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Archive for January 2011

Should You Invest In Real Estate?

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

Hey, they ain’t making any more of it!  Unlike the dollar, the government can’t print real estate; so, I’ve been a long proponent of real estate investing.  But, then, I’m also a proponent for investing in stocks.  I also like commodities.

What do they all have in common?   They all have had their ups and downs.  There have been times when people have made money – or been hurt – in all of them.  That’s why we diversify.

Because the real estate market is composed of non-interchangeable, unique, illiquid properties, it might be considered as less efficient than the stock and bond markets; but, that inefficiency is probably what creates exploitable opportunities for skilled investors.  But, because each investment is unique and non-liquid, it’s important that real estate investments be adequately diversified.

You can diversify your real estate portfolio by having ownership interests in different types of real estate, such as:

  • Office buildings
  • Residential apartment complexes
  • Shopping centers

And, you can diversify geographically, as well.

Want to buy your own apartment building?  You can, but you might consider this:  You wouldn’t be purchasing an `investment’ as much as you’d really be buying a full-time business.  Tie all your money up in that one business and you’re back to having all your eggs in one basket, hoping the equity will be there when the day comes you actually need it.   As recent history has shown, that can be problematic.

Equity real estate investment trusts (REITs) can provide an alternative method to provide real estate diversification.  Equity REITs are publicly traded operating companies that own and manage real estate properties.  Similar to mutual funds, equity REITs serve as a conduit for earnings on investments and avoid corporate taxation by meeting certain investment and income distribution requirements.

One of the reasons many investors include REITs in their portfolios as a diversification tool is because they’ve offered long-term total returns comparable to the stock market – dividend income has been a major portion of that return – and equity REITs have had a relatively low correlation with both the U.S.  bond and stock markets.

How big of a role should real estate play in your portfolio?  That’s something you should discuss with your advisor.    But, don’t fall prey to common misconceptions many investors have, thinking their home is a real estate investment (it isn’t, it’s shelter, and you’ll always need to have one). 

One thing is for sure:  If you don’t have a formal, written financial plan for your future, you really don’t know how much real estate – or what kind – you should have.  And, getting older without a plan is never a good idea.

Jim

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Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER™ and in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained herein should be regarded as tax or legal advice and the reader is urged to seek competent counsel to address those issues.   The above represents the author’s opinion and should not be regarded as investment advice which is provided only to IFG clients upon completion of a formal financial and investment plan.   For questions or comments, you can reach Jim at 805.265.5416 or through the IFG website, http://www.indfin.com.

Does Passive Investing Mean Buy-And-Hold?

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

You’d be surprised how many people will say they believe in ‘buy-and-hold’ and equate it to passive investing.  What they forget is that following a buy-and-hold strategy means there’s no portfolio rebalancing.

So what?  It means that as capital markets move, the portfolio’s allocation mix changes, producing changes in the portfolio’s risk and return characteristics!  It virtually guarantees an increase in risk over time and a very likely result, in the short run, of being wrong at every major market turn.

For example, with a buy-and-hold strategy, the portfolio’s allocation to stocks reaches its peak just when a bull market ends and a bear market begins.  The opposite is also true.  The allocation to stocks reaches its bottom just as a bull market begins.

As the exposure to stocks increase, so does a portfolio’s overall exposure to market volatility.  As time goes by, it means our investor is increasing risk even as the time-horizon is getting shorter.

Instead of buy-and-hold, periodic rebalancing would preserve the portfolio’s risk initial risk exposure while moving assets into asset classes when they are down and out when they go up.

Isn’t that what buy-low and sell-high is all about?

Jim

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Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER™ and in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained herein should be regarded as tax or legal advice and the reader is urged to seek competent counsel to address those issues.   The above represents the author’s opinion and should not be regarded as investment advice which is provided only to IFG clients upon completion of a formal financial and investment plan.   For questions or comments, you can reach Jim at 805.265.5416 or through the IFG website, www.indfin.com.

Americans Love Predictability

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

And the product manufacturers and the salespeople who sell the products all love it.  It’s unfortunate that our emotional desire for ‘safe’ predictable, stable returns is driven by emotion, rather than education.  No wonder so few truly achieve financial independence.

