I am continually surprised by questions from financial reporters who are still asking how my clients are faring after losing half of their retirement savings or by individual investors who are still fretting over losing half of their nest egg. If you followed our advice, as about 95% of our clients did, to stay the course and avoid selling during the drop in the market you would be close to break even now. If your risk tolerance precluded you from staying in the market, you may have realized a greater loss. This is a good reminder that we need to avoid acting on emotional reactions to the stock market. The stock market is cyclical and you can’t recover from a loss if you aren’t in the market. The stock market is counter intuitive – generally, the best time to buy is when you feel like selling and the best time to sell is when you feel like buying.
Here are some figures that will illustrate the actual change in the market over the last three or four years. The S&P 500 hit an all time high of around 1561 in October of 2007 and dropped about 56% to around 683 by March of 2009. Since March of 2009 the market increased by about 88% to 1286 on January 31, 2011. While it hasn’t reached the peak of 1561 it has returned to the 1200-1300 level where the market hovered throughout the summer of 2008 – before the significant drop in September 2008. The NASDAQ hit an all time high of around 2810 in October of 2007 and dropped about 54% to around 1293 by March of 2009. Since March of 2009 the NASDAQ has increased by about 109% to 2706 on January 31, 2011.
By Jane Young, CFP®, EA
February 27, 2011
February 23, 2011
The New Normal
A number of clients have expressed alarm at the recent clamor of commentators who have been predicting a cataclysmic economic change worldwide. These pundits claim that we are facing an economic “New Normal” and express concern that the ‘old’ economic rules on which we rely no longer operate.
Their conclusions? Drastic changes are needed in our lives and investments to accommodate the “New Normal!”
Usually they question the viability of the U.S. dollar and offer the possibility that China, or perhaps a block of other nations, are somehow positioned to ‘take over’ the U.S. because they hold so many U.S. bonds. Another variation of this calamity centers on the recent collapse of the real estate market, the precipitous drop in the stock market, and extraordinarily low interest rates. Taken together, these developments presage the end of American prosperity for our children and ourselves.
Of course these apocalyptic pronouncements are more effective if they are tied to some political viewpoint, the more extreme the better. More often than not, far right political viewpoints proclaim that doomsday is the certain result of left-wing politics. Leftist views generally emphasize the inevitable revolution that suppression of the masses will cause.
(Note to “Investment Advice” file: Never let your politics drive your investments!)
It’s time to confront these ridiculous assertions. Yes, it is true that the investment and economic travails of the past decade have been severe and have impacted many people worldwide. Some of these changes have not occurred before during many of our lifetimes. It is enticing to point the finger of blame and shame at our financial, economic, investment and political leadership. But that is not the whole story.
The power of momentum in democratic economies is easily underestimated. Although dramatic from time to time, the impact of severe financial shifts must be kept in proportion and viewed within a broader historical perspective. We need to recognize that most extreme economic shifts are self-correcting.
Even with unemployment at over 9%, over 90% of our citizens are employed. Real estate crashes, weather-related disasters, stock market crashes, low interest rates, etc. have all happened before. Indeed the damage done by seismic economic shifts during the Great Depression, the severe stagflation in the 1970’s, and the collapse of S. & L.’s in the 1980’s were all worse than we have seen today…and all of these are relatively minor when compared to the disruption of the financial markets in the 19th century. And whatever happened to the “New Economy” theory that gave rise to the ‘dot-com’ frenzy of the 1990’s?
It is folly to fret about how much of our debt is owned by the China (interestingly, Japan owns nearly as much U.S. debt as China, even though that fact is not usually noted). What can the Chinese do with our debt? They can’t dump it on the White House lawn and demand to be paid off with gold. They can’t go on the world markets and exchange dollars for Euros or Yen, or even buy gold. Any of these moves would be self-defeating because dumping huge amounts of money in any market would decrease the value of their remaining dollars. Actually, their only realistic option is to spend it in the U.S.!
There is a concern that the U.S. dollar is at a “tipping point” and will soon lose its status as the world’s reserve currency. But no other currency is in a position to take its place. The Euro’s stability is much too questionable. The Yuan doesn’t have a long enough history to be relied upon, especially when a dictatorial government can arbitrarily determine its value. Neither these nor other ‘respectable’ currencies such as the Yen, the British Pound, the Swiss Franc, etc. have enough depth to support a global economy.
Those who espouse extreme economic outcomes are invariably selling something. Usually it is their newsletter or book, or some strategy to beat the market, or gold itself. The most eminent economists in the world have never been able to predict any economic cycle with a meaningful consensus. Why should you believe the extreme voices of charlatans who use their advanced marketing techniques to dupe the fearful?
What can you do? I suggest that you sit back and follow sensible advice. The Functional Asset Allocation model, which is used by nearly 200 fee-only members of ACA (Alliance of Cambridge Advisors), focuses on the basics.
Consider this…there are only three possible economic scenarios: we can have inflation, deflation, or prosperity. It is a waste of time to try to determine which is coming next. The prudent approach is to be prepared for all three possibilities. As the ancient wisdom of the Torah exhorts: “Invest a third in land, a third in business, and a third in reserves!”
