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Archive for September 2011

Do Commodities Make Sense for You?

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

There’s a question every financial advisor hears virtually every day; and it starts with the words, “What do you think of…..”

How that question ends, of course, depends on what’s happening in the economy right now.   You see, what’s happening NOW is regarded as more important than something that happened last week, even if what happened last week has a 90% chance of repeating and what’s happening right now has only a 10% chance.  It doesn’t matter.  If it’s NOW, it’s more important.  That’s called ‘recency bias’, and most investors suffer from it.

Today, of course, there’s fear.  Fear of the government, fear of the dollar (same thing), fear of the global economy, fear of inflation, etc., etc., etc.  So, people begin asking about gold.  The more sophisticated investors don’t limit the question:  They ask about commodities in general.

What do I think of them?  I like them.  I also like stocks, bonds, real estate, and cash.  It’s like a diet:  I like almost all foods (except liver and sushi).  While I like seafood and chicken dishes, I do enjoy an occasional steak; but, my diet is balanced.

Commodities can be good for many portfolios – talk to your advisor first.  As you can see from this Morningstar chart, commodities were the top performers during seven of the last twenty years when inflation was increasing.  As you can also see, those years would have been hard to predict.   Talk to your advisor and see if/how they may fit into your plan.  If you don’t have a plan, that’s your first place to start.  Don’t have an advisor?  You know where I am.

 

Commodities and Inflation

 

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 provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here.  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®

September 28, 2011 at 8:05 am

Beware of Easy Answers

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

There I was with my feet up on a Sunday afternoon watching football when a commercial break came.  As I started for the refrigerator, a friendly voice asked the question many people ask:  “How much can you withdraw from your nest-egg without worrying about running out of money?”   

Since this is an issue I’ve been dealing with for more than twenty years, I was interested in their answer.  So, I postponed my trip to the refrigerator; but, then the voice then said, “The answer in a moment…” and went on with the commercial.  That was my cue; but, I returned in time to hear their answer.  It was their belief that investors should be able to draw between 4-5% annually.  I won’t tell you which company aired the commercial – okay, it was Fidelity.

4-5%?  Really?  Well, maybe. 

Morningstar published a hypothetical 50% stock/50% bond portfolio and the effect various inflation-adjusted withdrawal rates had on the end value of the portfolio over a long payout period.  Each hypothetical portfolio has an initial starting value of $500,000 and assumed that a person retired at age 65 and withdraws an inflation-adjusted percentage of the initial portfolio wealth ($500,000) each year beginning at age 66.  Morningstar concluded that someone withdrawing 4% annually would have a 95% chance of achieving his/her goals.  At a 5% withdrawal rate, the investor would still be somewhere around an 87% confidence level.

Here’s a point worth noting:  Annual investment expenses were assumed to be 0.83% for stock mutual funds and 0.64% for bond mutual funds.   Interesting, since most stock mutual funds have much larger expenses.  It’s also worth noting, they were using historical data covering for the 1926-2010 in a Monte Carlo simulation.  Monte Carlo does test all possible outcomes, but often it assigns the same weighting to events that happen often as it does to those that may have happened only once in all of human history.  Sophisticated planning platforms not only weight outcomes, they also allow you to perform ‘stress-tests’ by performing some `worst-case’ scenarios on timing.

The commercial, however, reminded me of when I opened my first office in Winter Park, Florida in the early ‘90s.  In those days, the stock market was doing extremely well and there was a local independent broker who used to buy a lot of radio ads promoting his retirement seminars – Florida has a lot of retirees.  His commercials used to promote attendance by saying something like, “You can withdraw 8% a year with possible growth of principal!”  He packed them in.   

Commercials seem to do well when they tell people what they want to hear.  The problems came, of course, for those who clung to that belief when markets weren’t so friendly.  While I think most advisors would feel comfortable with the 4% figure, few are likely to be comfortable with the 5% figure, at least for a 65-year-old in good health; and, the wealthier you are, the less likely you’ll have significant stock exposure, which would likely result in a withdrawal rate closer to 3%, or maybe less.

As usual, it depends.

Jim

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 provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here.  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.

Investor Behavior Influenced by Bias

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

In a study titled “Risk Aversion or Myopia? Choices in Repeated Gambles and Retirement Investments,” Shlomo Benartzi and Richard Thaler, professors at the Anderson School at UCLA and the University of Chicago, respectively, studied a group of defined contribution plan participants.  The participants were divided into two groups and each group was told they could choose between only two funds, A and B.  They were then given some information about the historical returns of these funds and were asked to decide, based on this information, how much of their retirement money they would invest in each fund.  The returns for the funds were derived from actual stock and bond returns.  The manipulation in the experiment was the manner in which the fund returns were displayed.

