Jim'sMoneyBlog

Financial Opinion and Insights

Archive for May 2012

Does Diversification Really Help?

The Independent Financial GroupApparently it does!  Of course, that comes as no surprise to us financial types who’ve been preaching that gospel to anyone who would stop in front of our soap box; but, it’s still worth taking a look at this chart, supplied to us by the folks at JP Morgan Asset Management.  While some asset classes seem to have done better than others in a number of years, none of them have consistently outperformed the others and, indeed, a few have been all over the map.

Obviously, predictions can be difficult, especially when you try to make them in advance – take that, Yogi Berra!

 JP Morgan Chart-AssetClassReturns_3-31-2021

Besides the unpredictability of the markets, there is another lesson we can see pretty clearly:     Diversified portfolios, connected here to highlight their volatility, seemed to provide a smoother ride.  No surprises here.  Allocated portfolios apparently were never the stars, but they never seemed to be the ‘dogs’ either. 

The lesson seems clear:  Those who have diversified seem to sleep better at night.  The reason is simple:  It’s hard to buy back losses.  For example, if a stock drops from 100 to 80, that’s a 20% loss.  But, to get from 80 back to 100 requires a 25% gain!   If it takes a 25% gain to offset a 20% loss, it naturally follows that reducing volatility can be important to successful portfolio management. 

The right diversification can do wonders for reaching long term goals.  It’s just a matter of resisting short-term temptations.

Jim Lorenzen, CFP®, AIF®

—————–

Jim Lorenzen, CFP®, AIF®Jim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st 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 has no financial relationship with any investment service or provider.  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. 

Additional IFG Links:

IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  IFG does not provide legal or tax advice and nothing contained herein should be construed as  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®

May 31, 2012 at 8:00 am

Data Shows Investors Chasing Returns

Ever since the credit meltdown, investors seem to have been doing what they’ve historically done after most major market turns:  Reacting to headlines. 

During the previous period of `irrational exuberance’, as former Fed Chairman Greenspan referred to it, everyone seemed to be talking about their stock buys or learning to `flip’ houses; but, since the meltdown, gold commercials have been filling the airwaves as investors, many of whom say they are ‘long-term’, have been leaving the stock market.  Those still investing say they are seeking high-dividend stocks, which they consider safer.

Are those seeking safety in gold or value stocks right?  Or, are they just chasing the latest fad?  Does market data confirm their actions… or are individual investors getting it wrong again?

To learn more about this, we’ve called on the folks at JP Morgan Asset Management to supply us with some recent market data, which you’ll hopefully find interesting, if not enlightening.

As you can see, since 2000, there have been only four years when there were net inflows into mutual funds; and, as the chart shows, people exited during the 2008 downturn, and continued exiting even as the market has been recovering.

Meanwhile, as you can see, money has been flowing into bond funds, presumably chasing increasing valuations, despite the fact it also meant declining yields. 

 JPMorgan Chart_MutFundFlows_3-31-12

But, has all this performance-chasing done any good?    You can  see our entire take on this in our eZine for individual investors.   To subscribe, you can use the eZine Sign-Up link on this page.

 Enjoy!

Jim Lorenzen, CFP®, AIF®

—–

Jim Lorenzen, CFP®, AIF®Jim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st 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. 

 

Additional IFG Links:

 

IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  IFG does not provide legal or tax advice and nothing contained herein should be construed as  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®

May 29, 2012 at 8:00 am

Think You’ll Spend Less in Retirement? Really?

IFG BlogConventional wisdom:  When you retire you’ll be spending less.  You’re not commuting and you won’t need clothes for work; so your financial needs in retirement will be less.

Not my experience.

I’ve been helping people plan for, and manage, retirement for more than twenty years, and here’s what I’ve learned:

When people retire, they have time to do all the things they’ve been wanting to do for years:  Travel, play golf, visit family and spoil grandkids, take classes, start new hobbies… you get the idea.

Advisors – me included – have been preaching the 4% rule:  “You probably don’t want to take more than 4% of your initial assets, plus a cost-of-living increase, each year you’re in retirement.   It’s a mantra we all have preached.

