Financial Opinion and Insights

Archive for August 2010

Keynesian Theory and Savings Apparently Don’t Mix!

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®


Ever hear of Keynesian economics?  Most people think of it in terms of `redistribution of wealth’ or government spending; but few understand the mathematical logic, if one can call it that.  

Let’s begin with a few quick equations – I know, I’ve already lost half of you, but I’ll leave imports and exports out if that’ll help.  

First, the standard definition for GDP (gross domestic product):  

Output (Y) = Consumption (c) + Investment (I) + Government (G)     

So, if you remember your algebra – something all of us love to revisit – you’ll see that:  

I = Y-C-G  

This means that total real investment (factories, equipment, inventories, etc.) can be created only by the output that is NOT absorbed by consumers or government, i.e., savings.  So, real savings and real investment is always equal, even if the investment represents unwanted ‘inventory investment’.   As you can see, this isn’t theory, it’s an accounting tool.  

Okay, Keynesian theory:  

C=cY   :  Consumption is proportional to income  

I = I_fixed :   Real investment is fixed  

That gives you  

Y=cY + I_fixed + G  

Getting dizzy?  Since consumption is proportional to income, you can `plug-in’ values to the GDP definition.  


Y = (I_fixed + G) / (1-c)  

You’re getting close now, trust me.  

Example:  G=100;  I=20;  c=.75  

So, (1-c) = .25 and Y = ((20+100) / .25 = 480.   

Every dollar of G or I (conveniently) has a “multiplier” effect of 1/.25 = 4  

Since Keynes assumed real investment to be fixed during a recession, the best way to increase production – more output – is to increase government spending.  How doesn’t matter.   

Note that if people try to reduce consumption (c) and save more, (1-c) gets larger, which means that output (Y) will fall.   So, using the formula, the only solution is to increase G.  

Keynes assumed that the only incentive to invest was a reduction in interest rates, meaning that rates were caught in a ‘liquidity trap’ during recessions.  He never addressed other incentives, i.e., profit motives, productivity, etc.  Those terms didn’t appear to be in his lexicon.  

Keynesians hate savings, apparently.  

Considering the fact that different forms of spending just might result in different forms of productivity, one has to wonder why the different dynamics of output are never considered.  

Indeed, it appears the Keynesian theory is lacking a productivity component.  


Opinions expressed in this post are those of the author and are not intended to provide investment advice.   Learn more about IFG!

IRA Advice Could Change!

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®


Brokers and registered investment advisors (RIAs) have been swimming in the same waters for many years; and, indeed, the investing public is very often confused about the difference between the two.  

Compounding the problem, of course, is that many in the financial services field call themselves `financial advisors’ without being registered as advisors, just as many call themselves `financial planners’ without having earned CFP® or ChFC® certifications. 

If that isn’t enough, many investors are also unaware that the so-called `broker’ they deal with is really not the broker!   This person is virtually always a registered representative working for a broker-dealer (the firm), if an employee or under the supervision of a B/D if an independent. 

That’s not all – are you getting dizzy, yet?  Many `brokers’ work for or under the supervision of firms which are `dually-registered’ as both broker-dealers and as registered investment advisors!  

Back to square one:  The individual investor, who often doesn’t know the difference between RIAs and brokers, also has to figure out why it matters!  I’ve written about this before; but change may be on the way, if the Department of Labor has it’s way. 

New regulations proposed by the DOL could change the landscape dramatically for registered representatives (RRs) of B/D firms in serving the $4.1 trillion IRA market by, practically speaking, excluding dual registrants – which is almost all of them – from giving advice on IRAs. 

While most of the attention has been focused on the regulation’s potential impact on the 401(k) market; but, the bigger impact may be on IRAs! 

Under the DOL proposal, advisors who advise clients on IRA accounts would, for all practical purposes, be fee-only advisors in that the new regulations require that the advisor give advice that’s either generated by a computer model, or give advice and be paid on a level-fee basis, which means that the fees don’t change because of the investments selected.  This is something RIAs do now, but many B/D firms are resisting. 

The prohibition against advising on an IRA kicks-in if a commission is paid on any assets under management by an advisor.  It appears the DOL is trying to avoid situations in which an advisor gets a hidden incentive or compensation from a fund company or the B/D firm for steering assets into a particular investment product. 

The proposed 401(k) regulations would do the same thing, except there’s a grandfather clause that allows B/D firms to maintain their existing agreements. 

It appears, under these proposed DOL regulations, B/D registered reps who advise on IRA assets would have to register a investment advisors and act as fiduciaries – and that’s a major shift because it would prohibit an advisor on IRA plans from collecting any 12b-1 fees, commissions, or sales loads on IRA assets. 

Stay tuned. 



The Independent Financial Group is a fee-only registered investment advisor embracing a fiduciary standard and does not sell any investment products or receive any third-party compensation in any form.  Opinions expressed in this post are those of the author and are not intended to provide investment advice.   Learn more about IFG!