One group was shown a distribution of one-year returns for both stocks and bonds.  The other group was shown a distribution of 30-year returns.  The academics predicted that subjects viewing the one-year chart would invest less in stocks than subjects viewing the 30-year return chart.  They based their forecast on the fact that the one-year chart accentuated the perceived risk of investing in stocks.  They stated that over a one-year period, the likelihood of stocks underperforming bonds is about a third, while over a 30-year period the likelihood is about 5%.

The results found that the group looking at the distribution of one-year returns allocated their portfolios much more conservatively: 60% to bonds and 40% to stocks.  In contrast, the group that saw the 30-year return distribution allocated their portfolios more aggressively: 10% to bonds and 90% to stocks.  Exposure to frequency of returns tends to affect an investor’s tolerance for risk.

Source: Shlomo Benartzi and Richard H. Thaler, “Risk Aversion or Myopia? Choices in Repeated Gambles and Retirement Investments,” Management Science, March 1999, Vol. 45, No. 3, pp. 364–381. The returns for the funds were derived from the CRSP (Center for Research in Security Prices, Booth School of Business, The University of Chicago) value-weighted NYSE index for stocks and Ibbotson’s annual returns on five-year government bonds.

Bias can lead to regret.

One major bias of individual investors is `recency’ bias; this happens when an investor attaches greater importance to one event than another simply because it occurred more recently.  This bias often leads to regret, which can take many forms. 

Consider the situation of each of the following investors. Investor A purchased shares in Company ABC on Jan. 1, 2007. This investor consequently sold the shares at the end of June because of the flat performance of the company. Investor B considered purchasing shares in Company ABC on the same day Investor A sold his shares, but after much consideration decided to take a pass. As the chart illustrates, Company ABC performed extremely well from July 2007 through November 2008 (although afterward it did slump a bit). Which investor is unhappier as a result of their decision?

Logically, the economic outcome is the same and therefore both investors should have the same amount of regret. However, studies have shown that the regret of having done something (commission) is greater than the regret of not having done anything (omission). Therefore, Investor A experiences more regret than Investor B.

In an unpublished study by two prominent academics in the field of behavioral finance, Daniel Kahneman and Richard Thaler, 100 wealthy investors were asked to bring to mind the financial decision they regretted most.  The majority of participants reported their greatest regret was from something that they had done.  Those who reported a regret of not having done something were shown to take on more risk.  They generally held an unusually high proportion of their portfolio in stocks.  In summary, people who regret the opportunities they missed tend to take more risks than people who regret attempts that failed.

The stock illustrated in this example was selected from Morningstar’s database of publicly traded equities.

It’s little wonder that the long-term investors using a plan tend to outperform those who think they can succeed without one.

Jim

Our thanks to Morningstar for their aid in the preparationof this post.

 

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 provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here.  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.

How To Use a CERTIFIED FINANCIAL PLANNER Professional

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

You’ve heard about certified financial planners – you’ve probably seen articles by them and some interviewed on television and radio!  Are these people the guru’s of all things financial?  Is a CFP® professional the only resource you’ll ever need?

Hardly.

First, a little background:  A CFP is required to meet certain experience, educational, and ethical requirements.  To fulfill the educational requirement, candidates must have a bachelor’s degree or higher from an accredited U.S. college or university and also master a list of nearly 100 topics on integrated financial planning through a CFP Board-Registered program.  The topics cover major planning areas such as:

  • General principles of finance and financial planning
  • Insurance planning
  • Employee benefits planning
  • Investment securities planning
  • State and Federal income tax planning
  • Estate, gift, and transfer tax planning
  • Asset protection planning
  • Retirement planning

The course of study can take up to three years to complete, depending on scheduling.  Today there are more than 300 colleges and universities across America offering CFP Board-Registered programs in their MBA programs.  Upon completion of the course of study, the candidate must pass a ten-hour exam, conducted over two days.  Board exams are conducted two times each year at selected locations across the U.S. on specified dates.

You’ll notice I indicated there are nearly 100 topics covering integrated financial planning.  There’s your ‘tip-off’.  CFP practitioners should be viewed as general practitioners.  Just as your family physician – probably a general practitioner – will refer you to specialists for various issues, the same should be true of your CFP.

A recent law school graduate, for example, must sit for his/her state’s Bar Exam to practice law.  During law school, subjects included contracts, torts (personal injury) crimes, real estate, taxation, evidence, constitutional law, estae law, procedure, and many other areas; but, you probably wouldn’t even want an attorney who ‘specialized’ in everything!  An estate lawyer may not be the one you want handling your personal injury case, just as you probably wouldn’t want a podiatrist performing a liver transplant.

Likewise, while CFP practitioners typically do provide comprehensive financial planning services, you should expect a good CFP to act as a ‘facilitator’ bringing together a group of legal, tax, insurance, and others who are experts in their respective fields in order to coordinate an integrated solution. 

If you find any advisor in any field telling you they can handle everything themselves, I would personally advise you run the other way.  My guess is they’re more interested in helping themselves than they are in helping you.

