Financial Opinion and Insights

Archive for October 2010

Are You A Sophisticated Investor?

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

All the children in Lake Woebegone are above average.

Everyone who returns from vacation at Las Vegas tells you they ‘broke even’.

Everyone loves to talk about the stock they own that’s done well for them.

No one is ever below average, it seems; but how true is it?   Despite the fact that innumerable independent studies have consistently shown that individual investors seem to do far worse than the market averages – and it doesn’t seem to matter which average you use – many, if not the majority, still continue to invest like poor people instead of doing what the wealthy do.  And, that may explain why so many are ill-prepared financially for the future they insist they seek.

One individual last week told me he wanted to retire in three years with a $600,000 nest-egg.  Without telling him that $600,000 may not do the trick – that depends on his spending habits – I asked him how much he had right now.  His answer: $60,000.   He’s sure he can do it.  

If you’ve wondered how sophisticated you might be, I’ve devised a simple, short, and admittedly unscientific five-question quiz.  If you get all five right, I think you might be fairly sophisticated.  If you get four right, I’d say you’re possibly above average.  If you get three right, you’re probably someone who is fairly aware.  Anything less:  I hope you’re getting help.

So, just for the fun of it, here it is.   If you have to cheat, the answers are at the end.  No one will know except you.

  1. Diversifying your investment portfolio helps you reduce which risk:
    1. Market
    2. Business
    3. Economic
    4. None of the above
  2. The best measure by which to evaluate a company’s ability to satisfy debts with highly liquid assets is the:
    1. Acid-test ratio
    2. Current ratio
    3. Relative strength ratio
    4. Capitalization ratio
    5. Profitability ratio
  3. The best measure of a portfolio’s total risk is:
    1. Beta
    2. Standard deviation
    3. The Capital Asset Pricing Model (CAPM)
    4. Alpha
  4. Which method of return calculation is most appropriate for evaluating the rate of return for an individual investor?
    1. Time-weighted return
    2. Dollar-weighted return
    3. The Sharp index
    4. Monte Carlo analysis
  5. Which of the following is NOT a probable effect of raising the reserve requirement of the Federal Reserve?
    1. Tightening of the money supply
    2. Lead to higher stock prices
    3. Raise interest rates
    4. Slow down the growth of GDP (gross domestic product)


You didn’t’ cheat, did you?   Want to know how you did?   The answers are below:


1.     2:  Business risk.  Each company has its own competitive risks.  Diversification can reduce this risk.   Market risk cannot be diversified away.  In fact, if you bought all the stocks in the market, you would only replicate market risk, not reduce it.  Economic risks affect the entire market.

2.     1:  Acid-test ratio.  Also called the ‘quick ratio’ is used because it eliminates the inventory factor from the calculation (it is included in the current ratio) and permits a better reading of the liquidity position of the business.

3.     2:  Standard deviation.  This is the measure of total risk in the portfolio because it measures its variability of returns, regardless of market factors.  Beta measures a portfolio’s volatility, not variability, relative to some benchmark index.

4.     2:  Dollar-weighted returns.  Also called internal rate of return (IRR), this measures total return on a portfolio from inception and includes the effects of all cash inflows and outflows.  Time-weighted returns measure portfolio performance without regard to cash flows either in or out and is therefore used for evaluating the performance of portfolio managers.   Sharp is expressed as the ratio of excess return of the total portfolio to its standard deviation.  Monte Carlo simulations are used to conduct probability analysis.

5.    2:  Higher reserve requirements with the banks leads to reduced lending which impedes growth and expansion for companies and are likely to cause stock prices to decline.


The Independent Financial Group is a fee-only registered investment advisor and does not sell products earn commissions, or accept any third-party compensation or incentives of any description.  IFG also does not provide tax or legal advice.  The reader should seek competent counsel to address those issues.  Nothing in this post should be accepted as investment advice which is provided only to IFG clients.  Opinions expressed in this piece are those of the author.  You can reach Jim at 805.265.5416 or through his website.

