so, the diversification benefits that many investors are seeking in commodities may not be as helpful as in the past. I tend to agree.

Retirement Crisis

2011-08-18T07:30:00.007-04:00

Jeff Schlegel wrote an interesting article in the August 2011 Financial Advisor magazine entitled "What is a Retirement Crisis?" and mentioned that, regardless of income, pre-retirees need to consider the lifestyle changes that may be needed.

The retirement crisis is often presented as households not saving enough but, more than that, is the author's "crisis of expectations". He succinctly states "...lots of people...will be disappointed when they...understand what they can actually afford to spend out of their accumulated portfolio...."

Here is an example that I would like to provide: if you have saved $150,000 then that may generate $500 per month in retirement but even that will depend on your life expectancy, how you allocate those funds and a variety of other factors. That may be sufficient for some if you have a nice pension and you have a modest lifestyle but there still may be a crisis of expectations.

If you have saved $1,200,000 then you may be able to "squeeze" out $4,000 per month. That, however, may not even be close to your current lifestyle spending needs resulting in another type of crisis of expectations.

Unclaimed Money

2011-08-17T10:22:00.003-04:00

According to Kiplinger's Personal Finance September 2011 article by Michael Stratford, "...billions in unclaimed assets are sitting in state and federal coffers..."

Here are some sites to check out:

http://missingmoney.com

www.unclaimed.org

www.treasuryhunt.gov

Is It A Return Problem?

2011-08-05T11:30:00.002-04:00

Thank you to Rick Adkins and his July 2011 article in the Journal of Financial Planning entitled "Guilt, Ego and Monthly Paychecks Threats to Wealth Building". There he states "...most of us don't have a 'return' problem, we have a savings rate problem caused by a consumption problem..."

Even with the market volatility, or because of it, saving and investing still needs more attention. So pay attention. Don't be like the lyricist/singer in a great blues song (title unknown) that says "...I'm so broke, I can't even pay attention..."

How Much Do You Pay for Managing Your Investments?

2011-08-04T20:43:00.003-04:00

An August 2011 article in Kiplinger's Magazine (p.44) reported on a study completed by PriceMetrix that "...found that 25% of advisers who manage investment accounts for households that have between $250,000 and $500,000 in assets charge their clients annual fees of 1.75% or more..."

Including transactions costs, turnover ratios, and fund expenses this will exceed 2%. In dollar terms, that is $5,000 per year on a $250,000 investment portfolio every year. If your investments had a 10% positive year and increased to $275,000, that comes to $5,000 (plus the increases) of your $25,000 gain or 20%. And next year the fee goes up higher than that $5,000. If you have losses, then the fee continues though at a slightly lower rate. Not much of a consolation unless you are getting more than investment advice services.

Think about the costs and keep that perspective when you are comparing the value obtained for the services. Investment management is only one aspect, but comprehensive financial planning advice will include so much more (insurance, tax, retirement and estate planning, too). If all you are receiving is investment advice, that 1.75% fee is really much, much more costly to you.

Utopia

2011-08-03T07:10:00.001-04:00

"...In Utopia, abundance is achieved by a restriction of needs..."

(From the book "Utopia" by Sir Thomas More, written in the early 1500's, with the introduction for the version I recently read by John Anthony Scott summarizing the writer's viewpoint)

Aftershock Survival Summit

2011-08-02T08:13:00.002-04:00

There is a video from NewsMax circulating the Internet entitled "Aftershock Survival Summit".

I am reminded of a quote from John Anthony Scott in his introduction to Sir Thomas More's book from the 1500's called "Utopia":

"...for the less a thing fits the hearer's ways, the less credence is it always given..."

So, since I disagree with the message in this video, I also give it less credence as the quote above warns me.

Here are my “9” comments on this NewsMax video (I actually read the entire transcript):

(1) The first stock market graph shown is misleading. In 2007 the DOW hit a high of 14,200 and today, though struggling now, hit 12,800 earlier in the year, so it is only off 10% from its high

(2) The graph on the drop in the dollar also looked precipitous but a close look at the graph shows it dropping from 88 -> 74 (it is a 16% drop but the graph was really misleading)

(3) The Federal debt held by the “public” is smaller than the total debt. Newsmax reports the total.

(4) Somehow they tried to correlate stock market movements with personal income or GDP. It is not meaningful to do so. The stock market averages increases of 6-7%, GDP average 3% or so and personal income averages even less, so of-course, when you compare the market gains to these changes it looks like it is “off the charts” out-of-control. I disagree with this approach.

(5) Inflation of 30% or 100%. Silly. Oh yes, inflation is going to return (maybe 4-5% versus the 0-2% we have had for many years). Anyway, pure “scare tactics” to believe that the largest economy in the world would go through that kind of scenario. Printing money and money growth have not resulted in inflation to-date, in part, because to have meaningful inflation aggregate demand must outstrip supply and with unemployment at 9.2% it will be hard for this to happen. Not impossible, just difficult.

(6) Yes, China and Japan own nearly $2 trillion of our public debt. So, if they decided to go elsewhere, where would they go?

a. Guess what? The U.S. – even if downgraded from AAA to AA is still the “safest” place to keep money

China

and

Japan

need our US Treasuries just as much as we need them to hold them and buy more

(7) 36% of the U.S. debt, Newsmax says, is short-term. From this, they deduce that if interest rates go up, the

U.S.

interest on its debt will skyrocket

a. Hmmmm…if they are correct about the 36% (it does sound reasonable), then doesn’t that mean that 64% of the U.S. debt is held in longer-term securities?

b. In addition, how much do you think the interest rate was on 10-year U.S. Treasury bonds sold in 2001? 6-7%? Yes, and those are coming due now and being replaced by 10-year Treasuries being sold at 2.7-2.9%. And what about 30-year Treasuries sold back in 1981 at 16%+ rates?

c. WOW! So the interest rates could DOUBLE from 3% to 6% and it would have minimal effect on the interest paid on U.S. debt

(8) The graph on interest on the debt started at around $600 billion. Wrong. The interest on the debt today is about $260 billion and significantly less than it was just a few years ago when it was closer to $360 billion because of the rollover of older, higher interest bonds to lower rates today.

(9) Finally, their suggestions at the end of what people should do about the future crisis to enfold is:

a. Get a low, fixed rate mortgage and don’t pay it off early (I agree for the most part, 15-years)

b. Buy Gold through ETF’s or mining stocks (This is the way to buy gold, if you do, but I’d limit the amount to 1-5% of a total portfolio if at all).

c. Buy currency ETF’s (Many advisors recommend this but it is volatile and risky and, in my opinion, not necessary for most investors)

d. Subscribe to their newsletter (I will leave that up to you; personally, no)

Do the "Right" Thing

2011-08-01T17:02:00.004-04:00

I am writing this on August 1st and the deadline for raising the debt ceiling is August 2nd.

"Tea Party" Republicans and a "few" others are trying to do the "right" thing (i.e. reduce government spending in phases and that includes everywhere, especially, entitlements like Medicare and Social Security) and yet some pundits are claiming that they are the "problem" for not compromising their values.

I personally do not think they are the problem, they are the solution. If other Democrats and Republicans would do the "right thing" then no compromise would be needed. For example, here are some "right" things:

(1) Social security age must be raised (that is, in effect, a reduction in benefits) but it is the "right" thing to do. Sorry.

(2) Medicare must be even more aggressively "means-tested" than it is now so high income retirees pay more. Sorry.

(3) Tax system must be reformed (taxes will go up for some) but it is the "right" thing to do. Sorry.

(4) Spending on discretionary, defense and other non-discretionary items must be reduced, too, possibly based on a running average percentage of GDP. Period.

As it is now, it appears that some evenly-divided committee (6 Republicans and 6 Democrats) will make the tough choices as a result of this "grand compromise".

This committee most likely won't agree and then reductions in spending will set in by default with no one voting "for" them. Cute. That way no one is "blamed" for allowing tax cuts to end in 2013 or "blamed" for cuts to Social Security or Medicare. Yet, those are the "right" things to do and phased in over time so we can get through the current malaise in this economy.

Sorry. Everyone except those committed to doing the "right" things should be voted out of office when their time comes - or sooner. It is not the "compromisers" that are right. They all should have agreed to do these things so no compromise (and, by default a "watered-down" non-solution) would be needed.

Bond Alternative: Emerging Market Bonds

2011-06-19T12:07:00.002-04:00

I hear some advisors considering investments in bonds in other markets besides the U.S.

U.S. bonds may be backed by the good faith and credit of the U.S. government (a subject of concern by some in and of itself) but when investing in bonds outside the U.S. there are several additional risks. The main one, besides political risk, is the currency volatility which may be much more than the bond price/yield changes.

Some consider bond investments in emerging markets as speculation so fully understand them not as a bond investment but as a risky alternative investment to stocks, bonds, real estate and cash categories.

WYSIWYG

2011-06-06T14:42:00.002-04:00

Often this phrase was used to mean: "What you see is what you get" but I'd like to twist it just a bit because the question comes up often enough as to what to invest in for short periods (i.e. want to save for a deposit on a home in 2 years, or save for Christmas in 6 months, etc.).

The answer is: WYSIWYG. That is, "What you save is what you get". With interest rates so low and with no time to take risks for short time periods (like 1-2 years), whatever you save is what you will have for your short-term purposes.

So, plan to save.

Social Security Statements

2011-05-14T15:28:00.002-04:00

Yikes! To save costs, the Social Security Administration (SSA), in April 2011, stopped sending out paper statements of your potential benefits and earnings history a few months before your birthday. So, if your birthday is in late June or early July 2011 you will be the first ones not to receive your statement.

Did you miss it? Will you?

You can (and should) still go online periodically at http://www.socialsecurity.gov/ and obtain the information but you will no longer be able to retrieve your earnings history.

If you are 60 years old or older, the SSA may restart mailing them in 2012 and a few months before your birthday but those younger than 60 will have to go online to obtain their benefit information.

Some Perspective on Japan's Disasters

2011-04-27T21:44:00.001-04:00

From the Murray Financial Group blog entry entitled: "Who’s telling the truth – Japanese officials or the U.S. media?" on March 19th, 2011, Chris Murray states:

"...I was fortunate enough this week to be invited to join in on a conference call that included four Japanese economists who live and work in Japan and are employees of JP Morgan...The bottom line is that even though there is concern and obviously uncertainty, the northern part of Japan where the earthquake and tsunami struck accounts for 4% of the country’s GDP. That means that 96% of the other goods and services produced by the world’s 3rd largest economy is business as usual. Also 10% of the country’s total electric supply comes from the damaged nulear power plant, so 90% of Japan’s energy sources are ship-shape..."

