Kimmunications

Financial Advisor Symposium: Choosing Which Retirement Account to Tap First

Choosing Which Retirement Account to Tap First

2nd Annual Financial Advisor Symposium - Las Vegas, NV

Saturday, April 28, 2006

 

 

David Carter, President, Carter Asset Management, Inc.

 

There is NO one formula that fits everyone's solution.

 

Some Deciding Factors in Choosing Which To Tap First

Qualified accounts and tax sheltered annuities will be taxed as ordinary income

Dividends and long term capital gains are taxed at 15%

Tax on social security benefit

Roth IRA money is not taxable

Is client over 70 1/2 and into required minimum distributions

Is client under 591/2 and taking 72(t) distributions

Clients desire to reduce income for their decedents

Clients desire to leave an estate for charity or heirs

 

Some people are really resistant to taking RMD's but if you look at the tables, the amounts are really very low that you are required to withdraw

 

Fredrick Adkins, CEO, Arkansas Financial Group

 

What's deducted?

What's taxed?

How is it taxed?

 

The problem with tax deferred accounts is they convert long term capital gains and dividends to ordinary income that could be taxed as high as 35% in the top tax bracket. Variable annuities do the same thing. Tax deferral is a "sucker bet"

 

Asset classes that were shunned in the accumulation phase are now favored in the distribution phase.

 

Peter Lynch, years ago, got a lot of press for suggesting that you should never own bonds in an investment portfolio. When you got to distribution, you just took capital gains and lived on those. Anyone who followed that advice was devastated in 2000 - 2002.

 

If you put qualified versus non-qualified on a pie chart and equity versus fixed income on another chart, the closer those two charts match up, the easier distributions are. Ideally you would prefer equities in the non-qualified and fixed income to match up to the qualified.

 

Bond interest is tax neutral - it is taxed the same whether it comes form qualified or non-qualified accounts. (True of Snider Method income as well.) That is not true with equities. Rule of thumb is to take fixed income assets first and move towards equity.

 

Gregory Sullivan, President, Sullivan, Bruyette, Speros & Blayney, Inc.

 

There is a world of difference between a plan that assumes linear returns, in other wrods, just takes the average return and running it out to some estiamted longevity number. In the scenario Greg showed, using the average return, the client could live to 95 and still have 1.2M left.

 

But if you run a Monte Carlo simulation, which takes into account volatility, or non-linear returns, there is a very real possibility that same client could run out of money, even while achieving the average assumed in the linear. As I demonstrate in all my speeches and information sessions, this is the hidden cost of risk.

 

If you simply look at taxes, you may get the wrong answer. It is a broader question than tax. Letting tax rule the decision making could run the client out of money.

 

If you have a $1M IRA and a $1M taxable account, you cannot have the advisor withdraw the fees for both from the IRA. IF the fee was $10K per, and you withdrew $20K from the IRA, $10K of it would be considered a withdrawal. In the other hand, you could take all $20K from the taxable to pay fees on both. It goes one way but not the other.

 

Interesting side note, all three speakers were adamantly opposed to the use of variable annuities.

Financial Advisor Symposium: Big Retirement Investing Challenge

Big Retirement Investing Challenge

2nd Annual Financial Advisor Symposium - Las Vegas, NV

Friday, April 27, 2006

 

Eleanor Blayney, Managing Director, Sullivan, Bruyette, Speros & Blayney, Inc. (AUM$1.6B)

Judith Shine, President, Shine Investment Advisory Services, Inc. (AUM $350M)

David Carter, President, Carter Asset Management, Inc. (AUM $

 

Endowment style of portfolio management - which is to retain some portion of the principal at the end - as opposed to the annuitization model where the portfolio is spent down to $0 at the end - requires that the portfolio generate income so that the withdrawal rate can be balanced with standard of living.

 

Where do we get a decent income when we expect bonds to pay 4%? - We have to seek alternative assets to moderate volatility and still generate income. That may be hard assets, hybrids, hedged products - you cannot take a cookie cutter approach to meet the needs of a retirement portfolio - either immediate or future.

 

Baby boomers have a mindset that is very different than any cohort that came before

"Never trust anyone over 30"

"I am not going to die. I am going to be cured"

Managing baby boomer investments is more about managing their expectations and behavior than their investments - Baby boomers don't have an investing problem, they have a spending problem

 

The "Thou shalt not spend principle" construct is a holdover from the children of the Depression. But the reality is that many or most people will have to spend their principle to make it.

 

You can put together the greatest portfolio, or the greatest solution, but if you undersave or overspend, it absolutely won't matter. There is no shortcut. You can make your money work harder but you have to save it in the first place and you have to be careful with it - it takes an enormous amount of capital to be financially free today - you can not afford to make very many mistakes.

 

Someone sees Exxon go up or down $2 or $3 in a day and they go apoplectic - Exxon is a huge and complex entity - how is its value really going to change that much in a day - it is all noise - it is imperative that people ignore all the information swirling around

 

Of all the investment principles we can throw around, there are only two that are always operative:

Reversion to the mean - your entry point matters

Relative aversion to loss - People prefer avoiding losses to making gains

Financial Advisor Symposium: Investing for Retirement in a Low-Return Era

Investing for Retirement in a Low-Return Era

2nd Annual Financial Advisor Symposium - Las Vegas, NV

Rob Arnott, Research Affiliates - April 27, 2006

 

The Arithmetic of Returns

 

Any investment has three components of return

Yield

Real growth in earnings

Multiple expansion

 

Real rate of return on stocks will be3% (the return over and above inflation) over the next five years

Real rate of return on bonds will be 2% over the next five years

TIPS will have 3% real rate of return

REITS will have 2.5% real rate of return

 

No place to hide! No major markets are priced to deliver the 5% or higher returns we all seek

You can't earn an investment return on money you haven't saved

Hope is not a strategy

 

Is this the end of the storm or the eye of the storm for equities?

 

• Earnings Quality Far Lower Than Investors Believe
  • Non-expensed stock options
  • Unrealistic pension return expectations
• Valuation Still High by Historical Standards
• Equity Risk Premium - still not far from zero
• Demographics - Require Lower future returns

 

Arnott believes these factors point to early stages of a secular bear market. "It is very dangerous for us to invest our clients money in a fashion that this scenario leads to ruin. We must invest their money so that they can weather this sort of scenario."

 

Historically, secular bear markets have lasted fifteen to twenty years. Doesn't mean you prepare your clients to prosper in a twenty year bear market but instead you prepare them so they survive a twenty year bear market. You prepare them so that they are going to be OK either way, meaning you have to give up some of the upside if the bear market doesn't materialize. That is not the case in an equity-centric model like the one we have adhered to historically.

 

Demographics - People Are Living Longer

 

We have gone from a life expectancy of 43 years at the beginning of the century to 78 at the end of the century

 

We have gone from a world in which most people didn't make it to retirement to one in which most do, it is expected to last fifteen to twenty years, and there are more of us than ever.

 

The big pension story of the first quarter century will be the abrogation of the pension promise. America cannot afford for people to retire at 65. People are living longer, they are healthier and therefore will have to work longer. What will make us work longer, as a generation, is that our assets will not last long enough to allow us retire at 65.

 

What Do We Do To Improve Returns

 

Stocks and bonds are not the only choices

Unconventional assets can be priced to offer better returns

Seek alpha - find managers who can beat their markets

Avoiding losses is just as important, if not more, than beating the market

Include alternatives in the asset mix

 

"Markets do not reward you for being comfortable." Move some money to areas which are out of favor or not mainstream. They are usually priced more attractively to reward you for moving away from the herd.

 

Which Risk Do You Want To Control?

 

"It's not assets that define wealth. It is what spending stream or standard of living those assets can support."

 

2001-2005 was only a bear market for those with an equity-centric portfolio

 

High risk strategies are on the tails. Risk is a double edged sword. In order to get return, you have to be willing to take some risk, but contrary to popular belief, risk does not guarantee you a higher return. It often creates a lower one, with potentially big negatives.

 

"The essence of investment management is the management or risk, not the management of returns" ~Benjamin Graham

 

"Investing is a "loser's game" in which the winner is often the investor who makes the fewest errors." ~Charley Ellis

 

Beating Andre Agassi at tennis very is easy. All you have to do is keep the ball in play and not make any mistakes. You have to ask yourself, "Who is on the other side of the trade and why are they willing to lose so that I can win?" Few people approach investing from this perspective. Instead they analyze markets, companies, news, fundamentals, etc. In other words, I don't have to outrun the bear. I only have to outrun you.

 

Rob Arnott and Anne Casscells; "Will we retire later and poorer?" Journal of Investing; Summer, 2004

 

Retirees don't actually consume money. They consume goods and services. As we save for retirement, we are saving assets in hopes they can eventually provide goods and services.

 

The way society will impose a stable support ratio is simple supply and demand. Asset prices will move to a price where the average 65 year old will look at their assets and say, "We don't have enough. We have to work a little longer."

 

When companies retain most of their earnings, 10 year earnings growth is negative. When companies retain a little, earnings growth is positive. The idea that today's low dividend rates are going to help us out with earnings growth in the future is not borne out by the data.

 

What if we took your liquid investable assets and divide it by your life expectancy? That is how much they have to spend. Anything you spend beyond that is speculation that future return will be greater than 0%.

 

If plan spending that way, your customer will never run out of money. It is also not what a customer wants to hear.

 

Going back to the idea of "Who is on the other side of your trade?", those that have the greatest confidence that they can pick stocks and pick stocks well are those that are probably the worst stock pickers. Those that have the least confidence are probably the best.

 

Commodities have a modest place in an investors portfolio as an insurance policy only - with no expectation for profit. If Saudi Arabian oil was wiped out by a dirty bomb for two years - 20% of the world's oil went offline - what would happen to commodities and what would happen to stock prices? Commodities are a hedge because they are non-correlated but should not be bought as speculative.

 

BIOGRAPHY:

 

Robert Arnott is chairman of Research Affiliates, LLC, and editor of Financial Analysts Journal. Recently, he introduced the concept of Fundamental Indexation, built on a theoretical foundation that challenges some of the core assumptions of modern finance. Previously, Mr. Arnott joined forces with PIMCO, serving as a sub-advisor, to offer the first global asset allocation product to make active use of alternative markets, beyond conventional stocks, bonds, and cash. Prior to this, he developed quantitative asset management products and teams as chairman of First Quadrant, LP, global equity strategist at Salomon (now part of Citigroup), president of TSA Capital Management (now part of Analytic), and vice president at The Boston Company (now PanAgora). Mr. Arnott has received five Graham and Dodd Scrolls/Awards, awarded annually by the CFA Institute, and two Bernstein-Fabozzi/Jacobs-Levy awards, awarded by the Journal of Portfolio Management and Institutional Investor, for the best articles of the year. He has authored over 70 refereed articles for journals such as the Financial Analysts Journal, the Journal of Portfolio Management, and the Harvard Business Review. Mr. Arnott has also served as a visiting professor of finance at UCLA, on the editorial board of the Journal of Portfolio Management and two other journals, and on the product advisory board of the Chicago Board Options Exchange and two other exchanges. 

Why Doesn't Everyone Do It?

I get this question a lot: "If the Snider Investment Method does what you say it does, why doesn't everyone do it?" Just think about that question for a second. Name me something that everyone does.

 

Seat belts save lives - why doesn't everyone wear them? We know giving up cigarettes will increase your life expectancy - why doesn't everyone do it? Indexing has beat active portfolio management over time - why do the vast majority of Americans still employ active investment strategies? Each year, there is one mutual fund that outperforms all others - why doesn't everyone own it?

 

My father always said, "Different strokes for different folks. That's why there's Cokes and Dr. Peppers." (He often talks in that folksy East Texas sort of way.) But you get the point. The question isn't why doesn't everyone do it. It's why don't more people do it?

 

So why don't more people do it? First, let's define "it". Are we talking about investing for income or the Snider Method specifically? Because let's face it. It is hard to get people to do mainstream income investing let alone something that is unconventional like the Snider Investment Method.