According to an article by Lee Barney writing for Financial Planning magazine just last week, MetLife’s lifetime income annuity sales has passed the $1 billion sales mark since it was first offered just one year ago. 

They’re not alone.  Many providers sell  guaranteed income benefits through some form of annuity product.  Withdrawals are often equal to some percentage of a single premium investment, and it’s not uncommon to find withdrawal rates in the 4-6% range.  Withdrawals, of course, are taxed as income and they’ll likely be taken in a higher inflation environment.  And, it’s unlikely you’ll find withdrawal benefits indexed to inflation.

My parents retired in 1974.  If my dad had retired with $800,000 and purchased a 5% guaranteed income annuity, his $40,000 annual retirement income would have looked great in 1974; but, I don’t think he’d have been too happy in 1979 when interest rates and inflation were in the high teens.  He would have actually seen a decline in purchasing power.  And, if his friends had purchased `safe’ CDs, they would have seen their interest income soar in the late ‘70’s only to see them fall through the floor later, even as the cost of living continued to rise.

From 1979 through 1981, Treasury bill returns averaged 12.1% annually, producing an after-tax return of 8.5% for a 30% marginal tax bracket investor.  Inflation averaged 11.5% during the same period, producing a real loss of 3% per year.  Three years later, the same investors who loved the 12.1% return while losing purchasing power were complaining as T-bill yields from 1982-84 declined to 9.7%, which equated to a 6.8% return for the 30% tax-bracket investor; but these returns were achieved when inflation averaged 3.9%, providing a real return of nearly 3% per year.[i]

Too many investors need to understand the money illusion of supposed safety.

It reminded me of a 1954 Life magazine I’d seen in an old book store in 1984.  I noticed the magazine was 30 years old.  As I looked through it, I came upon one of those old ads from a large life insurance company.  This 1954 ad depicted a happy man with his feet up in a rowboat while fishing out on a beautiful lake.  He didn’t seem to have a care in the world.  The insurance company ad headline read:  “How To Retire in 30 Years on $500 a Month For Life!”   I guess it looked good in 1954; but, it didn’t look so good in 1984.

People love stability and predictability.  It’s an easy sale! 

What investors need to know:  No liquid investment alternatives with stable guaranteed principal values exists that can provide real returns by consistently beating the combined impact of inflation and income taxes.    Anyone living with these misconceptions will learn to their detriment later.  Those buying high-cost products hoping for the best will likely experience a difficult disappointment.

Why do Americans fear volatility and uncertainty?  Why is predictability so important?  Maybe it’s because they wait so long to plan.  People should begin formal planning at age 25 – yes, you read that right – but, of course they never do.   The typical investor, if he plans at all, usually waits until five years before retirement.  Some wait until after they retire and already have their mistakes firmly entrenched.  Either way, even those that do attempt planning often gravitate toward easy answers that end-up hurting them.   In my Why Investors Fail, I discussed how the easy answers are often the most expensive.  Of you’d like to receive a copy you can request it by using the `Request Info’ button on the IFG website.

IMHO[ii], there’s really no substitute for solid, real-world goal-based planning – done well in advance – and implemented with a quality, low cost asset allocation strategy, coupled with the acquired education that allows an investor to sleep at night, knowing that risks cannot be avoided; but they can be managed and even utilized to benefit the realization of long term goals.

Jim


[i] Asset Allocation, Roger C. Gibson, McGraw Hill, Fourth Edition

[ii] In my humble opinion

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER™ and in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained herein should be regarded as tax or legal advice and the reader is urged to seek competent counsel to address those issues.   The above represents the author’s opinion and should not be regarded as investment advice which is provided only to IFG clients upon completion of a formal financial and investment plan.   For questions or comments, you can reach Jim at 805.265.5416 or through the IFG website, http://www.indfin.com.

Too Many Kidding Themselves About Retirement?

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

A report from Lee Conrad of Financial Planning magazine cites a new study from the Society of Actuaries concluding that nearly half – actually 48% – of America’s baby boomers have NO financial plan in place in case they live longer than expected.

In addition – and it should come as no surprise – 71% of the survey respondents indicated they’d be taking Social Security benefits before the age of 70.

