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Financial Opinion and Insights

Archive for March 2012

Principal plus Interest or Total Return

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

All our lives we’ve been told things like, `save the principal and live off the interest’, and `protect your principal and invest the interest’.  It may have even come from your parents; I know I remember mine saying it; but, then, they never learned much about risk management, asset allocation, or the financial planning process.  In those days, financial planning as a profession wasn’t even in its infancy!

But, old chestnuts like that are hard to shake.  

The principal and interest concept does, of course, have some relevance to the debt side of the ledger, when you’re loaning your money, i.e.,  to banks (CDs), government entities (muni-bonds, treasuries, etc.) or corporations (corporate bonds with various safety ratings).  You loan them money and they pay you interest until they return your loan.   But, here’s what you need to know:

No liquid investment alternatives with stable guaranteed principal values exist that can provide real returns by consistently beating the combined impact of inflation and income taxes.

–       Roger C. Gibson
Asset Allocation, 4th Edition 2008, McGraw-Hill

When you ‘loan’, you’re not buying equity.  When you buy equity, you’re engaging in a long-term strategy designed to preserve and/or increase your purchasing power, after taxes, over time.  The key words:  Over time.  You didn’t buy real estate for a six-month hold, did you?

So, do we look at a portfolio composed of debt and equity as two isolated components?  Not necessarily.  Unfortunately, too many investors view their investments at the investment level, i.e., “I bought XYZ at $50 and I want to make sure I protect my $50 position in that investment!”   That’s a process that quickly degenerates into ‘market timing’ which doesn’t work consistently even for the best professional investors.  I’m not sure even Cramer’s picks have done that well consistently.

A better approach is to view investments at the portfolio level, recognizing that risk-adjusted ‘total return’ – a combination of price movements and dividends – is the long term objective of the entire portfolio, not its components.    Have you ever noticed that when someone buys an investment at $50 and sells at $75 to invest in another alternative, the proceeds from the $75 sale become the new `principal’, not the money originally invested at $50?

Most individual investors might be shocked to learn that a simple, low-cost, allocation among well-chosen indexes weighted for the investors’ objectives, timelines, and risk profile – and this would be true even for larger portfolios – would probably perform just as well, if not better, than all the supposedly sophisticated choices they made at higher costs. 

Next time you review your portfolio, take a portfolio-level view of return and volatility over different time periods and determine if both are consistent with your long term objectives and comfort level.  If you need to make changes, chances are you’ll be making a portfolio-level allocation decision; rather than an investment-level buy-sell decision which would likely have less than a 2% impact on your future success or failure.

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®

March 27, 2012 at 8:00 am

Procrastinating on Long-Term Care Insurance?

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

That may be a mistake!

Although I no longer sell insurance, I’m a firm believer in the product, particularly the two big ones most people spend little time thinking about:  Life and Long-Term Care.

 I’m fond of telling 40-somethings they should be buying long-term care for their parents – while they can – to protect their inheritance.  

In our own family, my wife and I have been caring for a parent afflicted with Alzheimer’s for more than seven years, with the help of a full-time live-in caregiver who has become part of our family.   My first impulse was not to disclose our financial ‘hit’ to the world, I realized that it might be important – especially if by doing this even one person takes action to protect his or her family.   When you add-in all costs – and they do go beyond the caregiving itself – they have run close to $70,000 per year – it’s not deductible and not covered by Medicare.   You can do the math. 

If you haven’t done the math, you can rest assured the insurance companies have been doing it – and they underestimated their risk.

Here’s what you need to know:  A recent Bloomberg piece noted that Prudential Financial Inc., the second-biggest U.S. life insurer, said it will halt the sale of individual long-term care policies, joining rivals in retreating from the industry.  Prudential indicated it will continue to offer group long-term care insurance, and existing contracts are guaranteed renewable and won’t change.

Other insurers, including CNO Financial Group Inc. have also been burned: They underestimated the number of claims, the cost of care or the life expectancy of their clients.   MetLife Inc., the No. 1 U.S. life insurer, said in back in 2010 it would also stop sales of new long-term care coverage.

Prudential, MetLife, CNO, and other companies simply “can’t price the product appropriately, and instead they’ve decided to exit the business.”

Deterioration in long-term care business pushed Unum Group into a $425 million fourth-quarter loss and prompted the Chattanooga, Tennessee-based insurer to announce its exit from sales of the products to groups.

The lesson in clear:  If you can get it, you might want to get it now.

Written by Jim Lorenzen, CFP®, AIF®

March 20, 2012 at 8:00 am

Avoiding The Crooks

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

Protecting Yourself Isn’t That Hard

First, some background:

Remember Allen Stanford?  Maybe you don’t; but a lot of people do.  He was convicted last week of running a $7 billion Ponzi scheme.  So what else is new? 

He was found guilty on 13 counts of a 14-count criminal indictment, including fraud, conspiracy and obstructing an investigation by the U.S. Securities and Exchange Commission.   According to a Reuters report. “The Stanford case was the biggest investment fraud since Bernard Madoff’s.”