Uncertainty remains and there are many difficulties ahead for the people of Japan but, keeping perspective, this article helps.

China and the U.S. Economies

2011-04-26T21:07:00.005-04:00

Subject: Marketwatch Article about China and US economies by Brett Arends
http://finance.yahoo.com/banking-budgeting/article/112616/imf-bombshell-age-america-end-marketwatch

Our son, Nate, sent me the above link. Thanks for sending the article. My comments:

Brett Arends is a reasoned and good financial writer. I liked the article. I don’t think it matters though what measure is used to evaluate the size of the U.S. and China (or any other country for that matter) because within 5-10 years China’s economy will, indeed, be near the same size as the U.S. and that is OK. It does not mean the “end” of the U.S. and so that part is not realistic (dare I write: nonsense?).

What does it mean to have two economies nearly the same size? It means more and more people to buy goods and services. Not just from the U.S. or China but other countries also. It is quite a good thing. Just like the past “era” of having the U.S. four times the size of the once second largest economy of Japan and China in 10th place. Not that long ago actually.

It is truly wonderful to have more and more people entering the middle-class and buying products and services. There is plenty of room for the U.S.’s Treasury bonds in the market just as there is room for Japan’s and any other country's debt. And with more people no longer on farms living on dollars a day but instead participating in the world economy we have everything to be optimistic about.

Marriages, Divorces, Statistics and Financial Security

2011-04-25T08:08:00.001-04:00

First marriages now are lasting 59% of the time (41% divorce rate). A few decades ago, the divorce rate was over 50% and climbing but that has reversed. Yes, there are more couples living together who are unmarried and breaking up and therefore not in these new numbers. This is one way statistics can be misleading since if they had all married first the divorce rate may, indeed, be higher. Who knows?

For sure, couples have much higher security financially but that is also misleading. Most of the divorces are over "money". So, once a couple is on the same page financially and the marriage survives, then the picture brightens. See a NAPFA financial planner and get started.

Working More Years

2011-04-21T16:44:00.002-04:00

According to another conclusion from Michael Tucker's July 2009 article in the Financial Planning Journal, "...working more years to decrease the probability of exhausting savings at a more advanced age appears to be warranted only for the most risk averse..."

The author's analysis used a 4% withdrawal rate from a portfolio of $450,000 and social security income representing ranges of 20% to 80% of total retirement income. If you can earn a real rate of return of 10% or more (that is substantial), then delaying social security may be justified. If not, then the more safe your investments/savings then it may be better to take social security earlier to avoid using up those savings.

Delaying Social Security Beyond Age 62

2011-04-20T16:16:00.001-04:00

The Social Security Administration reports that 6 out of 10 retirees begin collecting social security at age 62 at the reduced benefit. Though each year of delay results in about a 7-8% increase (depending on your birth date) in payments, the key point may be best defined by Michael Tucker in a July 2009 Financial Planning Journal article. There are other considerations, too, for married couples and the calculation of survivor amounts. For this blog entry:

He states "...the greater the proportion of retirement income derived from Social Security the more advantageous is delayed retirement..." If, and the big "if" here is if "...enhanced standard of living is the decision criterion."

The question must be raised whether you desire to maximize your wealth or maximize your retirement income. Not everyone wants to just accumulate and some choose the lifestyle of retirement living.

So, if you are one who expects your social security payments to account for 10% of your retirement income, then taking it at age 62 may be economical.

For some retirees who will be counting on 20% and up to even 80% or more of their retirement income from social security, then delaying may be a better solution.

YouTube Video from the CFP Board's "Let's Make A Plan" Campaign

2011-04-19T06:44:00.002-04:00

Enjoy this short video on YouTube:

http://www.youtube.com/watch?v=HLIhtnshN6A&feature=youtu.be

CFP Board Launches Campaign Today (4/18/2011)

2011-04-18T18:19:00.006-04:00

Please take a look at the CFP board's campaign to get you involved in planning your future:

http://letsmakeaplan.org/Why-You-Need-A-Plan/Benefits-of-Financial-Planning.aspx

Frontier Markets - 9 Risks

2011-04-15T07:10:00.003-04:00

Emerging markets (like China, India, Russia, Brazil) are bigger in comparison to the Frontier Markets. This includes 29 countries like Vietnam and Argentina.

Risky, yes.

Here are nine possible risks to consider:

Corrupt governments
Few public companies
One industry
Export-driven
Lack basic processes
Illiquid (small markets)
Inefficient (could be a good thing)
Local investors drive prices
Low correlation to other markets (again, could be a good thing but still a risk)

Definitely an alternative type investment.

How To Manage Your Money

2011-04-14T18:58:00.000-04:00

What does it mean to manage your money efficiently? Go to: http://www.9simplesteps.com/ and click on the "9 Steps" icon to see the .pdf and/or PowerPoint versions of what I mean. Simply:

Plan (taxes, giving, insurance)
Spend less than you make
Have no credit card debt
Be honest about your spending plan (that budget word)
Save and Invest

Repeatedly I read that 50% of the population lives paycheck to paycheck. Really? One out of every two people you meet (unless you are one of the two).

Emerging Markets and Inflation

2011-04-13T06:51:00.002-04:00

Something to keep in mind about these developing (emerging) markets is that food prices may make up more than 50% of the CPI (inflation index) in many countries.

Therefore, food price increases may inflate emerging market economies faster than in the United States.

The Risk Conversation

2011-04-12T14:21:00.003-04:00

According to several studies, individual investors are still fearful of stock (and bond) markets and may be more conservatively positioned than they should be for their age and time horizon. Stocks and bonds do hold many varied and legitimate risks to be considered.

Risk tolerance, though, should not be as much a matter of how you feel about the risks of the markets but rather of your personal:

Risk Capacity = your ability to withstand losses; for example, because:

your time horizon is long,
your income needs are being met by other sources, or
your emergency funds are in "safe" money and sufficient

Risk Need = the amount of risk required to meet your goals and still:

meet or beat inflation, and
overcome the tax burdens

Many risk questionnaires do not measure your capacity or need to take on risk.

Thankfulness

2011-04-11T14:17:00.001-04:00

There should be a point where "enough is enough":

"...Expressing gratitude for life's blessings is likely to elevate happiness..."

- by Robert Emmons, Ph.D. in his book, Thanks

To Pensionize or Not to Pensionize

2011-04-08T16:00:00.002-04:00

One final comment on Moshe Milevsky's and Alexandra Macqueen's book Pensionize Your Nest Egg is that it is not for everyone. The use of "should lean" is important:

The authors clearly state on page 121: "...those who have no concern for leaving a financial legacy should lean towards pensionization, while those who have a very strong preference for creating a financial legacy and little fear of outliving their assets should not pensionize their nest egg..."

Social security is an annuity and should be considered when evaluating how much, if any, of your investments may be considered for an annuity (and there are plenty of riders and varieties of annuities as well and you can read about those elsewhere on this site).

Pensionize Your Nest Egg (Part 2 of 2) by Moshe Milevsky and Alexandra Macqueen

2011-04-07T15:36:00.001-04:00

Pensionizing (that is, purchasing an annuity to guarantee some monthly income) has benefits and costs (risks). They need to be weighed. For some examples, an:

Annuity has no legacy value (either you want the money for you or for your heirs)
Annuity is quite illiquid (you can't get at the money without substantial surrender charges/penalties)
Annuity does not have the potential to grow like your stock investments over long periods (due to participation limits, caps, and the like)...compare them to bonds not stocks

But an annuity can protect against:

Longevity risk
Inflation risk (possibly, if you ladder annuities over a period of years rather than index them to the CPI)
Sequence of return risk

There is something to be said for planning your retirement spending based on the probability that you will be alive to spend it. In other words, spend more early and worry less about how much you have left as the chances of dying increase over the years. This assumes that you are more interested in spending your hard-earned money rather than leaving it to your survivors. The problem of-course is knowing when you can run out of money.

If you have an annuity (if you pensionized a portion of your income), then you will always be able to rely on that much at least.

The authors bring up an interesting point and the book is very good and easy to read.

Pensionize Your Nest Egg (Part 1 of 2) by Moshe Milevsky and Alexandra Macqueen

2011-04-06T15:16:00.002-04:00

Excellent book and I highly recommend you read this if within 10 years of retirement or in retirement now.

The key phrase that continues to pop up in this book is the reminder that "...in retirement, the key is having enough income as opposed to enough money..."

Three major risks can affect you and your money in retirement:

The randomness of longevity (no one knows how long or short we are going to live)
The randomness of stock, cash and bond investments (the sequence of those returns can damage a portfolio even though you started out with enough money - or so it seems)
Inflation (it really does eat away at your purchasing power even in small doses and it is your personal inflation spending that matters more than the government's reported CPI)

The answer is in yet another type of diversification: product allocation. We have discussed stock versus fixed income diversification and tax location diversification and sector/size/growth/value diversification. Those are important, too. Now...

Product allocation. Maybe a portion (note: a portion, most likely no more than about 25%) of your investments should be in an annuity (social security and other monthly resources you might have count towards that 25%) which this author calls "pensionizing your nest egg".

It depends on how much your fixed expenses are in retirement and what income is guaranteed to come in to cover these needed expenses.

Books - Updated List Since Last List posted in 2007

2011-04-05T02:51:00.006-04:00

Additional books that I would highly recommend (after "Buckets of Money" and "Pensionize Your Nest Egg" - the links for these can be found on the bottom left-side of the blog page) are:

THE TOTAL MONEY MAKEOVER by Dave Ramsey
THE TRUTH ABOUT MONEY (New 4th edition 2010-11) by Ric Edelman

See the Label: "Books" on the top left-side of the blog page for other entries also

Monte Carlo Methods

2011-04-04T14:31:00.000-04:00

Monte Carlo statistical method is a computer simulation of hundreds or even thousands of sequences of returns with variables for inflation rates, interest rates, growth rates and other metrics.