A few weeks FINRA, the industry’s regulatory body, launched a web tool that investors can use to test their financial I.Q.  Another one investors can use to test their economic IQ is available from the Council for Economic Education.  How much do people know?  You can read the entire 82-page report here.

A few days ago I was talking with a family that said they planned to buy a rental home inside their 401(k) plan.  I asked them if they had a written financial plan.  They didn’t.  So, I asked, ‘How do you know you should buy a rental income house at all?”  They wanted to. 

While a rental income property might very well be an excellent investment, no investment should be made in a vacuum – every investment should be made within the context of how it fits with an overall plan.  One additional point I doubt they’d considered, since they’d never owned income property before:  Owning rental income property isn’t as passive as owning other investments.  In fact, it might better be described as a business.  Owning income property and being a landlord isn’t as easy as the infomercials make it look.  It takes work, and it’s not all profit.

Acting on financial decisions made with no plan in place is literally like putting the cart before the horse.  Hopefully, in 2011, more Americans will get the message.

Investors Get No Free Lunch!

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

Investors love predictability and will take stable returns over unpredictable returns every time; yet, intuitively most people understand that no ideal investment exists that is liquid, has a stable principal value, and generates returns sufficient to stay ahead of the combined impact of inflation and income taxes.

Once the fantasy of the ideal investment dissolves, most people begin to understand that building a sound portfolio strategy is all about compromise.  It IS possible to get stable, predictable returns from some investments, but the stability is purchased at a price of lower returns and most often with a loss of purchasing power over time.   Other investments will provide an expectation for long-term growth, but necessarily entail the assumption of volatility.

It’s human nature to seek constants in a world of uncertainty.  One constant is people prefer stability over uncertainty.  The good news is that the longer an investor’s time horizon extends, the more opportunities there are for good and bad years to offset one another, producing an average return that converges toward the long-term growth path of the asset class

Step #1 begins with understanding the purpose of your money.   Most people like to think of their goals; but goals can change or even abandoned.   For example, ‘retirement in ten years’ may be a fine goal; but you need to know the purpose of money first – that’s something that’s less likely to change.   

A client who tells me, “I want to make sure I don’t have to ever reduce my lifestyle” or “I want to be free from worry in my old age” is giving purpose to their investing.  All goals can then be chosen within the framework of that purpose. 

It’s helpful to understand your purpose; then you can choose your goals, providing inflation and tax assumptions that can be expressed in both today’s dollars as well as in future dollars.   After that, it’s time to prioritize.  Those of you who are IFG clients have experienced this process and probably even experimented with alternative scenarios in the planning platform. 

Your purpose will likely not change – and it provides the framework for the decisions you’ll have to make.

Jim

 

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Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER™ and in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained herein should be regarded as tax or legal advice and the reader is urged to seek competent counsel to address those issues.   The above represents the author’s opinion and should not be regarded as investment advice which is provided only to IFG clients upon completion of a formal financial and investment plan.   For questions or comments, you can reach Jim at 805.265.5416 or through the IFG website, www.indfin.com.

Investment “Noise” is Everywhere

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

Turn on the financial channels and everyone has advice for you.  Even AARP and Consumer Reports are providing ‘financial advice’ to you – never mind they don’t know you or your family, your income, your tax status, or goals, let alone your current or future obligations.

I just received my Consumer Reports “Bottom Line” Winter 2011 Special Edition – the bottom of page 1 says, “BOTTOM LINE Makes You Healtherier, Wealther, Wiser… Happier, Too.”  I wonder what the regulators would say if I made than claim in my newsletters.

The issue I just received did contain an interesting cover article, “Warren Buffet Reveals What You Should do If You Lost Money in the Stock Market Crash.”  It does contain some good advice:  Recognize that markets always bounce back; bad news is an investor’s best friend; buy a great business and don’t listen to the market; Invest in what you understand; and diversify your investments.  Too bad the crash was two years ago.  There are also a couple of other pretty nice short articles in the issue; but most of the issue was dedicated to hyping a series of special reports with a series of benefit bullet points…. All filled with great FREE advice!

Today investors are bombarded with information overload – all masquerading as advice!   And, frankly, the investment community is part of the ‘conspiracy’ urging investors to make ‘easy’ decisions.