Today, that translates into a balanced portfolio of real estate, equities (i.e. stocks in companies), and cash and bond reserves. Trying to market-time and pick the next ‘hot investment’ is foolhardy. If you allow the vagaries of global economics, i.e. exogenous factors, to be the focus of your attention, you risk making decisions based on emotion rather than rational thought. In truth, it is the ‘endogenous factors’ in your life that determine your financial future.
As Pogo once said, “We have met the enemy, and he is us!” Instead of dithering about what will happen in the Mideast, or where interest rates are headed, or when will real estate level off, look at the things in your life that make a difference. Are you saving at least 10% of your gross income? Are you living within your means? Do you have enough liquidity to ride out a financial setback? Do you have a long-term fixed rate mortgage to protect you from inflation? Do you have government bonds to weather another bout of deflation.
Obsessing about the various complexities and possible outcomes in today’s global economy inevitably leads to rash and unwise leaps. Keep an eye on the issues within your reach! It is the key to a confident journey and a serene financial future.
I appreciate the editorial review contributed by Chip Simon, CFP®, an ACA colleague in Poughkeepsie, NY.
By Bert Whitehead, MBA, JD
Their conclusions? Drastic changes are needed in our lives and investments to accommodate the “New Normal!”
Usually they question the viability of the U.S. dollar and offer the possibility that China, or perhaps a block of other nations, are somehow positioned to ‘take over’ the U.S. because they hold so many U.S. bonds. Another variation of this calamity centers on the recent collapse of the real estate market, the precipitous drop in the stock market, and extraordinarily low interest rates. Taken together, these developments presage the end of American prosperity for our children and ourselves.
Of course these apocalyptic pronouncements are more effective if they are tied to some political viewpoint, the more extreme the better. More often than not, far right political viewpoints proclaim that doomsday is the certain result of left-wing politics. Leftist views generally emphasize the inevitable revolution that suppression of the masses will cause.
(Note to “Investment Advice” file: Never let your politics drive your investments!)
It’s time to confront these ridiculous assertions. Yes, it is true that the investment and economic travails of the past decade have been severe and have impacted many people worldwide. Some of these changes have not occurred before during many of our lifetimes. It is enticing to point the finger of blame and shame at our financial, economic, investment and political leadership. But that is not the whole story.
The power of momentum in democratic economies is easily underestimated. Although dramatic from time to time, the impact of severe financial shifts must be kept in proportion and viewed within a broader historical perspective. We need to recognize that most extreme economic shifts are self-correcting.
Even with unemployment at over 9%, over 90% of our citizens are employed. Real estate crashes, weather-related disasters, stock market crashes, low interest rates, etc. have all happened before. Indeed the damage done by seismic economic shifts during the Great Depression, the severe stagflation in the 1970’s, and the collapse of S. & L.’s in the 1980’s were all worse than we have seen today…and all of these are relatively minor when compared to the disruption of the financial markets in the 19th century. And whatever happened to the “New Economy” theory that gave rise to the ‘dot-com’ frenzy of the 1990’s?
It is folly to fret about how much of our debt is owned by the China (interestingly, Japan owns nearly as much U.S. debt as China, even though that fact is not usually noted). What can the Chinese do with our debt? They can’t dump it on the White House lawn and demand to be paid off with gold. They can’t go on the world markets and exchange dollars for Euros or Yen, or even buy gold. Any of these moves would be self-defeating because dumping huge amounts of money in any market would decrease the value of their remaining dollars. Actually, their only realistic option is to spend it in the U.S.!
There is a concern that the U.S. dollar is at a “tipping point” and will soon lose its status as the world’s reserve currency. But no other currency is in a position to take its place. The Euro’s stability is much too questionable. The Yuan doesn’t have a long enough history to be relied upon, especially when a dictatorial government can arbitrarily determine its value. Neither these nor other ‘respectable’ currencies such as the Yen, the British Pound, the Swiss Franc, etc. have enough depth to support a global economy.
Those who espouse extreme economic outcomes are invariably selling something. Usually it is their newsletter or book, or some strategy to beat the market, or gold itself. The most eminent economists in the world have never been able to predict any economic cycle with a meaningful consensus. Why should you believe the extreme voices of charlatans who use their advanced marketing techniques to dupe the fearful?
What can you do? I suggest that you sit back and follow sensible advice. The Functional Asset Allocation model, which is used by nearly 200 fee-only members of ACA (Alliance of Cambridge Advisors), focuses on the basics.
Consider this…there are only three possible economic scenarios: we can have inflation, deflation, or prosperity. It is a waste of time to try to determine which is coming next. The prudent approach is to be prepared for all three possibilities. As the ancient wisdom of the Torah exhorts: “Invest a third in land, a third in business, and a third in reserves!”