As mentioned by William F. Bengen in his book, "Conserving Client Portfolios During Retirement" about Monte Carlo simulations he states, "...they have been randomly generated from a set of mathematical rules and do not correspond to any actual historical data..." and this leads actually to "...lower success rates for withdrawal rates below about 5.25 percent, and higher probability scores for withdrawal rates above 5.25 percent..."

Since many advisors use withdrawals rates of 4-5%, then using Monte Carlo simulations may suggest that you have a starting "nest egg number" that is higher than you really may need in order to reach a 95% success rate where you do not run out of money.

The software is just not capable of providing the best answer - yet. But as Mr. Bengen states in his book, "...I have learned never to underestimate the ingenuity of man when he attacks a problem of importance to him..."

Rebalancing Thoughts

2011-04-01T02:10:00.002-04:00

Regular rebalancing (for example, once or twice per year on the same date) may not be as advantageous as "opportunistic rebalancing" where you rebalance when your pre-determined allocation percentages change.

I recommend this type of rebalancing. For example, if you want 10% in small-company stocks and find that it is now at 12% (which is 20% higher than you wanted), then rebalance back to 10%.

Gobind Daryanani in a June 2009 FPA journal article by Carly Schulaka stated "...historically, I have found that using a 20 percent relative band maximizes your rebalancing..."

"...in a turbulent market, it's better to go with a larger relative band - say 25 or 30 percent..."

Longevity Risk

2011-03-31T05:10:00.005-04:00

Another retirement risk that competes with sequence risk is longevity risk - the risk of outliving your money. For sequence risk, being conservative helps minimize this risk but for longevity risk, being more aggressive helps minimize this risk.

The answer: there is a balance needed in your investments.

And there are also probabilities to consider, too. The likelihood that you will need income from your investments when you start retirement are higher than the probability that you will live to 100 or beyond.

Balance is an important element of balancing risk in your portfolio.

Sequence Risk

2011-03-30T16:51:00.003-04:00

Sequence risk doesn't matter as much when working and building a portfolio as it does when you start to take money out of your investments during retirement. When adding money, it is called dollar-cost averaging and there is always the risk that stocks will continue to go up. Then the positive sequence of returns may not be as beneficial as compared to a lump-sum investment. If you have the money and the choice, this sequence risk is something to consider.

When withdrawing money, a negative sequence of returns may damage your portfolio value as you take money from a smaller pool of funds (think: a bear market like late 2007- early 2009). Minimize this risk by having "some" years of your retirement income needs in safe money (money markets, CD's) to last 2-5 years, so market risk investments don't need to be touched.

ARO: Absolute Return Oriented Funds

2011-03-29T08:14:00.003-04:00

I mentioned in a previous blog entry about this concept of "absolute return" and how enticing it sounds. Keep in mind the following:

1) Lack of historical performance (and no idea how they will perform in the future but I guess all investments have that issue to some degree)

2) Complex strategies (if you cannot understand the short-selling and hedging going on then do not invest; stocks go up more often than they go down)

3) Limited benchmarks (so how do you compare your absolute-return fund to others? There are plenty of indexed funds around to compare with your stock and bond funds)

Buy Your Cars With Cash

2011-03-28T06:48:00.002-04:00

Here is a slide show from the Dave Ramsey website:

http://www.daveramsey.com/media/flash/elearning/drive-free/player.html

The Effect of Diversification on Withdrawals from Retirement Funds

2011-03-25T06:44:00.001-04:00

Based on some number-crunching by Craig L. Israelsen, Phd, a $500,000 portfolio withstood 5% withdrawals ($25,000 at the start of the period and then increased annually by 3%) for the tested 25-year distributions during retirement.

Seventeen periods were analyzed: 1970-1994 through 1986-2010

Of-course "when you start" in comparison to when major bear markets surface has a big effect on whether you end up with $2 million (1970 start) or $7.8 million (1975 start, just after a major bear market ended). What a range, but you still end up with more than the $500,000 when you started.

The key though is his last sentence, "...diversification is a lifelong investing imperative..."

He says this because keeping 60% in stocks and 40% in bonds makes a tremendous difference over playing it safe with 100% in bonds (millions in almost every case), and investing equally in at least seven asset classes results in even higher ending values. Higher values become important over time because, otherwise, with no growth in the portfolio, those withdrawals become much higher than 5% as your years in retirement continue.

10-year Record

2011-03-24T09:33:00.000-04:00

According to Morningstar's Ibbotson records (and stated in the March 2011 Financial-Planning.com magazine article written by Donald Jay Korn), "...the best 10-year record for large-cap stocks...occurred in the post-World War II boom of 1948-1957..."

This intrigues me since the annualized return of that 10-year period exceeded 20% at a time when in 1944 the government debt as a percentage of GDP was a whopping 73% (see my blog entries on the Economy-General). This number gradually continued a decline to only 18% several years ago though it has been on the rise to around 25% today.

Misery Index

2011-03-23T07:20:00.000-04:00

The misery index was started in the 1970's and is the sum of the unemployment rate and the inflation rate. It almost reached 22 in the summer of 1980. Since inflation has been so low for so long it seems the index has not been mentioned much. As unemployment has decreased from over 10% to 8.9% (February 2011) the misery index may still not get much mention.

Why bring it up? The unemployment rate is still high and inflation, of some sort, may be around the corner.

Social Security - Changes as of 12/8/2010

2011-03-22T09:10:00.002-04:00

Previous entries from March of 2008 and May of 2010 describe a strategy where you could take your social security benefit at age 62, then repay those benefits and claim the higher monthly benefit at a later age. No more. Effective December 8, 2010 your decision to take social security is now an irrevocable decision. If you decide to take a lower monthly payment at any age prior to your Normal Retirement Age (or forego the increases available if you wait until age 70), then you cannot later change your mind.

EXCEPT...

You still can suspend your benefit, once started, and restart later.

Why Tax Increases are Never The Answer

2011-03-21T10:17:00.000-04:00

Grover Norquist, president of Americans for Tax Reform, is quoted in the Washington Post on Sunday March 13, 2011 stating:

"...every dollar of tax increase is a dollar you didn't get in spending restraint..."

Bingo! The goal to help the economy is, indeed, to reduce the size of government spending as a percentage of GDP. Although the U.S. government's spending is much less than many other countries as a percentage of GDP (over the past nearly 100 years - almost - we have never reached a level of 50%+ as many other countries have), it is higher today than in the recent past and headed in the wrong direction. (See my other blog entries by searching on GDP)

Many pundits claim that tax increases are inevitable but voters need to continue to make their voices heard that Mr. Norquist is correct.

College Planning Does Not Have To Mean Borrowing

2011-03-18T09:31:00.001-04:00

We know that debt is not a good thing but often "good debt" is considered OK for education that provides a better job opportunity.

Options to college loans, if a 529 plan was not put in place, include using home equity, taking a loan from your 401k, accessing ROTH IRA money, or sacrificing other spending and paying as you go. Start with a 2-year community college and then consider other options including commuting from home to your local university.

Many times parents are willing to pay for an Undergraduate Degree but not a Graduate Degree. Ric Edelman has a wonderful solution to this. He suggests that the student spend less in undergraduate courses and use the savings to help fund a better graduate school. The pile of money is the same but just distributed differently.

Media Does Not Help

2011-03-17T09:25:00.000-04:00

The news media confuses investors and increases anxiety. Oh well. The infamous investor, Peter Lynch, is quoted as saying:

"...Far more money is lost preparing for corrections..."

Interest Rates and History

2011-03-16T09:15:00.000-04:00

The Wall Street Journal's September 28, 2010 article by Andy Kessler noted an interesting reminder about interest rates:

"...we are at the bitter end of a 30-year interest rate cycle. Declining interest rates are the ideal environment for economic growth. In January 1981, short-term interest rates were 19.08% - now they are 0.14%. Thirty-year mortgages in October 1981 were 18.45% - now they are 4.28%..."

When interest rates go down, bond prices go up. From 1985 through 2009, bond returns dipped negative only three times (in 1994, -4.7%; in 1999, -1.2%; and in 2008, -7.8%).

When interest rates go up, bond prices go down.

10-year Periods of Negative Returns

2011-03-15T08:42:00.000-04:00

Since 1871 there have been 14 ten-year periods where stocks experienced negative returns.

We just lived through one such decade. That is 10% of the time.

According to analysis by Jeremy Siegel, the real stock market returns in the decade following every one of these 14 periods averaged in excess of 10%. Past performance is not an indicator of future returns, however, history does have lessons to teach us if we are willing to listen.

What are Alternative Investments?

2011-03-14T08:28:00.001-04:00

Alternative investments are financial vehicles outside of stocks, bonds and cash. Here are some examples:

(1) Long-short funds (shorting a segment of the market means betting that an item will go down when 68% of the time they go up)
(2) Bear Market funds (expecting markets to go down, not up, the odds are against you unless you know ahead of time)
(3) Currency trades
(4) Managed future contracts (commodities-related with hedging strategies)
(5) Hedge funds (often expensive with 2% expenses and 20% share in profits)
(6) Merger/Arbitrage funds
(7) Distressed Debt
(8) Structured Notes

and, my favorite (just teasing):
(9) Absolute Return funds (sorry, no guarantees)

Do you need them? Most investors and those that work with me do not. Besides, many Errors & Omissions (E&O policies) do not cover these alternative investments without extra costs.

Alternatives to stocks, bonds and cash that may be useful, depending on your circumstances, might include:

(1) Real Estate Investment Trusts (REITS)
(2) Emerging Markets
(3) TIPS = Treasury Inflation-Protected Securities (though, I have my doubts about whether the CPI (and therefore TIPS) is a good measure to base your own personal inflation rate)

Market Timing By Other Names

2011-03-11T07:32:00.000-05:00

I have heard:

Tactical Asset Management; Dynamic Hedge Options; and Momentum Investing to name just a few.

A recent quote from the Wall Street Journal says it best: "...Timing the market means trying to predict future movements of asset prices and moving money in and out of markets to take advantage of those predictions..."

In my opinion and in those of many of my colleagues, it does not work consistently over time. A short-term success can easily be reduced by one bad move. The bible recommends "steady plodding" as do I.

On Past Performance

2011-03-10T07:28:00.001-05:00

Author, Hersh Shefrin, of the book entitled Beyond Greed and Fear writes: "...past performance is a great predictor of future expectations, not future performance..."

