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Archive for February 2012

Smart Investors Think Long Term – And Know What Questions To Ask

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

According to a Morningstar study I saw that was conducted in 2010, the odds for those trying to `time the market’ didn’t look too good – and I doubt they’ve improved much – but there are still a lot of financial tv shows picking stocks for all of us.  Are they doing us a favor? 

Anyway, the study I saw analyzed the cost of market timing using the S&P Index over the 10-year period of 1990-2009 inclusive, which comprised 5,044 trading days.

An investor who stayed invested during the entire period would have experienced an average annual return of 8.2%.  Hmmm, didn’t that include the period of the 2008 market meltdown?   But, I digress.  Here’s what the study found:

· Missing only the 10 best days reduced that percentage to 4.5% – almost in half!

· Missing only the 20 best days meant realizing only a 2.1% average annual return for the entire ten-year period!  Returns were cut in half again… and 75% less than the investor who stayed invested!

· Missing the 30 best days meant an average annual return of only 0.1% – for the entire 10-year period!!!  It’s worth noting that those 30 best days may not—and probably didn’t—run consecutively, which makes it even more problematic.  Can YOU guess those 30 days—in advance?

· Missing the 40 best days meant a return of –1.8% as an average annual return for the entire 10-year period; and missing the 50 best days took that percentage down to –3.5%

Other studies I’ve seen show that individual investors do underperform indexes by a wide margin!  The reason seems to be because they react to current events.   One CFO I talked with told me he constantly sees people ‘get out’ after drops only to be left there during rebounds!

Why do they do this?  Maybe because they simply don’t have an investment discipline.  It becomes too easy to react to headlines.   The next time someone tells you they manage their own portfolio, ask them, “If you had a choice of ten managers – nine professional institutional money managers and yourself, would you pick you?  Would anyone else?”

Oh, well.   But, choosing an advisor can be dicey, too.   Smart investors, however, do ask smart questions. 

Here’s a sample set of screening questions you can use.   Ask your potential advisor to answer them in writing before you begin your discussions.   For example:

  • Are you a registered investment advisor, a registered representative, or both?

       Note:  A registered investment advisor (RIA) works for fees.  A registered representative works on commission.   Some `advisors’ are `dually’ registered.   A registered representative (broker) is free to operate under a `suitability’ standard while an RIA is legally required to work under a `fiduciary’ standard, which means the client’s best interest must be paramount.   `Dually-registered’ representatives will often adopt the fiduciary standard for the planning process, then adopt the `suitability’ standard when it comes time to select investments.  Under that standard, an investment may not be in the client’s best interest; but, if it’s suitable, it passes.

  • Do you work for fees only, commissions only, or a combination?

       Note:  If a combination, you want a breakdown on each.  When does the `fiduciary hat’ come off and the ‘suitability hat’ (commissions) go on?  Some adopt fiduciary status for planning but switch to the ‘suitability’ standard when it comes to the investment process.

  • Do you accept fiduciary status and are you willing to put it in writing?

       Note:  If your candidate isn’t willing to accept fiduciary status in writing – for both planning and investments – one has to wonder just what you’re paying them for.  Chances are it might be simply product sales.

  • Who provides the reporting on my account?

       Is it his own firm?  That’s not necessarily bad, but it’s worth knowing.

  • What firm will serve as custodian of my assets?

       His own firm again?  Again, not necessarily bad, but again worth knowing.  If it’s one thing all the `bad guys’ have in common, it seems to be the lack of an independent custodian.  If a firm has custody of your assets, does the managing internally, and also provides the reporting, where are your checks and balances?  Where is your independent verification?   All those so-called sophisticated investors who lost money to Bernie Madoff and every other crook could have asked this simple question.

  • Are the managers you recommend in-house managers or outside managers?

His own firm again?  Hmmm.  Be careful.  Sometimes a ‘proprietary’ solution won’t transfer so easily if you decide to move to another advisor.  When was the last time an `in-house’ manager was fired in order to use an outside manager?  Thankfully, this isn’t as much of an issue today as it used to be – I don’t think; I’ve been away from that environment for some time now.

Spotting a good advisor shouldn’t be too hard:  A good one will focus on you and not the markets.  S/he will talk about process and risk management and take time to learn about your issues and concerns.

A bad advisor – or worse, a rogue – will focus on investments, returns, and markets.  And, s/he’ll love if you should ask, “What kind of return do you get for your clients?”  That’s a question Bernie Madoff loved to hear.   Only novices and `marks’ would ask it.

Smart investors take a high-level view of portfolio makeup, knowing an 80-year old retiree has a financial and risk profile completely different from a 45-year-old high-earner who’s trying to accumulate assets for the future. 