Today, that translates into a balanced portfolio of real estate, equities (i.e. stocks in companies), and cash and bond reserves. Trying to market-time and pick the next ‘hot investment’ is foolhardy. If you allow the vagaries of global economics, i.e. exogenous factors, to be the focus of your attention, you risk making decisions based on emotion rather than rational thought. In truth, it is the ‘endogenous factors’ in your life that determine your financial future.
As Pogo once said, “We have met the enemy, and he is us!” Instead of dithering about what will happen in the Mideast, or where interest rates are headed, or when will real estate level off, look at the things in your life that make a difference. Are you saving at least 10% of your gross income? Are you living within your means? Do you have enough liquidity to ride out a financial setback? Do you have a long-term fixed rate mortgage to protect you from inflation? Do you have government bonds to weather another bout of deflation.
Obsessing about the various complexities and possible outcomes in today’s global economy inevitably leads to rash and unwise leaps. Keep an eye on the issues within your reach! It is the key to a confident journey and a serene financial future.
I appreciate the editorial review contributed by Chip Simon, CFP®, an ACA colleague in Poughkeepsie, NY.
By Bert Whitehead, MBA, JD
February 19, 2011
How to Bullet-Proof Your Portfolio
I read an interesting article this weekend in the Wall Street Journal that really got me thinking. The basis of the article was how to profit from the impending inflation that the media is telling us is right around the corner. While I don’t necessarily discount that fact that inflation may be headed our way, I do disagree with the idea of trying to time economic cycles.
If you’re a reader of my blog, you understand that as a holistic, big-picture, fee-only financial advisor I find market timing or economic timing to be a poor choice. If now is the time to sell long bonds due to the threat of inflation, when is the right time to buy? If now is the time to buy small cap stocks, when is the right time to sell? This is the market timer’s dilemma.
I find the best response to the threat of inflation, deflation, or economic prosperity (the only three economic cycles we can face) is to develop a portfolio to handle all three. The difference between my theory and the article is that my theory is designed to be permanently implemented into the portfolio….not a moving target that requires guess work and timing to accomplish the task. Here’s how to handle the three economic cycles.
Inflation – To ward off the effects of inflation there are a couple things investors can do. First, holding cash is a good inflationary hedge. While interest rates rise, the rate paid to you in your interest bearing type accounts will increase.
Secondly, a properly leveraged home (having the right size mortgage) will also provide a buffer against inflation. Imagine this….locking in a long term fixed rate mortgage will allow the owner to pay for tomorrow’s housing cost in today’s dollars. The mortgage payment will not increase while inflation pushes housing cost around you higher.
Economic Prosperity – We don’t want to hedge against economic prosperity; we want to participate. Therefore the best way to participate in an economic upswing is by holding equities. My choice is through low-cost mutual funds and ETFs. If everything is moving along swimmingly in the economic world, which unfortunately is not currently the case, then equities as a whole will rise.
Deflation- deflation is a portfolio killer. Deflation usually creeps up after a strong market cycle, so it often catches do-it-yourself investors holding a larger percentage of equities. The market then tumbles and the investor is devastated due to the large percentage of equity holdings.
The armor required to battle the effects of deflation can be found in two forms: US Treasury Strips and CDs. Both assets hedge against falling interest rates by carrying a locked in or guaranteed rate of return. While Treasury Strips are marketable and can be sold at market rates (meaning at a loss), the idea is to buy and hold until maturity, which guarantees the return. Certainly the same can be accomplished through corporate bond….but with one big disadvantage: security! Need I say more than Enron and Worldcom!
Holding a Treasury strip or CD to maturity may sound boring, but the theory is based on protecting the interest earning side of the portfolio and providing a basis of stability. Little or no risk should be taken on this side of the portfolio. Risk should be saved for the equity portion of the portfolio.
Some of the ideas presented above may lead to a bit of confusion or fog for the non- professional, but that’s okay. The most important fact to take away is to remember that the total portfolio, which includes the primary home, should be designed to participate in a thriving economy, while buffering against the effects of both inflation and deflation. The ideas discussed above are simple and can be effective, and the best part is they are not based on market timing. Timing the market or the economy is not a wise play.
I know it’s the boring approach. I know it won’t make you rich overnight, but it won’t make you broke overnight either! If you are not sure whether your portfolio is designed to handle the three economic environments, it would be wise to speak with an advisor. The Alliance of Cambridge Advisors is a great place to start your search.
By Troy Von Haefen, CFP
If you’re a reader of my blog, you understand that as a holistic, big-picture, fee-only financial advisor I find market timing or economic timing to be a poor choice. If now is the time to sell long bonds due to the threat of inflation, when is the right time to buy? If now is the time to buy small cap stocks, when is the right time to sell? This is the market timer’s dilemma.
I find the best response to the threat of inflation, deflation, or economic prosperity (the only three economic cycles we can face) is to develop a portfolio to handle all three. The difference between my theory and the article is that my theory is designed to be permanently implemented into the portfolio….not a moving target that requires guess work and timing to accomplish the task. Here’s how to handle the three economic cycles.
Inflation – To ward off the effects of inflation there are a couple things investors can do. First, holding cash is a good inflationary hedge. While interest rates rise, the rate paid to you in your interest bearing type accounts will increase.