Do You Need To Budget?

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

Let’s face it, spending is fun!  We enjoy taking trips and indulging our desires; but everything has a cost.  Like the man says, “Pay me now, or pay me later.”  The truth is, one way or the other, everything has a price.

My parents grew up in the Depression-era, so they knew the value of a dollar.  I grew up in a middle-class home that resembled the Cleaver’s and didn’t think much about money other than the fact I had to mow the lawn and do other chores to get an allowance.  My dad worked hard and excelled during his career and ended-up moving us to Alexandria, Va., just prior to the Kennedy administration, as he took a new position in Washington, D.C.   For the next fifteen years he rose even further and when he retired, at age 62, he never had to worry about money again.

I wasn’t in the financial world then.  But, now that I have been for nineteen years, there are some memories that have begun to crystallize. 

I began to realize:

  • We never took expensive trips.  We did have a summer cottage on a beautiful lake two hours outside Washington; and, that’s where we spent vacations – while he was building equity.
  • Despite his success – he had more than a thousand people below him – my parents never bought a second car.  My dad rose at 5:30 each morning and walked to a bus stop more than three blocks from home to commute to downtown D.C. – even in the snow and ice of January through March.   The second car money paid for the cottage, I guess.
  • Both my parents were budget conscious.  They weren’t frugal, but they were extremely practical.  Dad wouldn’t buy tires unless they were on sale and while mom always bought ‘quality’, she insisted we take care of our clothes, etc., so they would last.
  • They ate out seldom; but, when they did, they looked for ways to save.   One couple they spent time with were quite well-off – he was a prominent physician – and also from the Depression era.  They would have before-dinner cocktails at home before going out in order to save spending the extra money in a restaurant (we all know that liquor and desserts are the high-markup items).
  • As I said, we were always a one-car family.  And, that car always lasted nine years.  I remember my dad had a ’50 Plymouth, then a ’59 Dodge, then a ’68 Dodge which lasted until the day he retired.  When he retired, my parents – and all their friends – all moved to an island off the coast of Florida and they all purchased homes on the water complete with a boat dock and, of course, the boat.  Then they all bought Lincoln Town Cars – paying cash.  They all lived in comfort for the next thirty (!) years in retirement!

Not all of my parent’s friends ended-up that way.  I remember a few who always seemed to have money to spend all their lives… until they retired, which not all were able to do.  In that group, even the ones that could retire at all soon ran into problems as inflation began to eat away at the purchasing power of their dollars.

They didn’t plan.   They didn’t budget.

Corporations have budgets.  Sound businesses have budgets.  But, for some reason, many people believe the natural laws of the financial universe have somehow been suspended when it comes to their future.  It’s called ‘denial’.

Don’t be one of them.  Those who fail to plan are surely planning to fail.

I learned those lessons growing up and they’ve been confirmed during my years helping people navigate the financial marketplace as their advocate.

If you’d like to learn how – and why – many investors fail, just give me a call or contact me through our website by using the Request Info button.  I’ll send you a copy of a report I think you’ll find interesting.


The Independent Financial Group is a fee-only registered investment advisor and does not sell products earn commissions, or accept any third-party compensation or incentives of any description.  IFG also does not provide tax or legal advice.  The reader should seek competent counsel to address those issues.  Nothing in this post should be accepted as investment advice which is provided only to IFG clients.  Opinions expressed in this piece are those of the author. 

Time To Be Cautious About Gold?

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

It might be! We all know that all asset classes tend to cycle; but, you might also agree that whenever we experience a run-up in pricing for virtually any asset class, people tend to jump on the band wagon thinking it’s the right place to be to make money. That’s called speculation.

It may be questionable at this point just how much exposure the average investor should have to gold.