 

Modern portfolio theory, which is the basis for most conventional investment ideology, says that you should spread you portfolio over various non-correlated asset classes to spread risk. In its simplest form, this would include stocks, bonds and cash equivalents. Asset allocation models spread your money over those asset classes in different percentages depending on what stage of life you are in and your tolerance for risk. The classic example is the 60/40 portfolio - 60% stocks and 40% bonds that is the rule of thumb for people as they are nearing retirement.

 

I speak to groups of investors several times each month. The groups I speak to are pretty evenly split among recent retirees, near retirees, and those that are still a ways off from retirement. I have been doing this every month for years. As part of my program, I ask for a show of hands - "How many of you have EVER owned a bond?" Typically, about 20% of the hands in the room go up. "How many of you have EVER owned a bond fund?" A few more hands, but not many.

 

Why are people so fixated on the accumulation model? Some of it is historical. Some of it is structural and has to do with the financial services industry itself. And the other piece is behavioral. Let's look at all three.

 

Income investing is all about two things - creating an income stream while protecting principal. Strangely enough, these have not been top of mind for the majority of investors until 2001. Think about that for a minute.

 

Our parents and grandparents lived in a world where a reasonable standard of living was guaranteed by a combination of Social Security and employer pensions. Not since before the Great Depression did Americans have to provide their own retirement income. And I would point out that before the Great Depression, there really wasn't any such thing as retirement as we know it today. People worked and then they died. Historically, all invested capital has essentially been risk capital.

 

If we look through the long lens of time at the change that has taken place, that scenario has shifted in what is a microscopically short space of time. We have gone from having a guaranteed retirement income to having to fund 100% of a 30 year retirement ourselves, in just 20 years. Income and risk management, in this new scenario, become paramount. Yet, our awareness of this fact is lagging far beyond the shift in reality that has taken place. Why?

 

A vast infrastructure has been built over the last century that supports the high risk accumulation model. Wall Street spends $19 billion on marketing each year. How much of that is around risk management and creating income? Almost none. What products pay brokers and financial advisors the highest commissions? Those with the highest risk? Compensation systems have been built around gathering assets, not distributing them.

 

To encourage you to move from accumulation to income is a very expensive proposition for most advisors. Unless, their firm was built that way from the start, chances are, they are going to find it very difficult to put your best interests ahead of their own.

 

The final issue is behavioral. One of the strongest concepts in psychology and sociology is social proof. Social proof says, in the absence of certainty, humans will look around them and do what everyone else is doing. In other words, we are instinctively herd animals. The more uncertainty, the more likely we are to seek out social proof.

 

Social proof creates a momentum that is very hard to break. If everyone else is taking a lot of risk and continues to invest for growth, it is pretty hard to break away from the perceived safety of that herd. It takes enough early adapters to create critical mass in the new way of doing things before the mainstream will join in.

 

We are not there yet. But we will be. I predict, in 20 years, income and risk management will be the dominant approach. In all fairness, I also have to tell you that is not a very bold prediction - although it may sound bold now.

 

Industry groups, like the Retirement Income Industry Association, are being formed. Magazines are being created, like Boomer Market Advisor, that focus on the issues of retirement income. Big players, like Fidelity and Merrill Lynch have teams who are working on new ways to help their investors make the transition. Financial engineers are working feverishly on new products that allow higher sustainable maximum rates of withdrawal and products that are not denominated in dollars but rather in future streams of income.

 

Which bring us back to the Snider Investment Method. The Snider Investment Method is out on the forefront of this movement. It is one such product engineered to manage risk and provide consistent income, over long periods of time, independent of market movements. Those who use it today are still among the early adopters. It requires them to break from the perceived safety of the herd, which is very hard for most of us to do.

 

I'll make another prediction. One day, in the not too distant future, we will look back at the Snider Investment Method and it will appear quaint, even antiquated - like placing ads in the newspaper to buy and sell options contracts appears today. And when that day comes, I will be thankful. It will mean that we, as an industry, and a society, have solved a pressing problem for millions of Americans.

 

Until then, I can only say, you have to evaluate it for yourself. I can make that easy for you to do. But only you can know if the Snider Investment Method is right for your temperament and objectives.

Kiyosaki Says Short the Dollar

I was asked by Roger Chang, one of my Snider Method Workshop alumni, to comment on some articles Robert Kiyosaki has posted recently in his Yahoo Finance column. (You can find the articles here and here.)

 

Robert sums up the gist when he says:

 

In my opinion, that means getting out of anything else that's "paper with ink on it" -- anything backed by the full faith and confidence of the SS U.S.A. That means I'm very suspicious of stocks, bonds, savings, and mutual funds, especially if they're U.S. dependent. Although I love real estate, I'm suspicious of any piece of property that doesn't generate cash flow today. I don't invest in future appreciation of real estate -- not today, at least.

 

Today, I invest in assets with tangible value, especially assets that go up in price as the dollar's purchasing power sinks. Today, I have large positions in gold, silver, and oil.

 

He elaborates on this further in the second article:

 

The primary reason why I keep my dollars moving is because I'm bearish on the greenback. We have all heard the saying, "The U.S. dollar is backed by the full faith and confidence of the U.S. government." It is unfortunate that faith and confidence in the U.S. government is eroding. I don't believe Americans have the stomach to make the changes that are required to run a fiscally responsible government and save the dollar.

 

When President George W. Bush attempted to reform Social Security, that proposal was more unpopular with Americans than the Iraq war. People love their entitlements. When Bush pushed the Prescription Drug Benefit plan through, I decided the U.S. dollar is toast. To me, all hope of avoiding financial disaster was gone. The American people have voted.

 

My concern is that very soon, citizens of the world will tire of America's gross fiscal mismanagement and hesitate to take U.S. dollars. In order to keep the world interested in the greenback, interest rates must rise. When that happens, U.S. assets, especially paper assets such as U.S. stocks, bonds, mutual funds, and savings will drop in value. Some real estate prices will increase because replacement costs are high, but overvalued real estate will drop.

 

Here is the problem I have with Robert's position. It is based on if. He has staked out his claim to fame as a cash flow investor. He restates that position in the paragraphs above. Then he flip-flops and says that he thinks the best investment today is in something that will hold its value or even rise as the dollar falls. Don't ignore the magic words:

 

If and when the American public wakes up to the reality that their dollars are not money, but a currency, the panic and stampede will begin. Should that happen, today's prices for gold and silver will look like bargains. [emphasis mine]

 

People have been concerned about the U.S. dollar since 1999. Could the dollar crash? Of course it could. Nothing's impossible. Will it? Who knows? That is the trouble with these things. No one ever knows for sure.

 

My personal boogie man under the bed isn't the dollar but the millions of baby boomers who are retiring without enough money. I see a crisis of epic proportions just on the horizon. As certain as I am there is a catastrophe looming, there are others who argue that the retirement crisis is overblown.

 

We all see problems lurking around the next corner. Pick your poison - rising interest rates, runaway inflation, a tanking dollar, $100 oil, terrorism, a nuclear Iraq, 60 million starving retirees. They never go away. That is where the old adage about "Wall Street climbing a wall of worry" comes from.

 

It's OK to see them. It's OK to talk about them. It's OK to protect yourself against them. Where I have a problem is when you start betting on them.

 

NO ONE knows what is going to happen - no matter how obvious it seems. The cruel trick of our brain's hardwiring is that fear and greed cause us to think we know what we cannot possibly.

 

You simply cannot, in my opinion, change your investment strategy to react to the crisis du jour. That guarantees you will be poor because I can guarantee what you think is going to happen in financial markets rarely does. Markets don't care what you think and they don't care what your time table is.

 

The only sane way to invest your money is to do so in a way that protects you either way. Find an investment strategy that works well no matter what happens and stick with it. I think Robert had it right originally - income investing is that way.

 

In order to be an income investor, you have to get over the idea that financial success is a rising account value or a return percentage. Financial success is a sham if the gains are paper - subject to being wiped out tomorrow by the whims of a capricious market.

 

Financial success, to me, is being able to pay your bills. Financial success is being free from worry. Income, real money that comes in at a steady rate, no matter the market value of your portfolio will soon replace account value and return percentage as the yardstick because they are real.

 

I admire Robert Kiyosaki a great deal. He's been on my radio show several times. We've appeared onstage together. He spoke at a dinner we threw honoring graduates of our Snider Investment Method Workshop. He has created a widespread awareness of the value of cash flow. That, in and of itself, is a monumental accomplishment and shows he is a very smart man.

 

Which makes his metals and oil play all the more puzzling to me.

 

I can't tell Robert what to do or not to do with his money. He has a lot of it. Far more than me. So maybe he can afford to gamble. I can't and I won't. I worked too damn hard for it. You want to know what I do with my money? I ignore all this noise and stick to my knitting - low risk, high yield portfolio paychecks.

 

So what is your take? Do you make adjustments based on recent events? Fear or greed? Or do you have a sane investment approach you stick with no matter what? I'd like to hear from you. Leave your thoughts and comments below.

Managing Retirement Income Conference

I promised to blog from the Second Annual Managing Retirement Income Conference that I attended at the end of February. I broke my promise!

 

I have received several emails saying you are waiting - with baited breath -to find out what was new in the world of managing retirement income. Truth be told - not much. That is why I didn't blog it in real time.

 

Not much has changed since last year's conference, although the conference itself was both better organized and better attended. Kudos to the conference co-chairs - Francois Gadenne of Retirement Engineering, Inc. and Charlie Ruffel of PlanSponsor for that.

 

I did, however, walk away with a couple of themes that seemed to run throughout the conference. Before I summarize them for you, I would warn you that the themes I walked away with are the product of my own very real biases and filters. It is not only possible but highly likely that the other attendees walked away with an entirely different set of themes. But you are reading my blog, so here they are:

 

The problem is real. Believe it or not, there is still some debate about this. But at the end of the day, it is plainly obvious that the retirement income problem is very real and very pressing. As to what is being done about it, I think the news is mixed. Clearly, the attendees to this conference are very aware of the problem, if for no other reason than that it represents a big, fat, hairy opportunity for those who address it - or a big, fat, hairy threat to those who ignore it.

 

My sense is that the big industry players cannot let go of the idea yet that they can solve the problem with existing products. There is still a overwhelming desire to cram a square peg (modern portfolio theory, mutual funds, annuities, et. al.) into a round hole (a very new and real problem). Yes, they may add a few bells and whistles to them but you can't put a suit on a pig and pass it off as a prince!

 

People wait until it is too late. Another flash of the blindingly obvious. You can posit many thoeries on why but the fact is that people in general wait until far too late to address retirement issues. They wait far too late to begin accumulating assets in retirement and then are forced to take on far more risk than is appropriate for money you absolutely know you are going to have to have someday. They wait until it is far too late to begin understanding the issues and risks that need to be addressed to successfully negotiate 30 years of retirement. And finally, they wait until they are far too late to switch from accumulation to income.

 

One of my biggest Aha! Moments came when Professor Zvi Bodie, from Boston University, mentioned that the academic evidence completely contradicted the conventional wisdom in the area of asset allocation theory. According to Dr. Bodie, this research indicates that rather than taking more risk when you are younger and less when you are older, a person is best served by a constant level of risk over their investment horizon.

 

This would be totally consistent with my view and my way of investing, not to mention my own experience. I will post more on this idea later. For now though, it supports two points I harp on all the time: 1) manage risk and the performance will take care of itself; and 2) income investing isn't for old people. The time to switch your portfolio to an income stream is early, way before you need income, in order to avoid the conversion risk. After all, income re-invested is growth.

 

There is a huge disconnect between retirement expectations and the retirement reality. The data suggests that we are largely still in a state of total denial! Proof of this fact lies in five major areas.

 

First, the replacement rate is steadily shrinking. Replacement rate is the amount of pre-retirement income that will be replaced by government entitlements (like Social Security and Medicare) and employer sponsored pensions. The federal government is mired down in finger pointing and politics as usual and with each passing day gets farther and farther away from fixing the Social Security and Medicare problems.

