Behavior Gap

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?

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?

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

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?

Unclaimed Money

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

How Much Do You Pay for Managing Your Investments?

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.

WYSIWYG

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.

Marriages, Divorces, Statistics and Financial Security

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.

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

Enjoy this short video on YouTube:

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

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

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

How To Manage Your Money

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).

Market Timing By Other Names

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.

AUM - Assets Under Management

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.

Interest Costs

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.

Maintaining a Standard of Living

Maintaining a certain standard of living is the goal of 4 out of 5 middle-class families. And it is tougher to maintain these days. Why is that the goal? Especially if the current standard of living may be higher than what was honestly sustainable in the first place.

Rather than adjust your debt (increasing it) to match your living expenses, maybe the goal should be adjusting your lifestyle to your income. And, if that income goes down due to medical expenses or a job loss or retirement, then adjust your living expenses to your revised income.

Yes, it may mean selling a car, or a house or a variety of other changes that will, indeed, change your lifestyle dramatically but, in the end, will truly allow you to live within your means.

Implement Your Plan

Thank you to Bill Bachrach, Chairman and CEO of BAI which is a full service training and development company for financial advisors, and his recent article in the January 2010 Financial-Planning.com magazine stating:

"...having a plan does not move [you] toward [your] goals. Implementation is the key to getting results. Just like thinking about exercise will not make a person physically fit, having a financial plan is not what actually produces results. Implementation and action rule when results are the goal..."

Human Capital

Human Capital = your ability, your knowledge, your earnings capacity over your working life. More precisely, it is the present value of an individual's future labor income.

Guess what? This is an asset. It is an important one, too. It also needs to be considered when you are deciding how much to invest in stocks versus cash, bonds and alternative assets.

As Alan Lavine wrote in a May 2007 issue of the NAPFA Advisor journal, "...if human capital is viewed as an asset...its level of risk must be considered..."

How stable is your job? Your income? Besides job loss there is also the possibility of death or disability that can affect this asset. Insure against these obstacles.

Recent Research by Zvi Bodie (professor at Boston University and author), mentions that "...human capital is predominately stock-like [early in one's career] and becomes more bond-like [later in one's career]...and accounts for 80% of a worker's total wealth..."

Human capital declines in importance as you get older and accumulate home equity and investable assets.

For example, if your income earning ability is:

(1) Risk-laden, [new job] then you might want to consider having some safer investments [an emergency fund] to offset potential job loss; and insure this asset against death and disability issues
(2) Stable, then you may be able to be less risk-averse
(3) Coming to end (close to retirement, for example), then this human capital has become more bond-like and will need to be replaced by safer investments

This is why when you are young, an emergency fund and appropriate insurance are so important since the human capital asset is such a large portion of your life and at-risk.

It is also why having some safer investments in your portfolio become more important as you near retirement. But, being too conservative is also a danger and why balance comes with a full understanding of your income needs in retirement.

NAPFA Consumer Webinars

NAPFA (The National Association of Personal Financial Advisors of which I am a member) presented their first free consumer education webinar on August 7, 2009 entitled: "Money 101: Knowing the Basics".

This was the first in a year-long monthly series (September and October are achived also) and NAPFA may have either archived presentations or future ones that you may be interested in watching. Free. They reach all income levels, wealth, ages and financial experience so you may find something helpful.

The complete schedule can be found at:

http://www.napfa.org/consumer/ConsumerWebinarSeries.asp

Investment Advisor's Conflict of Interest

You may not want to lose money but neither does your advisor if he has your assets under management (AUM) and is charging you a flat fee of 1%, 1.5% or even as high as 2%.

If cash earns less than 1%, you may be losing money on that portion of your portfolio with the advisor. Laddered CD's should not be managed by your advisor. You can do this. You can do this all but certainly don't leave cash to be managed by your AUM advisor.

Most advisors know that they cannot time the markets but if their first priority is "protecting their income base" (oh, I mean, keeping you from experiencing losses in your portfolio), then this may be a major conflict of interest.

Your best interests may be served by holding stocks long-term and not trying to determine when to get in and get out, but your advisor just might be telling you that he is "controlling risk in a financial crisis" by selling. He may know that you will most likely miss the turnaround. If he did not tell you this, then he may be managing his own interests.

IPS and Removing the Passionate Response

Our emotions can get the best of us. Jason Zweig wrote an excellent book entitled "Your Money and Your Brain" (2007). I will review highlights in a later post.

In the meantime, develop a plan and to help you stick to it make sure you have an IPS - an Investment Policy Statement (all of my clients have one).

One important key to a financial plan (especially the investment portion) is to make it dispassionate. Remove the emotion as best you can by re-reading your IPS so you recall why you would make changes to your strategy.