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Archive for August 2011

Scared of Stocks? Take a Lesson from Warren!

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

If you have to ask, “Warren Who?”, you probably should just pass on this posting altogether.

If you do know who Warren is, read on – you may enjoy this.  I’ll let him talk to you in his own words, taken from The Essays of Warren Buffett, which is really a collection of his reports to Berkshire Hathaway investors.  This from Essay II, Section A, entitled, Mr. market:

“Whenever Charlie and I buy common stocks for Berkshire’s insurance companies (leaving aside arbitrage purchases, discussed in the next essay) we approach the transaction as if we were buying into a private business.  We look at the economic prospects of the business, the people in charge of running it, and the price we must pay.  We do not have in mind any time or price for sale.  Indeed, we are willing to hold a stock indefinitely so long as we expect the business to increase in intrinsic value at a satisfactory rate.  When investing, we view ourselves as business analysts – not as market analysts, not as macroeconomic analysts, and not even as security analysts.”

The rest of the essay goes on to point out that market movements in the pricing of the company’s stock are immaterial and largely go unnoticed.  Again, it’s the intrinsic value of the company that’s important.  Mr. Buffett says that each day, “Mr. Market” offers him a price for his share of the company; but, if the company is still meeting his business performance expectations (not price performance), he simply ignores the offer.  He says that even though the business may be stable, Mr. Market’s price quotations virtually never are.

It’s an interesting read.   For those of you who want to know how one of the best investors who ever lived does it, I recommend the essays, which I’m sure you can find through one of the online stores.

Jim

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NOTE:  Jim Lorenzen was interviewed by The Wall Street Journal’s Glenn Ruffenach for an article appearing in SmartMoney magazine.  You’ll find it on page 46 in the September 2011 issue now on newstands.

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER™ and an Accredited Investment Fiduciary®  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 `Downgrade’ is Old News

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

Last Friday’s jobs report looked good on the surface –  over 100,000 jobs were created – over 200,000 people left the workforce and there have been over 200,000 net job losses over the past two months at a time when 250,000 new jobs are needed each month just to break even.  So, it’s still too early to pop the champagne.

While arguments continue in the media over the causes of the current gyrations, my guess is the credit downgrade by S&P isn’t one of them.  After all, not only was the downgrade telegraphed well in advance, but frankly, credit is what it is, regardless of the label provided by a discredited third party, and institutional investors – the biggest buyers of bonds – know what they’re buying.

The bigger `boogie man’ is the underlying issue:  Government debt and the desire to continue spending to add more.  And, the other shoe just may occur in the municipal bond market as municipalities across the country face the music brought on by their own spending.  The same holds true for states like California, Minnesota, and plenty of others.

Maybe the markets have been voting on the government’s ability to manage our money – after all, it is done by committee; and a large one made up of largely of lawyer/politicians, at that.

What should investors do?  Maybe nothing.  Reacting to  news has seldom, if ever, proven to be a sound strategy.  For those still working and contributing to 401(k) plans, this market is very likely a blessing since they can buy more cheap shares on sale for the same money.  Likewise, those not needing to tap long-term investments for living expenses will likely see little long-term effect, provided their allocations are well designed (see below); the Rip Van Winkle pill should work. 

The real impact of stock market gyrations, of course, is on those who need to live on retirement income from their investments.  Few of these people, depending on their financial plan input, probably shouldn’t have a greater than 20% allocation to equities, anyway – a statement of opinion requiring greater explanation than a blog post would permit.  Nevertheless, this is one of the reasons having the proper allocation is so important:  A 40% loss on a 20% allocation. For example, would result in only an 8% impact on total portfolio value, provided values in the 80% bond portion of the portfolio don’t change.   Bond values do change, of course; but, those with short-intermediate bond positions in a separately managed account, are largely unaffected since all bonds in the portfolio can mature at face value, rendering interim price movements moot. 

But, whether in a separately managed portfolio of individual securities or a mutual fund, active management on the bond side of a portfolio doesn’t add much to the expense side and does allow for the potential to manage interest rate risk, something that’s problematic in an index fund or ETF.   Longer term, properly allocated inflation hedges may prove more worthwhile in virtually all allocations.