International Investing Part 2 of 2 - The Risks

2011-03-09T07:31:00.000-05:00

9 risks to international investing (yes, maybe you should invest a portion of your diversified portfolio internationally but adjust the amount based on these risk factors):

(1) Interest rates globally
(2) GDP year-over-year changes within countries you are considering (growth rates)
(3) Economic future
(4) Central bank's influence
(5) Political stability
(6) Level of exports versus imports (the U.S. exports much less than other countries)
(7) Assets and commodities versus a country's capabilities (their intellectual, service industry)
(8) Debt to GDP (Japan's is 200% for example); also, the current deficit versus their reserves
(9) Per Capita value (not just the population size); for example, much of the world still lives on dollars a day, including China and India though their populations are large

I believe that future growth is, however, in these non-U.S. countries, but stock market performance is based on growth "expectations" not necessarily the actual growth rate.

When looked at through this prism of these nine factors, the U.S. truly does shine in comparison to other countries. Here is the question:

"...If the U.S. is "expected" to grow at a rate of 2% and it grows at greater than this rate, would investors like that better than if an emerging market country's growth rate was "expected" to be 8% but it only grew at 6%?.." Something else to think about.

International Investing

2011-03-08T08:02:00.004-05:00

There is much written about investing in international markets.

First, in the developed countries of Europe and Asia and, then, investing in Emerging Markets (like Brazil, Russia, India, China [BRIC for short]). Now, the Frontier Markets (smaller developing countries) are also recommended by many advisors.

The size of the financial markets based on market capitalization, though, reveal an interesting statistic based on 2007 numbers (the numbers are always changing but I just want to make a point):

The United States...is at 47% of the world's market (almost twice the size of the next largest)
Japan.........................is at 26%
U.K. ...........................is at 14%

Note that these 3 countries make up 87% of the world market's financial size (capitalization).

GDP (Gross Domestic Product) is another measure of the financial influence of countries. From that perspective in round numbers (2010 numbers):

European Union........$15 trillion
U.S.............................$14 trillion
China.........................$10 trillion
Japan..........................$ 4 trillion
India............................$ 4 trillion

All other countries are less than $4 trillion each.

Although there is something to be said for investing internationally in developed countries as well as in emerging markets of "developing" countries, please do not lose track of the additional risks involved. These markets are still very small in relation to the world economy (China is the exception now but per capita is yet another story).

I will highlight the risks (including per capita) in my next blog entry.

Bonds Are Not Always Safe

2011-03-07T21:52:00.002-05:00

In the April 2010 issue of Financial Planning magazine, author Jim Grote, CFP(r) quotes another respected financial planner, Ross Levin. Mr. Levin, like me, does not consider bonds "...an automatic safe haven for retirement portfolios..."

"...People who bought 10-year Treasuries at 5% [10 years ago, for example] may have avoided a gut-wrenching crash in the market, but now they must reinvest in Treasuries paying only 3.5% [or even less, as this was written in April 2010]..."

The point he makes though is that this is a 30% drop in income from these bonds and, indeed, that is a point well taken.

Student Loans 2011-2012

2011-03-04T17:40:00.001-05:00

Stafford student loans that are subsidized (meaning that the interest is deferred until after you graduate) are reduced from the 6.8% fixed rate to a low of 3.4% for 2011-2012 school years.

Something to consider is: (1) not taking on any debt of-course and paying with cash at a school you can afford or (2) going to a school you can afford but taking on some 3.4% debt and holding on to the cash, especially if it means saving your emergency fund, for example.

Your savings, though, may not beat the 3.4% cost without risk and debt always adds risk to your college payment strategy. Not good.

Planning ahead for these days obviously is the preferred approach. Plan.

Municipal Bond Investing

2011-03-03T17:14:00.002-05:00

There is much discussion of whether investing in tax-free municipal bonds (especially if from the state you reside) is a good idea. It, of-course, depends on your income need, your tax situation and other issues. Municipal is just another name for bonds offered by states, counties and cities instead of the Federal Government or from Corporations.

Remember that bond issue for a new school or whatever that you saw on your last ballot when you voted in the last election? You could be a buyer of those municipal bonds.

Though many state budgets are under duress during this 2007-2011 period, the default rates are really quite low. Really low like .03 percent for the 30-year period ending in 2009. And in 2010, those default rates still remain well under 1%. Many states have regulations that require paying their bond debt before other expenditures (usually education gets a first seat at the table, then bond payments).

For those in high-income tax brackets, the 3.8% additional tax (in 2013) on investment income will not apply to municipal bond interest. So, this may be another enticing factor to consider municipal bonds within a diversified strategy.

This is not a recommendation to buy but rather a thought to consider if they may be appropriate for you. Discuss this with your independent Fee-Only financial planner. You have one, right?

Simple International Investment

2011-03-02T15:53:00.000-05:00

Keep in mind that 40-50% of the revenues from S&P 500 companies (those multi-national companies whose names we all know that represent 80% of this index) come from their sales to overseas countries.

Wow!

Tax Law Changes for 2011

2011-03-01T15:40:00.001-05:00

On December 17, 2010 several tax laws were extended for 2 more years but, in addition, there were a few new enhancements. Always seek a professional in these matters. Here are a few:

(1) Estate tax exemption is now portable for married couples. So, for the next two years everyone gets a $5 million exemption and, if married, the surviving spouse receives a $10 million exemption without creating any trusts. Be careful though since it is only temporary and also because these are Federal limits only - not states (MD is still $1 million, for example).

(2) Qualified dividends are taxed like long-term capital gains (15% bracket is zero and in higher tax brackets it is a maximum of 15%) but now the definition includes dividends from Real Estate Investment Trusts (REIT's). They used to be taxed at regular income rates.

(3) Some tax credits (like for education) and the phase outs of itemized deductions were also extended.

So, be sure to watch your tax calculations carefully and seek the advice of a tax professional or a certified financial planner before you take action.

Investment Adviser versus Financial Planner

2010-09-08T19:35:00.004-04:00

I have heard it said that a financial planner can provide more value with planning techniques than with just managing your money (an investment adviser only).

According to Kiplinger's Personal Finance (Washington Post August 8, 2010), "...Morningstar analyzed investor returns of institutional funds and funds sold with sales charges, both of which are typically purchased with the "help" of advisers. Measured against no-load funds, which individual investors usually buy on their own, these funds produced roughly the same poor results..."

Guess what? Market timing does not work. Buy low, sell high. Simple. But there were not many interested in selling in October of 2007 (market high) and even fewer interested in buying in March of 2009 (market low).

The answer is a strategy, a plan and an allocation of financial assets based on your personal situation.

The Economic Slump

2010-09-05T05:35:00.000-04:00

In the July 2010 issue of Money magazine, the question was asked: "Has the economy really pulled out of its slump?"

Although 65% of those polled say it is either the same or getting worse, the statistics show a different story:

92% of companies plan on hiring this year

1.9% was the average raise for workers in 2009 (higher than the inflation rate)

9.9% (in April but now 9.5%) unemployment rate, when in October of 2009 it was over 10% - that is the right direction

19.8% increase in auto sales year over year (now comparing August of last year to this August showed a decrease but remember that "Cash for Clunkers" distorted last August's numbers)

9.6% increase in retail sales year over year

2.8% increase in restaturant sales year over year

It may not feel like it, but things are economically better than the doldrums of 2008-2009.

Size of Global Wealth

2010-09-04T05:00:00.001-04:00

How much wealth is there in this world anyway? We hear of trillions of dollars of debt but not much about the assets that back them up. We also have heard of the trillions of dollars of wealth lost during the economic crisis of 2007-2009 but not of any recovery.

$111.5 trillion is the total amount of global wealth as of the end of 2009. And guess what? This is, as reported in August 2010 Journal of Financial Planning, "...nearly back to its peak level at year-end 2007 of $111.6 trillion..."

There appears to be a recovery going on after all.

ON THE BRINK by Henry M. Paulson, Jr.

2010-09-03T13:48:00.004-04:00

It has been since March 22nd that I last wrote a blog entry. This first foray into writing again is a brief summary of Hank Paulson's book, On the Brink. It is a good book and I recommend it. It is a reminder of what we have been through, as he writes:

"...The crisis that began in 2007 was far more severe, and the risks to the economy and the American people much greater. Between March and September 2008, eight major U.S. financial institutions failed - Bear Stearns, IndyMac, Fannie Mae, Freddic Mac, Lehman Brothers, AIG, Washington Mutual, and Wachovia - six of them in September alone. And the damage was not limited to the U.S. More than 20 European banks, across 10 countries, were rescued from July 2007 through February 2009. This, the worst financial crisis since the Great Depression, caused a terrible recession in the U.S. and severe harm around the world. Yet it could have been so much worse. Had it not been for unprecedented interventions by the U.S. and other governments, many more financial institutions would have gone under - and the economic damage would have been far greater and longer lasting..."

Most importantly, Mr. Paulson writes, "...By early 2009, it was clear that our actions had prevented a meltdown..."

Actions by Dr. Ben Bernanke (Federal Reserve Chairman) and others at the U.S. Treasury and FDIC Insurance actions, "...stabilized the financial system, restarted credit markets, and helped to limit the housing collapse..."

Hank Paulson remains "...optimistic about the economic future of the U.S. and its continued leadership role in the global economy...." I also am optimistic and tired of the doom-sayers.

This book is well written and gives us all a chance to look back on the crisis and reminds us that we are now in "recovery mode" and, though slow, it is happening and there are encouraging signs all around us if we dare to look.

Social Security Rules of Thumb

2010-03-22T08:54:00.003-04:00

Two-thirds of Americans take social security at age 62. At 95 years of age, that could mean the loss of over $300,000 in additional earnings potential had the recipient waited until age 70 to start taking the benefit.

Rule of thumb: wait to start your benefit, if you can, and have other sources of retirement income. By the way, I hate rules of thumb because there is always another side.

Rule of thumb: the social security office's default advice to applicants is to explain to them how they can obtain the highest benefit NOW. They often will not explain the potential benefits of waiting until age 70.