Remember, success isn’t about being brilliant; it’s about being smart –  and the definition of smart is not being dumb.

 

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.

Market Swings: Good or Bad?

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

It depends.  If you’re a retiree seeking a dependable income stream, it may actually depend on the size of your asset base.  Those with modest portfolios will likely need some long-term allocation to equities simply to keep pace with inflation, while those with very large portfolios may not have inflation issues to worry about – Let’s face it, Bill Gates isn’t worried about inflation.

But, for most us Americans still working in the real world, we’re still trying to grow our assets long-term to provide for a secure future.

For those still contributing to their company retirement plans, market swings can actually be your friend!  Unfortunately, too many plan participants seem to be unaware of the opportunities these swings represent since their contributions can buy more shares during the dips and just before markets recover, as they always seem to have done so far.

The February issue of Financial Planning contained a chart from ICON Advisors that illustrates economic conditions at various market peaks and the subsequent returns.

Here’s a brief sampling from the eighteen periods they cited:

Surrounding Conditions Year Subsequent S&P50052-week return
Post 1929 Market Crash 1929

-9.9%

Depression Market Bottom 1932

40.3%

Pre-Cuban Missile Crisis 1962

19.2%

Recession Bear Market Bottoms 19701974

1982

27.6%

33.5%

19.2%

Post 1987 Market Crash 1987

15.2%

Technology Bubble Break 2000

-12.3%

Recession, Financial Crisis Low 2009

22.6%

European Debt Problems 2010

24.4%

European Debt Problems, Round 2 2011

????

As I indicated, ICON’s table included 18 different market conditions.  The best recovery came after the Great Depression market bottom at 40.3%; the worst came after the terrorist attacks in 2001, at -18.9%.

Their conclusion:  Using the rear-view mirror to reduce volatility may risk long-term underperformance.  Remember, those who are recognized as America’s most successful investors seem to have one thing in common:  They tune-out the `white noise’ of the media and invest in quality for the long term.

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 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®

February 21, 2012 at 8:00 am

Preserving Retirement Plan Assets

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

Help Preserve Your Retirement Assets by Taking Smaller Distributions

But, watch out for the order of returns…. More on that later.

Let’s imagine you own two pots of money: The money that has already been taxed (let’s call it “regular money”) and the money that has not been taxed (let’s call this “retirement money” such as IRA, 401k, 403b, etc.). When you spend a dollar of regular money, the cost to you is exactly $1. When you spend $1 of retirement money, the cost to you could be as much as $1.54[1] (1/.65) because you may have to pay off federal income tax on the amount you withdraw. Therefore, if you want to reduce your taxes, consider not taking more than the required distribution from your retirement money.

Some people think they should never spend their principal, but this can be a mistake if you want to save taxes. It could be better to spend some of your regular assets first, so that you can take advantage of the tax-deferral benefits associated with IRAs and qualified retirement plans. You could be better off financially from an income tax standpoint. Your lifetime tax bill can be less or you will at least defer taxes for many years.

Consider the following hypothetical example that assumes you have a taxable regular money account and a tax-deferred retirement account with a $100,000 balance each. Let’s assume the money in each account earns a return of 6% per year. Let’s further assume that annual distributions of $6,000 per year are being taken for a 20-year period.

Under one scenario, the $6,000 will be taken first from the taxable money and the other scenario considers what would happen if the money was taken first from the qualified money. Under this example, you would have $150,000 more at the end of 20 years by spending your regular money first. The upside is that you could potentially hold onto more money while you are alive.

Of course, the down side is that your beneficiaries will eventually have to pay income taxes on the money when you are gone. As the information provided by this example is hypothetical, actual results will vary depending upon the performance of your investments.[2]

 

Today

In 20 Years

Spend Regular Money First
Regular Money

$100,000

$40,916

IRA Money

$100,000

$320,713

TOTAL

$200,000

$361,629

Spend IRA Money First
IRA Money

$100,000

$0

Regular Money

$100,000

$211,247

TOTAL

$200,000

$211,247

 

Spend Regular Money First

Assumptions: All money is assumed to earn 6%. This assumed rate is used for tax illustration purposes only and does not reflect any particular investment. Federal income taxes are assumed to be 35% in this example, and your income tax rate could be lower based upon your annual income. This illustration covers a 20-year duration, with distributions of $6,000 occurring each year. The income taxes on withdrawals are also deducted from the IRA account.

Now that I’ve told you all this, you should beware of easy answers.  Few investors earn a constant rate in their retirement plans throughout retirement simply because they’re in mutual funds, not long-term fixed income instruments; and the ‘order’ of returns can have a huge impact on outcomes during the withdrawal phase of your retirement. 