Secondly, a properly leveraged home (having the right size mortgage) will also provide a buffer against inflation. Imagine this….locking in a long term fixed rate mortgage will allow the owner to pay for tomorrow’s housing cost in today’s dollars. The mortgage payment will not increase while inflation pushes housing cost around you higher.
Economic Prosperity – We don’t want to hedge against economic prosperity; we want to participate. Therefore the best way to participate in an economic upswing is by holding equities. My choice is through low-cost mutual funds and ETFs. If everything is moving along swimmingly in the economic world, which unfortunately is not currently the case, then equities as a whole will rise.
Deflation- deflation is a portfolio killer. Deflation usually creeps up after a strong market cycle, so it often catches do-it-yourself investors holding a larger percentage of equities. The market then tumbles and the investor is devastated due to the large percentage of equity holdings.
The armor required to battle the effects of deflation can be found in two forms: US Treasury Strips and CDs. Both assets hedge against falling interest rates by carrying a locked in or guaranteed rate of return. While Treasury Strips are marketable and can be sold at market rates (meaning at a loss), the idea is to buy and hold until maturity, which guarantees the return. Certainly the same can be accomplished through corporate bond….but with one big disadvantage: security! Need I say more than Enron and Worldcom!
Holding a Treasury strip or CD to maturity may sound boring, but the theory is based on protecting the interest earning side of the portfolio and providing a basis of stability. Little or no risk should be taken on this side of the portfolio. Risk should be saved for the equity portion of the portfolio.
Some of the ideas presented above may lead to a bit of confusion or fog for the non- professional, but that’s okay. The most important fact to take away is to remember that the total portfolio, which includes the primary home, should be designed to participate in a thriving economy, while buffering against the effects of both inflation and deflation. The ideas discussed above are simple and can be effective, and the best part is they are not based on market timing. Timing the market or the economy is not a wise play.
I know it’s the boring approach. I know it won’t make you rich overnight, but it won’t make you broke overnight either! If you are not sure whether your portfolio is designed to handle the three economic environments, it would be wise to speak with an advisor. The Alliance of Cambridge Advisors is a great place to start your search.
By Troy Von Haefen, CFP
February 15, 2011
Happy Financial New Year!
By Linda Leitz, CFP®, EA
Colorado Springs, CO
www.pinnaclefinancialconcepts.com/
The economy still isn’t out of the woods. Many people still feel the pressure of a sluggish financial landscape. As the year beings, it’s good to get some financial goals in place. Basics are a good starting point.
Spending – Spend less than you make. If you need to make adjustments in your spending, buckle down and do it. Also, you’ll want to include in your budget the next three items.
Debt – If you have credit card or other unsecured personal debt, work on paying it down. Pay the biggest amount possible on the debt with the highest rate. If you’re working on spending, the debt won’t increase.
Emergency savings – Put money away for emergencies. You want to have some money that you can use to cover unexpected financial needs. If you have no emergency funds, work toward 5% of your pre-tax income.
Retirement savings – Things will get better in the financial world, so save toward not having to work to cover expenses. If your employer matches part of what you contribute, get to that level as quickly as possible.
If you’ve got these under control, get with a fee-only financial planner to work on some bigger goals. The financial world will get better. The faster we all get away from the behaviors that brought on the meltdown, the faster the economy will get better.
Colorado Springs, CO
www.pinnaclefinancialconcepts.com/
The economy still isn’t out of the woods. Many people still feel the pressure of a sluggish financial landscape. As the year beings, it’s good to get some financial goals in place. Basics are a good starting point.
Spending – Spend less than you make. If you need to make adjustments in your spending, buckle down and do it. Also, you’ll want to include in your budget the next three items.
Debt – If you have credit card or other unsecured personal debt, work on paying it down. Pay the biggest amount possible on the debt with the highest rate. If you’re working on spending, the debt won’t increase.
Emergency savings – Put money away for emergencies. You want to have some money that you can use to cover unexpected financial needs. If you have no emergency funds, work toward 5% of your pre-tax income.
Retirement savings – Things will get better in the financial world, so save toward not having to work to cover expenses. If your employer matches part of what you contribute, get to that level as quickly as possible.
If you’ve got these under control, get with a fee-only financial planner to work on some bigger goals. The financial world will get better. The faster we all get away from the behaviors that brought on the meltdown, the faster the economy will get better.
February 11, 2011
Ever Been Caught in the Rain?
By Troy Von Haefen, CFP®
Nashville, TN
http://www.vhfinancialmanagement.com/
We’ve all been caught out in the rain, and as an avid golfer, I can honestly say I have played golf in weather bad enough to make passersby shoot me strange looks from inside their dry cars. While an all-weather suit is a plus, a good umbrella is a must to stay dry. Just as an umbrella is a necessity in any die-hard golfer’s bag, a financial umbrella policy is a wonderful tool to protect your family.