Should ‘Builders’ Avoid Choppy Markets?

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®


Uncertainty has been a part of investing since investing began; and the world is full of people who are always ‘waiting to see what the market will do’.  Unfortunately for them, it keeps doing the same thing and they never begin investing. 

The result?  Most Americans are unprepared for retirement. 

So, what about now?  Should you be investing in your 401(k)?  Does it make sense for someone who wants to grow assets to invest in a choppy `non-bull’ market?   

In my own opinion, it does!   

Here’s a  little  hypothetical exercise might provide a clue as to why most investment experts advise consistent investing.  

In our example, the price of our fictitious investment begins and $50 and goes down.  In fact, it takes 10 years just to get back to it’s initial price!   Did systematic investing seem worthwhile?  You be the judge. 

For a benchmark, lets use a beginning value of $20,000.   How would someone compare who invested $2,000 a year for ten years?

Systematic Investing In a Down Market            
         Benchmark      Second Investor    
Market Year Price    $ Amt # Shares    $ Amt  # Shares Cum # Sh
  1 $50   $20,000 400   $2,000 40.000 40.000
-20% 2 $40     0   $2,000 50.000 90.000
20% 3 $48     0   $2,000 41.667 131.667
-25% 4 $36     0   $2,000 55.556 187.222
20% 5 $43     0   $2,000 46.296 233.519
-30% 6 $30     0   $2,000 66.138 299.656
20% 7 $36     0   $2,000 55.115 354.771
20% 8 $44     0   $2,000 45.929 400.700
-10% 9 $39     0   $2,000 51.032 451.732
28% 10 $50     0   $2,000 39.869 491.600

Lets examine the results:

Totals       $20,000 400   $20,000 491.600
Portfolio Value     $20,066     $24,661  
Average Cost per Share   $50     $40.68  
Value Per Share     $50     $50  
Profit Per Share     $0.16     $9.48  
Portfolio Profit     $66     $4,660.91  

Interesting!   Our systematic investor made a $4,660 profit on $20,000 – that’s 23%! –  in a market that never went rose above its beginning point! 

Our ‘systematic’ investor averaged a compounded 4.57% per year in a ‘flat’ market! 

Sure, it’s hypothetical; but the lesson seems clear;  maybe money is made when everyone else is biting their nails. 


Opinions expressed in this post are those of the author and are not intended to provide investment advice.   Learn more about IFG!

How Much is Enough?

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

There’s the magic question everyone wants answered.  Television commercials ask people, “Do you know your number?” and others show a young father meeting his `older self’ who reminds him that it’s time to start planning; but few do.

Not only do most Americans NOT have a plan of any kind – probably a reason most don’t have any savings to speak of, as well – but, those that are even mildly interested tend to get their advice from financial entertainment television and purchased sets of CDs, DVDs, books of `financial secrets’ others don’t want you to know, and whatever looks enticing on the magazine rack…. Just about anywhere they can get help, as long as it’s cheap, or free, and always entertaining.

Is it any wonder the level of financial illiteracy is so high in this country and that so many people are totally unprepared to face their financial futures?

There isn’t an easy answer to ‘how much is enough’, but many advisors – this includes yours truly – have often used the `cocktail party, golf course, off-the-cuff’ response that you need to identify your annual need and divide that by 0.04. 

For example, if you feel you’ll need $60,000 a year in retirement, your `number’ is probably, maybe, arguably, somewhere around (60,000/.04) $1,500,000 in financial assets.

Of course, there are some moving parts in that assumption, as you can tell from my list of qualifiers.  First is identifying what your annual income requirement actually will be! 

Then, of course, there’s the `time’ factor – when you will retire and what your age is/will be at that point!  What other income do you have or do you expect?  What tax bracket will you be in – it helps if you can divine the policies of the next five presidents and the next ten to twenty congresses, of course; it also helps with your inflation outlook.

The mathematical computations are too complex for the golf course, cocktail party, or other social gatherings, so we’ve come up with a way to look like we can simplify the un-simplifiable, if that’s even a word.

If you haven’t begun planning, I would suggest you contact a qualified financial planner (CFP, ChFC, etc.) and begin, regardless of your age.  If you have a plan that’s three years old, you are overdue for talking with your advisor. 

At the risk of sounding self-serving – I apparently have no shame whatsoever – your problem isn’t the cost of planning; it’s the cost of failing to plan.

It’s Good To Know Time Value of Money

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

Every time we spend $1, there’s an alternative use we’re rejecting.

For example, I bought a camera that was quite expensive at the time, $500!   I loved photography – we won’t even talk about what I spent on lenses, filters, other gadgets,  film (remember film?) processing and printing. 

I could have invested that $500 and, despite our current economic crisis, would have still made quite a bit of money.