Rule of thumb: married and lower income person's PIA (primary insurance amount due at full retirement age) is more than 1/3rd of the higher person's PIA benefit:

(1) lower wage earner takes benefit based on their own record at age 62
(2) higher wage earner takes spousal benefit at full retirement age (that is a 50% benefit)
(3) higher wage earner then switches to their own benefit at age 70 (much higher benefit)
(4) lower wage earner then takes 50% of higher earner's record, if higher than their own

Rule of thumb: when lower wage earner spouse is much lower than higher earner (less than 1/3 rd):

(1) lower wage earner takes benefit based on their own record at age 62
(2) higher wage earner "files and suspends" at their full retirement age
(3) why? so the lower wage earner spouse can then take the spousal benefit of the higher wage earner

THIS IS LEGITIMATE (at least today) AND GOOD PLANNING.

(4) higher wage earner then takes their age 70 benefit (which is much higher)

It is important to note that age 62's reduced benefit and the age 70 increased benefits are in actuarial terms the same and carefully calculated by the social security agency. Delaying benefits is a way to obtain "longevity insurance" should you live longer than the "averages". Otherwise taking the benefits at age 62 or age 70 come out the same if you have an average life expectancy.

Social Security Planning Strategies

2010-03-21T01:25:00.002-04:00

With married couples, the one with the higher benefit should generally wait until age 70 to start benefits (note that benefits do not increase past age 70) because the surviving spouse is eligible for that higher benefit too.

Exceptions to this rule for maximizing this government "longevity insurance" would be:

(1) shorter life expectancy due to known illness
(2) need the lower benefit now to meet income needs
(3) desire to minimize withdrawals from current investable assets so they can grow
(4) convinced that you better get it now before the benefit runs out (wrong reason, I do not believe this and will write more about this at a later date)
(5) plan to take it at age 62, pay it all back at age 70 and then get the higher benefit (if you die before age 70, then spouse is limited to lower benefit, too)

By the way, the spousal benefit (receiving income off of other spouse's record) does not increase after full retirement age (FRA), so there is no reason to wait past FRA if eligible.

You are eligible to do this off a divorced spouse's record (once they file) also if you had been married to that ex-spouse for at least 10 years prior to divorce. But, you cannot be remarried when filing for benefits or remarry while receiving those ex-spouse benefits.

Widows and widowers can remarry after age 60 and benefits have begun off of their deceased spouse's record.

Again, it is worth repeating that if you start your benefit at age 62, then die, your surviving spouse is limited to your lower benefit (unless their own record allows them a higher benefit).

Social Security - Interesting Concepts

2010-03-20T01:07:00.002-04:00

Once you reach your FRA (full retirement age), you can "file & suspend". Basically this means that you are telling the social security agency to not start paying you yet but it allows others, like your spouse, to file for their benefit based on your record.

This is an interesting strategy to begin receiving some social security in the household. Then, when your spouse reaches full retirement age that person can begin to receive their full benefit based on their own record. You, in turn, have allowed your benefit to continue to grow until you decide to take the benefit.

It is simple to do, check the box at the end of the normal application form.

"File & Withdraw" is another strategy that may be useful, if applicable. Complete Form 521 and repay all benefits previously received (but note that all interest/gains on those funds do not have to be repaid, you can keep those).

Why?

Social security is just like an annuity except the payout is better than a life insurance company and it is backed by the government. So, with this strategy, you are purchasing a single-premium annuity for your lifetime. And, your surviving spouse, continues to receive your higher benefit after your death as the survivor.

If, for example, you had started your benefits at age 62 (at 70%-80% of your normal retirement age benefit) and are now age 70 with a very healthy lifestyle and longevity in your family, then you can repay the benefits and begin receiving the age 70 benefit. This may be a substantially higher monthly benefit (from age 62 to 65, the monthly benefit increases 20%-30% and then from age 65 to age 70 it increases at 8% per year, for another increase of about 35% - substantially more than your age 62 benefit.

Why not?

It still takes about 15 years to break-even on this deal, so if you get hit by a bus, then your heirs lost out on that nest egg that you just used to purchase your new lifetime annuity through social security. If you are married, though, consider the potential remaining lives of both of you.

ETF's Can Reduce The Cost of Investing

2010-03-19T07:49:00.000-04:00

Go to: www.personalfund.com to learn the cost of the funds you use in your investment portfolio.

ETF's are often less expensive than actively-managed mutual funds, however, when compared to indexed mutual funds they may be more comparable.

One disadvantage often overlooked for those choosing ETF's over an indexed mutual fund is that you cannot reinvest dividends, gains and interest. These additions will end up in your money market core account at your brokerage firm and then you will have to decide how to re-invest these funds. If you re-invest in the ETF, then each purchase requires another commission to be paid so it would be better to do this after large quantities have accumulated. In a mutual fund, this can be done for you automatically and at no additional cost.

Do not overlook dividends. These represent 2% now of the return of the S&P 500 and over 10 years is the difference of more than 20% compounded. It is important and it is a disadvantage of ETF investing not often mentioned by those selling them.

Reverse Mortgage Websites

2010-03-18T09:32:00.001-04:00

Kiplinger's recommends: www.goldengateway.com to do the math and I recommend also the AARP site: www.aarp.org/revmort/ for an estimate of benefits based on age.

The older you are, the more the monthly payments you receive but the less time you may have to amortize closing costs over your remaining life.

Upfront costs could be from 4%-6% but over the life of the loan could be as much as 10% so it is wise to run the numbers with a financial planner and consider other solutions that may be less expensive.

Interest rates may be variable and in this environment may end up going up and costing you more and depleting your remaining equity faster than you had thought. A fixed rate would be preferred, especially when interest rates are low.

Federal (FHA) loans provide limitations on variable interest rate changes where a private loan may not have these safeguards:

(1) Rate changes cannot occur more than once per year
(2) Change is only based on the 1-year Treasury bond rate change
(3) Maximum change of 2% in any year and maximum of 5% point change over the lifetime of the loan

The most complete list of HECM lenders, per the AARP report, can be found at:

www.hud.gov/offices/hsg/sfh/hecm/hecmhome.cfm

Pros and Cons of Reverse Mortgages (HECM)

2010-03-17T08:52:00.001-04:00

Remember that there are other alternatives to boost income if needed later in retirement than a reverse mortgage. An intra-family transfer to a child or just obtaining a HELOC (home equity line of credit) may be good possibilities.

PROS:

(1) Provides financial independence
(2) Can stay in the home you love
(3) No loan payments required - you get money instead
(4) Reverse mortgage does not have to be repaid until last surviving borrower dies or home is sold or borrower moves out permanently (but, of-course, then the monthly income stops)
(5) Non-recourse (big, fancy term but what it means is that you can never owe more than the home is worth so you never have to worry about other assets being at risk)
(6) Many options of payments (lump-sum or monthly payments or a credit line that you use as you need to)

Now for the CONS:

(1) Can't do it unless your home is free and clear (otherwise proceeds must go first to paying off the current mortgages leaving less for you, but it could save you that mortgage payment)
(2) It is costly to obtain (total closing costs can be 6-10%), therefore, the less time you do end up living in the house due to health issues or death, the more costly the loan to you (you need time to spread those costs)
(3) If you live in an expensive area (like the DC area) you most certainly won't be able to get all of your equity
(4) All borrowers must be at least 62 years old
(5) The interest rate is continually added to the amount borrowed so it is possible that no equity will be left for heirs to inherit.
(6) Private loans may allow you to borrow more but are more costly and may, again, deplete your remaining equity quicker leaving no legacy values to inherit
(7) Heirs may be able to help with income needs at a lower cost and maintain the inheritance and at a much lower cost

Again, because interest is added to the outstanding balance borrowed it is very possible that further home appreciation (or in a market like we have been with depreciating values) will not keep up and you may not have much, if any, home equity to leave to anyone or to use to pay for long-term care (or other bills) if you need to vacate the home.

FHA Limits on Reverse Mortgages

2010-03-16T20:29:00.000-04:00

Although you can obtain a reverse mortgage privately, FHA provides a level of safety as it is government regulated.

FHA has a maximum amount that can be obtained as a reverse mortgage, calculated as follows:

(1) This must be the first mortgage (so others must be paid off before-hand or with the proceeds)

(2) For each year over age 62, the formula limit is increased approximately 2%

(3) Rate used is based on 10-year Treasury rates

(4) The low interest rates (in the 2010 market place) provide for a higher amount available to borrow than in high interest rate environments

NUMERATOR:
(5) [ (Appraised home value or FHA maximum for your area) x (1 + CPI rate)^ Client's remaining life expectancy] . . . in this formula the symbol ^ means "raised to the power of" (for example, 20 if you were 75 years old)

DENOMINATOR:
(6) [ (1 + 10-year Treasury Rate) + (FNMA spread, which has been 1.5% but does change) ]

For example, a $300,000 house for a 75 year old with 3% expected growth rate in CPI and 10-year Treasury rates of 3.5%, results in slightly more than $200,000 available for a reverse mortgage.

Closing costs can be 4% or more of the loan and can be paid from proceeds but are most likely lower than closing costs on the private market.

I still believe that there are only rare instances where this is the better alternative than other options (see other posts in this blog under: Debt-Mortgages) but it can work.

AUM - Assets Under Management

2010-03-15T01:54:00.001-04:00

My financial planning practice does not charge for assets under management (AUM) but the majority of planners do. Though there are conflicts-of-interest with all forms of compensation, let's look at advisors that manage your money and charge a fee to do so.

Does your advisor "disclose all conflicts of interest"? Disclosure is key.

Here are a few examples:

(1) Should you keep your money at your 401k with your employer?

If yes, the AUM advisor then cannot (should not) charge for those assets; unless you rollover those 401k dollars to an IRA the advisor can manage. If you are between the ages of 55 (the age you can remove money from a 401k without the 10% penalty) and age 59 and 1/2, then you have lost the opportunity to access those funds penalty free if you roll them over.

(2) Should you borrow from your home equity or use some of your investable assets to make a substantial purchase (car, second home, etc.)?

Going into debt safeguards your investable assets under management and does not lower the fees being charged by your advisor. Many reasons may be given for why debt is the better option but is there not a conflict of interest?

(3) Should you invest in a 529 college plan or invest by segregating your own funds?

Again, the money removed from your portfolio and managed by a state's 529 plan is no longer under the fee structure of the planner charging AUM (or should not be). This does not mean that investing through a ROTH IRA may not be a better solution than a 529 and provide you with more flexibility but, again, might there be a conflict of interest?

