Do we need the government to make us save?

It may seem hard to remember now, as we sit here mid-way through 2009, but back in 2002, the scandal of the day was Wall Street analysts issuing buy and sell recommendations based on the opportunity for investment banking business with the company, rather than their true opinion of the stock.

Eliot Spitzer to the rescue.

"This has been about one thing," he said before a flock of television cameras at the New York Stock Exchange. "It has been about ensuring that retail investors get a fair shake."

Ultimately, a settlement was reached with ten of Wall Street’s biggest firms. Regulators would oversee a 5-year, $450 million program, funded by investment banks, to support so-called "independent research" on stocks, plus an additional $85 million for "investor education."

It was all about taking care of the little guy who couldn’t take care of himself. With 20/20 hindsight, it turns out that many investors couldn't have cared less.

The Wall Street Journal reports:

“Since Mr. Spitzer's landmark settlement in 2003, annual reports show that few individual, or "retail," investors took advantage of the offering. During one recent year at Credit Suisse Group, for instance, just 16 retail clients had retrieved reports from the bank's Web site.”

In a recent interview, Mr. Spitzer maintained the settlement achieved its aims. "The system was broken," said Mr. Spitzer, who resigned from office amid a sex scandal in 2008. "Our first task was to reveal to the public that the system was fundamentally flawed, that the research was tainted and the public was being misled."

The second task, he said, was to come up with a better product. "It's better to have what we have than have fraudulent research," he said.

It's not that what the investment banks were doing wasn’t wrong or that they didn’t deserve to be punished for it. I agree government’s role is to make sure the investing public isn’t misled. But it is not to come up with a better mousetrap. Their record at that is pretty dismal.

In a bit of déjà vu, the latest bear market has brought out all manner of people, politicians and otherwise, determined to make sure we take care of the little guy who is so obviously incapable of fending for himself.

A May 18, 2009, editorial in Investment News, which bills itself as “the leading news source for financial advisors”, calls for mandatory enrollment of workers in 401(k) plans and a mandatory minimum contribution to the plan by employees:

Robert Reynolds, president and chief executive of Boston-based Putnam Investments, is on the right track in proposing changes to 401(k) plans to reduce the risks for participants and in urging other financial industry leaders to join him in pushing Congress for action, as reported in InvestmentNews last week.

He has identified the two most critical changes that are needed. First, all employers should be required to enroll all employees in a 401(k) or similar plan, and all employees should be required to contribute a minimum percentage of their pay to the plan.

This would address the greatest weakness of the U.S. retirement system — the significant number of private-sector workers who aren't participating in any retirement plan.

Just 66% of full-time workers participate in such plans at large and midsize companies, and just 37% at small companies, according to the Employee Benefit Research Institute of Washington. Small companies, especially those with very slim profit margins, may need government assistance with the costs of starting and running such plans.

Second, employees must be given an opportunity and encouragement to annuitize a significant part of their retirement plan assets beginning at 50. Annuitization minimizes the damage to retirement income that can be caused by a major bear market as retirement approaches.

Although many other improvements to 401(k)s and similar plans are possible, these two would go a long way toward helping private-sector workers build a comfortable retirement.

The recession and bear market have revealed the weaknesses of the U.S. retirement system.

Perhaps the downturn also will spark the reforms needed to strengthen it.

Oh my aching head! The obvious benefit to Putnam specifically and the investment management industry at large aside, do these people really believe that government should be mandating retirement savings?

Wasn’t that the idea behind Social Security and Medicare? And gosh, look at what an overwhelming success that has been! And whatever happened to personal accountability? 

While I'm on the subject, partial credit goes to the Obama administration for pulling back on the pay limits they tried to impose on the companies that received government bailout money.  

The government had announced plans to "fix" the pay problems of the banking industry by having conflicting plans, one from the administration and one from Congress, to limit pay in the companies that took TARP money.  And it turns out we need a "pay czar" to watch over the whole thing.  What's with all the czars?  I hear we need a car czar, too.  Is this because the drug czar idea worked so well?

As it turns out, the government's plan (plans?) could hurt the very companies we all now "own" by pushing talent out the door to hedge funds, private equity firms and foreign firms.  Or, some attorneys and compensation consultants would get rich designing plans to get around the limits anyway.  

This is just another example of government trying to legislate the end result rather than addressing the root causes.  Passing these laws help get politicians reelected.  They help some special interest groups score some short-term revenue increases.  But in the end they come years after the market finds a different way to fix the problem, and they leave behind an entrenched bureaucracy whose only job is to perpetuate their own existence long after their usefulness has expired.

There has to be a better way to fix the retirement system. Here are my ideas (and a few of Jim’s).