An excess liability coverage policy (A.K.A. umbrella policy) covers additional liabilities beyond the coverages of the underlying policies. An umbrella policy is a broad form of coverage that covers both automotive and general liabilities when purchased in addition to basic liability plans (home and auto). When the limits of the underlying policies max out, the umbrella policy kicks in.
Let’s go back to golf. If while playing golf in the rain a golf club slips out of my hands and injures a person, the underlying coverages of my homeowner’s policy will kick in first. If the damages were severe and beyond the limits of my homeowner’s policy, my umbrella policy will jump in and cover the excess up to the limit of the umbrella, which range from $1M to $5M plus.
The good news is the costs of umbrella policies are inexpensive: usually roughly $200for a $1,000,000 policy…..if you don’t have teenage drivers. Purchasing an umbrella policy will most often require an increase in underlying limits. This is most often seen in auto policies. While each state has its own minimum liability requirements for auto policies, most umbrella insurers require limits much higher than the minimum state limits. For example, the state of TN requires drivers to carry at least $25,000/$50,000/$10,000 in coverage. To learn more what these numbers mean check out my article about the importance of limits: http://bit.ly/dTMey3 . To obtain an umbrella policy the insurance company mayrequire the insured to carry limits somewhere in the $250,000/$500,000/$100,000 range. While this is a ten-fold increase in liability limits, it doesn’t mean the cost will increase by ten. The increase will be fairly small. Remember, we don’t want to risk a lot for a little! The purpose of insurance is for protection.
We also must understand the distinction between personal liabilities and commercial liabilities. A personal umbrella policy will not cover a liability created by a business liability. Commercial ventures require a separate business umbrella policy. Also, it’s important to make sure the underlying policies and limits are in place. For example, if a parent decides to reduce the limits on a teenage driver to the state minimums in an effort to save money, the underlying requirements of the umbrella policy will not be met. Therefore, if the teenage driver is involved in an at-fault accident, the umbrella policy will not pay out. The parents would be ripe for a law suit.
So just as I won’t risk playing a round of golf in the rain without an umbrella, it’s important to have proper liability protections in place to protect your financial assets. While not everyone requires an umbrella policy, most people do. Umbrella policies are an inexpensive way to give yourself peace of mind and help you sleep a little better at night. While my liability protection concerns are not something that will keep me awake at night, the weather forecast for my next round of golf might.
Nashville, TN
http://www.vhfinancialmanagement.com/
We’ve all been caught out in the rain, and as an avid golfer, I can honestly say I have played golf in weather bad enough to make passersby shoot me strange looks from inside their dry cars. While an all-weather suit is a plus, a good umbrella is a must to stay dry. Just as an umbrella is a necessity in any die-hard golfer’s bag, a financial umbrella policy is a wonderful tool to protect your family.
An excess liability coverage policy (A.K.A. umbrella policy) covers additional liabilities beyond the coverages of the underlying policies. An umbrella policy is a broad form of coverage that covers both automotive and general liabilities when purchased in addition to basic liability plans (home and auto). When the limits of the underlying policies max out, the umbrella policy kicks in.
Let’s go back to golf. If while playing golf in the rain a golf club slips out of my hands and injures a person, the underlying coverages of my homeowner’s policy will kick in first. If the damages were severe and beyond the limits of my homeowner’s policy, my umbrella policy will jump in and cover the excess up to the limit of the umbrella, which range from $1M to $5M plus.
The good news is the costs of umbrella policies are inexpensive: usually roughly $200for a $1,000,000 policy…..if you don’t have teenage drivers. Purchasing an umbrella policy will most often require an increase in underlying limits. This is most often seen in auto policies. While each state has its own minimum liability requirements for auto policies, most umbrella insurers require limits much higher than the minimum state limits. For example, the state of TN requires drivers to carry at least $25,000/$50,000/$10,000 in coverage. To learn more what these numbers mean check out my article about the importance of limits: http://bit.ly/dTMey3 . To obtain an umbrella policy the insurance company mayrequire the insured to carry limits somewhere in the $250,000/$500,000/$100,000 range. While this is a ten-fold increase in liability limits, it doesn’t mean the cost will increase by ten. The increase will be fairly small. Remember, we don’t want to risk a lot for a little! The purpose of insurance is for protection.
We also must understand the distinction between personal liabilities and commercial liabilities. A personal umbrella policy will not cover a liability created by a business liability. Commercial ventures require a separate business umbrella policy. Also, it’s important to make sure the underlying policies and limits are in place. For example, if a parent decides to reduce the limits on a teenage driver to the state minimums in an effort to save money, the underlying requirements of the umbrella policy will not be met. Therefore, if the teenage driver is involved in an at-fault accident, the umbrella policy will not pay out. The parents would be ripe for a law suit.
So just as I won’t risk playing a round of golf in the rain without an umbrella, it’s important to have proper liability protections in place to protect your financial assets. While not everyone requires an umbrella policy, most people do. Umbrella policies are an inexpensive way to give yourself peace of mind and help you sleep a little better at night. While my liability protection concerns are not something that will keep me awake at night, the weather forecast for my next round of golf might.