Despite the fact that numerous academic studies for decades have shown that allocation decisions are what truly drive investment performance, tv gurus, newsletters, the financial press, and even most investment providers all advance the proposition that success is driven at the investment level rather than the portfolio strategy level.   Let’s face it:  If the media had to talk about portfolio strategy, they’d run out of things to say pretty quickly.  The MTV formula – lots of noise and rapidly changing images – works well in our entertainment driven society and wearing suits while sitting in front of trading desks seems to lend it all amazing credibility.

Investors share some of the blame, too.  In a world where skill cannot protect them from bad outcomes, they cling to the worldview that skill drives results and that both market timing and superior security selection is not only possible, but it happens all the time.   That’s an easier path to follow than going through all the boring steps of financial and investment planning which require self-analysis and answering some difficult questions that must take place over several weeks before the first dollar is invested.  

Time?  Work?  That’s not what they say on television!   Investors seldom realize they actually have to make informed and difficult decisions concerning expected return, inflation, taxes, and expected volatility among investments, not to mention making correlation assumptions about the various asset classes.  They also have to project their needs forward in inflation adjusted after-tax dollars to be sure they don’t outlive their money.   And, there’s also personal responsibility for maintaining discipline as the plan is implemented and pursued.  It’s little wonder investors often prefer to embrace the worldview that stock-picking and market timing is their key and all they need to do is find the right manager. 

So, watching the financial channels for tips and reading newsletters for star-ratings to find the right fund manager is still what many investors do.  Unfortunately, they don’t appear to be the successful ones.

The world of successful investing is built around a sound planning process.  But remember, information isn’t advice – and it certainly isn’t education.   Education is required to process information and advice can be rendered when the person providing the advice is someone who knows your personal situation, has all the facts, and can use his or her education to guide you through the decision-making process.

Yes, YOU must make the decisions.  Your advisor is your guide who’s duty it is – or should be –  to keep you from making avoidable mistakes.  Yes, it takes time, work, analysis, and decision-making.  It’s not as much fun as following tips and selecting investments first – always a bad mistake – but, it is your route to success.

Jim

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Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER™ and in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained herein should be regarded as tax or legal advice and the reader is urged to seek competent counsel to address those issues.   The above represents the author’s opinion and should not be regarded as investment advice which is provided only to IFG clients upon completion of a formal financial and investment plan.   For questions or comments, you can reach Jim at 805.265.5416 or through the IFG website, www.indfin.com.

All Your Investments Went Up?

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

That may actually be bad!

Believe it or not, you may not want all of your investments to go up at the same time.   That may seem silly; but designing portfolios so that some investments don’t make the same movements at the same time is actually a risk management tool!

When investments move together – in the same direction at the same time – they are considered to be `correlated’.   Most investors have never had their investments, whether individual securities or mutual funds, analyzed as a portfolio for their correlation.   That’s because most individual investors think in terms of `investments’, not portfolio strategy.

Think of it this way.  Your investment portfolio is a vehicle – just like your car – which you hope will take you to your destination.   A car’s engine has pistons that provide the power.  Let’s say each piston represents a segment of your investments, divided evenly.  

Suppose all the pistons went up and down – moving together at the same time in the same direction.   That means at any given moment everything is up – or everything is down.   My guess is that would produce a pretty bumpy ride and you could never be confident where your pistons – investments – would be when the car shut down.

Now suppose the pistons move up and down like they’re actually designed.  One is always up when one is down, and the remaining pistons have varying degrees of correlation with all the others.  That’s a smoother ride – and, you’ll likely have a greater sense of confidence in greater overall stability of value no matter when the car shuts down.

Does your portfolio contain non-correlating assets?  Are your investments and managers selected in a way designed to help reduce correlation where possible?

If all your investments went up together – or down together – it could be a `red flag’ that you don’t have a real `portfolio’ at all, but just a collection of stuff you’ve been accumulating because they looked good at the time.

You’ll not be surprised when you hear me say. `It all begins with a plan.’

Jim

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER™ and in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained herein should be regarded as tax or legal advice and the reader is urged to seek competent counsel to address those issues.   The above represents the author’s opinion and should not be regarded as investment advice which is provided only to IFG clients upon completion of a formal financial and investment plan.   For questions or comments, you can reach Jim at 805.265.5416 or through the IFG website, www.indfin.com.