Don’t get me wrong; the argument for owning gold as part of a multi-asset class portfolio, I believe, is sound. Gold bullion as a safe haven against market uncertainty and inflation would seem to make sense; and during periods of market stress, gold has tended to display low correlations to traditional equity and fixed-income portfolios, making it an attractive diversification tool.   But, have some of the recent substantial asset flows into gold bullion come from speculative sources, helping to push up the pricing to (non-inflation adjusted) historical highs?   Remember, gold is a commodity; and commodity pricing is driven largely by supply and demand and accessibility to gold through exchange-traded funds (ETFs) may have contributed to the recent steep run-up in prices.

How much should YOU have invested in gold? That depends on a number of factors which ultimately determine your overall portfolio allocation strategy.

The gold weighting in my clients’ portfolios, for example, are based on their investment plans and each has a unique investment policy statement (IPS) which becomes the roadmap for the investment process their managers follow. That’s a good idea for the rest of us, as well.


The Independent Financial Group is a fee-only registered investment advisor and does not sell products earn commissions, or accept any third-party compensation or incentives of any description. IFG also does not provide tax or legal advice. The reader should seek competent counsel to address those issues. Nothing in this post should be accepted as investment advice which is provided only to IFG clients. Opinions expressed in this piece are those of the author.

Written by Jim Lorenzen, CFP®, AIF®

October 19, 2010 at 8:00 am

Posted in Uncategorized

When NOT To Rollover Your 401(k)

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

Every year people who retire or change jobs face decisions regarding their old retirement plan.  Unfortunately, making a simple mistake can cost thousands of dollars.

Sometimes it’s good to NOT rollover your qualified plan into an IRA. 

If you’re retiring between the ages of 55 and 59½ and distributions are required, you’re better off staying in your qualified plan since there is no penalty on withdrawals after age 55 and separation from service  (age 50 for qualified public safety employees). [i]   Once funds are rolled into an IRA, there is generally a penalty for withdrawals prior to age 59½. 

Often, people who have already completed their rollover are younger than age 59½ and need a distribution.   In those cases, they can use rule 72(t) to avoid penalties.  When they do this, it’s best to split the IRA into two pieces for maximum benefit.

Each IRA stands on its own.  This means that taking 72(t) distributions from one IRA has no effect on the others!  So, if one IRA produces more income than is needed when placed on 72(t) distributions, you could split the IRA into more than one account, and use one of the smaller accounts to make the withdrawals.  Later, if you need more income, you can begin equal distributions from another account, as well.[ii]

If you’d like to learn more about this question, you can request my free report, Six Best and Worst IRA Rollover Decisions.  Just use the ‘Request Info’ button on our website and let me know!


[i] IRS Publication 575

[ii] Once rule 72(t) is selected, distributions must be taken for at least five years on that schedule or until age 59-1/2, whichever is later.  Failure to complete the schedule will result in a 10% penalty on prior withdrawals.

The Independent Financial Group is a fee-only registered investment advisor and does not sell products earn commissions, or accept any third-party compensation or incentives of any description.  IFG also does not provide tax or legal advice.  The reader should seek competent counsel to address those issues. Opinions expressed in this piece are those of the author. 

Can Small Investors Compete?

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

You’ve seen the cable tv investment gurus and you’ve read all the stock market newsletters – you’ve even attended one of those trading system seminars at a downtown hotel.  You’re convinced the small investor can `beat the market’.  Trouble is, studies show that for the vast majority of small investors it’s seldom the case.

Now, admittedly, what I’m about to tell you is only my opinion.  But, after 19 years in this business, I feel qualified enough to go ahead a blurt it out.

Yes, I think the small investor can compete; but, probably not the way you constantly see, hear, or read.  As usual, some financial education is in order:

Diversification:    Warren Buffett once said, “Diversification is protection against ignorance”.   What he was saying was, I think, quite correct!   The more you diversify, the more you’re merely creating, or replicating, an index of a broader market.  So, you’re not diversifying away market risk or giving yourself a chance at outperforming an index.   I’ve written about the ‘benchmark myth’ before. 

So, if concentrated portfolios would seem to have the best chance at achieving outperformance, does that mean we buy only ten high-fliers and hope for the best?  I don’t think so.  This is where asset allocation comes in.