 

Meantime, the percentage of workers who are participating in pension plans is shrinking every day. According to the Bureau of Labor Statistics, the percentage of full-time workers covered by a defined benefit plan has gone from 42% in 1990 to 18% in 2005. Given the almost daily news of major corporations like IBM, Verizon and Gerneral Motors freezing or terminating plans, that trend is likely to increase or even speed up. And yet, the worker is in my view, very slow to recognize the implications or make course corrections. You have an entire generation, that being the baby boomers who are standing there like deer in the head lights!

 

If you ask baby boomers how they intend to deal with their savings shortfall, 66% say they plan to work past age 65. In reality though, only 26% of them actually do and EBRI studies say that a majority of recent retirees were forced to retire earlier than they wanted to by job or health issues. If this is plan A for 66% of 76 people, I would suggest we need to find a plan B and find it fast!

 

I heard at least one person argue (John Ameriks from Morningstar) that the problem wasn't as dire as all of us worry worts are making it out to be. I think it is worse. One reason I think so is the spiraling cost of healthcare. This was my other Aha! We know that few people have even done a thorough analysis of their income needs in retirement by the time they retire! I would bet that even those that have underestimated the cost of healthcare over their lifetime. In his talk, Jerry Kinney, Vice Chairman of Merrill Lynch reminded us that healthcare costs are increasing at 10X the rate of the CPI!

 

For someone turning 65 in 2006, it is estimated that, on average, 37% of their Social Security benefit will go to Medicare premiums, co-payments and out-of-pocket expenses. By 2026, that number is expected to be 53%. Combine that with the fact that Social Security benefits make up over 80% of the income for more than half of the over 65 population and that leaves little or nothing for even the most essential items like food, clothing and shelter.

 

Here is another example. The person who turns 65 in 2015 and lives to be 90 (which is a much higher probability than most people think) will spend an estimated $426,000 in cumulative healthcare premiums, co-payments and out-of-pockets expenses. That is huge by any measure, but especially scary when you consider that the average retiree doesn't have anywhere near that much saved, in total, at retirement. It's pretty hard to see that scenario playing out in a positive fashion.

 

Earl Wilson says we are a generation "driving mortgaged cars on bond financed roads using credit card gas." Strange but true, baby boomers will enter retirement with more debt than assets. According to FRC, the average American is now in a net negative financial situation.

 

Given that, it isn't surprising that Americans do not have enough saved to maintain their current standard of living. The average 401(k) balance for those in their 50s as of December 1999, in other words, the near retiree group, was only $129,218! According to the Employee Benefit Research Institute, 60% of baby boomer sill have to make hard choices about reducing their standard of living in order to keep from running out of money and another 20% will, barring some unforeseen miracle, run out of money before they run out of breath!

 

Call me Chicken Little but I really do believe the sly is falling. I am eagerly looking forward to the day that someone shows me overwhelming evidence to the contrary but until then I feel we must continue to ring the church bells and shout from the rooftops, "Retirement is coming! Retirement is coming!"

 

I am always very interested inhearing your thoughts and feedback. Please post your coments below.

 

SOURCES:

 

Too numerous to list here. General attributions were given throughout. If you need a source for any of these numbers I will be happy to provide them. Just email me.

Investments That Pay Today - And Tomorrow

Robert Kiyosaki, author of the Rich Dad Poor Dad series of best-sellers says words have the power to make you rich or keep you poor. Do you know the difference between cash flow and capital appreciation?

 

If an understanding of any two words has the power to change your financial situation, it is these two. In an article on Yahoo Finance, Robert explains cash flow and capital appreciation this way:

 

One of the reasons I was able to retire at age 47, and my wife, Kim, at 37, was simply because we had enough cash flow coming in (primarily from our real estate investments). It wasn't much -- about $10,000 a month -- but we only had about $3,000 in monthly expenses. That left us with $7,000 a month to do with as we pleased.

 

On the other hand, capital gains are when you buy a stock for a dollar, and it goes up to $10 so you make $9 a share. Or, you buy a house for $100,000, and it appreciates to $150,000. You sell it and make $50,000.

 

One of the reasons people do not become financially free is because most of them are focusing on capital gains rather than cash flow. Chasing capital gains alone is gambling -- not investing. Want proof? You don't have to go back very far to find it: Between 2000 and 2003, millions of investors lost trillions of dollars in the stock market.

 

I have said over and over again that the traditional investment model, which is the capital appreciation model, subjects the investor to too much risk in a world where we are now responsible for funding our own retirement. Robert says:

 

Most retirement plans are based on hope and promises stretched over many years. That makes very little sense to me, yet it seems to make a lot of sense to the millions of investors who are hoping the money they expect will be there at age 65.

 

Traditionally, cash flow investing has been associated primarily with real estate investors who own property in order to collect rent or near retirees who convert their assets to income generating securities like bonds, REITs, or preferred and dividend paying stocks.

 

In today's day and age, income investing does not have to be so limited. Financial engineers are coming up with new income generating financial products every day because they recognize the same shift I have been evangelizing for the last five years.

 

Income, aka cash flow, that is low risk and high yield (two important caveats and the reason cash flow has historically been associated with the real estate world) serves three important functions. When you do not need the income to meet living expenses, the income can be reinvested to create growth. Income and growth are not mutually exclusive.

 

If you have a stream of income from your investments and a financially disruptive life event occurs, like losing a spouse or a job, that income stream can be temporarily diverted to supplement or replace lost income.

 

Finally, when the time comes that you want to stop working and live off your assets, you already have the mechanism in place. You simply route that portfolio paycheck to your checking account instead of reinvesting it.

 

One of the risks near and future retirees overlook is what I call conversion risk. Let's say you are 50 years old and plan to retire in 15 years. You have accumulated enough in retirement savings to retire comfortably.

 

But what happens if between now and the time you retire the stock market, and therefore your assets, lose 50% of their value and that is where they sit when you hit 65? Now, when you convert them to income generating assets that pay a percentage of the value, say 5% if you were going to use bonds, you are getting 5% of a much smaller number.

 

Converting to a cash flow approach early, again provided the risk is low and the yield high enough to generate sufficient growth in the meantime, gives you the best of all possible worlds without many of the risks that exist in the traditional approach.

 

So how about you? I am curious if you have ever seriously considered income as your primary investment model or is it something you are planning to do only as you reach retirement? Does the income model make sense? What would keep you from switching to an income approach from your current capital appreciation based approach? Leave your comments below.

 

My thanks to Harold Nelms for the heads up on the Kiyosaki article.

 

SOURCE:

 

1. Robert Kiyosaki. "Investments That Pay Today - And Tomorrow" Why The Rich Get Richer, Yahoo Finance; 13 Dec 2005.

http://finance.yahoo.com/columnist/article/richricher/1795

Investment Advice From Mark Cuban

I love Mark Cuban. I didn't want to like him. When he first bought the Dallas Mavericks I thought "Ugh!" Here is some young punk who got lucky, made a billion dollars in the Internet bubble that he probably doesn't deserve, and has bought the Mavericks to show everyone that he can.

 

Then I heard him speak. He was phenomenal. No airs. No bull. Just straight from the hip. I realized in that 90 minutes that, while he may have been in the right place at the right time, there was serious business acumen behind the bad boy image.

 

I left that program with a tremendous amount of admiration. That admiration has only grown as I have watched him over the years. As businesspeople, we share many of the same values. Truth-telling, putting the customers best interest ahead of your own, being accessible, and having fun with it.

 

Everyone wants to know what you have to say about the stock market when you are a billionaire. Mark Cuban gives us his investment advice for 2006, which is, not coincidentally, right in line with my own. Here are a few choice excerpts:

 

Every year at this time, everyone and anyone who has a vested interest in selling stocks comes out and talks about how great a year its going to be in the stock market.  Of course its all nonsense and bullshit. NO ONE knows what the market is going to do. Not timers. Not technical charts. Not economists, Not brokerage Heads of Research, Not stock pickers. No one.

 

[ … ]

 

According to an ad for one family of mutual funds, there are 17,000 mutual funds on the market for purchase.  How amazing is that ? How in the world can there be 17,000 fund managers that are worth a damn ? There cant be. How many are good ? How many suck ? How many of the funds will close every year taking your money with them ? Are you completely confident in the fund that is taking money from your paycheck every 2 weeks ?

 

Then of course there are the brokerages. I swear that there are few things that turn my stomach on TV more than watching commercials for brokerages. The guy who gives the toast at the wedding, Paul McCartney, the guy from Law & Order, all trying to con people into thinking that any of their stockbrokers can take you to a financial promised land.

 

[ … ]

 

Simple, avoid risk.

 

Risk is what Wall Street lies about every day. Risk is what they try to sweep under the covers knowing that we all are addicted to the dream of financial freedom. Risk is the poison that is masked by the commercials.

 

[ … ]

 

You can however make the personal decision to avoid risk. Avoiding risk allows you to sleep at night. Avoiding risk allows you to have more at the end of the year than when you started.

 

Lots of people spent a lot of money on commissions this year. If you put your money in the bank, in a CD or in treasuries, you not only slept better than them, there is a very, very good chance you kicked their ass in total return. Your interest compounded, they probably paid interest on their investments.

 

I get emails every day asking me where people should invest. I tell them all the same thing, and I will say it here. Put your money in interest earning investments.

 

Amen Mark! What he is saying is you should avoid risk and put your money in something that provides a consistent payment or paycheck. You know I agree although I know a place where I can get significantly better interest than treasuries with only slightly more risk. The full text of Cuban's post is on his blog, Blog Maverick, and is worth the read.

Net Asset Value

I believe we are in the midst of an inevitable shift in the investment model. We are moving from a model where our lifetime investment objective is accumulation to one where our lifetime investment objective is generating income. Such a shift requires us to retool old thinking - something which is never easy - and may be impossible for some.

 

The accumulation model is a race against time. We measure success in the accumulation model by our performance - a number - our net asset value at any one point in time. The goal is for the market value of your portfolio to be as high as possible at all times. But ,in particular, we are working toward the net asset value at two different artificial milestones.

 

The first milestone is the day you retire. The assumption is that as you approach retirement, you will convert larger and larger percentages of your assets to income producing assets. If you are going to convert them over time - in other words sell them so you can replace them with assets that accomplish a different goal - the market value at the time of conversion is very important. It is devastating to your lifetime net worth to sell assets when their value is sharply depressed because you have to. The second milestone is the day you die. The assumption here is that, on the day you die, whatever you have left will pass to your heirs.

 

Our grandparents and great-grandparents were not concerned with either of these two outcomes. Our great-grandparents worked all their lives then they died. The life expectancy after age 65 was short. If they happened to outlive the normal life expectancy they were cared for by their family. What our great-grandparents passed to our grandparents who then passed to our parents was, in all likelihood, not money or securities but possessions: their house, land, businesses, furniture, jewelry and family heirlooms.

 

In 1965, stock market investments were rare. Less than 10% of us owned common stock. Most of our parents were guaranteed a lifetime income by employer pension plans and Social Security. Even as the life expectancy lengthened healthcare was affordable and provided by retiree health benefits and Medicare.

 

Our world changed significantly in 1974 when congress passed the Employee Retirement Income Security Act, better known as ERISA. Contrary to its name, ERISA began the process where the burden and risk of providing retirement income shifted away from employers and on to employees. ERISA began the inexorable shift from a certain, if modest, retirement income to an uncertain future based on high-risk stock market investments in 401(k) plans and IRAs.

 

Accumulation using diversified, high risk investments came into being not because it was the best alternative but because it was the ONLY alternative. The only way to guarantee a secure retirement was to work for 40 years, during the prime of your life, at something you didn't really enjoy, so you could accumulate enough money that you could maintain a decent lifestyle for an indefinite period of time on safe but low bond yields.

 

It doesn't have to be that way any more. And shouldn't. The Internet and the democratization of the financial markets have brought about game changing shifts in the way we can and should invest. Because we have cheap and real-time access to information and to markets that twenty years ago was reserved for only the institutional investors, new and better ways to meet lifetime investment objectives are coming to market on a daily basis - which brings us to the reemergence of the income model. Only in the last few years have financial engineers devised high yielding investments with low levels of risk.