But, people are living longer and there’s a factor many haven’t considered:  Inflation.

Yes, we did address cost-of-living increases in our 4% distribution formula; but, there’s more that hasn’t been addressed, even by yours truly!

Some time ago, I wrote a paper, ‘Why Investors Fail’, in which I addressed the `order of returns’ as a significant factor in retirement success.  I was by no means the first to talk about this and I certainly didn’t discover it.  But my discussion of the order of returns was limited to the investments.  It applies to inflation, too!

Bob Veres, writing in the current issue of Financial Planning, pointed out something interesting:  Inflation tends to strike retirees harder than preretirees.  The biggest reason:  Health care costs are rising faster than the inflation rate!  But, adding to the mix is the concern about withdrawal rates and their relationship to inflation.

Jim Otar, a Thornhill, Ontario-based financial analyst and planner, conducted a study of withdrawal rates over 111 years.  The results, cited in this month’s Financial Advisor, shows that the sequence of returns and how much prices move up and down contribute 32% to the total return of a portfolio and inflation can contribute 21%, with asset allocation and management making up 31%.   So, the order of inflation numbers, combined with withdrawal rates, can have a significant impact on how long money lasts!

The insurance industry, of course, has been jumping on this issue for some time offering guaranteed future or ‘longevity’ income annuities to ease investors’ worries.  Indeed, many planners are beginning to include these products in their planning for clients; however, there are some drawbacks everyone should consider, including their high internal costs, surrender charges, and high sales commissions – all paid by the purchaser.  Another concern is the risk that the insurance company could fail!  We’ve seen what’s happened in the credit markets before.  If an insurer fails, the policy holders would be subject to the payout limits and state insurance guaranty associations.

Another consideration:  Immediate annuity income won’t likely keep pace with inflation, even with cost-of-living adjustments.  And, government COLA data doesn’t include food or energy, and I wouldn’t put it past them to factor out health care before long.  The old-fashioned approach of simply diversifying assets among asset classes, using low-cost vehicles, according to age and risk tolerance, and using dividends and capital gains to meet income needs, as well as retirement plan distributions is still, in my opinion, the best way to keep your money for yourself instead of making the product sellers rich.

——————–

Jim Lorenzen, CFP®, AIF®Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 21st 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.  Additional resources:   IFG Investment Blog. Retirement Plan Insights Archive.

Twitter:  @JimLorenzen.

Why Would Anyone Buy A Bond Fund?

IFG BlogThat’s a question a few professionals have asked, including Fidelity’s star former manager, Peter Lynch, in his book One Up On Wall Street.    It’s a valid question, too.  Individual bonds do have some advantages:

  • Individual bonds have a maturity date.  Regardless of market swings and valuation changes, you know what your bonds will be worth on their respective maturity dates.  So, if you’ve ‘laddered’ intermediate bonds, you know each will mature at face value – a strategy that can provide some comfort, since it can alleviate concern over valuation changes prior to maturity. 
  • Gains are realized only when taken, which is true for virtually all individual securities in taxable accounts.  A mutual fund, however, is a ‘pooled money’ vehicle.  When a fund takes a gain on a position, you pay your share of the freight on the fund portfolio’s entire gain for that position, even if you’d been a shareholder for only a day!  The reason:  you didn’t’ own that security; the fund did, and you are a shareholder in the fund, not the position.
  • Direct ownership can lessen the impact of other investor trades.  Think of it this way:  When – I say `when’ because it’s bound to happen at some point – interest rates begin to rise, bond values will begin to decline.  As those values – the fund prices investors see on their statements – begin to fall, you can expect many bond fund investors to begin selling their shares.  When they do, fund managers are forced to sell-off bond positions to raise money in order to meet redemption requests from selling shareholders.   That means they’d be selling when prices are heading lower… the very time they’d likely rather be buying!   When fund managers sell-off with block trades, common sense tells you there has to be a ‘market impact’ cost attached.  Owners of individual bonds aren’t forced to sell due to market swings when their purchases were made with a maturity date in mind because, as we said earlier, those bonds will mature at face on a date certain.