February 7, 2011
Ten Investment Resolutions for 2011
By John Scherer, CFP®
Middleton, WI
http://www.trinfin.com/
It's that time of year when many of us establish one or more New Year's resolutions. This often means committing to improving one's lifestyle by losing weight, exercising more, or drinking less. Many investors could benefit from resolutions targeting their financial health as well. Just as many individuals endanger their well-being with bad habits, numerous investors suffer from ill-advised practices that are detrimental to their wealth. Perhaps a set of New Year's investment resolutions, along with an advisor capable of helping investors adhere to them, will lead to a more prosperous future.
Most of us are creatures of habit and discover that making permanent changes in our behavior is surprisingly difficult. To make matters worse, our commitment to change is sometimes tested by examples of those who ignore prudent behavior to their apparent advantage and those who follow it to their apparent detriment. Winston Churchill lived to age 90, fortified by an ample supply of champagne and cigars, while author and jogging enthusiast Jim Fixx died of a heart attack at age 52. These isolated examples may test our faith but should not encourage us to abandon a proven set of prescriptions; continuing to apply them will still improve our odds.
So, for those who find making such promises useful, here are ten investment-related resolutions that will stack the deck on your favor for better long-term wealth:
1. I will not confuse entertainment with advice. I will acknowledge that the financial media is in the entertainment business and their message can compromise my long-term focus and discipline, leading me to make poor investment decisions. If necessary I will turn off CNBC and turn on ESPN.
2. I will stop searching for tomorrow's star money manager, as there are no gurus. Capitalism will be my guru because with capitalism there is a positive expected return on capital, and it is there for the taking. And for me to succeed, someone else doesn't have to fail.
3. I will not invest based on a forecast—whether it is mine or anyone else's. I will recognize that the urge to form an opinion will never go away, but I won't act on it because no one can repeatedly predict the future. It is, by definition, uncertain.
4. I will keep a long-term perspective and appropriately consider my investment horizon (i.e., how long my portfolio is to be invested) when determining my performance horizon (i.e., the time frame I use to evaluate results).
5. I will continue to invest new capital and work my plan because it is time in the market—and not timing the market—that matters.
6. I will adhere to my plan and continue to rebalance (i.e., systematically buying more of what hasn't done well recently) rather than "unbalance" (i.e., buying more of what's hot).
7. I will not focus my portfolio in a few securities, or even a few asset classes, as diversification remains the closest thing to a free lunch.
8. I will ensure my portfolio is appropriate for my goals and objectives while only taking risks worth taking.
9. I will manage my emotions by learning about and acknowledging the biases and cognitive errors that influence my behavior.
10. I will keep my cost of investing reasonable.
Most of us find it hard to follow a sensible diet or a sensible investment strategy 100% of the time. If you must stray when managing your wealth or well-being, moderation is the key. Chocolate cake is OK, as long as it's not for dinner every night. Speculating on a stock or two is all right as well, as long as you don't do it with your investment capital.
Finally, just as successful athletes rely on coaches and trainers to help them achieve their goals, most investors can benefit from having a "financial coach" to remind them about their New Year's resolutions and keep them on track toward a more prosperous future.
Here's to good health and good wealth in 2011.
Middleton, WI
http://www.trinfin.com/
It's that time of year when many of us establish one or more New Year's resolutions. This often means committing to improving one's lifestyle by losing weight, exercising more, or drinking less. Many investors could benefit from resolutions targeting their financial health as well. Just as many individuals endanger their well-being with bad habits, numerous investors suffer from ill-advised practices that are detrimental to their wealth. Perhaps a set of New Year's investment resolutions, along with an advisor capable of helping investors adhere to them, will lead to a more prosperous future.
Most of us are creatures of habit and discover that making permanent changes in our behavior is surprisingly difficult. To make matters worse, our commitment to change is sometimes tested by examples of those who ignore prudent behavior to their apparent advantage and those who follow it to their apparent detriment. Winston Churchill lived to age 90, fortified by an ample supply of champagne and cigars, while author and jogging enthusiast Jim Fixx died of a heart attack at age 52. These isolated examples may test our faith but should not encourage us to abandon a proven set of prescriptions; continuing to apply them will still improve our odds.
So, for those who find making such promises useful, here are ten investment-related resolutions that will stack the deck on your favor for better long-term wealth:
1. I will not confuse entertainment with advice. I will acknowledge that the financial media is in the entertainment business and their message can compromise my long-term focus and discipline, leading me to make poor investment decisions. If necessary I will turn off CNBC and turn on ESPN.
2. I will stop searching for tomorrow's star money manager, as there are no gurus. Capitalism will be my guru because with capitalism there is a positive expected return on capital, and it is there for the taking. And for me to succeed, someone else doesn't have to fail.
3. I will not invest based on a forecast—whether it is mine or anyone else's. I will recognize that the urge to form an opinion will never go away, but I won't act on it because no one can repeatedly predict the future. It is, by definition, uncertain.