 

The income model is not new. It is a throwback to the days of our grandparents. But, as the old car ad said, "This is not your father's Oldsmobile." The income model is about outcomes instead of numbers and artificial milestones. The income model is about creating a real and increasing cash flow over your lifetime. Success for the income investor is the amount and consistency of that periodic paycheck generated by their portfolio instead of by their labor.

 

Market value of the portfolio is not a primary concern of the income investor. The income investor has a luxury the accumulation or growth investor doesn't. The income investor does not have to concern himself, or herself, with temporary losses in value, only in permanent ones. This is indeed a luxury given their is no way to avoid short term, unrealized losses of capital except by putting your money in CD's, savings accounts or burying it in the back yard. The market value of all investments fluctuate commensurate with the level of return. The higher the return, the more fluctuation in market value. The lower the return, the less fluctuation.

 

In trying to mitigate short term market risk, accumulation investors achieve the opposite result. Accumulation investors, who keep score by trying to maintain an ever-increasing net asset value, try to outsmart the market by timing. Unfortunately, the academic evidence tells us markets cannot be timed and stocks cannot be picked successfully over long periods of time.

 

The focus on net asset value for the accumulation investor achieves the opposite result from what they seek. Over the 19 year period 1984 to 2002, the S&P 500 was up an average of 12.9%. U.S. stock mutual funds had a return over the same period of 9.6%. Even professional mutual fund managers cannot beat the market by picking stocks. The stock mutual fund investor had a return of only 2.7% which goes to show investors who try to pick funds or time the market do so at their own peril.

 

As I said previously, the objective of the income investor is to generate the biggest paycheck possible for his portfolio with the least amount of risk. I will talk about how that is accomplished in a moment but for now, let's just assume that it can be. Income investing provides for all of the outcomes the accumulation investor is seeking, it removes some of the potential pitfalls and has additional benefits as well.

 

A portfolio which generates a reliable and consistent cash flow is much more flexible than a portfolio aimed at some future date. What happens if you need that money sooner? What happens if your future date comes at the wrong time? Conversion, in either case, can be crippling.

 

At this point, it may be helpful to use an example. Although there are other ways to generate portfolio income, the one I am most qualified to speak on and the one I assume you are most interested in hearing about is the Snider Investment Method. The Snider Method has two objectives: no permanent losses of capital and to generate a real cash flow equal to 1% of the investment each and every month.

 

Let's address the permanent loss of capital first. The Snider Method makes no attempt to pick stocks that are going up in price. The method focuses on fundamentally sound, well run companies that are unlikely to go bankrupt. We use the academic work of Dr. Edward Altman, the father of forensic accounting and the inventor of bankruptcy predictors as our primary means of evaluating companies. (I should note that in my ten year history with the method, I have only had one Snider Method position experience a permanent loss of capital. The stock was Redback Networks. It did go bankrupt but it was picked prior to the implementation of the bankruptcy screens.)

 

The second objective is a paycheck which is as close to 1% of the net investment each and every month as we can possibly make it. The mechanics of the method - the way and the order in which we combine the underlying stocks and the sale of options together - are what allow us to do this consistently over long periods of time, even if we are in a secular bear market or long term economic recession.

 

« ­­ »

 

So let's take the hypothetical case of Sally and Stan. Sally and Stan are 35 years old. They invest $500,000 in the Snider Method during a ten year period that the market is going up, on average, about 10% a year. Assume that over this period of time, the Snider Method portfolio yields its historical average of 13%. On average, Snider Method positions close within six months, and they do not need the money so they reinvest it to get compounding growth. Net asset value is going up over this period of time because stock prices are rising and positions are closing. At the end of the ten year period, their portfolio has grown to $1,697,283.

 

Sally and Stan are now 45 years old. The economy is stagnant. The stock market spends the next ten years trading sideways. The average return for the S&P 500 over that ten year period is 1%. Stan, the primary breadwinner in the family, is a software developer. He earns $120,000 a year. At the beginning of that ten year period, Stan is in a car accident. He cannot work for one year. Sally and Stan's Snider Method portfolio is generating a monthly cash flow of 1% or $16,970. They need that in order to meet their living expenses while Stan is recuperating. Each month, they withdraw $10,000 and reinvest the remainder. There is no need to liquidate assets. At the end of that one year, the portfolio has a market value of $1,780,923 even though the market has been flat and Stan has been out of a job.

 

After a year, Stan goes back to work and the income generated by their portfolio is again reinvested. Nine years after Stan has gone back to work, his portfolio has a value of $5,349,967. It has more than doubled in a period the stock market was only growing by 1% and it gave them a safety net when Stan had his accident.

 

Stan and Sally are now 55 years old. Osama bin Laden has attacked the United States, the economy has really gone in the dumper and the stock market with it. In the first year, the market lost 60% of its value and it remained at that level for the next nine years. The market value of Stan and Sally's portfolio dropped from $5,349,967 to $2,139,986 but their portfolio paycheck remains unaffected. The real cash flow being generated and reinvested is $53,350 a month!

 

Stan and Sally are now 65 years old and Stan decides its time to retire. The market value of his portfolio is still only $2M but he does not need to sell his portfolio for $2M to convert it to bonds. He holds the portfolio in the Snider Method and takes the income he needs for his living expenses.. The next ten years are just as bad as the last ten but Sally and Stan are unaffected. The market on average, loses about 3% a year. The market value of Stan and Sally's portfolio declines to $1,578, 077 but their paycheck is unchanged. Last time their kids heard from them, they were on safari in Africa and having a ball. The stock market was the least of their worries. The mosquitoes were a much thornier issue.

 

Stan and Sally are now 75 years old. They are still traveling and having a ball. Fortunately, they have weathered the twenty year bear market quite nicely and the stock market begins to show signs of life. Over the next five years, the stock market return is 4% a year on average. Their portfolio value increases to $2,335,939 but their paycheck is still around $50,000 a month. They are thinking about many things, but their financial security is not one of them.

 

Sally is now 85 years old. Stan passed away a couple of years ago. The next few years are tough on Sally. She and Stan were together for a long time. It's hard, and lonely without Stan. But she has her kids and fortunately, she wasn't having to deal with financial issues at the same time she was grieving Stan's death. Over the next ten years the market went up 6% a year on average. Sally's portfolio value is now back to $4,183,311.

 

Sally passed away at the age of 95. She lived through a 30 year bear market when stock market returns stunk at a time when most people can least afford it. Even though the market value of the securities in her portfolio are still not back to the highest point, 30 years later she has collected payments totaling $19M. Do you think she cares about the value of her portfolio? Do you think her kids care?

 

Upon Sally's death, her kids inherited equal portions of her portfolio. Neither sold off any of the Snider Method positions but had learned from watching their parents to keep them intact. Each now has a monthly paycheck of approximately $25,000 which, when the market rebounds, will likely grow. Until then, they are just happy their Mom and Dad lived well, without worry and left plenty for them as a foundation.

 

« ­­ »

 

There are a lot of assumptions in this little story - some of them as yet unproven. But I feel comfortable in making them or I wouldn't have 100% of my own available assets invested this way. The first is that the income stream would remain constant even if positions lost value and remained depressed for 30 years. While I cannot guarantee that, of course, I believe it to be true. That is what it is designed to do and I think it will. Hopefully, we will never have to find out. The second is that the yield will remain constant at 13%. There is no way to know that for sure either.

 

But, given my own belief in the outcomes, I think the Snider Method is the best alternative to meet my objective, which is to always have enough passive cash flow to pay my bills - no matter what. That is my objective. Only you can say whether the Snider Method meets your objective or whether there is something you believe can meet your objectives better with lower risk.

 

I've done my job. I have created an investment method that I believe will take care of me and my family indefinitely out into the future. Now your job, as your Family CFO, is to evaluate and decide what's best for you.

 

DISCLAIMERS: The hypothetical example uses current averages which may or may not hold true over time. In addition, even if they do hold over time, you may not be average. This story is for illustration purposes only. Past performance is no guarantee of future results. All investments incur risk and the Snider Method is no exception.

I Believe - December 7, 2005

I believe work should be a choice – not a necessity. I believe you do your best work when losing your job wouldn't matter. I believe your objective the day you start working should be not having to work. I believe they should tell you that as they hand you your diploma. I believe work is best when it is done for gratification, not for a paycheck. I believe the sole purpose of your investments is to attain financial success. I believe financial success is when you have enough passive income to pay your bills and support a comfortable standard of living.

 

I believe there are four keys to financial success - they are saving, entrepreneurialism, mindset and investing. I believe as a culture we are spending like drunken sailors with no regard for the future. I believe the key to financial success is making money for yourself, not for someone else. I believe that financial success requires discipline and delayed gratification. I believe those of us who are doing the right thing by saving and investing in our future will end up paying for those that aren't - and that sucks. I believe people have to stop assuming that it is someone else's responsibility to take care of them and start taking care of themselves. I believe that no one cares about you or your money as much as you do.

 

I believe nature has played a cruel trick on us and wired our brains backward. I believe the hardest thing about investing is fighting our natural survival instinct which tells us to stick with the herd. I believe there is a world of difference between investor return and investment return. I believe the traditional investment model is nothing more than glorified gambling. I believe hope and luck is a lousy foundation for financial success. I believe the traditional investment model is old, outdated and no longer appropriate. I believe you have to seek out alternatives if you ever hope to be financially free to do what you went when you want. I believe you have to find a formula that works and stick with it.

 

I believe your money should work for you, you shouldn't have to work for money. I believe your money shouldn't benefit your broker more than it does you. I believe your money should pay for your kid's college and your retirement, not your financial planner's. I believe you should be in investments that benefit you, not the person selling them. I believe in transparency. I believe you should know to the penny how much you are paying to invest your money and how much your advisor is making as a result. I believe you should learn how to manage your own money.

 

What do you believe? Post your comment below.

Advisors Don't Get It

If you are unhappy with your investments it may be because your advisor "doesn't get it." An article in the October, 2005 issue of Financial Advisor shines a spotlight on the increasingly large disconnect between advisors and their clients. According to a study called "Cultivating the Middle Class Millionaire":

 

The idea of losing their wealth is a top concern of middle-class millionaires. Nearly nine out of ten of middle-class millionaires (88.6%) are very concerned about the potential to no longer be able to afford a lifestyle they have become accustomed to.

 

A substantial number of middle-class millionaires are engaging in a financial balancing act. Many of them are often only a few steps away from significant financial reversals. This places a great deal of pressure on them to maintain their lifestyles.

 

The complication is that most financial advisors fail to recognize that their middle-class millionaire clients are concerned about this issue. Only 15.4% of the financial advisors believed that 20% or more of their clients with these levels of investable assets are very concerned about losing their wealth.

 

Russ Alan Prince, one of the study's authors says, "Advisors think things are much better than clients do. Most of the advisory industry is doing a poor job of dealing with clients. Advisors are ineffectual; they run through clients left and right."

 

What do you think? Does your advisor understand what you need from your investments or are they still focused on their needs, not yours? Weigh in with your thoughts below. I'd like to know what you think?

 

SOURCES:

 

1. Grove, Hannah Shaw and Russ Alan Prince, "Understanding The Middle-Class Millionaire" Financial Advisor October 2005

http://www.fa-mag.com/past_issues.php?id_content=3&idArticle=1080&idPastIssue=102

 

2. Drucker, David J., "Chasing the Wrong Clients" Financial Advisor November 2005

http://www.fa-mag.com/issues.php?id_content=2&idArticle=1101

Unconventional Success: by David Swensen

David Swensen is the extraordinarily successful manager of the Yale endowment fund who has recently resleased a book titled "Unconventional Success: A Fundamental Approach to Personal Investment.

 

According to a review in the New York Times by Joe Nocera, Swensen originally set out to write a book about how you can invest like Yale does but upon commencing the writing ultimately decided that the small guy can never invest like Yale does and that is the problem.

 

According to Nocera:

 

For all the "democratization" that has taken place in the world of personal investing the deck is still stacked against the individual. That was Mr. Swensen's fundamental discovery. And his willingness to change course and turn "Unconventional Success" into a polemic aimed primarily at mutual fund companies, but also at other Wall Street types who fleece the little guy, is to his everlasting credit. After all, he could have told us to buy stocks in companies whose products we buy at the supermarket, like a certain investment genius of a previous era.