(4) Most egregious in my opinion is when planners manage your assets, charge a flat fee for all of them, yet suggest that some be held in cash or laddered CD's and/or fixed income that earn less than the fee charged by the advisor. Are you paying the same rate regardless of the asset type?

You can invest in CD's on your own. An advisor has little room to add value to the fixed income portion of your portfolio that may average 5%. If he charges 1%, for example, then that is 20% of what you make. That is excessive, don't you think?

The problem, of-course, is that planners know that asset allocation is where the volatility of returns can be managed. Therefore, if you only have the planner manage your stock investments then they have no effective way to allocate funds, manage risk and, therefore, manage the amount of fees they receive if (actually, when) the stock market goes down again.

New Tax Schedules for 2009 Returns

2010-03-14T11:13:00.004-04:00

As you prepare your 2009 tax return, there are several changes. As an example, two new schedules should be reviewed in case they affect your return:

Schedule M - related to last year's Make Pay Work tax credit where many earners received a little extra in their paychecks to help stimulate the economy.

Schedule L - for those who do not itemize deductions allows some extra add-on deductions if you qualify.

There are many changes besides these examples so keep a watchful eye.

Another Day, Another Dollar

2010-03-13T11:05:00.000-05:00

We have all heard this before but it was commonly said in the 1930's when day laborers made $1 per day for working in the fields. Think about that when you reflect on inflation.

Inflation is, in effect, a tax on income as it dwindles your purchasing power. Do not believe that, in retirement, you can park all your money in CD's and money markets and live off the interest because two things can happen:

(1) The interest rate can go down (like now) reducing your income

(2) The principal stays the same but you require more and more income from that same amount

Now, if your savings and investments are not needed for income in retirement, then keeping it safe still leaves less purchasing power for the future or to leave as an inheritance.

More on Debt in our Economy

2010-03-12T18:11:00.004-05:00

The "public" debt of the federal government is over $6 trillion (as mentioned in previous posts, the total debt of the government is higher but it is not all held publicly). It is a lot, though, and the Treasury is selling Treasury bonds on a regular basis to cover the annual deficits.

State governments combined are over $2 trillion in debt.

Corporations and other non-corporate businesses sell bonds, too. That debt is actually more than the federal and state government's debt at over $11 trillion.

Of-course, households top both the governments (state and federal) and all businesses with $14 trillion of debt ($10 trillion on mortgages alone).

However, with all of this debt that is only one side of the coin. Those debts bought "stuff" in many cases.

The total net worth of the U.S. (land, buildings, businesses, etc.) is over $55 trillion. So even though the debt seems high at a combined $30-$35 trillion (and it is), it is important to keep those huge numbers in context as compared to what the U.S. owns in aggregate.

Just a thought.

Government Debt

2010-03-11T01:50:00.001-05:00

The government debt will exceed $12 trillion and yet balance is necessary. About half of the debt is held by the public (through Treasury Bonds), while the rest is borrowed from within the government itself. Social security may soon be paying out more than it takes in but over the last 75 years (since its inception in 1935) the system has collected more than it has paid out so far. That amount is expected to peak at near $6 trillion. Yes, $6 trillion.

The real issue, just like your personal finances, is not how much the mortgage is (I am sure if you have one the balance exceeds your annual income, too, just like the government), but how much that mortgage is as a percentage of your spending plan.

The government, in effect, is paying "interest only" on its debt. Here are some numbers:

In 2000, the government's annual interest on its debt was $220 billion.
In 2003, that had fallen to $150 billion.
From 2004 to 2008, the annual interest slowly was rising to $250 billion by 2008.

In 2009, the interest cost was under $200 billion again and in 2010 is expected to be slightly higher than $200 billion. The is between 5-6% of the 2010 government budget of $3.8 trillion.

Not much. The average household spends almost 15% on interest costs as a percentage of income per year (mortgage, cars, credit cards, etc.).

Another interesting point is that 20 and 30 years Treasury bonds issed by the government in 1980 and 1990 are reaching maturity and being replaced by bonds with today's much lower interest rates. This is like re-financing your own debt and helps the government be able to withstand more debt because of the lower interest costs.

I am NOT condoning the over-spending but, again, keep things in perspective.

HECM = Home Equity Conversion Mortgage

2010-03-10T05:10:00.002-05:00

Home Equity Conversion Mortgage is the official phrase for "reverse mortgages". Here are some highlights:

(1) All borrowers must be at least 62 years old

(2) You must use your personal, primary residence

(3) Reverse mortgage must be the "first mortgage", so any existing mortgages must be paid off

(4) TALC = Total Annual Loan Cost are expensive (the fewer years in the home the more costly)

(5) Closing costs include "up to" 2% broker's commission (but this can be negotiated)

(6) If using FHA, then another 2% mortgage insurance premium is a part of closing costs; now we are up to 4% front-end costs

(7) Balance, plus interest, must be paid within 9-12 months after the borrower vacates the property (as a result of moving to an assisted-living facility, death, or sale)

This is an expensive means to an end and can result in significant degradation in the equity in the home and potential value for heirs to inherit.

It is important, therefore, to seriously consider the alternatives to obtaining a reverse mortgage to meet immediate income needs, for example:

(1) Sell the house instead and downsize
(2) Adult children "gift" money to the parents to meet income needs (protects home value)
(3) SSI = Social Security Supplemental Income (available if very low income)
(4) Size of the reverse mortgage (only obtain what is really needed to meet basic income needs)
(5) DPL = Deferred Payment Loans for repairs (in effect, a regular HELOC or mortgage though you do have to make monthly payments instead of receive monthly payments)
(6) PTD = Property Tax Deferrals (some counties waive property taxes based on income and assets owned outside of the home's value)...I will write more about this separately.

AARP has a very nice brochure called "A Consumer's Guide to Reverse Mortgages".

The PIGS - What?

2010-03-09T07:38:00.002-05:00

Portugal, Italy, Greece and Spain - the PIGS. Their economies are faultering and many pundits want us to believe that international investing is more dangerous now because of it.

Again, I ask for perspective.

Greece is the most often cited these days for its out-of-control government debt that threatens the EURO. As reported in the WSJ opinion page (Monday March 8, 2010), "...the Euro Zone would never miss Greece, which accounts for only 2% of its total GDP..."

Now there is perspective. Some of these smaller countries have needed austerity measures to put in place but they are small relative to the overall world and/or just the Euro economy.

More Stock Market History - Worst 3-year Periods

2010-03-08T04:30:00.004-05:00

Investors in stocks should have a long-term horizon: 10-15 or more years before they need that portion invested in stocks. Most consider 1 year long and 3 years an eternity.

Here are some interesting statistics on 3-year rolling periods since 1926 (there are many 3-year rolling periods when measured month by month). For example, July 1, 1929 through June 30, 1932 is one and August 1, 1929 through July 31, 1932 is another, etc.)

As measured by the S&P 500 (and this index was actually started in 1970 so interpolation is required for this data provided by the Center for Research in Security Prices and Bank of America):

Of the 25 worst 3-year periods in stock market history since 1926, 22 occurred in 1931, 1932 and 1933 (with market declines ranging from (43% ending 7/31/1933) to (81% ending 6/30/1932).

The worst two (only 2) 3-year periods of recent history were for the periods ending 2/28/2003 and 3/31/2003 (39% and 42% respectively) before the market took off again during late 2003 through October 2007.

The 3-year period (March 1, 2006 through February 28, 2009 just before the March 9, 2009 low from which the market posted sizeable double-digit gains), is measured as a loss of (38%).

As bad as this recent period has felt for most investors, it ranks as #25 out of the worst twenty-five 3-year rolling periods. Now there is some perspective.

As Samuel Dedio, head of U.S. Equities at Artio Global Management, stated "...even professional advisors were stunned during the downdraft..." but, in reality, it has not been the worst 3-year performance on record.

ROTH Conversions

2010-03-07T16:09:00.004-05:00

Before you decide to convert a 401k, 403b or TSP from your previous employer or any Traditional IRA's you might have to a ROTH...stop and consider a few things. This is not a "no-brainer" for most investors.

Read Ric Edelman's downloadable report entitled "the ROTH Conversion Conundrum" from his website at: http://www.ricedelman.com/ (you have to provide your name and e-mail addres to get it but it is worth it).

For example,

(1) If you have children near college age, the conversion will increase your reportable income on the FAFSA form for college aid and may require additional hoops to go through to explain the unusual income spike (not in the Ric Edelman report but yet another consideration)

(2) If you are older, and maybe near retirement or in retirement, then that conversion increases your income and with the 2-year delay may increase your premiums for Medicare which are income-based (this is in the report by Ric)

(3) Do not assume that you will be in a higher tax bracket when you are ready to withdraw this IRA money. For starters, today, income tax brackets are indexed to inflation so for a married couple almost $20,00 of income is not taxed. With 3.5% inflation, in 20 years that amount may be nearer to $40,000. If, in retirement, you only had to withdraw $40,000 per year from your Traditional IRA or 401k or 403b or TSP, then that amount would come out tax-free anyway.

The answer to the question of whether to convert depends on:

(1) Your age
(2) Years to retirement and actually needing the money
(3) Whether you can pay the taxes on the conversion from other funds (but remember that you must calculate the future value of what those funds used to pay taxes could grow to also)
(4) Whether you plan to use the money or allow it to remain as an inheritance for your heirs
(5) Your tax bracket now and in the future (don't assume it will be higher)

This is one of the value-added propositions of good financial planners who are not selling you products or assets under management and can and will be independent and objective.

The $100,000 income limit to convert has been removed as of January 1, 2010 and it is not scheduled to return so there is plenty of time to consider your alternatives. The option to pay the tax over a 2-year period, however, only exists for 2010 conversions but that still does not mean you should do this in one lump-sum now.

Special Needs Trusts - A Unique Concern

2010-03-06T05:45:00.000-05:00

More and more families seem to have a need/use for Special Needs Trusts for someone with a disability whether minor or major.

To qualify for Medicaid (not MediCare for seniors but healthcare for disadvantaged and poor):

The government says you can have a house, a car, a prepaid funeral, and $2,000 to your name.

Don't you (and don't let your parents, grandparents or others) leave items to your "special needs" dependent child in wills but specify that this portion go to a "special needs" trust. It does not have to be as much money as with other children, since it will cover only the "extras" the child needs and not maintenance and support (see a planner and a lawyer).

