Jim'sMoneyBlog

Financial Opinion and Insights

Archive for April 2011

Why Buy An Annuity? Build Your Own!

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

You’ve heard the annuity pitch.  It says you can participate in market gains while being protected against loss!  You can do the same thing! 

Are insurance companies able to invest in some hidden market that you can’t access?   Of course not.   They access the same markets you do; so, why pay them to do what you can do yourself?

This is a nifty little strategy I learned when I first entered the investment business twenty years ago.   Last week  I saw an article in Financial Planning magazine that reminded me of it and I thought you’d like to see how it works.

In all fairness, there may be one reason to purchase an annuity, but I’ll get to that later.  For now, here’s how you can create your own.

I’ll use round numbers to make it easy.   Let’s say you’d like to invest $100,000.  You’re willing to pursue a strategy that allows you to invest some of it in the market, but you want a guarantee you won’t lose your $100,000 at the end of five years.

First let’s guarantee the $100,000

According to Bloomberg, as I write this, the 5-year U.S. Treasury is yielding 2.25%.  You can check current rates now.

What amount do you have to invest in 5-year Treasuries today at 2.25% so that the bonds will mature at $100,000 five years from now?  According to my trusty HP-12C, it’s $89,471 – I won’t bore you with the pennies.  You put the other $10,529 into stocks or something that replicates an index, like an S&P 500 Index fund or ETF (you can’t invest in an index itself). 

Now, let’s face it, anything can happen in the stock market.    Here are three hypothetical outcomes – the real world is bound to be different:

  1. You lose half your money.  You get $5,264 back from your stocks.   You end-up with $100,000 from your treasury + $5,264 from stocks:  Total: $105,264.   Not very good, but at least you have your money with a little profit.
  2. Your stocks go nowhere.  You end-up with $100,000 from your Treasury and $10,529 in stocks:  Total: $110,529.  Still not great, but you did average 2.2% per year on your money.
  3. Your stocks go up.   Let’s not talk about doubling your money.  Let’s assume 9% a year – an assumption everyone on the planet thought reasonable until the `meltdown’ of 2008 destroyed all the averages.   At that hypothetical rate – who can predict? – you’d end-up with $16,200 in stocks to add to your $100,000 in maturing Treasuries.  Total: $116,200 – you would average 3.05% per year.

 

Not bad, considering you’ve eliminated your risk of loss!

“But Jim”, you say, “Annuities are tax-deferred!”  

Yes,they are.  But, when you take your money out, it’s taxed at ordinary income rates!   Stock dividends get favorable tax treatment.   Not only that, but if you die first, the cost-basis is stepped-up for your heirs!   Hmmm.

Insurance companies can go out of business, too!  I like the Treasury `guarantee’ better –  I use quotes only because the word `guarantee’ doesn’t appear anywhere on a Treasury or any other government note, bill, or bond.  The wording is, `backed by the full faith and credit of….’.   Nevertheless, it’s a better guarantee.  We’re not Greece, yet.

Now, my little strategy discussed above does not take into account taxes or inflation – the latter being the huge, hidden tax ignored by too many people.   So, you shouldn’t pursue this, or any other, strategy without discussing this with your advisor first.

Okay, so why would someone want to buy an annuity when they could just do it on their own?  There might be one good reason.   The insurance company will do it and often the investor won’t.  What I mean by that is individual investors often lack discipline.  They’ll begin a strategy, but they don’t stick with it.  They hear a new story or investment idea and are prone to change horses prematurely.  The insurance company will see it through; and will likely charge the investor a surrender charge for leaving early – sometimes those nasty things do serve a purpose.

The drawback:  Investors shouldn’t purchase anything unless you know how it fits-in with an overall plan!   

Success always begins with a plan.   I’m here to help and I hope I can help you; but, if you want to find someone else, you might be able to find the right professional here.

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.  He’s been a headline speaker at conventions throughout the United States, Canada, and the U.K. and has appeared in `The Journal of Compensation and Benefits’, as well as in The Profit Sharing Council of America’s `Insights’.    Jim has also appeared on American Airlines’ `Sky Radio’, heard on more than 19,000 flights.  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.

The Inflation Shell-Game

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

You watch the news.  And, you’ve seen them quote the Consumer Price Index (CPI) almost daily.  They tell you the CPI is currently below 2% and that the U.S. is enjoying one of the lowest inflation rates in the world!

Is that true?