So, if individual bonds seem to offer some distinct advantages, do bond funds ever make sense in a portfolio?  You could probably ask ten different advisors and get ten different answers; so, for what it’s worth, my humble opinion is as follows:

While there is some obvious knowledge, skill, and talent attached to the selection of and management of domestic and foreign bonds, in terms of credit quality, etc., particularly where longer maturities are involved, most serious individual investors aren’t trying to beat the bond markets.  Their larger concerns revolve around either dependable income, risk mitigation, or some combination of the two.  

For the most part, particularly when it comes to what individual investors care about, bonds are what they are.  A Treasury is a Treasury.  For dependable income and risk mitigation, it’s hard to beat owning bonds directly.   But, for most people trying to achieve long-term goals, there is one alternative worth consideration in certain types of accounts.

While you might continue to use individual bonds in taxable accounts for reasons cited above, you may want to consider some sort of low-cost pooled vehicle in your tax-deferred accounts, i.e., 401(k)s, IRAs, etc.   The reason is simple:  It’s hard to rebalance your overall asset allocation with individual bonds.   Who wants to sell-off individual bonds and rebalance into equity or vice-versa?  It’s cumbersome and can be quite costly.  There’s an old saying in the bond market:  Buyers buy the market and sellers pay the freight.  There’s a better way:  Usef low-cost, no-load bond index funds or exchange-traded funds (ETFs) to fill-out your bond allocation and provide an easier vehicle for periodic rebalancing.  Costs are low; you’re in a tax-deferred vehicle; and you’re managing more efficiently for risk mitigation.

 

Jim Lorenzen, CFP®, AIF®Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 21st 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.  Additional resources:   IFG Investment Blog. Retirement Plan Insights Archive.

Twitter:  @JimLorenzen.

Written by Jim Lorenzen, CFP®, AIF®

May 22, 2012 at 8:00 am

“I’m from the Government and I’m Here to Help You.”

The same people that have been spending your money – some say with a tremendous amount of waste built-in to help guarantee reelection back home – now seem to be talking in the hallways – the first step before talking ‘out loud’ in a committee room – about another way they can raise more money to fund more future spending.

Of course, they won’t be talking out loud before the election; but, there are a few who would like to tax your 401(k) – because, as we all know, apparently it’s only rich people who are investors.  How?  By eliminating deductions and reducing contributions, or some combination thereof.

According to ERISA attorney, Ary Rosenbaum, these proposals in the whispering stage (my description) include:

  1. Capping retirement-plan contributions at $20,000 a year or 20% of compensation, whichever is less-including employer contributions. Currently, the limits are 100% of compensation or $50,000 a year.
  2. Replacing deductions for retirement savings with an 18% tax credit, deposited directly into an individual’s retirement savings account.
  3. Accelerating “automatic enrollment” of workers in retirement-savings plans, along with their default savings rate, and automatically increasing workers’ savings rates each year.
  4. Simplifying the paperwork involved for small employers’ adopting existing types of plans, with the goal of increasing access for more workers.

Actually, #3 and 4 would make some sense.  Most Americans are woefully unprepared for their old age; but, #1 and 2 may be rather short-sighted.  Sure, there’s the up-front revenue generation; but, it’s important to remember that tax-deferred growth is ultimately taxed.  It would seem that a `money grab’ now might just result in a lot less revenue later; but, then, how else could they possibly get reelected?

——————Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 21st 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.  Additional resources:   IFG Investment Blog. Retirement Plan Insights Archive.  Twitter:  @JimLorenzen.  See IFG on Brightscope.

 

Written by Jim Lorenzen, CFP®, AIF®

May 17, 2012 at 8:00 am

Converting Savings to a Lifetime Income

Jim Lorenzen, CFP®, AIF®

It seems there are more stories in the financial press today concerning people being afraid of outliving their money.  Who can blame them?   And, this concern isn’t confined to just the poor or middle class, either!  Believe it or not, the mass affluent and even the wealthy are concerned, too.  After all, it doesn’t do you much good to have $10 million if you’re consuming $1 million per year… that’s a recipe for disaster, too.