M2 - The Money Supply

2010-03-05T08:04:00.002-05:00

The money supply (M2) includes physical currency, bank deposits and money market funds. As reported in the WSJ (March 4, 2010 by Kelly Evans), the growth of money supply is about 5% and with overall GDP growth of about 3%, we can kind-of see why inflation targets are around 2% - the difference.

During the economic crisis, the money supply spiked to over 20% (2008-9) and yet we had negative GDP. The pundit's and some respectable economist's conclusion: inflation is on the horizon.

However, since mid to late 2009 and certainly in these first couple of months of 2010, the money supply growth came back down to its historical average of 5% and in 2010 has hovered near zero. Why? We are still in a credit crisis and the money being poured into the system has been used to pay down debt not create demand for more goods and services - yet.

Yes, there is much "unwinding" to be done (the Federal Reserve increased its balance sheet from $.8 trillion to over $2 trillion in the past two years) - a brilliant move, in my opinion, to avoid depression. But not one without ramifications as they eventually sell the debt (mainly $1.25 trillion in mortgages they bought) back into the market. But that can be done in a way that mitigates the inflation risk. Only time will tell if the Fed is successful.

Saving Too Much?

2010-03-04T05:37:00.003-05:00

There are a few planners that think many of us are saving too much and that it is OK to have debt as you approach retirement. The reasoning is that it is OK to hold liabilities (debt) as long as the assets (your investments) are growing faster (as Ken Shapiro, a planner in NJ, was quoted in the April 2007 Financial Advisor magazine).

What is forgotten is risk-adjusting the return. If your mortgage is at 5.5% but your investments are growing on the average of 7%, then you should be fine. In retirement? Unlikely.

While working and accumulating? Maybe so.

The sequence of those 7% returns are important. If in the first few years of retirement, you experience losses, then those withdrawals to pay the mortgage quickly drain your portfolio and make it difficult to recover. The mortgage rate is guaranteed but the investment rate is not guaranteed so you have to adjust for that "risk".

Since 1925, large-cap and small-cap stocks have lost money 31% of the time over "one-year" (note: 1-year please) rolling periods. They have gone up 69% of the time. Those are not great odds in your favor that holding a mortgage in retirement is a good idea unless you have a "Buckets of Money" (see Ray Lucia's book and strategy) and have enough money to fund it properly (In other words, 7-15 years worth of the mortgage payments in safe money and also enough for your other income needs in retirement).

DCA - Dollar Cost Averaging

2010-03-03T05:47:00.001-05:00

Dollar Cost Averaging is often used by investors because they are worried that their investments will go down in value.

Wrong reason.

I have stated before that the reason to put a set amount of money into investments on a regular basis (paycheck deduction, for example) is because you simply do not have a lump-sum to invest. If you have a lump-sum, then diversify it appropriately but immediately - not in stages.

Markets, overall, rise over time (15 year or longer time horizons). They have up to this point and that includes the Great Depression, world wars and double-digit inflation periods.

So...

as long as you have a time horizon measured in many years, then do not dollar-cost average (DCA). This DCA technique is simply an easy way to regularly invest if you don't have the cash.

Oh, by the way, if you stopped contributing anytime during the past 2 years, then you truly are defeating the purpose of dollar-cost averaging anyway.

Tax Loss Harvesting

2010-03-02T05:35:00.003-05:00

Financial advisors often suggest to their clients to "harvest tax lossess" - sell those stocks or funds that have lost money. It is true that losses can offset gains and also that up to $3,000 in losses can be offset against regular income. Nice.

As Dan Moisand in a February 2010 issue of Financial-Planning.com reminds us, though, "...the process of harvesting losses...reset[s]...cost basis to a much lower amount. [You], therefore...increased future taxable gains..."

Since the next purchase you make, assuming it is a successful investment and has a gain when later sold, resets the cost basis, then over a studied 10-year period you may find, as he did, that taxes paid on future investments offset, in part, the losses supposedly "harvested".

Watch out for phrases like "capture the equity" in your house and "harvest your losses". They are not the panacea they appear to be at times.

Estate Taxes for 2010

2010-03-01T05:26:00.003-05:00

As of this writing, March 1st 2010, Congress has still not fixed the Federal Estate Tax issue. The limits that passed tax-free to heirs has increased over the years and at 12/31/2009 was $3.5 million (easily $7 million for a married couple with a simple by-pass trust in their will). The tax rate in 2009 was 45% on estates over these amounts.

In 2010, there is no Federal Estate Tax. Many know this, but fewer know that there are two exceptions to this "no" tax.

(1) On death, the first $1.3 million receives no taxes but the excess does not receive a "step-up" in basis. In other words, your heirs receive the original cost basis of assets over $1.3 million and, if they sell them, they must realize a capital gain. (Prior to 12/31/09, all assets passed to heirs at their market value, so if then sold, there would be no gains)

(2) If you are married, then an additional $3 million can pass to heirs with the "step-up" in cost basis so heirs can avoid further capital gains treatment.

Let's hope that Congress fixes this soon (and the AMT tax, too) because trying to calculate the original cost of something that may have been purchased many, many years ago could be difficult if records are not properly maintained.

Keep in mind, this is the gross estate which includes items like life insurance proceeds, too, and home equity values. Some can reach these limits pretty quickly.

Defer, Defer, Defer

2010-02-21T05:35:00.001-05:00

Deferring taxes may not be in your best interests. Do not assume that this is always the best alternative. Reasons:

(1) Today the tax brackets change based on inflation so more and more income may be taxed at low 10% and 15% rates when your income drops in retirement.

(2) Social security income may be taxed but the income limits at which they are taxed are NOT indexed to inflation. Income over only $44,000 (if married) makes 85% of social security taxable.

(3) If you have money in ROTH IRA's or taxable brokerage accounts, then using some of this money first in retirement may reduce your taxes later. Maybe.

(4) Deferring withdrawals from retirement accounts may result in a higher Required Minimum Distribution at age 70 and 1/2 that could have been avoided by taking some of that money early in retirement or not putting as much in there in the first place. Maybe.

(5) Don't forget estate taxes. ROTH's and taxable accounts may not be taxed to your heirs depending on "step-up-in-basis" laws (There is no estate tax but currently $1.3 million for 2010 and another $3 million pass tax free but these laws are expected to change).

Lost Money

2010-02-20T06:01:00.000-05:00

If you think there is money from an unclaimed pension, life insurance, retirement plan or other asset, then it may be worth researching online. Sites to try:

www.missingmoney.com

www.unclaimed.org

There is the National Association of Unclaimed Property Administrators (NAUPA). Check it out especially for loved ones that may have passed away and not left proper documentation.

Questions Posed to Kiplinger's Magazine Part II

2010-02-19T05:44:00.000-05:00

The second question posed to Kiplinger's in the March 2010 issue that I did not like the answer to is: "...I'm finally ready to buy a home. How much cash do I need?..."

Kiplinger's answer explained that 5% down is needed for a conforming loan (up to $417,000) and 10% if a larger mortgage is needed. 20% down is needed to avoid Private Mortgage Insurance but only 3.5% is needed to consider a Federal Housing Administration (FHA) loan. Another 2% to 7% will be needed for closing costs.

Now my "real" answer:

What Kiplinger's stated is correct but off the mark. The amount of cash you need is dependent upon your household income. Don't let a mortgage banker or Realtor tell you what you can afford. See an independent financial planner.

If you are in your "earning years" for the next 35-40 years, then no more than 28% of your gross income should be spent on the mortgage (principal, interest, taxes and insurance). In some areas of the country, maybe you could stretch this to 31%, but Dave Ramsey (another radio and TV personality) suggests no more than 25% of disposable income.

So, the amount of down-payment has nothing to do with the answer to this question of how much you need.

Determine the amount of the mortgage you can afford first and then back into the down-payment. If you don't have the cash required without depleting your emergency funds then purchase a smaller home or continue to rent.

Questions Posed to Kiplinger's Magazine Part I

2010-02-18T05:09:00.000-05:00

In the March 2010 issue of Kiplinger's magazine, readers posed questions and the responses were overall pretty reasoned but here is one that I had trouble with:

"...Stocks still terrify me. How can I get back in the market with less risk?..."

Kiplinger's response was first to invest through a merger fund and second to consider a balanced fund (that owns stocks and bonds) and finally, regardless of fund chosen, to buy in gradually.

Now for my "real" answer:

Get over it. Stocks are risky. Short-term, that is. They go up and down.

Long-term, however, stock returns are not your worry. Inflation and taxes are what should be terrifying you. Don't invest in the market with a short-term outlook.

You can not lessen risk (the original question) by buying a merger fund (one of the riskier styles) nor by buying a balanced fund (if bond interest rates go up, then that portion of the fund will go down).

And, do not dollar-cost average into stocks if you have the funds already. That is useful for payroll deductions when you do not have the money readily available but makes no sense if you happen to have a stash. Diversify immediately. That may require some lump-sum purchases into stocks if none exist in your investment portfolio.

Understanding market volatility certainly would help. Time horizon is so very important as well as what your income needs are from your investments.

MPT - Modern Portfolio Theory

2010-02-17T08:11:00.000-05:00

Modern Portfolio Theory (MPT) is a fancy term for developing an asset allocation strategy that combines different asset classes with low correlations with each other into an optimized combination of risk versus return. Since it was developed by Markowitz in 1952, some would say hardly "modern".

But it is modern and it does work. That is, over long time periods of regular and irregular distributions of investment returns and correlations it works. However, as Brian Dightman writes in the February 2010 issue of Financial Advisor magazine "...it fails miserably to model the frequency of extreme events over shorter time frames..."

So, be careful when you hear about new theories and strategies to manage your money. Over the long-term, asset allocation and diversification works. New theories abound these days but are mostly new market-timing strategies of one sort or another over short-term time frames.

Here are some that Mr. Dightman cites:

PMPT - Post-Modern Portfolio Theory (tries to identify that losses are worse than gains)
DPO - Dynamic Portfolio Theory (dynamic is just another word for market-timing)
GARCH - Generalized Auto-Regressive Conditional Heteroskedasticity (with univariate, bivariate and multi-variate steps in the optimization process)

Over the short-term, when markets plunge, all assets seem to go down together so the efforts made to have different assets with different correlations does not seem to work very well. But, keep in mind, that this is over a short period (meaning months to maybe 2-3 years).