The fact is the broad-based indexes like the S&P 500, comprised of the 500 largest companies, generally contain the widely-followed companies and all the analysts and professional managers on Wall Street all have access to the same public information (trading on inside information is a felony and, trust me, all those people who tell you they have ‘inside information’, don’t).

It’s virtually impossible, in my opinion, to outperform the pros in an area that’s so widely followed.  If you’ve ever read Warren Buffett’s annual reports or books about his early investing, his early highly concentrated positions tended to be in companies that weren’t widely followed, i.e., the `small cap’ and `emerging’ companies.

But, Warren went to Columbia and studied under Benjamin Graham.  Most of us didn’t go to Columbia, Yale, Harvard, or Wharton or many other notable institutions.   That being the case, how can you get an edge?  How can you compete?

You may not be able to – or even want to –  invest in those markets on your own; but, there are professionals who specialize in companies and markets that aren’t so widely followed.  For the small investor, those are the areas where you have the best chance, I believe, to add some performance; but, you want to be prudent and responsible with your approach.

Here’s an easy-math hypothetical example:  Let’s assume that 90% of a portfolio is invested in a well-balanced portfolio of quality large company stocks along with a well diversified assortment of quality short to medium term investment-grade corporate and government bonds, as well as some cash.  Let’s further assume that 10% is invested with managers managing small and emerging market companies.  Those companies generally tend to be more volatile in their price movements.

Even if your well-diversified 90% does nothing at all, a 20% move on 10% of assets will affect overall performance by 2%  (20% x 10%).   Obviously, your moves can go either way, plus or minus, and you can move more or less than my example; but, the point is that a major move in either direction will affect overall portfolio performance by a lesser amount due to the smaller allocation.  Why is this good?  Because you can create a highly concentrated approach with a small portion of assets with the goal of adding 2% a year to performance of your overall portfolio!

And,2% a year can add-up to a LOT of money!  On $100,000, a 7% return over a ten-year period instead of a 5% return means an extra $33,826!   A 9% return instead of 7% over the same period would mean an extra $40,021, and on $500,000 the difference would be over $200,000… on only 10% of assets!

Okay, so much for hypothetical examples.  Should YOU invest a portion of assets in concentrated portfolios of not-so-widely followed companies?   If so, how much?  That depends on your age, time-frame, the level of your assets and the future obligations you face, including tax and estate issues.  In short, you should talk to your advisor about creating a professional plan with an investment discipline.

You may want to request a report I have available: Why Investors Fail.  You can use the ‘Request Info’ button on our website.

And, of course, feel free to call me at 800.257.6659 or 805.265.5416, Ext. 1 if I can be of help.


The Independent Financial Group is a fee-only registered investment advisor and does not sell products earn commissions, or accept any third-party compensation or incentives of any description.  IFG also does not provide tax or legal advice.  The reader should seek competent counsel to address those issues. Opinions expressed in this piece are those of the author. 

Stock Selection or Market Timing? Which is Most Important?

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®


You see the ads on tv for trading systems and you see the tv shows telling you which stocks to buy.  Which is most important?  Is it both?   

How about neither….   

The world is as full of armchair investors who think they can outsmart Wall Street as it is of amateur golfers who can hit a 300-yard drive and still not qualify for the mini-tour.    

In the world of investing, this is where education diverges from financial entertainment.    

Gary P. Brinson, Brian D. Singer, and Gilbert L. Beebower found in their study[1] that among well-qualified institutional portfolio managers, market timing could account for only 1.8% of the average return differential.  Security selection accounted for only 4.6%.  Portfolio allocation, however, accounted for 91.5% of the average return differential among these investors.  2.1% was due to all other factors combined.   

But, if you talk with your friends about stock selection or market timing, it’s interesting!  It’s fun!  It’s exciting!   Asset allocation conversations are dull.  No wonder you never hear it talked about on tv.   