Ever since the market melt-down, many insurance companies have been rushing to market with retirement income products designed to provide a stream of income for life – a concept fairly new to the typical investor.

Most people are familiar with the old ‘pension plan’ most companies used to have.  You worked for a company for thirty years and retired with a pension.  That’s something that’s easy to understand; but, what most people didn’t realize was what was going on behind the scenes:  Companies would be funding the plan based on what their computations indicated  would be needed to arrive at the promised benefit amount.  For example, if an employee’s pension was projected to be $30,000 per year and the computations indicated that enough capital would have to be accumulated to achieve a 4% withdrawal rate, the company would invest to reach a $750,000 target – I’m oversimplifying, but you get the idea.  What the employees didn’t really think about was that the $750,000 would be converted at the end to a stream of income.

Today, most plans are defined contribution plans, i.e., 401(k)s and the like.  So, people are funding their own retirement and ending up with a lump-sum just like the employers of old would; but, the idea of converting that lump sum, or any part of it, to an income stream is a foreign concept to most investors – they weren’t managing pension funds in the old days, so why would they be familiar with the concept now?  Most people see it as giving up liquidity; but, exchanging liquidity for an income stream just might make some sense for part of someone’s nest-egg.

Why do I say ‘part’?  Like anything in life, nothing comes without some kind of risk.  The two front-burner risks an investor should be aware of are these:  (1) inflation, and (2) security.

  1. Does your income replacement product come with inflation adjustments?  How many times and how often? 
  2. The ‘guaranteed income’ is only as good as the insurance company backing it.  Insurance company products should be viewed as “IOUs”… not worth much if the company won’t be around; and don’t be dazzled by the ratings… remember Fannie and Freddie? 

Now, I don’t sell insurance – or anything else for that matter – so, you might want to get a referral to a quality insurance agent to learn more about these.  I would suggest looking for an agent who has a CFP®, ChFC®, or CLU credential.  And, it wouldn’t hurt to do some of your own independent study about these products before you begin talking with them – you’ll at least know what questions to ask.

 —————————–

Jim Lorenzen, CFP®, AIF®Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 21st 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.  Additional resources:   IFG Investment Blog. Retirement Plan Insights Archive.  Twitter:  @JimLorenzen.  See IFG on Brightscope.

Written by Jim Lorenzen, CFP®, AIF®

May 15, 2012 at 8:00 am

Waiting to Fund Your 401(k)? Not Good.

Jim Lorenzen, CFP®, AIF®

In fact, that may be the most expensive mistake you’ll ever make!

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 does make a huge difference!

Here’s a little lesson that will prove just HOW important it is.    I’ll keep the numbers simple for my little hypothetical comparing Fred and Gary.  

Let’s start both of them at age 25; this would give them 40 years before the normal retirement age of 65, though many today are working or even starting businesses past that date.   Also, 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%.

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! 

What if Fred had invested $3,000 each year instead of $2,000?   That would have been an additional $40,000 in savings over that 40-year period; but, given the same returns, the ending dollar figure would be $777,169…. $259,056 more!     And, all of it accomplished on $250 a month!

So, the $40,000 would have purchased a nice car – or, it would have created over a quarter million dollars in additional wealth!   How does that new car look, now?  Pretty expensive, huh?

But, the market is risky, you say?   Good!  You’d better hope it is!  Without risk, you don’t get volatility; and without volatility, investors would have a hard time building wealth.  Volatile markets actually work in favor of the person who’s building; but, that’s another article.

In the meantime, think about what a publisher can accomplish starting early enough!   Then, when sale-day comes, you’ll be adding additional value to a base-line that could be pretty sweet!

Dad was right, as usual.  Tell everyone you know:  Start NOW.

——————————

Jim Lorenzen, CFP®, AIF®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 retirement and wealth management services for 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.  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.  Twitter; @JimLorenzen

Plan Sponsors: Retirement Plan Insights Archive.

Written by Jim Lorenzen, CFP®, AIF®

May 10, 2012 at 8:00 am