 

Any regrets about that advice, Peter Lynch?

 

I have not read the book yet. I plan to. I will also see if I can't wrangle an interview with Swensen for my radio show. Based just on what I have read from the review, I agree with many of his points. For example:

 

But as he looked around at the alternatives for individuals, he found himself horrified by what he saw - especially at the $8 trillion mutual fund industry, which is the primary means through which individuals invest in the market.

 

And this:

 

Even the mutual fund monitoring companies don't help even the odds. Mr. Swensen absolutely skewers Morningstar, the company that has built its reputation rating mutual funds. His data shows that, like Moody's belatedly downgrading a corporate bond, Morningstar downgrades this or that poorly performing mutual fund only after the damage has been done. His core point, though, is that the for-profit fund industry has a fundamental conflict between its desire for corporate profits and its fiduciary duty to its investors. And the profit motive wins out every time.

 

And of course this:

 

There is a reason we as a culture have accorded hero-like status to great investors like Warren E. Buffett and Peter Lynch. For all the cultural reinforcement we get that investing is something anybody ought to be able to master, we know in our bones it's not true.

 

Larry Ribstein at IdeoBlog suggests the following in his comments on the Nocera review:

 

Nocera and Swensen are onto something bigger here. Though Nocera talks about “cultural reinforcement,” it goes deeper than that. The securities industry desperately needs a constant supply of little guys who fail to realize that they can’t make money on frequent trading, and that they should stick to index funds.  Otherwise, where would all those commissions and fees come from? 

 

And securities regulators need us to think that we can win as long as the market isn't "rigged" and the "truth" is spelled out nice and simple for us.

 

Agreed.

 

But what I vehemently disagree with is Swensen's final conclusion that investors should just buy and hold the index funds. That is fine if an investor has a 100 year time horizon like the Yale endowment but not if you must live off the proceeds of your little endowment in the next twenty years or so. That simply exposes the individual to too much risk.

 

When is the mainstream going to wake up to the fact that what the little guy needs is a way to safely accumulate and then turn his portfolio into a paycheck? We are no longer in a world where accumulation and growth are the first priority. A steady paycheck the investor doesn't have to work for or worry about is.

 

As always, your thoughts on the topic are welcome. Post them below.

The Differences Between Ostriches and Owls

I’ve been thinking about the animals we associate with the stock market – the most obvious of which are bulls and bears. There is some question as to where the terms bulls and bears first came from.

 

Many historians believe the terms came from the way the two animals fight. A bull tosses its horns upward to gore its opponent. A bear slashes downward with its sharp claws. But I am thinking of much more mundane creatures than fighting bulls and bears. In fact, I have been thinking about stock market birds – ostriches and owls.

 

Investors who invest in the traditional way remind me of ostriches - they stick their head in the sand and hope it all works out. I don't want to be an ostrich. I don't want you to be an ostrich. I want you to be an owl. Here is what I think are the differences between ostriches and owls:

 

Imagine you have two young birds – one an ostrich and the other an owl. Both have to be taught how to invest. Neither knew instinctively what to do when they were young.

 

The ostrich looked around to see what everyone else was doing and felt most comfortable doing the same thing. He looked to the same sources as everyone else for information.

 

His advisors saw a great opportunity here and taught him early on that he should rely on them for advice – they were “the experts.” After all, this was all too complicated for his little ostrich brain to understand.

Once he had accepted this belief system, his advisors were able to sell the ostrich ridiculously bad investment, charge absurd fees and commissions, and answer any questions with nonspeak worthy of a politician. The ostrich, believing from a young age that he was incapable of understanding, just rubber stamped anything his advisors told him.

 

Owl though, got a much better education. Owl was brought up to be self-reliant. He was told that he should be accountable for his own financial well-being and the way to do that was to get a good financial education and be willing to apply it throughout his life. “There was nothing to be afraid of”, his friends and family said. “This isn’t rocket science. It is mostly common sense. Anyone can learn if they were willing to make the effort.”

 

Over time, the ostrich learned from his advisors that his focus should be on portfolio growth. That is how you will know an ostrich - he will be talking about things like asset allocation, stock picking and market timing. Ostriches focus on maximizing return and the question they ask themselves every night before they go to bed is, “how did my portfolio do today?”

 

The owl learned that so long as he could generate a paycheck from his portfolio that he didn’t have to work for or worry about, he would be financially free. For owl, work, and when to stop working, would be a choice. You will know an owl because he talks about financial engineering –using all the latest knowledge and research to create new and better ways of investing his money so that it creates the steady paycheck he seeks. Owls focus on managing risk and the question that drives them is “what if I live to be 120?”

 

Ostriches and owls come from totally different points of view, based on their upbringing and belief system. Ostriches are eternal optimists. They say to one another, “Remember, stocks always go up in the long run.” Owls respond with, “Yes, but in the long run we’re all dead.” Owls are more realists. They don’t spend time thinking about what they would like to happen but rather on all the things that could possibly happen that they should plan for – for example, “What if what I want to happen, doesn’t?” or “What if the worst thing that could happen, did?”

 

Because ostriches are eternal optimists (and it makes the most money for their advisors), they invest by betting. They bet on the future direction of stock prices in the same way someone else might bet on Cactus Jack in the 6th at Churchill Downs. Listen closely and you’ll hear them. “I’d like to put ten thousand dollars on Cisco to win and I want Google, Taser and Baidu in the Trifecta.” Like all gamblers, this means their portfolios are very volatile – most of the time they are losing but every once in awhile they win big, which keeps them convinced there is a huge payday just around the corner.. Just as the handicapper spends his days poring over the racing form, stock market gamblers pore over news, newsletters, stock charts and data. Heck, there is even a 24 hour gambling channel now. It is called CNBC – the Can’t Not Bet Channel.

 

Owls are different - much more relaxed. They don’t care which direction the market moves because they don’t bet on stocks. Owls have figured out a much better game. They know statistically that the gamblers lose the vast majority of the time. So rather than gambling on stocks, they just bet against the gamblers. It’s the closest thing to a sure bet there is – bet against the bettor, hedge away the risk of the one time in ten that the gambler actually wins and you have a nice steady stream of income that is independent of the market’s direction. So instead of poring over stock charts, you will find the owls enjoying their families, spending time with their grandchildren, playing golf, or hanging out with their buddies in Bora Bora.

 

The ostrich’s best friend is named Luck. He has another guy he likes to hang with called Hope. Ostriches biggest vices are fear and greed. Because Luck and Hope are so unreliable, the ostrich often feels like he is on an island, and the future holds mostly fear and uncertainty. Thinking about whether or not he will ever be able to retire is a source of great anxiety. He often thinks to himself, “Where are Hope and Luck? They are never around when I need them!”

 

The owl’s best friend is a very smart fellow called Probability and another useful chap named Intellect. Probability and Intellect never fail the owl and because they are so trustworthy, owl has trained himself to rely on them whenever he finds himself confronted by the evil fear and greed. With friends like Probability and Intellect at his side, the owl sees the future as a source of joy and can’t wait to see what tomorrow will bring.

 

One day, Money Mustang was standing nearby watching the ostrich go about his investing. “Are you a sheep?” he called out to the ostrich. “Of course not. Everyone can see I’m an ostrich,” he replied. “Humph! Looks like a sheep to me,” thought Money Mustang.

 

Then Money Mustang came upon the owl. He watched the owl taking care of his investing. The mustang noticed the owl was very different from the sheep/ostrich he had encountered earlier. “Are you a Snider Method Investor?” asked the pony. “Why yes I am,” said the owl delighted to find someone who understood him. “I am just leaving for Bora Bora for a month. Care to join me?”

 

If you would like to view a chart that I posted that summarizes the differences between owls and ostriches, it is in the previous post. If you would like to comment on my little parable, leave your thoughts below.

Ostriches and Owls

Investors who invest in the traditional way strike me as ostriches. They stick their head in the sand and hope it all works out.

I don't want to be an ostrich. I don't want you to be an ostrich. I want you to be an owl. Here is a chart outlining what I think are the differences in the two approaches:

So what do you think? Are you an owl or an ostrich? Leave your comments below.

The Fred Fiasco ...

Let me illustrate the predicament for most investors trying to grow their portfolio.

 

We had a client who approached us last year. Fred had inherited a sizeable portfolio when his dad had passed away.

All of his life, his father, a successful businessman, had relied on Merrill Lynch to do his investing for him. Since he was a novice investor at best, Fred felt like the best course of action was to leave the portfolio at Merrill Lynch.

 

Fred's portfolio had remained with Merrill Lynch's private banking group for ten years. It had been managed by a "superstar money manager" by the name of Nicholas Applegate.

 

In the table below, you can see the actual returns from the stock portion of Fred's portfolio year to year, taken directly from Merrill Lynch's AIMS Report on the account and compare those to the returns of the S&P 500.

 

Right away, you can see that Fred's account was no different than the average investor - he badly under-performed the market over the ten year period of time.

 

What did this really cost Fred? A lot more than you think!

 

Let's assume that Fred started with $1 million in his portfolio and his account grew consistently by the average instead of through an average consisting of ups and downs. How much more money would Fred have had? Let's compare an average of 7.2% to a consistent 7.2%.

 

That is a 30% difference in just nine years - $435,000 additional real dollars in your account. Imagine how much more pronounced this effect would be over longer periods of time - say the forty years it takes someone to save for retirement? To quote Warren Buffett on how to be a successful investor, "Rule No.1: Never lose money. Rule No.2: Never forget rule No.1."

 

So where does one find this kind of consistency in a devilishly inconsistent market? Here is the bad news - it doesn't exist - not at that level of profit. But here is the good news - it is feasible to get a lot closer to the ideal than most people think. I try to keep this blog from being a blatant sales tool, but here is a hint. If this sort of low risk approach appeals to you, but with a yield of 13% instead of 7%, have a look at our track record.

 

Thoughts? Comments? Feel free to post them below.

Retirement: Why Are Americans So Ill-Prepared?

Hopefully, you have already read my previous post about 2006 being the year the first baby boomer will reach age 60. All of the data says Americans, as a group, are doing an inadequate job of preparing for their non-working years. This begs the question - why is that? I think there are five reasons:

 

1. This is the first generation to be almost solely responsible for replacing their pre-retirement income. But we were never told that. It just crept up on us. When this generation first went to work, pension plans and government checks were still the norm. The height of the defined benefit or pension plan was during the 80's.

 

So it has only been in the last twenty years that the landscape has changed so dramatically for those planning to exit the workforce. For the early baby boomers, the rules were changed late in the fourth quarter and we were slow to recognize and understand the implications of the change.

 

2. Our parents did not manage 401k and IRA money. Chances are they had little money invested in the stock market at all. 75% of their income comes from pensions and Social Security benefits according to William Keller, Jr., Vice President, Annuity Product Development for AIG. Which, by the way, is not to say that life is all yippy skippy for them. Quite the contrary.

 

Among 85 year olds, 38% have less than $25K in non-housing assets! They are having to make dire choices between eating and prescriptions that keep them alive. Matt Greenwald, President of Greenwald & Associates suggests that this generation is not serving us well with their stoicism. He believes boomers need to hear their complaints to wake us up. The level of privation that is acceptable among the old-old today is not going to be acceptable in the future.

 

So another reason I believe we have done such a poor job planning for life after 65 is that boomers have no role models. Elmer Rich, a Chicago based marketing consultant to the financial services industry calls the boomers the "fearful pioneers."

 

3. We are being bombarded by millions of messages a day to spend, spend, spend. As I said in my previous post, the era following WWII has been one of unmatched prosperity and opportunity. Along with that has come plummeting rates of savings. For the average American, they have far more in debt than they do in savings.

 

As one of my readers posted in a comment, "Bad decisions make for bad results." I fear most of us are making bad decisions today that those of us who have saved and prepared will have to pay for later. Another reader's son asked his Dad, "What's the government going to do? Let 50 million people starve?" Where does he think the money to keep those people from starving is going to come from. From you and I, that's where. Today we all want what we want when we want it and that is definitely contributing to the problem.