4. I will keep a long-term perspective and appropriately consider my investment horizon (i.e., how long my portfolio is to be invested) when determining my performance horizon (i.e., the time frame I use to evaluate results).
5. I will continue to invest new capital and work my plan because it is time in the market—and not timing the market—that matters.
6. I will adhere to my plan and continue to rebalance (i.e., systematically buying more of what hasn't done well recently) rather than "unbalance" (i.e., buying more of what's hot).
7. I will not focus my portfolio in a few securities, or even a few asset classes, as diversification remains the closest thing to a free lunch.
8. I will ensure my portfolio is appropriate for my goals and objectives while only taking risks worth taking.
9. I will manage my emotions by learning about and acknowledging the biases and cognitive errors that influence my behavior.
10. I will keep my cost of investing reasonable.
Most of us find it hard to follow a sensible diet or a sensible investment strategy 100% of the time. If you must stray when managing your wealth or well-being, moderation is the key. Chocolate cake is OK, as long as it's not for dinner every night. Speculating on a stock or two is all right as well, as long as you don't do it with your investment capital.
Finally, just as successful athletes rely on coaches and trainers to help them achieve their goals, most investors can benefit from having a "financial coach" to remind them about their New Year's resolutions and keep them on track toward a more prosperous future.
Here's to good health and good wealth in 2011.
February 3, 2011
Cut Your Losses!
By Bert Whitehead, MBA, JD
Franklin, MI
http://www.bertwhitehead.com/
When should you sell an investment if the value drops?
Investors agonize over this and often let themselves be guided by the old adage: “Buy low, sell high.” Based on this logic, they decide they will hold any investment they buy until they can at least break even. Once a client adopts this mantra, it is difficult to convince them to sell their holding at a loss, even when it keeps dropping in price.
There is a strategy of ‘averaging down’ when an investment drops in price. For example, suppose that you buy a mutual fund or stock when it is $20 a share and then it drops to $15 a share. If you had decided it was a good buy at $20 then, logically, you should buy more because it is even a better buy at $15. And if it drops to $10, then buy even more.
This is an aggressive strategy, and requires undaunting confidence in the investment. It can work out, but it often doesn’t. When it doesn’t, the results can be catastrophic. Employees who buy their company stock are particularly prone to make this mistake. I have seen situations where clients have stubbornly held on to Pan Am, GM, Chrysler, Enron, etc. and continued adding to their holdings only to end up losing it all. On the other hand, Ford shareholders have done well using this strategy over the past few years.
A more sound investment approach is to decide that, when you buy an investment, you will reevaluate it if it drops. You evaluate the losing investment with other investments, and then make a “keep or sell” decision. For example, let’s go back to your $20 per share stock. Rather than wait until it drops to $15 you could have decided that, if it drops 10% or 15% (i.e. to $18 or $17), you will reconsider the investment. If there are other investment options with better upside potential, sell your loser and reinvest in something with better prospects. This prevents you from blindly holding on to the shares hoping they will go back to $20.
For many people, selling a loser means they made a mistake, and they are adamant about not losing money on their investments. The blatant truth is that holding on to the stock means you still have a loss, you just haven’t ‘realized’ it yet.
One technique I have used with some success is to explain to clients that by selling the stock, they are ‘harvesting’ their losses for tax purposes. The tax loss will save them tax dollars by offsetting other gains, thereby reducing the capital gains tax. It often gives them an additional $3,000 deduction against other ordinary income, which can save them about $1,000 in taxes at the 33% tax bracket.
The beauty of this is that the client can buy the stock back after 31 days. If bought back sooner, the ‘wash sale rule’ precludes them from taking the tax loss. It’s interesting to note that, no matter how resistant the client was to selling the stock at a loss initially, once they sell it they never buy it back!
Of course we do not recommend ‘market timing.’ When managing clients’ portfolios we take into consideration other factors such as the overall balance of the portfolio, the amount of the single investment relative to the total portfolio, as well as tax issues and clients’ long term goals.
For example, we don’t sell stripped Treasuries in a client’s ladder just because the market value drops. The function of this investment is to assure that the maturity value provides the cash flow necessary for spending goals (usually in retirement), without fail. We know and expect that the market value will fluctuate in the meantime, but the ending value is government guaranteed.
On the other hand we don’t hesitate to sell a mutual fund that has underperformed its peers significantly for two or more quarters in a row. We also take losses in the Cambridge Index Portfolio when we can capture them as short-term, which are the most tax advantaged.
Cutting losses isn’t limited to securities like stocks, bonds, and mutual funds. A huge concern of many clients today is whether they should ‘dump’ their real estate in this depressed market or wait until they can ‘get their money back out.’ This issue is more complex, but here are some guidelines I consider.
If the home is your personal residence, and you like it and can afford the payments, keep the house unless you have to move (e.g. new job, changing neighborhood). If it is a vacant house or vacant property, it is generally better to sell (even at a loss) because the carrying costs of keeping vacant property and running the risk that the value will continue to drop generally makes this type of real estate a bad investment at this time. You may want to review my previous blog of April 29, 2010 titled “What To Do When Your House Is Underwater.”