How about economic cycles?  In 1991, Jeremy Siegel examined the relationship between stock prices and the business cycle.  While the stock market has been known to be a leading indicator, it’s also known to have given false signals, particularly with regard to impending recessions.   The market, however, seems to have been a better indicator of coming economic expansions.   

When do you jump-in?    Sorry, my crystal ball is in the shop – it’s been acting-up lately.    I wouldn’t suggest trying to time the markets.  Smarter people than us don’t do it very well – see the stats cited above.     My suggestion:  Stick with a disciplined process, combined with a long-term outlook, a solid plan, and realistic expectations…  and let the ‘timers’ and ‘pickers’  enjoy their exciting conversations at Happy Hour.   

If you’d like to learn what else to avoid – and what you should know – you might want to request a free copy of my report, Why Investors Fail.  Just use the `Request Info’ button on the IFG website!


[1] “Determinants of Portfolio Performance II: An Update”, Financial Analysts Journal (May-June 1991) pp 40-48. 

The Independent Financial Group is a fee-only registered investment advisor and does not sell financial products or receive commissions.  IFG also does not provide tax or legal advice.  Competent counsel should be consulted for help in those areas.

Three Components of Investment Success

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

Planning to retire?  Hoping to live off your retirement assets and never run out of money?  No matter what your situation is, it’s important to understand the three components of investment success – and especially their relationship to each other.

  1. Time
  2. Amount
  3. Return

Time:  How much time do you have?  During your working years you need to know how many years you plan to work, as well as the number of years you plan to spend in retirement.  If you’re retired, I think you should plan to live to age 100.  Yeah, I know, you don’t expect that.  It’s okay.  I’d rather you be wrong on that side than planning shorter.   Let’s face it, running out of money too soon is NOT fun. 

Amount:  How much do you plan to invest monthly or quarterly during your working years?  How much do you plan to withdraw during your years in retirement?  Think you’ll need less?  Think again.  I’ve been watching new retirees for almost 19 years now and this is what I’ve noticed:  Sure, they have no commuting costs and they’re not eating lunch at work anymore, but they also have more time on their hands and they want to travel, visit grandchildren, go out to eat, play more golf, see plays, etc.  I’ve seen people spend more, not less, in their early years of retirement.  You may be different, but if you think you’ll just sit around and watch Oprah, you may be in for a surprise.

Return:  What return do you think your investments will generate during your working years?  How much return do you think they will generate during your retirement years when you’re making withdrawals?  Did you know it’s possible to earn a 12% average annual return each year while withdrawing 12% annually and STILL run out of money?    It really doesn’t matter what percentage you use – that’s not the point.  What IS important to understand that an average annual return is just that – an average.   But, most investments don’t return the `average’ every single year!  It’s not just volatility, but the ORDER of returns that can hurt you.  Nevertheless, you need a planning process that allows for testing for both volatility (fluctuations) as well as the order of returns.

How are these three inter-related?

Let’s look at the relationship during your working years.  Those three components differ.  While the amount you invest and the return you achieve can both fluctuate, the first component – time – doesn’t.  In fact, `time’ is the one factor that ONLY goes DOWN!    If you have ten years left now, you’ll have only nine years left next year.  Time doesn’t increase and it doesn’t stand still.

The `rub’ is this:  As time diminishes, one or both of the other two components must be increased in order to achieve the same result!    You must either invest more or achieve a greater return.  And, that is where, for some people, the seeds of destruction are sewn.  Most people put-off planning and investing.

Let’s analyze this.  If `time’ and is declining and these people are putting off investing, the amount is zero.

Guess what has to be increased to make up for lost time and zero as the amount during those years?  You guessed it:  Return.  People who wait too long often feel forced to `reach’ for a higher return… which means more risk.  Not good.

It’s common sense.  Begin early.  The more time you have in front – and that component will never get better – the less pressure you put on the other two components.

To learn more about investment success, you might want to read our report, Why Investors Fail.  You can use the ‘Request Info’ button on our website to request your copy.