Jim

 

Jim Lorenzen is a Certified Financial Planner® professional 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 provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here.  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.

Member - Retirement Plan Advisory Group

The Retirement Plan `Shell Game’

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

I thought you might like hearing about an actual case history related to me by another advisor.  The names are unimportant because the practice is so widespread, you could probably substitute any number of the usual suspects.

A rep from a well-known, big-name insurance company called on an employer and talked him into transferring his plan and allowing the company to bundle everything for him.   `Bundling’ means the three main plan functions could all be packaged together by the insurance company:  Recordkeeping, administration, and investments.   In an unbundled plan, the three functions are performed by independent providers, usually under the watchful eye of an independent plan consultant, which provides the employer – our plan sponsor – with a system of ‘checks and balances’.

The reason for the change?  Well-known investment options and it would be cheaper!  In fact, for the employer, it was practically free!

The tooth fairy lives.

How did they do it?  The funds in the investment line-up were all ‘load’ funds and carried 12b-1 fees.   This is where the lack of oversight reveals itself.  The insurance company rep is the investment salesman as well as a salesman for the record keeper and administrator.  There’s an incentive to choose funds that charge 12b-1s because they traditionally pay revenue-sharing out of those 12b-1 fees back to the administrator, reducing the amount that the administrator has to charge the company or the plan!   

But, there’s more.  Quite often, as was the case here, the insurance company also charged a wrap fee, which is not part of the 12b-1 and almost always hidden.  Even though not all the 12b-1 fees went to revenue sharing, most of it did, as well as the wrap-fee!   What’s worse, the amount of the 12b-1s that didn’t go to revenue sharing was not being returned to the participants in the plan!

All of this was accomplished so that:

  • The representative could make greater commissions without having to charge the employer or the plan,
  • The employer could move to a `cheaper’ plan – it actually turned out to be more expensive, and
  • The insurance company could make more money since the revenue-sharing hid the true cost of providing needed services, at the expense of participant’s retirement returns

Okay, what’s wrong with this picture?   Back in my management consulting days, if I chose a client solution based on the amount of hidden compensation a third party paid me, that would be called a ‘kick-back’.   Even disk jockeys know what payola is… and choosing investments based on the kick-back to service providers isn’t much different.

How about our employer!  He made an investment line-up decision affecting the participants’ retirement returns simply in order to reduce his own costs.   I’m no lawyer, but that smells like self-dealing to me and could be regarded as a prohibited transaction!

Our employer, by virtue of his decision to choose the insurance company and their funds, was acting as a fiduciary; and, under ERISA is required to act solely in the best interest of the plan participants and for the exclusive purpose of providing retirement plan benefits.  The key words are ‘solely’ and ‘exclusive purpose’.  That means just what it sounds like. 

Do you suppose that employer’s documentation will stand-up under fire?  

Does what our employer did sound like he fulfilled his fiduciary duty to you?

You know he’s trusting his vendor to `take care of everything’.  Wait ‘til he finds out the insurance company’s ERISA attorney works for the insurance company and not him.

No wonder brokers and agents don’t want fiduciary status; and, despite all the marketing material, are actively fighting the DOL and in congress to remain free of it.

Wait ‘til the employer finds out:  He’s a fiduciary.  His vendor isn’t.  And, he’s the one who will have to produce his own documented process for choosing the provider.

Wait ‘til he finds out he actually had the low cost solution before the change!  All the appropriate expenses were being paid by plan participants and the plan, anyway – and without the added drain of all the ‘kick-backs’.

How do you think your plan would ‘score’ on the fiduciary scale? 

When was the last time you had your plan benchmarked for all three main plan concerns:  (1)  fees and expenses, (2) services, and (3) investment line-up?

Smart plan sponsors are looking into this now – before the disclosure rules take effect and employees begin banging on the door.

Jim

 

Do you make decisions regarding your company’s retirement plan?   Stay ‘in the loop’ with Jim’s Retirement Plan Insights!  You can subscribe here!

 

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 provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors.  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.

Contributing To A 401(k)? Count Your Blessings!

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

Particpants in company 401(k) plans may be in the best market they could hope for! 

Yes, you read that right.  It was just about one year ago when I showed the math on why investors who don’t quit can win, even if the market goes down and only gets back to even!  You can read that post here.

Unfortunately, they don’t teach investment literacy in school; so, most plan participants know only what they see on the financial entertainment shows or in one of the consumer publications.   But, make no mistake about it, this is the time participants shouldn’t quit, especially if your employer is contributing for you with some kind of match!

Tune out the noise!  Just keep on contributing!  And, don’t try to pick winning stocks.   A good mix of low-cost indexes will likely do just fine.  Remember, studies show most investors can’t even tie an index, much less beat it – and that includes the so-called professionals!

Questions?  Talk to your plan advisor or to your personal advisor.  Of course, if all else fails, you know where to find me.

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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 provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors.  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.