Can individual investors really benefit from these so-called "sophisticated" strategies?

Probability of Failure in Retirement Distributions

2010-02-16T10:47:00.001-05:00

Often financial planners will use a fixed period (25-30 years) for determining the length of time that retirement distributions must last. Based on a Journal of Financial Planning reported study by Blanchett in the December 2008 issue, the withdrawal rate and life expectancy have dramatic effects on the amount of money you can take out of your investments during retirement.

All studies are based on 60% stock and 40% fixed income portfolio, so if you plan to have less than 60% of your portfolio in stocks at retirement then these numbers may not be valid.

If you take a 2% withdrawal rate, there is a 0% chance of running out of money from 10-40 years based on historical data (and we have plenty of rolling periods to look at that included the Great Depression and world wars and other difficult periods of history).

A 4% withdrawal rate, succeeded 100% of the time up to only 15 years. 92.5% of the time up to 35 years based on historical data.

But to reduce the probability of failure you could use joint life expectancy rather than a fixed period of time (these studies used age 100 or 35 years from age 65). Using a fixed period "...overstates the probability of the portfolio failing..." during a couple's lifetime (which is actuarily shorter than a fixed period to age 100, for example).

The withdrawal rates increase by 1% to 2% (4% becomes 5-6%) under the assumption that either one or both spouses are still alive before the portfolio runs out of money.

If a planner is paid for assets under management, then it is in "the planner's best interest" to use a longer distribution period but NAPFA planners are fiduciaries and will have "your best interests" in play before their own. A planner that has no assets under management (like myself) can be objective since our fees are fixed.

Foreign Currency Investments

2010-02-15T16:09:00.002-05:00

One alternative type of investment to stocks, bonds and international securities is investing in currencies of other countries. The cheapest and easiest method is through Currency ETF's provided by Barclays, Powershares, Rydex and Wisdom Tree as examples. Should you?

Institutional investors use these tools for short-term, strategic and/or tactical purposes but not so much for long-term "buy-and-hold" investing.

One reason to invest in foreign currencies is that they are not correlated with your other financial assets (so they may go up or down regardless of whether the Dow Jones is going up or down).

But...here is an argument against:

...if you already have investments in large U.S. companies that obtain 50% of their revenues from overseas and you also have investments in international stock and bond funds, then you have exposure to foreign currencies already.

If you have decided to invest 5%, for example, directly in foreign currency investments and experience a positive change in that fund, this may be more than offset by your other international holdings going negative.

Yes, this is what negative, low or no correlation does for your overall portfolio but it may make little sense unless you calculate how much of a percentage in foreign currencies is needed to truly offset your international positions.

Here is a better argument for avoiding foreign currency investments (from Financial Advisor magazine, February 2010 issue article "Taming the Currency Elephant" by Marla Brill):

"...simply that over long periods, currency moves tend to even out. Since it has been argued that long-term expected returns are essentially zero, a currency overlay for long-term holdings [buy-and-hold investors] would seem to make little sense..." I agree.

I am not alone, "...at the beginning of December, currency ETFs held some $6.3 billion in assets..." compared to an "...average daily turnover of $3.2 trillion...", so you can see that "...the daily currency turnover is more than ten times that of all of the world's equity markets combined..." The activity is high but the ETF participants are pretty insignificant (of-course there are other ways to participate). Just keep perspective, as I often say/write.

Deflation (Major) Avoided So Far

2010-02-14T10:38:00.000-05:00

The money supply plunged 29% during the Great Depression as a result of the Federal Reserve constricting the money supply. The result: the Consumer Price Index (CPI) declined 27%.

Japan's economy has suffered for over 10 years from the effects of deflation. So far, we have experienced a little deflation in the middle of this crisis but the CPI has not deflated to the extremes of the Great Depression mainly because the government is deficit spending and the Federal Reserve is insuring liquidity in the market place by many different actions (low interest rates, lending facilities of many newly invented types).

Look at housing, however, where deflation is major and a stumbling block to future recovery efforts. Some areas of the country have seen housing prices deflate by 50% or more. A bottom in the housing market (and also in the retail markets and the commercial markets) are necessary before a full, vibrant recovery can take place. Sometimes government intervention prevents the economy from reaching the bottom but it is necessary that we get there.

Interest Costs

2010-02-13T10:23:00.000-05:00

Much is said about the low interest rate environment we are in today.

The rate is important but the "volume of interest paid" is also important and possibly more important than the rate. It is like looking at your monthly spending and calculating that if an expense fits into the monthly plan then it is OK to purchase rather than looking at total costs.

On a $300,000 mortgage at 5% interest for 30 years, you will pay $280,000 in interest alone - almost the cost of the original mortgage. Yes, you most likely will not be able to buy a house with cash but you don't have to keep obtaining 30-year mortgages every time you move/upgrade.

On a $25,000 car at 6% interest for 6 years, you will pay almost $5,000 in interest alone - almost 20% more than the original cost of the car. Buy cars with cash and within your means.

Over a lifetime, it has been studied that 1/3rd of your income is spent on interest only. Interest paid for borrowing may be just as devasting to building wealth as taxes.

LTCI - Long Term Care Insurance Costs

2010-02-11T09:45:00.004-05:00

Private room nursing home costs average about $78,000/year (2009) but range from a low of $65,000 in Mississippi to $165,000 (more than double) in Connecticut, with New York not far behind that number.

The cost to you for a $150 daily benefit for a 3-year period at age 65 is about $3,000 per year.

I have run the numbers and found that, in general, saving/investing that premium money will only provide you with about a 1/2 year of this 3-year benefit. As stated in a previous post on LTCI, after inflation, you may find that the benefit you paid for with these premium dollars may result in still being under-insured by half.

But...interest rates, inflation and years before needing the care are all variables in that calculation and can change the results.

LTCI - Long Term Care Insurance Statistics

2010-02-10T09:24:00.000-05:00

From the American Association for Long-Term Care Insurance (2008 LTCi Sourcebook), 8 million Americans currently own long-term care protection; however, only 180,000 individuals received claim payments. That is only 2%.

So, the Long-term Care insurance salesman will tell you that you have a 50% chance of needing long-term care but not mention the above statistic. Is it accurate? Even a stay of 2 weeks (for knee surgery rehabilitation covered possibly by your medical insurance), is included in the 1 out of 2 who will need long-term care numbers. So be careful.

When is the best time to buy Long-term Care Insurance? The longer you wait the more the risk that you will not be insurable. Age 50-59, 13.9% were declined coverage and from ages 60-69, 20-33% were declined coverage.

However, at earlier ages, you must consider that inflation protection riders based on the CPI may not keep up with actual inflated costs of long-term care. At age 49, for example, you may not need that coverage for 40 years or more. If the CPI averages 3% but long-term care costs actually increase at an average of 6-8% (as they do now), then your coverage will cover less than 50% of that future value. In other words, you are better off than having no coverage but still very under-insured. What to do?

Consider Future Buy-Up Options. The answer may not be in inflation-protection but rather in the ability to increase coverage every 3-5 years without medical underwriting.

If married, Shared Care Option, allow both spouses to share a single benefit over both lifetimes.

More on the Great Recession

2010-02-09T08:59:00.001-05:00

To extricate us from the Great Depression, President Roosevelt started to spend taxpayer's money like crazy with the New Deal. Deficit spending did finally start to work.

However, 1937 saw another recession due, in part, to the government efforts at the time to balance the budget by slowing spending, the Federal Reserve's efforts to slow money supply growth by raising interest rates in 1935 and early 1936 and, of-course, the new anti-business regulations that pervaded the period. It all happened too soon and the recovery halted.

Yet many are clamoring for these things to be done again - already.

Do you think the government and the Fed will make these same mistakes again?

I do not think so. So far, they have not repeated the mistakes in this Great Recession like in 1929-1932 when they did not provide money supply growth like the have done today, for example.

Yes, it is painful to watch the soaring government debt and soaring money supply but I do believe it is necessary. Inflation and recovery (economic, not necessarily stock markets) may be years away and with unemployment so high still (9.4%; normal is nearer 5%) and productive capacity at 68% (normal is 78-82%). There should be plenty of slack to avoid inflation in the short-term.

By the way, the Fed raising interest rates is not the only way to begin the exit from this Great Recession. Programs like their buying US Treasuries and mortgage-debt are planning to end next month, in March, after reaching $1.25 trillion.

Historical Rates of Return of the S&P 500

2010-02-08T10:01:00.000-05:00

Long-term investing should be 10-15 years or more but so many investors have months or 1-year time frames. This is not effective in investing to be so short-term in your thinking.

Since 1945 (after most regulations were in place as a result of the 1929 Great Depression like FDIC insurance), here are the ranges of compounded annual rates of return for U.S Large-cap equities:

5-year returns averaged from a negative -2.4% (1970-1975) to a positive 28.6% (1995-2000)

10-year returns averaged from a negative -3.6% (2000-2009) to a positive 19.4% (1950-1960)

15-year returns averaged from a positive 4.3% (1960-1975) to a positive 18.9% (1985-2000)

After the 5-year decline of -2.4% that ended in 1975, the 15-year annual average (1970-1985) was 8.8%. To get there, of-course, the 5-year period of 1975-1980 and 1980-1985 experienced 5-year returns of 14.8%. The perspective of history is important but not a guarantee.

The 5-year period from 2005-2009 was not positive but a negative -3.6% following the negative -2.3% decline of 2000-2005. So there are anomalies, indeed. Up to now, there has never been a negative 15-year period.

Ineffective Strategies for Retirement

2010-02-07T08:48:00.003-05:00

Ineffective, or at least, inefficient strategies to withdraw money from your investable assets during retirement are keeping 100% of your "nest egg" in stocks (obviously) but also keeping 100% of your "nest egg" in CD'S, money markets, bonds (even if TIPS and I-Bonds and other inflation-protected securities are used) and other fixed income vehicles.

Study after study has proven that an allocation to stocks of at least 25% and, preferably, 40% or more to stocks are required when withdrawing an income from your portfolio.

The less the percentage in stocks, the less the safe withdrawal rate becomes going to as low as 2.4% if you want no stock exposure and want your money to last 30 years. If you want that money to last 40 years then 1.8% becomes the safe withdrawal rate.