So, for those with updated plans and allocations, the current market gyrations may likely have lesser impact than being advertised on the media, as well as little long-term effect on reaching overall goals.   Those without a plan or a strategic long-term allocation may find themselves getting ‘whip-sawed’ by the market – selling on emotion (when the market’s down) and buying back in when `confident’ (at a top).  Not a good way to manage money.

Or, if you want to manage money like the government, you could always borrow!   Naaaaaah.

 Jim

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NOTE:  Jim Lorenzen was interviewed by The Wall Street Journal’s Glenn Ruffenach for an article appearing in SmartMoney magazine.  You’ll find it on page 46 in the September 2011 issue now on newstands.

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER™ and an Accredited Investment Fiduciary®  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.

Written by Jim Lorenzen, CFP®, AIF®

August 16, 2011 at 7:10 am

If Treasuries Were Downgraded, Why Did Rates Fall?

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

It IS confusing, isn’t it?  The `downgrade’  was supposed to result in higher rates on Treasuries, which would depress the bond markets!   Some people thought it would affect all borrowing!

But, what happened isn’t that difficult to understand; and, in fact, was easy to foresee, as many bond traders apparently did.

But first, a little quick overview of how bonds trade might be in order:

Bonds are issued with a face value and a coupon.  The face value, for example, might be $10,000.  Let’s say our hypothetical bond pays a coupon of $200 annually.   That means if our bond was purchased at face value, the annual coupon payment would actually be a 2% yield.  T he coupon payment doesn’t change; but the calculations can produce different yields, based on market trading.   For our little example, I’ll be talking about current yields only – the yield realized based on the purchase price of the bond.  We’ll ignore yield-to-maturity, yield-to-calls, and tax issues for the purpose of this hypothetical.

In the marketplace, bonds seldom trade at face value.   They generally trade either at a premium or a discount, based on market forces – it’s basic supply and demand.   

When demand is high, the price goes up, just like for anything else!    So if there’s a huge demand for our type of bond – let’s say it has a 3-year maturity that is considered safe – the price of the bond will likely go up!   So what happens to the yield if the price increases?

Let’s say our bond was originally purchased for $8,000 and was therefore yielding 2.5% (the $200 coupon represents 2.5% of the purchase price).    If demand is high, our hypothetical bond seller might be able to get $9,000 for it, which means our buyer would have a bond that will have a current yield of 2.2%, since that $200 coupon represents an annual return of 2.2% on a $9,000 investment!    The price rose due to market forces, high demand, and the yield decreased as a percentage of the price, because the coupon remained the same.

Likewise, if demand was down and the price had been reduced to, say $7,000, the buyer’s current yield would be 2.9%.  So, as bonds trade up or down, yields move inversely down or up.

Okay.   Let’s go back to the downgrade.  When everyone expected rates to go up, why did they go down in the bond market?  Demand!

When the downgrade hit, my guess is that most investors knew the Government’s ability to pay creditors was, in fact, not in jeopardy.  Current revenue was more than sufficient to pay all outstanding debt obligations; so, that I don’t believe was an issue.  Here’s what I believed happened:

  • Stock market investors – mostly institutions that make large investments in American and global businesses on behalf of smaller investors – passed judgment on Congress’ ability to deal with our national debt.  The feeling was likely that the huge $14 trillion debt, combined with what’s already happened (looming increased health care costs, increased regulatory compliance costs, and an uncertain outlook for future taxes), produced a `no-confidence’ vote on Wall Street.
  • The stock sell-off produced sale proceeds that had to be invested somewhere.  There are no `coffee cans’ in the closets of these institutions.   There aren’t many choices:  Cash and short-term paper (money market and T-bills, for example).   This increased demand in the bond markets caused bond prices to increase;  and, as we’ve seen in our hypothetical bond example, when prices go up, the bond coupons represent a smaller percentage of the bond values being traded, so yields come down.

This market dynamic may or may not affect bank borrowing or mortgage loan rates, which also have their own demand-supply dynamics; but, it might explain what happened in the bond markets, and why.
 