 

4. Our brains are ill-suited, from an evolutionary standpoint, for investing. Harvard professor Terry Burnham refers to the pre-historic part of our brain as out "lizard brain" and the lizard brain is good at determining in a split second whether someone means us harm but lousy at rational calculations, probabilities and sticking to a plan.

 

In NAPFA's (National Association of Personal Financial Advisors) May 2005 newsletter, David B. Jacobs, president of Pathfinder Financial Services has an article about our tendency to get distracted from our financial plan by all the noise going on around us.

 

He notes that we give the most weight to our personal experiences, then to what we've been told by friends, then to what we hear in the media, and we give the least weight to the statistical facts. In short, we are giving the lowest weight to the most important information and the highest weight to the information subject to the most bias.

 

5. There are very few good products designed for wealth harvesting. The financial services industry is still stuck in accumulation mode and boomers know it. Research by McKinsey & Co. says consumers overwhelmingly believe that brokerage firms (56%), mutual fund companies (55%), insurers (67%) and banks (74%) are unable to address their income needs. McKinsey's Salim Ramji says the credibility gap is even more pronounced when you start asking about individual advisors instead of companies.

 

Howard Present, President of Helicon Partners says "In order to solve the income needs of customers, things are going to have to change. Existing products and tools can't be retro-fitted to serve the needs of the income market. It requires all new products designed for income from the ground up." I completely agree. It’s a whole new world. I believe you have to invest a new way, which is why I designed the Snider Investment Method to meet this need.

 

Can you think of some other reasons? As always, I'd love to know what you think. Please leave your comments below.

 

UPDATE: The first paragraph has been changed. Many of you wrote in or left comments to correctly point out that the baby boomers did not reach 65 this year. They reach 60. My mistake. Sometimes my brain just locks on the number 65 because we are so used to talking about it.

 

60, or more specifically 59 1/2 is one of the milestone ages we reach as we approach retirement. It is the year we are eligible to pull our retirement savings from our IRAs and 401k's without being penalized by Uncle Sam. Other significant milestones are 62 when we become eligible for (reduced) Social Security benefits and, of course, 65 when we become eligible for Medicare benefits.

 

Thanks to everyone who pointed out the error. Russ, I think it is right now. Thanks for the help.

Rich Dad's Investor Workshop

I had the opportunity to meet a lot of really great people this weekend at Rich Dad's Investment Workshop here in Dallas. I am told there were more than 1500 people in attendance at the event and if I shook one hand I shook a thousand.

 

The attendees ranged from a very impressive 10-year-old named John Paul who had read every single one of the Rich Dad books and could tell you the definition of an LLC or debate with you the pros and cons of licensing to 60 and 70 year olds who were just looking for a better way to manage their retirement assets.

 

I did one presentation with Robert Kiyosaki from the main stage in the morning in which I quickly made three main points. They were: 1) avoid permanent losses like the plague; 2) cash flow is superior to capital appreciation; and 3) the so-called "experts" are best at making themselves rich, not you.

 

I followed that up with two longer programs during the concurrent sessions which covered basically the same points but in much more detail. In those programs I showed the attendees another way of looking at the riskiness of the stock market, the real power of consistent returns, why your maximum rate of withdrawal from a retirement portfolio is so small, and a way to increase the growth and or withdrawal rate in a portfolio with about the same level of risk as an investment-grade bond portfolio.

 

I hope everyone who attended really enjoyed the show and learned a lot. For those who were unable to attend - you missed a great educational opportunity. My thanks to Kim and Robert Kiyosaki for inviting me to be a part of their workshop and to KRLD for putting the whole event together.

"Pick Winning Stocks! You Can Time the Market Like a Pro!"

Guess what? This is the dirty little secret of Wall Street.

 

The financial services industry make their money by selling you the impossible - a pipe dream - the ability to consistently predict the unpredictable.

 

Just today, the following advertisement arrived in my inbox, courtesy of Barron's:

 

Not only will The Money Show be in a brand-new location, it will feature a brand-new focus as well: stock selection and real estate investing for income & growth.

 

Since when are these new? Hasn't Warren Buffett very recently warned investors away from both stock picking and real estate?

 

Selecting which stocks are right for your portfolio can be a daunting and time-consuming task.

 

Don't you mean an impossible task?

 

Adding real estate to the mix, especially now in the face of rising interest rates, can be even more confusing.

 

As if stock picking wasn't foolish enough, you also want us to try to time interest rates, something our most learned and esteemed economists are unable to do?

 

Experts in both arenas will help you narrow down the plethora of possibilities and provide you with timely and actionable advice on how to incorporate both into your portfolio.

 

Experts? You mean bell-ringers, candy men, cheap jacks, dealers, drummers, hawkers, hucksters, medicine men, merchants, outcriers, pitchmen, pushers, and peddlars, don't you?

 

Last week, I posted an investment scenario and listed six mutually exclusive alternatives for investing your money. I asked which you would pick at different ages.

 

Just to remind you, the scenario was that you had accumulated $100K in retirement funds. We have a crystal ball that tells us twenty years from today, the S&P 500 will be either 20% higher or lower than it is today but it doesn't tell us which way it will go, only that the odds are 50/50. No other outcomes are possible.

 

The choices were:

 

A. Buy and hold a market basket of stocks and hope that it goes up 20% instead of down 20%

B. Try to time the market - get in when it is going up and out when it is going down

C. Try to pick stocks using historical data, company fundamentals, technical analysis, sector analysis or some other stock-picking methodology

D. Put your money in bonds which will return on average about 5% but have a small risk of loss

E. Put your money in a principal protected cash equivalent like CDs paying 2%

F. Put your money in an investment that will lose significant value if the market declines but will generate a consistent cash flow of approximately $1000 per month over the ten year period.

 

I asked which of these investments you would choose at age 35 and at age 55, if you had to pick only one and were locked in for the entire twenty year period.

 

In comments left in response to my post on the "buy and hope strategy", some people seemed to have missed the point. Whether the scenario unfolds over twenty years (less likely but still very possible) or five years (more likely), doesn't matter.

 

Dead money is a sin. And that is what you have for as long as your portfolio remains underwater in a capital appreciation investment strategy foisted on you by an industry that makes a lot of money from your naïveté.

 

So let's not focus on the number of years. It's irrelevant. It's the general concept I want you to understand. Also, as I did in the first scenario analysis, let's increase the starting number to $1 million instead of $100K, just to make it more realistic.

 

With that being said, let's dispatch choices 2 and 3:

 

Market timing and or stock picking - the evidence is pretty overwhelming here that neither of these two things do anything but lose you money. And yet, consciously or unconsciously, it is what most people do.

 

I have written on both pretty extensively on this blog, and pound on both relentlessly on my radio show. But for the uninitiated, here is a recap:

 

This is what you are trying to time or pick stocks in. This is the return of the U.S. stock market, by year, going back to 1873.

 

 

According to 2004 congressional testimony, the average managed mutual fund returns 2.5% to 3% less than the market and 80% of managed funds under-perform the market return in any given year. These guys get paid millions of dollars a year and they can't do it.

 

According to the database maintained by Hulbert's Financial Digest, the risk adjusted return of the average newsletter writer is less than half that of the market itself. They have every financial incentive in the world to out-perform the market - wouldn't you agree? They can't do it.

 

In a first-of-its-kind study of the trading records of 78,000 households who pick their own stocks done by Brad Barber and Terry Odean, the results were exactly what you would expect. Again, the stock pickers were performing worse than the market itself. We can't do it.

 

According to the Quantitative Analysis of Investor Behavior which has been done every year for over 20 years by Dalbar, a Boston research firm, the average stock mutual fund investor has had an average return of only 2.5% annualized over the last nineteen years - a period in which inflation has risen annually at the rate of 3.1% and the S&P 500 by 12.2%!

 

Look at the chart above. Imagine when those bars are going up, your portfolio isn't going up as much. And imagine when those bars are going down, your portfolio is going down more! The evidence is overwhelming. That is exactly what is happening to the vast majority of people who try to pick their own stocks or hire people to do it for them.

 

So exactly who is making the money here? Because it surely isn't you! Not if you invest by trying to predict the future.

 

If you are going to have to one day live off your portfolio, with little or no assistance from pension or government programs, you need to make as much as you can, as consistently as you can, and avoid losses like the plague.

 

Stock picking and market timing create the exact opposite result.

Indexing - Would you bet your retirement on one hand of Texas Hold 'Em?

Last week, I posted an investment scenario and listed six mutually exclusive alternatives for investing your money. I asked which you would pick at different ages. Quite a lot of people left their picks, and their reasons, in the comments section.

 

Just to remind you, the scenario was that you had accumulated $100K in retirement funds. We have a crystal ball that tells us twenty years from today, the S&P 500 will be either 20% higher or lower than it is today but it doesn't tell us which way it will go, only that the odds are 50/50. No other outcomes are possible.

 

The choices were:

 

A. Buy and hold a market basket of stocks and hope that it goes up 20% instead of down 20%

B. Try to time the market - get in when it is going up and out when it is going down

C. Try to pick stocks using historical data, company fundamentals, technical analysis, sector analysis or some other stock-picking methodology

D. Put your money in bonds which will return on average about 5% but have a small risk of loss

E. Put your money in a principal protected cash equivalent like CDs paying 2%

F. Put your money in an investment that will lose significant value if the market declines but will generate a consistent cash flow of approximately $1000 per month over the ten year period.

 

I asked which of these investments you would choose at age 35 and at age 55, if you had to pick only one and were locked in for the entire twenty year period.

 

Turns out that my quiz was more of a loaded question than I had intended. The readers of this blog have to be somewhat biased towards cash flow or they probably wouldn't stay readers for all that long. I also realize, in retrospect, that I didn't do a very good job of making D and F an apples to apples to comparison.

 

Even though I put F at a disadvantage because of the way my choices were worded, an overwhelming majority of the people who left their comments chose F. That would, of course, be my answer as well, which was the whole point of the quiz. Let's look at why I think the higher yielding cash flow investment is the better choice.

 

This is going to take some doing to explain, so you'll have to stick with me here for awhile. Let's take them one at a time, and just to make the scenario more realistic, let's assume the starting number is $1 million instead of $100K:

 

Buy and hold the indexes - This is a lousy choice. Mathematically, my expected rate of return is 0%. Some people pointed out that in reality, there is probably a greater chance that the market will go up than down. Over long periods of time, I would agree, but in the short run, who knows? As the famous economist, John Maynard Keynes said, "In the long run, we're all dead!"

 

What I do know is the possibility exists that there could be a 20 year bear market in my life time. It has happened in the past. It will happen again. And I have no way of knowing when or if it is coming. But as someone who must someday support myself from my portfolio, maybe for as long as 30 years, I believe the only reasonable thing to do is to plan as if it will - because if I don't and I am wrong … well, how does cat food for dinner sound?

 

Let's look at this from the two different age perspectives:

 

Let's say I am 35 and I am trying to achieve growth in my portfolio. If 20 years from now, the market is 20% higher, I am now 55 years old and my principal has only grown to $1.22M. Not great!

 

Worst case, my principal has shrunk to $800K - an unacceptable outcome for someone who will someday very soon have to live off this money.

 

Now let's say I am 55 and I will retire at age 65 and begin to withdraw money at the rate of 4% per year. Best case scenario, the market goes up 20% over the twenty year period. At the end of ten years, my principal has risen to almost $1.1 million but now I start taking retirement distributions of 4% of the previous year's ending value to live on.

 

Because my distributions are greater than the increase in the market, two things are happening: my principal is declining and, as a result, so is my income - even though the market is going up. At age 75, I only have $786K in principal generating only $32K a year in taxable income with presumably, a good number of years left until I die.

 

 

Worst case scenario is, well … worse. Much worse. Assume I am 55 and the market declines 1% per year for twenty years. Now my principal shrinks even faster, as does my income. Twenty years later, I have only $490K and my income has shrunk to only $20,848 per year, before taxes.

 

And just to throw more fuel on the flames, these little back of the napkin scenarios don't take into account the fact that inflation rises, on average, at a rate of 2% - 3% per year. So in terms, of purchasing power, this scenario is just devastating.