How much you can make on $500 depends, of course, on how you invest it, the return you achieve, and the time period involved.  But, let’s suppose the $500 is invested in something that returns an average annual compound return of 8% over a twenty-year period (not all that unreasonable to assume), a time-value of money computation on a financial calculator shows that the true long-term cost of the camera becomes $2,330 in future dollars!

Expensive camera, huh?

I also like golf – don’t get me started on the cost of lost balls – which not only has an initial cost for equipment, but ongoing costs to play (thankfully, I walk and don’t pay for a cart).  It’s not unusual for a golfer to play a couple of times a month; but even if s/he plays only once a month, walks, and pays only $30 each time, what does THAT add up to – in terms of lost investment capital?

Guess what!  That golfer spent about $7,000 over 20 years, but lost over $17,000 of retirement money, had it been invested in something that returned an average annual compound rate of 8%.

Think 8% is high?  If so, you probably suffer from what psychologists call `recency bias’ – attaching more importance to one event over another only because the occurence was recent.

You might want to pick up a financial calculator next time you’re in an office supply store.  Time value isn’t hard, but it IS eye-opening.

Fiduciary – Suitability – What’s the Difference?

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

Here’s some `inside baseball’ you probably don’t – but should – care about!  The big debate inside the financial industry  is whether brokers should be required to adopt the fiduciary standard of care toward their clients.  

Historically, they’ve been operating under a suitability standard.  The suitability standard is a somewhat lower standard in that it requires that investment recommendations need only be suitable for the client’s situation.  There’s no requirement that the recommendation MUST be in the client’s best interest.   

The suitability standard, as one can imagine, is much more compatible with a sales environment, where packaged investment products are sold on commission.   If two investment products are both suitable, under the suitability standard, a broker can recommend the product with the higher commission and still be in compliance with the suitability requirement.  

My guess is that the vast majority of brokers do put their clients’ interests first and would select the lower commission product because, like any other business, you keep clients by taking care of them the right way; but, rules are generally written for that small minority that prefer an alternate route to riches.  

According to an article appearing yesterday morning in Investment News, some brokers are afraid it will hinder their ability to sell initial public offerings (IPOs) to the public.  This is a legitimate issue since much of America’s growth capital for emerging companies and their entrepreneurs does originate with IPOs!  But, as I said, it’s the small minority that seem to drive regulation and, in this case, many of  the `boiler room’ operations are likely the targets.  

Registered investment advisors do operate under a fiduciary standard, which requires that recommendations and investment choices MUST put the client’s interest first; and indeed they – including yours truly – have been using this as a marketing differentiator for some time, always touting our ‘non-sales’ business model.  The brokerages moving to a fiduciary standard would likely eliminate this differentiator for RIAs.  

In another article in the same publication, the SEC is quoted as saying they will  “…craft rules that increase investor confidence while preserving brokers’ ability to offer a full spectrum of services.”  We’ve seen how well they do that.  

The debate usually occurs when there are `dually-registered’ entities – those that wear two hats.  When a broker is also an RIA, it often happens that the fiduciary hat is worn during the planning stage only to be taken off when the investment stage arrives.  Often, their clients don’t understand that and confusion can arise – much like the widow who invests at her bank’s brokerage department and is still under the impression she’s dealing with an FDIC-insured entity.  It all-too-often happens – one is enough – that she doesn’t realize she’s no longer dealing with the bank.  

Forbes weighed-in on this yesterday, as well. 

This debate isn’t new.  It has been going on for years!  Not a surprise.  The financial industry is famous for moving at a snail’s pace on virtually everything except getting new products to market.   Many have still yet to discover electronic signatures.  They have, however, whole-heartedly adopted both the telephone and the fax machine, so there is hope.

Where have the All the Market-Timers Gone?

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

Does anyone remember Joe Granville?  He was the market guru back in the early to mid-1980s.  He was even quoted in Time magazine – according to Robert Shiller’s book, Irrational Exuberance – as saying, “I don’t think that I will ever make a serious mistake in the stock market for the rest of my life.”  He even predicted he would win the Nobel prize in Economics!  In 1981, his investment newsletter was grossing over $6 million a year and when he once told his readers to “sell everything” it actually triggered a massive market sell-off with a record number of shares trading!  Just before the ’87 crash, he again warned of a crash and he was obviously correct… his picture made the covers of magazines and papers around the world.

Skill?…. or luck.  Maybe the crystal ball developed some fog.   A few years ago the Hulbert Financial Digest reported that the Granville Market Letter “is at the bottom of the rankings for performance over the past 25 years – having produced average losses of more than 20% per year on an annualized basis.”

I’m still looking for the market-timer that actually produces consistent results over the long term – no one can seem to name them.

The long-term winners have always seemed to be those who buy value.  And, we can actually name a few:  Benjamin Graham, Warren Buffett, and Peter Lynch will do for starters.