Jim

 

NOTE:  Jim Lorenzen was interviewed by The Wall Street Journal’s Glenn Ruffenach for an article appearing in SmartMoney magazine.  You’ll find it on page 46 in the September 2011 issue now on newstands.

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER™ and an Accredited Investment Fiduciary®  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.

Written by Jim Lorenzen, CFP®, AIF®

August 15, 2011 at 1:20 pm

10 Questions Plan Sponsors Should Ask Themselves

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

Do you make decisions regarding your company’s retirement plan?  For example, do you choose the plan provider or approve the investment line-up?  Did you choose your plan’s advisor or broker?

If you make decisions regarding your company’s retirement plan – it doesn’t matter what your company title is, you could be the janitor – the odds are excellent you could be considered a fiduciary by the Department of Labor. 

Under ERISA (Employee Retirement and Income Security Act), fiduciaries are charged with the selection and monitoring of plan service providers.  ERISA requires that fiduciaries act in the same way a prudent expert would act, solely in the interest of plan participants and beneficiaries.  In fact, fiduciaries must act for the exclusive purpose of providing benefits and defraying reasonable expenses in administering the plan.    But, how are plan sponsors to act at the level of experts in administering a plan?  According to many vendor salespeople, you simply `delegate’ it and they’ll `take care of everything’. 

It doesn’t work that way in the real world.  Plan sponsors are charged with documenting their service provider selection process, documenting the monitoring of their service providers, and checking for conflicts of interest!

Here are 10 Questions plan fiduciaries should ask themselves:

  1. Does everyone who makes decisions about your retirement plan know s/he has fiduciary status?  Are they aware of the implications of that status?
  2. Did your provider `bundle’ your plan so that you pay one all inclusive fee?  Have you uncovered a line-item breakdown of all charges paid for record-keeping, administration, investment management, employee education, and your advisor’s fee?
  3. Do you know what revenue-sharing is and if it exists in your plan?  Have you uncovered and documented all revenue-sharing arrangements?  (Note:  If your plan looks `free’, it’s an excellent bet there is revenue sharing going on behind the scenes.  Have you uncovered it and have all excess payments to providers been returned to the plan and/or participant
  4. Have you actually read your provider’s Service Agreement.  Do they really take fiduciary status or is it simply a marketing gimmick?  Look to see if they render advice or only make recommendations. 
  5. What kind of independent “third party” investment due-diligence do you receive?   Are the investments chosen from a limited menu or an `open architecture’.   Note:  If most are from a single fund family, with only a few other families represented, chances are there might be a `pay-to-play’ arrangement resulting in revenue sharing to other service providers (see #3).  This often results in higher investment expenses, which might create some headaches for a fiduciary; remember, you must act ‘solely’ in the best interest of participants and `exclusively’ to provide retirement benefits at reasonable cost.
  6. How were your investments chosen?  Were they chosen because they paid higher revenue sharing (see #3 and 5) and can you document the selection process?
  7. When was the last time funds were replaced?  Can you document why they were replaced?  If none were replaced, can you document why they were retained and other candidates weren’t chosen?
  8. How often do you hold educational meetings for your employees?  Are they getting real financial planning and investment advice – something that can actually reduce your liability – or are they simply going through enrollment meetings and/or being provided with only `information’  and left on their own?  (Hint:  What do YOU think a fiduciary should do?)
  9. Do all fiduciaries to your plan have a real internal process with systems for documenting all activities and fulfilling all their duties or are they simply trusting the plan provider, who in the vast majority of cases – particularly if the plan was sold by a broker, insurance company, or a mutual fund complex – is not acting in a fiduciary capacity.  
  10. Do you have a written provider search process you can follow and document when plan review time rolls around? 

Doing it right isn’t that hard; and in many cases can even save you money!  Doing it right always saves headaches.

Jim

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NOTE:  Jim Lorenzen was interviewed by The Wall Street Journal’s Glenn Ruffenach for an article appearing in SmartMoney magazine.  You’ll find it on page 46 in the September 2011 issue now on newstands.

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Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER™ and an Accredited Investment Fiduciary®  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.

Investors Vote on Washington

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

It was interesting to watch the markets last week as our elected politicians enjoyed spending much of the entire last two weeks of July grand-standing in front of the cameras on a daily basis – and somehow magically managing to stay on camera right up to the time they left town for the August recess.