 

 

Is this a reasonable scenario? Absolutely it is. Has it happened before? Yes. Is it likely to happen again? Dunno! But you wouldn't bet your retirement on one hand of Texas Hold 'Em would you? Why would you bet it on one hand in the stock market?

 

Next, we'll tackle scenarios B and C - stock picking and/or market timing. We can dispatch with both of these relatively quickly I think, so stay tuned. In the meantime, your comments are welcome. Post them below.

Where should you invest your money?

Let's take a little quiz to check your investor IQ. Imagine the following:

 

You are 35 years old. You have accumulated $100K in retirement funds. I tell you that over the next twenty years, the S&P 500 will move 20%. I don't know which way it will move. I just know at the end of twenty years it will either be up 20% from current levels or down 20% from current levels and there is a 50/50 chance of each. No other outcomes are possible.

 

You must pick one investment strategy in advance and live with it for the entire twenty year period. You will be locked in once you choose and you can't mix and match. 100% of the $100K must go in one investment. Given that knowledge, which investment would you choose?

 

A. Buy and hold a market basket of stocks and hope that it goes up 20% instead of down 20%

B. Try to time the market - get in when it is going up and out when it is going down

C. Try to pick stocks using historical data, company fundamentals, technical analysis, sector analysis or some other stock-picking methodology

D. Put your money in bonds which will return on average about 5% but have a small risk of loss

E. Put your money in a principle protected cash equivalent like CDs paying 2%

F. Put your money in an investment that will lose significant value if the market declines but will generate a consistent cash flow of approximately $1000 per month over the twenty year period.

 

Now imagine you have the same six choices but you are 55 years old. Which would you choose? Would it be the same choice, or different, given your age?

 

Please give me your answers in the comments below. I'll give it a few days and them give you a post on what my answer would be.

Different Investment Objectives

Previously, I wrote a couple of posts about what makes cash flow investing and the Snider Investment Method Two Day Workshop different from what brokers, financial planners or Optionetics, Trade Secrets, Wize Trade, Options Made Easy, Trend Traders, Turtle Traders, or CNBC University do. If you are interested, you can find them here and here.

 

Not only is our philosophy and methodology different, so is our objective. Under the capital appreciation model, whether we are talking about a mutual fund or what you learned in an infomercial seminar, the objective is to make as much in capital gains on every transaction as possible and hope that the gains are greater than the losses.

 

What this creates is "yo-yo investing". Sometimes you make 28%. Sometimes you are down 30%. Yo-yo investing has serious drawbacks. Namely, 1) "yo-yo investing" creates a ton of anxiety and stress; 2) studies show capital appreciation investors take on more risk than the market itself while performing significantly worse; and 3) if the market goes down for an extended period of time, the capital appreciation investor is sitting on dead money.

 

What happens to the capital appreciation investor if we were to experience a ten or twenty year bear market - which has happened in the past and I daresay will happen again in the future? What affect would twenty years of dead money have on their retirement savings or retirement lifestyle?

 

The objective of my Snider Investment Method is totally different. It is to produce an income, or yield, which deviates as little as possible from the average, each and every month, regardless of market conditions.

As you can see from the chart above, we have accomplished that quite successfully. Over the past two and a half years, our yield has averaged 13%, plus or minus 6%, 75% of the time. And that is regardless of the roiling around that the markets and the economy were doing at the time.

 

That consistent income has several benefits: 1) We avoid dead money - our portfolio works even when markets are down for very long periods of time; 2) we don't have to engage in stock picking or market timing which are impossible to do anyway; and 3) the consistency of the cash flow allows a withdrawal during retirement at a much higher rate than traditional investments that are bouncing all over the place.

 

If your primary investment objective is income, find out how the Snider Method can protect and improve your standard of living.

 

If your primary investment objective is growth, find out how much faster your portfolio will grow by avoiding dead money using consistent cash flow.

 

And as always, relevant comments are welcome. You can post them below.

Think About It ...

"You can shear a sheep many times but you can skin him only once."

-- Vermont Proverb

Another great analogy for the difference between cash flow investing (shearing the sheep and selling the wool) and capital appreciation investing.

How Are You Different From … < Fill In Name of Any Investment Seminar Here >

I get this question a lot. And it is a logical question. The investment landscape is littered with people promising easy money. Here is the answer ...

 

There are innumerable differences between what I do and what the big, national seminars tell you. Too many for me to list in fact. But the one glaring difference is that every seminar out there, whether it be Optioneer, Optionetics, WizeTrade, TradeWize, Trade Secrets, Options Made Easy, or what have you, are all based on doing the impossible. In order to make money, you must correctly guess which way the market will go. Every time you guess wrong, you lose.

 

All of the data says it is impossible to guess right consistently over long periods of time. Forget seminars, that is the basis for almost all investments sold to individual investors!

 

I take the opposite approach. I am just playing the odds, not the stock market. We know that in the options markets, those bettors lose nine times out of ten. It is a statistical fact. So instead of betting on stocks, we bet against the bettors. Instead of playing stocks, we play the fools who bet on stocks. We hedge away the risk in the one time the bettor wins and what we are left with is a nice steady income.

 

Our returns are never going to be obscene. Someone emailed me just the other day and said "George and the Optionetics gang informs us that some traders make up to $5K-$10K a day! My questions to you are can I realistically make up to $5-$10K/day with your trading program and can I quit my current job and use your trading program to supplement my monthly income?"

 

My answer back was ABSOLUTELY NOT! There is no such thing as "get rich quick", only "get broke quick". What I didn't say but I should have is if you are dumb enough to even think that is a possibility, I don't even want to talk to you. Go lose your money somewhere else.

 

People who think that way have unrealistic expectations fueled by greed. These seminar providers are simply cashing in on the greed and stupidity of people who want to believe that there is a free lunch.

 

The Snider Investment Method is never going to double our money over night. But like the house in Las Vegas, that little bit over long periods of time makes us a very nice living. And more importantly, the only thing required to make it work is a willingness on the part of others to gamble on stocks.

 

Since that is the way 99.9999% of individual investors are told to invest, and Wall Street spends $19 billion each year to perpetuate that, I have no worries that the Snider Method will continue to work for the remainder of my life time, regardless how many people I teach it to.

 

So the question to consider is, "Do you believe it is possible to correctly predict the future direction of a stocks price consistently over long periods of time?" If your answer is yes, then you should take someone's seminar. If you believe it is no, or you don't want to find out with your hard earned money, then my way - cash flow investing using the Snider Investment Method - is better. You just have to decide what you want. Do you want a safe, consistent income that has averaged 13% with almost no deviation from month to month or do you want the fun and excitement - and risk - of gambling?

 

So what are your thoughts? Would you prefer the steady, albeit unspectacular returns of the house, or are you the gambler who prefers the fun and excitement of gambling? I'd love to hear your thoughts. You can post your comments below.

Be Scared! Be Very, Very Scared!

In this weekend's Barron's, Randall Forsyth makes note of the dire lack of savings among the Baby Boomers. The average household spends $1.04 for every dollar they bring in. Nearly one third of seniors have unpaid balances on their credit cards. And their average balance is just over $4000.

 

Problem? You bet!

 

Using traditional methods, it would take a nest egg of almost $4 million to generate a pre-tax income of only $150,000 per year. It is safe to say that many of you have a household income in excess of $150K and your savings are nowhere near $4 million.

 

Am I right? Care to comment? Post your thoughts below.

 

SOURCES:

 

Forsyth, Randall. "Playing the Angles." Barron's 22 Nov 2004: 5-6.

The Case for Cash Flow Investing

I am not afraid of storms, for I'm learning how to sail my ship. -Louisa May Alcott

 

When stock prices go down, that’s bad for those investing for capital appreciation. Those investors buy stocks with a goal of selling them for a profit when the price goes up. If the price goes down, their plan fails. A cash flow investor, like those using our method, buys stocks with the goal of producing a monthly yield for as long as we own those particular stocks.

 

We know there are always going to be storms which buffet our stocks. Sometimes it may be a localized event specific to the stock you own. Sometimes it will be more global. In fact, stocks and markets go down much more often than people think. The stock market has had negative returns in 50 out of the last 130 years. That is almost 40% of the time.

 

We also know that there have been many five, then, even twenty year periods in the U.S. stock market where the return was less than 2%. Researchers point out that some European markets have experienced 50 year periods with a negative return!

 

In an interview with Dr. Benoit Mandelbrot, the father of “Fractal Finance”, I asked him about the predictability of stock prices. Dr. Mandelbrot explained it this way: Owning stocks is like owning a fleet of ships. A ship owner knows there will be storms, and if his ships must sail long voyages over weeks, months and years, there is no way to predict when those storms will occur and where.

 

So the ship owner has a dilemma. He cannot know what the weather is going to be in advance, but his ships must ply the seas day in and day out. One possibility is try to avoid bad weather. That may be possible for the casual sailor but it is impossible if you make your money sailing ships from Point A to Point B.

 

With traditional investments based on stock picking and market timing, you are in a small craft that cannot sail through a bad storm without sinking, or at least being badly damaged. The game the capital appreciation investor is playing is to try to guess when the storm is going to come and then hide his ship in a safe harbor.

 

The better alternative is to design ships that can withstand the storms. That is the essence of cash flow investing. Cash flow investing in general, and my method of generating cash flow regardless of market conditions more specifically, is the sturdy sea-going ship that sails around the world regardless of the weather. It may not always be the most pleasant sailing experience, but the ship is built to plough through dangerous storms and reach its destination unharmed.

 

SOURCES

 

1. Benoit Mandelbrot, interviewed by author, 26 August 2004, http://www.bethefamilycfo.com/kimreading.html, Dallas, TX.

 

2. Dimson, Elroy, Marsh, Paul and Staunton, Mike, "Irrational Optimism" (December 2003). LBS Institute of Finance and Accounting Working Paper No. IFA397. http://ssrn.com/abstract=476981

If Cash Flow Investing works so well, why isn't everyone doing it?

It is ridiculous to judge the merit of an idea by how widely it has been adopted. Benoit Mandelbrot, the father of fractal geometry, describes the movement of financial markets in terms of power laws, or what I call "jump states. He says, "Markets don't glide, they explode."

Innovations do the same thing, whether in personal finance or technology. They gradually seep through the bedrock of society until one day they finally explode on to the scene. To us it seems that they appeared overnight, when in fact, they had been here all along.

Time Magazine devoted the October 11, 2004 edition to "The Next Thing". There was an essay by Bill Buxton, "The Future is Already Here", I found especially relevant.

In it, he shows us that most of what we take for granted today took decades to come into the mainstream. Some examples from his essay:

"Consider the LCDs on our watches, cell phones, PDAs, laptops and, increasingly, TVs. Liquid crystals were discovered in 1888 by Friedrich Reinitzer, an Austrian botanist, and named a year later by Otto Lehman, a German physicist. Since then, they have taken a leisurely route to our homes. The first prototype display emerged from RCA's Sarnoff Research Center in 1968. Two years later, Optel began producing the first watches with an LCD. I first got a computer with an LCD (an Apple Portable) 15 years ago. The road from discovery to mass market took about 116 years."

Other examples from his essay:

"Disk brakes, which we take for granted, were introduced by British inventor Frederick William Lanchester in 1901. They didn't appear in North American cars until Chrysler introduced them in the early 1950s, and they became standard only in the 1980s. Likewise, the Golden Age of television arrived some 20 years after TV was invented, around 1935."

"All this suggests that the technologies that will significantly affect our lives over the next 10 years have been around for a decade. The future is with us (or at least some of us). The trick is learning how to spot it."

Here is the link to Buxton's essay.

Are you playing Russian roulette with your retirement money?

First of all, let me start out by defining a term that we have all heard, and that I use a lot to describe the current investment paradigm and that is capital appreciation. The idea behind capital appreciation investing, which is what you are all doing, whether you bought AT&T stock sixty years ago and are still holding it, or you are an indexer, or you are a day trader, is that you are trying to profit by buying something low and selling it for more. Your profit is the capital appreciation on the asset you bought and sold.