Stanford, who was head of the now defunct Stanford Financial Group, based in Houston, was charged on Feb. 17, 2009, by the SEC with fraud and other violations of U.S. securities laws for his $7 billion Ponzi scheme that involved supposedly “safe” certificates of deposit. His personal fortune was once valued at $2.2 billion.

Besides Allen Stanford and Bernie Madoff, there have been lots of others – all you have to do is turn on the tv and watch American Greed to see the laundry list – people who make it pretty difficult for those who try to do things the right way.

So, how do investors protect themselves?  Here are a few short, simple rules that would have saved a bunch of investors had they followed them:

  1. ‘Too good to be true’.  You know this one – who doesn’t?  Just remember this:  Everyone who invests in registered securities is investing in the same marketplace.  No one has a special ‘in’ or ‘deal’ that no one else has.  If the investment is unregistered, i.e., a private transaction, then independent due diligence is crucial.   Remember, there’s swamp land everywhere. 
  2. No independent custodian.  A custodian is the firm or institution that actually holds your money, i.e., they have custody of your assets.   If you’re working with an advisor from a major Wall Street firm, the firm will likely be the custodian and that shouldn’t be a problem.  However, if you’re dealing with an independent advisor or advisory firm, which more and more people are opting to do, `Who has custody of my money?’ becomes a relevant question.  For example, my firm is an independent Registered Investment Advisor; but, we don’t take custody of client assets.  While we can use any number of custodians, we generally use Pershing, which is owned by Bank of New York-Mellon (BNY-Mellon).  It’s an arms-length relationship and we receive no compensation from them; nor do we have access to client money.  Our clients’ money is in their own accounts in their own names.   One thing Bernie Madoff, Allen Stanford, and others all have in common:  They had custody of client assets.  Checks were made out to their firm.  They were able to put their hands in the cookie jar.
  3. Internal money managers.  This isn’t necessarily bad; but if your independent advisor has custody of your money and is providing the management, too, it’s worth asking more questions.  For example,  in my practice we use no-load mutual funds, ETFs, and, where ongoing management is required, we use independent third-party managers.  The managers are paid a fee directly from client assets on a fully disclosed basis.  We do not share in the managers’ fees, nor does any other service provider.
  4. Lack of independent reporting.  Again, if your working with a major Wall Street firm, this shouldn’t be a problem; but if you’re working with an independent advisor, you should ask, “Who generates my reporting and what kind of reporting to I receive?”  This doesn’t mean that firms providing their own reporting should be considered suspect, but it should be viewed in light of the other answers.  For example, our client’s assets are held at Pershing, but the reporting is handled by an independent third party who is paid directly from client assets on a fully-disclosed basis.  We do not share in their fees and they do not receive compensation from the managers they cover or any other service provider.    The crooks we all hear about seem to custody the assets, manage the money, and create their own reports.   And, finally….
  5. Independent due diligence.  Is due-diligence provided by the firm selling the investment?  This process should not only be independent, it should be provided by a firm without a stake in the outcome and provided by an advisor in a non-sales environment.  For example, manager due-diligence is provided by an independent third-party for our clients.  The third party is not compensated by the managers they cover and all of our work is done in a fee environment, i.e., compensation does not vary based on investment selection.  Guess what our crooks did?  Yes, they provided the due-diligence to go along with the reporting, custody, and management.

How convenient for the crooks!  I’m sure I left a few things out; but, this short 5-point list should be a good starting point for anyone worried about getting taken.  Again, remember that no single answer should be determinative; but, all the answers taken together should form a picture.

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®

March 13, 2012 at 8:00 am

Fund Expenses Do Matter

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

For the Up-Teenth Time…..

You’ve just been introduced to the Acme Tactical Strategic Allocation Contrarian Fund of Funds with an overlay manager who monitors the other managers to make sure the overall fund objectives are met.

Run.

They’ll very probably meet their fund objective okay:  To make money on layers of fees extracted from investor assets.

I’ve always been a little suspicious of funds with long names that contain words like ‘strategic’, ‘tactical’, etc.  I think they charge by the word, but I could be wrong.

These funds will usually have all the typical fund fees for each fund, and often have an additional wrap fee that’s `wrapped around’ all the funds inside.   So, hypothetically, the internal funds could have, say, 1.5% in expenses, wrapped with another 1% or more in overlay fees.   In a case like that, you could be looking at 2.5% or more in total costs!

Did your advisor recommend this fund?  How about advisor compensation?  Oh, it’s included?  Where?   Why?  Why didn’t the advisor simply construct a blend of low-cost index funds for the core of the portfolio and use an active manager for a small portion for return enhancement?  That would have been a lot cheaper, and without getting into risk management theory, would have accomplished most of the same objectives!

Even if the blended indexes representing this exotic offering achieved a return of 10% in its first year, the offering’s underlying portfolio would have to achieved 12.5% just to tie the indexes.  Remember, a 2.5% premium on a 10% market represents a 25% outperformance.  Not as easy as 2.5% makes it sound.

Yes, I think the fund objectives will be met.

But, will yours?

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®

March 6, 2012 at 7:55 am