As they kept talking about the impending ‘crisis’ and the potential downgrading of the government’s debt (Treasuries), the pros on Wall Street were selling stocks and buying the very debt that no one would presumably want – the same debt that would presumably lose value after the downgrade.   If that doesn’t reveal a lack of confidence in their handling of the economy, I don’t know what does.  The pros were willing to buy `safe’ Treasuries, even if downgraded resulting in higher rates and lower prices in the future, than stay in stocks!  It really doesn’t sound like a professional strategy, does it?

What does this mean to the individual investor?   It’s unclear, at least to me at this point, how much of the selling was done as part of an asset management strategy and how much was done simply to raise cash in order to meet redemption requests by individual investors. 

Short-term volatility has always been a part of stock market investing.  Many of us can remember the early ‘90s when a 50-point swing in a single day was so unheard-of (at the time) that trading curbs were installed once a 50-point move occurred!  Today, 50-points seems like a day off!   If the institutional selling was done in order to meet redemption requests, I fear many of those individual investors – once again reacting to headlines – will once again get ‘whipsawed’ by the markets.

If past experience is a guide, most of the individual selling was likely instigated by individual investors acting on their own; and very little, if any, was done by investors working with advisors who have them allocated with a long-term plan in mind.  Give it six months – say, March – It wouldn’t surprise me to see the markets recovered and the same people buying back in at higher prices.

Jim

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Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER™ and an Accredited Investment Fiduciary®  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.

 

Written by Jim Lorenzen, CFP®, AIF®

August 9, 2011 at 8:10 am

Smart Kids Don’t Follow The Crowd

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

When I was young, my father told me, “Jim, if you just save 10% of everything you ever make – and start NOW – you’ll never have to worry about money the rest of your life.”    Parents.  What do they know?

The fact is, the “start NOW” part is the most important part of that sentence!  I didn’t know it, of course; but, saving during those early years truly do make a huge difference.

Most recent grads not only find it difficult finding work; but, it’s difficult paying the bills in those recent years; so, savings is something that’s easy to put-off until they “can afford it”.  Nevertheless, if they buy an old car instead of a new one and resist the urge to ‘keep up’ with their friends, they can usually find a way.

Do you have kids or grandkids that have recently graduated and entered the workforce?  They may benefit – we all hope so, anyway – from this little lesson.  Since concepts are more important than numbers – you can always change the numbers, I’ll keep the numbers simple for my little hypothetical comparing Fred and Gary.  We’ll also assume all investing is done in a retirement account, so we can ignore taxes.

First, to give Fred and Gary some time to get going, we’ll start them both at age 25, giving them 40 years using the normal 65 age to retire, though many are working and even starting businesses past that date.  

To keep our hypothetical simple, let’s assume that each saves only $2,000 a year and never increases their savings, and that they earn an average annual return of 8%.

Annual savings:  $2,000
Average annual return: 8%

Fred saves $2,000 a year for ten years from age 25 to age 35 and stops saving.  But, he does leave his money in his account to accumulate at 8% until he’s 65.

Gary waits until he’s 35 before starting.  But, Gary invests $2,000 a year, beginning at age 35, for thirty years… all the way to age 65.  Who won?

At age 65, Fred, who invested during only the first ten years, ended up with $291,546.  Gary, who invested for thirty years but started ten years late, ended up with $226,566… almost $65,000 less!    In fact, for Gary to have tied Fred, Gary would have had to invest $2,573 a year – 29% more – each year for all thirty years!

Fred invested for only ten years!  But, it was the FIRST ten!   What if Fred hadn’t quit after ten years?  What if he’d kept going to age 65?  His final number, on only $2,000 a year, would have been $518,113?  That means those first ten years, by not investing, cost Gary $291,547!

Do the math:  Those first ten years, by not investing $2,000 in each year, cost Gary $29,154 per year!

Dad was right:  Start NOW.

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Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER™ and an Accredited Investment Fiduciary®  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.

Written by Jim Lorenzen, CFP®, AIF®

August 2, 2011 at 8:10 am