Now within the capital appreciation model, there are two schools of thought on how you get the capital appreciation – one is known as active investing and the other is known as passive. Active portfolio management is about using some means of analysis to predict when something is likely to go up or down, and to adjust the portfolio accordingly. Within active management, there are many different approaches – you have technical analysts who study charts, you have fundamental analysts who study financial data and trends, you have quantitative analysts who are very rigid and you have some managers who just go on their gut instinct. So an example of active management is a portfolio manager or individual investor, who by using some method of divining the future, has decided that the stock of Google is going to go up, so they buy it in hopes that they can sell it later, for more.

On the other side of the capital appreciation coin, you have the passive investor. The passive investor is going for the same outcome but they try to achieve it in a different way. The passive investor just let’s time do the work – or at least that’s the plan. The idea behind passive investing is rather than trying to predict what individual securities are going to go up or down, which is called stock picking, or trying to figure out whether the market as a whole will be going up or down for the foreseeable future, which is called market timing, the passive investor just buys a index fund, like an S&P 500 index mutual fund, which will almost exactly mimic the performance of the S&P 500 itself because it owns all 500 stocks that make up the S&P, and hold that index fund for many, many years.

Passive investing is based on the widely disseminated statistic that says, over the last 100 years or so, the market as a whole, has gone up, on average, about 12% a year. So the passive investor says, “If I just hold the index long enough, I should get about a 12% return.”

Now Wall Street, you have to understand, is built on this capital appreciation model. And anything that threatens it, they are going to fight tooth and nail. And between the two schools – active and passive – they heavily promote the active, because active management generates a lot more fees and commissions than passive does. But the fact is, neither one works. Let me repeat that … neither one works! I am telling you the emperor has no clothes. You know he has no clothes because you have seen the havoc capital appreciation can wreak in your retirement savings – but you continue to do the same thing and hope that will never happen again - the definition of insanity.

Let me explain the fallacy in the capital appreciation model. Let’s start with active investing. This one is easy. No one can consistently predict whether prices will go up or down next. It is an illusion. All the data says so. Like what data you ask? Well here are just a few examples.
A study done a few years ago at Harvard looked at over 100 investment newsletters. Only four of the 107 newsletters were able to beat the returns of the market itself. Did those four have some extraordinary skill or were they just lucky? The data says this number of four falls easily within the laws of probability or chance.

Zack’s Investment Research conducted a study by creating a portfolio of the analysts’ “best picks” of 1998 and 1999. They selected stocks that were followed by more than three brokerage firms and were recommended a “strong buy” by all analysts who covered the stock. This portfolio lost 24% over the two year period while the S&P 500 was up 48%!

And here is the clincher … according to Morningstar, the average domestic equity fund, with a track record of at least 15 years, trails the S&P 500 by more than 2%. Study after study, fact after fact, says active investing doesn’t work. No one can predict.

In any given year, two-thirds of actively managed mutual funds do worse than the market itself, and the ones that out perform this year will be different next year. So why do we continue to invest this way? Because we ignore the large number who underperform the market each year and latch on to the ones who out-perform. And specifically, we latch on to the ones who have outperformed over several years. Are these few fund managers savants? No! Here is what happens.

The author of the book, “Fooled by Randomness”, Nassim Taleb, was on my radio show in August and we discussed that just as surely as a room full of coin flippers will produce one person who flips heads six times in a row, out of tens of thousands of active portfolios, it would be strange if you didn’t have a few Warren Buffets.

He makes his point by saying if an infinite number of monkeys banged on typewriters, one of them might actually produce an exact copy of “The Iliad”. He goes on to ask, who, if any, would invest their life savings on a bet that the same monkey could produce “The Odyssey” next?

I just gave you some data showing you how poorly active managers do, and how our mind tricks into believing that the success of a few, even though produced through luck, not skill, keeps alive the hope that one day you might also be successful even though your portfolio balance tells you otherwise.

Now, I will confess, that up until fairly recently, I was an honorary member of the passive investing camp. I believed that if your only two choices were between active and passive investment, that you should choose the lesser of the two evils and just buy and hold index funds.

I no longer believe that. If those are my only two choices, then I wouldn’t play the game. I would take my ball and go home. In fact, we are looking at setting up a retirement plan at our company. Jim and I were talking about how we would invest the money that we can contribute through our new plan. Since it isn’t enough to use with my SYGMA ™ Investment Method, our contributions to the plan will sit in a money market fund or some other cash equivalent.

Now, I know this flies in the face of everything you have ever thought about investing for retirement. You may be wondering to yourself, “Why on earth would she contribute to a 401k and then leave it sitting in cash?” The answer is that I want to defer taxes on the money but I am not willing to risk losing it. I worked too hard to get it. And even though I can’t take withdrawals for another 20 years, I wouldn’t even put it in an index fund. Let’s look at why.

There have been five, ten, even twenty year periods in the past where the U.S. stock market returned less than 2%, which is what I would get by holding cash. I can also make a very good case that the U.S. stock market has been on an extended wining streak since 1929 that is unlikely to continue. So return numbers based on the oft quoted 1929 forward are unrealistically high. There have been several papers published lately that compare the U.S. market to the markets of other developed countries in Europe and they find that the expected returns for the U.S. stock market in normal conditions is likely to be around 6 -7%.

So, what if I had bought and held the indexes in the late 1920’s, the 1930’s or the 1970’s? I would have lost money, even over a period of years. Now it is true that over most periods, I would have made money – but the problem is, I can’t know in advance which is which – which makes it gambling … or Russian roulette, and I am not willing to gamble that way with my retirement money. That sounds funny coming from a former options trader - but it is true.

What we are tempted to try to do is a sort of market timing. If I am not planning to retire for twenty years, I might say to myself, well I’ll just leave it in index funds until five years before retirement and then I will move to something safer. Fine. But what if five years before you get ready to retire, we just went through a three year bear market like we did beginning in 2000? So then you have saved for most of your life only to lose 80% of it just before you get ready to retire.

You see, if I am a pension plan or big institution that is going to manage a pool of money indefinitely, then indexing makes sense, because I truly have an indefinite time horizon, but for the individual who is going to need that money in a very definite period of time, the inability to predict which periods will be winners and which will be losers means I am just hoping that when I need that money it won’t be right after I just lost a big hunk of it.

So what we are left with, is that for individual investors, the capital appreciation model of investing just doesn’t work. It doesn’t work because no one can predict what prices or markets will do in the future with any degree of consistency – no one. And the inability to predict is what makes investing this way – too risky.

Let’s go back to Russian roulette. Suppose I offered you a million dollars if you survived a game of Russian roulette. The upside is that if you survive, you get a million dollars but there is a good chance that you will be dead instead. The game isn’t worth playing because the upside can’t possibly outweigh the downside. I view investing using the capital appreciation model the same way. The upside potential just isn’t enough to offset the risk that I may lose fifty, sixty seventy percent of my savings just before I need it.

SOURCES:

1. "S&P 500 Index Nominal Returns" Crestmont Research, Inc., http://www.crestmontresearch.com/content/Matrix%20Options.htm, 2003.

2. Nassim Taleb, interviewed by author, 8 August 2004, http://archives.kimsnider.com/archive.php?type=Interview, Dallas, TX.

3. Dimson, Elroy, Marsh, Paul and Staunton, Mike, "Irrational Optimism" (December 2003). LBS Institute of Finance and Accounting Working Paper No. IFA397. http://ssrn.com/abstract=476981

One in the Hand is Worth Two in the Bush

Why cash flow is superior to capital appreciation

DALLAS, TX - Robert Kiyosaki has a great metaphor for cash flow versus capital appreciation investing. It is the difference between the dairy farmer and the rancher. Both own the same underlying asset - in this case cows - but their objectives and how they manage their cows is totally different.

The rancher buys cows, holds on to them for a short period, and then, if all goes well, sells them for more than he has in them. This is the capital appreciation model of investing. The dairy farmer, on the other hand, never intends to sell his cows. He intends to sell the milk they generate instead. The value of the cows is immaterial, so long as they continue to produce milk. That is the cash flow model.

The problem with capital appreciation investing is that the investor must constantly find investments that will increase in value so they can sell them for more than they bought them for. I believe that is impossible to do for two reasons: 1) because prices are unpredictable; and 2) because there are prolonged periods in the market where everything is going down. In other words, declining stock prices are a fact of life that cannot be avoided.

Let me give you two examples - one short run and the other longer run. The stock market hit its recent highs in January of 2004. The Wall Street Journal showed a graph in the August 16 edition showing what has happened to the one hundred stocks that make up the NASDAQ 100 since that date. 76 of them are down from January. That's three out of four. And 40 of them are down by more than 25%! But the NASDAQ itself is down 18%.

At the same time, a review of the historical performance of stocks shows that there have been many periods of twenty years or more, where the return over the twenty year period was less than 2%. In those cases, the investor would have been better off in a money market fund. A recent paper by three London Business School professors looked at stock performance worldwide. They argue that the assumption that the stock market will return 12% over any 20 year period is irrationally optimistic. In fact, they found some periods of time in other developed markets where the investor would have had to wait 50 years to get a positive return.

The fact of the matter is, no stock market investor has a long enough horizon to make capital appreciation models work. In addition, when an investor approaches investing from a capital appreciation mind set, that is to say, always in search of appreciating investments, it creates the tendency most investors manifest, of buying high and selling low - the exact opposite of what they intend.

A cash flow investor, on the other hand, does not try to avoid declining prices. Instead, they try to avoid permanent losses by owning quality assets and make the best of the situation by owning assets that generate cash, regardless of whether the market value is up or down.

Let me give you an example many of my SYGMA Workshop Alumni are already familiar with. In February of 2001, the market had been declining for just about a year at that point - post dot com bubble. Many pundits were claiming that the bear market was over. To make money, the capital appreciation investor either had to correctly determine that they were wrong, sit out until April of 2003, correctly determine that prices would begin to rise in April, 2003 and then have the courage to get back in, in spite of a war that was going badly in Iraq, OR, he would have had to consistently found stocks that were going against the tide and rising over that entire two year period. So you either had to be a great market timer, or a brilliant stock picker. That sort of ability just doesn't exist.

Compare that to the cash flow investor. In fact, compare that to the SYGMA investor who bought Checkfree (Ticker: CKFR) on February 14, 2001 at $49.94 a share, without regard for the future direction of price. The SYGMA investor accumulated 1000 shares of CKFR over a period of months and used them to generate an income. By August of 2002, CKFR had fallen to a low of $8 a share. Its market value had declined by 84%, but over that entire period of time, it continued to generate a positive cash flow averaging about $240 month. That is real money that could be withdrawn and used to pay bills.

Had you looked at the market value of that position, it would have shown a horrendous loss, in spite of the fact that it was throwing off cash flow. Now, if you had bought CKFR as a capital appreciation investor at the same time, there were two possible outcomes. One would be to sell CKFR somewhere along the way at a loss. While it is true that you may have avoided the slide to $8 a share, where would you have put your money that it wasn't doing the same thing? Remember, at that time, there was no place to hide if you were in stocks!

The other possibility was to hold on tight and hope for the best. Now your account value is down 84% and you will not have earned one thin dime yet. Your money is just dead while you wait for CKFR to get back to $50 a share and that point, you still haven't made anything. You have simply broken even.

The SYGMA investor, however, didn't have to hide. As of June 2004, that position in CKFR had thrown off over $8000 in income or an average of about $240 a month. In spite of the fact that CKFR had recovered to only around $31 a share, the SYGMA investor was in the black. The CKFR position could be liquidated at a $4000 profit - but why would you? The CKFR position is still throwing off cash at the rate of about 10% per year on the original $25,000 investment. The capital appreciation investor, on the other hand, is still down by a little less than half of his original investment.

The key to this example is to think about the following - where else could you have put your money over that period of time where it would have generated a 10% yield and been up on a total return basis? That is the power of cash flow. Yes, it is true that the account value experienced serious declines at some points, but the only better alternative is to be able to consistently time the market and pick winning stocks. Because that is impossible over any length of time, I believe cash flow is far superior to capital appreciation investing.