Not according to my economist, who also happens to be in charge of purchasing for the Mr. and Mrs. Lorenzen household partnership.   She’s been telling  me for the past year how the prices we’re now paying at the checkout are far different from the CPI numbers she’s hearing on newscasts – and, she’s probably right.

DWS Investments recently conducted a study to find out what prices were going up and which ones were going down.  Using Morningstar data, they divided the prices into `wants’ (luxury items) and `needs’ (basic items).

They found the `needs’ included seven food items , two energy-related items, and one for delivery services.  The `wants’ category included 4 in recreation, 3 in housing-related luxuries, 2 food, and 1 in software and accessories.

Here’s the interesting part:  ALL of the `needs’ items have gone up in price; and ALL in double-digits!   The highest was butter (food category) at 21.88%.  The lowest increase was `uncooked other beef and veal, also in the food category, at +10.81%

How about the `wants’?  All of them were down in price.  The biggest drop was in televisions (recreation category) and the smallest drop was in lettuce (food category).

Now consider the following:

  • There are 7 food items and 2 energy items in the `needs’ category – all up in price double-digits.
  • There are 2 food items and 0 energy items in the `wants’ category  which went down in price
  • Food and energy are not included in the CPI numbers you see quoted on television.

 

My household economist is right.  Our personal CPI – let’s call it PCPI – is different from the news CPI; and both the DWS study and my economist appear to be in agreement – it’s by a large margin.

So, what inflation number should you be using in your planning?  That’s between you and your advisor; but it’s an excellent conversation to have.

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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 in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.  The Independent Financial Group does not sell financial products or securities and nothing contained herein is an offer or recommendation to purchase any security or the services of any person or organization.

How Long Will Your Money Last

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

If you plan on withdrawing from your retirement savings for a long period of time, it is important to examine the effect various withdrawal rates may have on a portfolio.

Several factors need to be examined when determining an investor’s withdrawal rate. The answer may depend upon the portfolio mix, how long an investor expects to withdraw from the portfolio, and the investor’s risk aversion and consumption patterns.

This image looks at a hypothetical 50% stock/50% bond portfolio and the effect various inflation-adjusted withdrawal rates have on the end value of the portfolio over a long payout period. The hypothetical portfolio has an initial starting value of $500,000. It is assumed that a person retires on Dec. 31, 1972, and withdraws an inflation-adjusted percentage of the initial portfolio wealth ($500,000) each year beginning in 1973.

How Long Will Your Money Last?

How Long Will Your Money Last?

 

 

The reproduction of this Morningstar slide leaves a lot to be desired – where’s a nine-year-old when you need one? –  but the withdrawal rates from left to right are 9%, 8%, 7%, 6%, and 5%.  As you can see, the higher the withdrawal rate, the greater the chance of potential shortfall.   The lower the rate, the less likely you are to outlive your portfolio.  Therefore, early retirees who anticipate long payout periods may want to consider assuming lower withdrawal rates.  For me personally, the comfort zone begins at 4%.  Naturally, 3% or less is better.

Government bonds are guaranteed by the full faith and credit of the U.S. government as to the timely payment of principal and interest,  but have not proven to be a hedge against inflation.   Meanwhile stocks are not guaranteed and have been more volatile than the other asset classes, yet have proven over time to provide real returns in excess of inflation and taxes.  The key, of course, is determining the mix of assets that ‘s right for your needs and risk profile.

As you know, it all begins with a plan.

Jim

 

 

About the data  

Stocks in this example are represented by the Standard & Poor’s 500®, which is an unmanaged group of securities and considered to be representative of the stock market in general. Bonds are represented by the five-year U.S. government bond and inflation by the Consumer Price Index. An investment cannot be made directly in an index. Each monthly withdrawal is adjusted for inflation. Each portfolio is rebalanced monthly. Assumes reinvestment of income and no transaction costs or taxes.

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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 in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.  The Independent Financial Group does not sell financial products or securities and nothing contained herein is an offer or recommendation to purchase any security or the services of any person or organization.

Are You Managing Assets or Simply Collecting Investments?

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

It happens far more than you might imagine. 

New clients go through the normal first steps of the planning process:

  1. We establish a risk profile – How the client feels about money, including their expectations and attitudes about risk.
  2. We collect data – We list and categorize all current holdings for both taxable and tax-deferred accounts.  We then conduct a technology-driven portfolio analysis to determine the risk level of their current portfolio of investments.
  3. Revelations begin to appear:  Are the current investments, the rate of return, and the current risk level assumed in line with their risk profile, needs, and expectations?