The issue of when to “cut your losses” is also perplexing when applied to employment and other relationships, but my expertise in these areas is limited (though I have done a lot of research…). The best approach usually is to get a therapist!
In any situation, cutting your losses sooner rather than later is usually the better course of action. Not only does it minimize financial losses, but it also reduces stress. Continually dealing with these kinds of decisions is emotionally toxic.
So make a New Year’s resolution to cut your losses in three areas that have been plaguing you. Get the monkeys off your back, and get on with a rich fulfilling new year!
I appreciate the editorial review contributed by Chip Simon, CFP®, an ACA colleague in Poughkeepsie, NY.
Franklin, MI
http://www.bertwhitehead.com/
When should you sell an investment if the value drops?
Investors agonize over this and often let themselves be guided by the old adage: “Buy low, sell high.” Based on this logic, they decide they will hold any investment they buy until they can at least break even. Once a client adopts this mantra, it is difficult to convince them to sell their holding at a loss, even when it keeps dropping in price.
There is a strategy of ‘averaging down’ when an investment drops in price. For example, suppose that you buy a mutual fund or stock when it is $20 a share and then it drops to $15 a share. If you had decided it was a good buy at $20 then, logically, you should buy more because it is even a better buy at $15. And if it drops to $10, then buy even more.
This is an aggressive strategy, and requires undaunting confidence in the investment. It can work out, but it often doesn’t. When it doesn’t, the results can be catastrophic. Employees who buy their company stock are particularly prone to make this mistake. I have seen situations where clients have stubbornly held on to Pan Am, GM, Chrysler, Enron, etc. and continued adding to their holdings only to end up losing it all. On the other hand, Ford shareholders have done well using this strategy over the past few years.
A more sound investment approach is to decide that, when you buy an investment, you will reevaluate it if it drops. You evaluate the losing investment with other investments, and then make a “keep or sell” decision. For example, let’s go back to your $20 per share stock. Rather than wait until it drops to $15 you could have decided that, if it drops 10% or 15% (i.e. to $18 or $17), you will reconsider the investment. If there are other investment options with better upside potential, sell your loser and reinvest in something with better prospects. This prevents you from blindly holding on to the shares hoping they will go back to $20.
For many people, selling a loser means they made a mistake, and they are adamant about not losing money on their investments. The blatant truth is that holding on to the stock means you still have a loss, you just haven’t ‘realized’ it yet.
One technique I have used with some success is to explain to clients that by selling the stock, they are ‘harvesting’ their losses for tax purposes. The tax loss will save them tax dollars by offsetting other gains, thereby reducing the capital gains tax. It often gives them an additional $3,000 deduction against other ordinary income, which can save them about $1,000 in taxes at the 33% tax bracket.
The beauty of this is that the client can buy the stock back after 31 days. If bought back sooner, the ‘wash sale rule’ precludes them from taking the tax loss. It’s interesting to note that, no matter how resistant the client was to selling the stock at a loss initially, once they sell it they never buy it back!
Of course we do not recommend ‘market timing.’ When managing clients’ portfolios we take into consideration other factors such as the overall balance of the portfolio, the amount of the single investment relative to the total portfolio, as well as tax issues and clients’ long term goals.
For example, we don’t sell stripped Treasuries in a client’s ladder just because the market value drops. The function of this investment is to assure that the maturity value provides the cash flow necessary for spending goals (usually in retirement), without fail. We know and expect that the market value will fluctuate in the meantime, but the ending value is government guaranteed.
On the other hand we don’t hesitate to sell a mutual fund that has underperformed its peers significantly for two or more quarters in a row. We also take losses in the Cambridge Index Portfolio when we can capture them as short-term, which are the most tax advantaged.
Cutting losses isn’t limited to securities like stocks, bonds, and mutual funds. A huge concern of many clients today is whether they should ‘dump’ their real estate in this depressed market or wait until they can ‘get their money back out.’ This issue is more complex, but here are some guidelines I consider.
If the home is your personal residence, and you like it and can afford the payments, keep the house unless you have to move (e.g. new job, changing neighborhood). If it is a vacant house or vacant property, it is generally better to sell (even at a loss) because the carrying costs of keeping vacant property and running the risk that the value will continue to drop generally makes this type of real estate a bad investment at this time. You may want to review my previous blog of April 29, 2010 titled “What To Do When Your House Is Underwater.”
The issue of when to “cut your losses” is also perplexing when applied to employment and other relationships, but my expertise in these areas is limited (though I have done a lot of research…). The best approach usually is to get a therapist!
In any situation, cutting your losses sooner rather than later is usually the better course of action. Not only does it minimize financial losses, but it also reduces stress. Continually dealing with these kinds of decisions is emotionally toxic.
So make a New Year’s resolution to cut your losses in three areas that have been plaguing you. Get the monkeys off your back, and get on with a rich fulfilling new year!
I appreciate the editorial review contributed by Chip Simon, CFP®, an ACA colleague in Poughkeepsie, NY.
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