Average annual return is just what it means:  It’s an average.  

Here’s a `pitch’ you will sometimes hear:  If you achieve, for example, an 11.6% (purely hypothetical percentage) average annual return over ten years, you can withdraw the same percentage, 11.6% in our example, annually and still have your principal intact!  Is it true?  Unlikely.    Only problem:  Returns don’t come at 11.6% every single year.  Investments have fluctuations!

You can take any fluctuating series of returns that comes out to an average annual compounded 11.6% return over ten years while withdrawing 11.6% each year and then reverse the order and you’ll get two entirely different outcomes! One may have made money and the other very well might reveal the investor went broke! 

So, while withdrawal principles like the one I talked about at the beginning of this post are interesting, what they really are is worth discussing with your advisor who, hopefully, is a CERTIFIED FINANCIAL PLANNER® professional.

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.


[1] Federal income tax rates range between 10% to 35% under the 2010 federal tax code, and are based upon the taxpayer’s level of annual income. State income taxes could also apply, which vary from state to state. Please note that federal and state tax laws are subject to frequent changes.

[2] The fact that the beneficiaries are going to pay income taxes at a later date could be an advantage if they are in a lower tax bracket. As previously explained, estate taxes could also apply if the decedent’s estate exceeds $1 million after 2012.

Written by Jim Lorenzen, CFP®, AIF®

February 14, 2012 at 8:00 am

Plan Sponsors Guide To The Ideal Plan Structure

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

Everyone hates report cards; but, without them, we’d never know how we stand against expected standards of conduct.

When it comes to a corporate retirement plan sponsor’s fiduciary responsibilities, failure to know where one stands can result in serious consequences.

How do you know when your plan structure is ‘best-in-class’?  Northern Trust in their October 2010 study  identified “Characteristics of Ideal Plan Structure”.     Their findings cab help plan sponsors identify and remove headaches before they begin.

A true fiduciary MUST act SOLELY in the best interest of plan participants and for the EXCLUSIVE purpose of providing retirement plan benefits.    I’ve capitalized the key words for a reason:  They’re critical… and they apply to plan sponsors who make decisions on their company plans… they also affect anyone else doing the same thing.

Recognizing the difference between a true fiduciary advisor and a vendor rep is key.  Patrick C. Burke, Managing Principal of Burke Group, a retirement, actuarial and compensation consulting firm in New York stated in a recent  interview for Fiduciary News,  “Bundled providers’, brokers’, and financial intermediaries’ operating models cannot be considered best-in-class due to their inherent and unsolvable conflict.   This would include any RIA who participates in a revenue sharing or 12b-1 compensation package. They are primarily in the investment business which excludes their ability to be conflict free, a basic requirement of any plan sponsor that desires to achieve best in class status. These firms are the classic example of a fox in sheep’s clothing.”

Think 12b-1 fees and revenue sharing are unimportant?  You need only follow the money.  If providers are being paid from the revenue sharing of those 12b-1 fees, what are the chances a fund paying revenue sharing will be replaced with a low-cost, true no-load fund that charges no 12b-1 fees or pays revenue sharing?    Unfortunately, far too few plan sponsors are even aware of this issue’s seriousness or the extent of their personal liability. 

I even heard one exclaim, “I’ll take my chances.”    I once heard another say, “Our advisor isn’t a fiduciary on the plan…”, as if this was a good thing. 

Still another once said to me, “We provide a huge selection of funds…”, and in the same breath said, “we don’t worry about providing investment education.”  

Does that sound like a fiduciary to you?    If a vendor doesn’t want to take fiduciary status, the question has to be, ‘Why not?’ 

Back to planet earth. 

Burke, among many other true fiduciary advisors advises plan sponsors to have a Fiduciary Report Card completed by an independent, outside, non-conflicted plan consultant.  This approach helps  plan sponsors focus on “best in breed” service providers and also helps create evidence of a true fiduciary process.

Fiduciary Report Card Topics:

1) Regulatory Compliance

2) Independence of Providers – Vendor & Provider Conflicts of Interest;

3) Integrated Investment Policy Statement (IPS)

4) Documented Investment Due Diligence and periodic provider benchmarking

5) Trustee and Participant Education.

If you haven’t addressed these issues in the past twelve months, this might be the time to do it.   Those who are depending on their retail vendor-driven providers for new disclosures might find themselves scrambling to play catch-up later.

You may want to contact an ERISA attorney and an independent plan consultant.   I’m not an ERISA attorney; but, I think I might know a plan consultant…. if I can just think of his name……

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.

Written by Jim Lorenzen, CFP®, AIF®

February 7, 2012 at 8:05 am