What people say they want is different from what they’ve done.   In short, they haven’t created the portfolio characteristics they themselves said they want!  It’s not really their fault.  It’s just how things happen in the absence of relevant information.

Most investments tend to be `purchased’ at retail a-la-carte without regard to other holdings.   Based on my experience, this virtually always results in a portfolio they never would have purchased if they’d planned it in advance; but now, it’s the one they have.  Then, when bad things happen – they always seem to when you least expect it – they end-up with unpleasant surprises.

Here’s how to avoid this happening to you:

  1. Remember:  The plan comes first –  Is your plan out of date?   It is for most people, if they even have one.  You wouldn’t build a house without a blueprint; so, it stands to reason a professionally-prepared financial blueprint for the future is a good thing to have before you start buying tools and materials.   Ideally, your plan is technology-driven so that key inputs are always being integrated from the back-end keeping your plan data and assumptions constantly current.
  2. Make sure your plan is complete –  The plan input should include all your holdings in all accounts, including credit unions, banks, brokerages, your company 401(k), etc.  If you don’t have complete information, you’ll have meaningless results – or worse, even potentially damaging, because you’ll be making decisions based on faulty data.  Dynamic plans will provide answers to `what-if’ questions like whether you buy a car every 3, 5, or 10 years – the results of your decisions 10, 15, or even 30 years out can be dramatic.
  3. Do a complete plan review at least annually –  Do you have an annual checkup with your doctor?  You probably should.  Your financial health is important, too; it also affects other people in your life.  If you have a constantly updated plan, your spouse will be in far better shape if something happens to you.  In my experience, spouses who are disengaged – they don’t know what they own or why they own it – are the ones who make the worst decisions at the very time they shouldn’t be making any big decisions at all. And, make sure your risk profile is updated at each review. 
  4. Consolidate assets and reporting – Do you have assets scattered among four or five institutions with the right-hand not knowing what the left-hand is doing?  Is your reporting fragmented without your receiving a true consolidated picture of what you actually own?  Few investors know the risk profile of their entire portfolio simply because they don’t have consolidated reporting and analysis.  How close is your portfolio profile to your true risk profile?  How close is your existing portfolio allocation to an optimized allocation?  Consolidating your planning, custodians, and reporting will simplify your life and probably reduce, rather than increase, your assumed risk. 

There’s a difference between making `investment’ decisions and managing assets.  One usually results in a collection of `scattered assets’ and the other usually results in a more simplified life with greater control over what you’re really doing.

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.  He’s been a headline speaker at conventions throughout the United States, Canada, and the U.K. and has appeared in `The Journal of Compensation and Benefits’, as well as in The Profit Sharing Council of America’s `Insights’.    Jim has also appeared on American Airlines’ `Sky Radio’, heard on more than 19,000 flights.  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.

Boomers On The Bench

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

A recent poll conducted by MetLife included 500 Baby Boomers with $200,000 or more in investable assets.  What’s interesting is that they know why they’re paying a high price for keeping money in liquid investments because they see themselves in a vulnerable position – unable to maintain their lifestyle should unexpected expenses arise.

49% say they couldn’t cut spending by more than 10% without a dramatic change in lifestyle.  52% have had at least one unexpected expense in the past year that cost them $2,000 or more.  26% need money to help a friend or family member.  45% are using money from emergency savings to pay expenses.  22% used a credit card or other revolving debt; 9% took out a home equity loan and 4% borrowed from a retirement plan to pay bills.

Some simply become too conservative too quickly, often without understanding their true situation.  I recently had a client contact me saying his company may be relocating outside California – there’s a surprise – and, even though he’s a senior executive with a strong track-record, he wasn’t totally sure his position would be safe and wondered if he should reallocate about $100,000 of his equity holdings into short-term fixed income.   I must admit, my `gut’ reactions was the same as his.  I told him, “That sounds like a good idea, but let’s update your plan just to be sure.”

After going through the entire planning process using a `worst-case scenario’, the analysis of his current holdings revealed he had a much more secure position in place than he’d realized and that no changes were required at all!   This kept him from making what may have been a huge mistake – the kind that comes back to haunt you ten or fifteen years later, not to mention the current tax ramifications.

It pays to have 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.  He’s been a headline speaker at conventions throughout the United States, Canada, and the U.K. and has appeared in `The Journal of Compensation and Benefits’, as well as in The Profit Sharing Council of America’s `Insights’.    Jim has also appeared on American Airlines’ `Sky Radio’, heard on more than 19,000 flights.  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.