1.    Let’s get rid of the 401(k) system altogether. It was never intended to be the cornerstone of our retirement anyway. Why is it up to the employer to decide what investment choices you have, what your contribution limits are (based on what type of plan they choose)  or whether you even have access to a retirement plan? It’s a bad investment vehicle, it is inefficient and it is limited in access.

Let’s give everyone the exact same plan – an IRA with higher contribution limits that is the same for everyone and has access to the entire range of investment choices. If I have to bear the risk of funding my own retirement, at least give me access to the full range of choices to be able to manage the risk!

2.    Let’s address the disease rather than the symptom. If you want people to save, don’t force them – teach them. Let’s take some of the money government wastes each year and use it to fund basic financial education in our schools.

I would love to hear your ideas. What should be done, if anything to address retirement savings in this country? I will temporarily open up comments on the blog just for this special occasion. What say ye?

Sources:

 1. ‘Stock-Research Reform to Die? - WSJ.com’ < http://snurl.com/jt42m > [accessed 10 June 2009].

2. “Let's rebuild retirement's three legs - Investment News,” <http://snurl.com/jt45r> [accessed 10 June 2009].

The Five Biggest Mistakes Investors Make

I was doing a program the other evening for a group of employees from one of the larger DFW area employers. Before it started, I was talking with one of the attendees about how your emotions are what make investing so difficult. We had a really nice conversation but, try as I might, I don't know think he was totally convinced of the impact our emotions have on us as investors.

 

Given that “emotions are your worst enemy” is one of the six fundamental tenets of my investment philosophy, I was somewhat frustrated by my inability to help him see something which to me is so plainly obvious. Then a funny thing happened. As the night wore on, the attendees themselves demonstrated each of the mistakes I was trying to get the gentleman to understand. Sometimes, a picture really is worth a thousand words.

 

Expert bias

 

I spoke with one woman who told me she appreciated my talk very much but had no interest in managing her own investments. I asked what she was investing in currently. She wasn't really sure.

 

"How do you know whether the investment is the best one for achieving your objectives?"

 

"I don't,” she replied, “I am really not happy with my investments. I’ve been investing with him for fifteen years and I don't have anything to show for it."

 

When I asked why she didn't manage them herself, she seemed shocked at the notion.

 

"That would be like doing surgery on myself," she said.

 

This is what is called "expert bias." It is very strong and it can be very dangerous. In the medical field, researchers attribute many of the errors in patient medication, for example, to a blind deference to authority. Take the rather comical story of a physician who ordered ear drops be given in the right ear of a patient with a painful ear ache. Presumably to save time, the doctor wrote, "Place in R ear." Upon reading the prescription, the on-duty nurse promptly put the required number of drops in the patient’s rear!

 

Clearly, treating an earache through the backside makes no sense at all. But apparently neither the nurse nor the patient questioned it. The moral of this story is, when someone we perceive as an expert gives instructions, we take leave of our own powers of critical thinking, even when it directly contradicts what we know to be true. As an investor, this is a very costly mistake.

 

What to do about it: Do not assume that just because someone is a financial advisor, regardless of the letters behind their name, they know what they are talking about or are putting your best interests ahead of their own. The only way to avoid what I call the tax on the uninformed is to know enough to, at a minimum, be able to participate in all decision-making related to your financial future. An even better solution is to manage your own money.

 

Stock picking and market timing

 

Another gentleman was a trader type. He bought and sold constantly. I asked him how he was doing. "Not very well right now," he said. "But that's just because I don't have enough time to pay attention to it." If only I had a dollar for every time I have heard those words.

 

Here’s the deal. Stock picking and market timing are incredibly seductive. 20/20 hindsight gives you the false impression that both should be fairly easy. So if you fail at it, or your advisor fails at it, the natural response is to make up some excuse for why they failed.

 

Here is the real skinny on each. Let's start with stock picking. Stock picking is the misguided idea that through either fundamental or technical analysis we can pick the "best" stocks. So let's think rationally about this. In theory, who should be the best judge of whether or not this is really possible?

 

Mutual fund mangers, right?

 

Isn't that what they get paid millions of dollars a year to do? To pick the stocks which will go up more than the market? Or to pick the stocks that will not go down as much in a bear market?

 

But an objective viewing of the evidence shows us that stock picking can't be done. Two-thirds of actively managed mutual funds under-perform the market in any given year. In other words, if the market goes up, they go up less. If the market goes down, they go down more. And the ones that do outperform are different from year to year which tells us the ones who outperform do so not from skill but rather from luck.

 

What about market timing? Market timing is the practice of getting in or out of an asset before an anticipated move up or down. So in its most basic form, a market timer would go to cash when the market was trending down and be fully invested in the stock market while it is trending up. Again, the evidence says it can't be done. Many studies have been done of the market timers, and none are able to consistently beat the market over any length of time.

 

Why is it that something which seems so easy is so hard? Here is what no one tells you. Most of the market gains and losses occur in a very small number of days. For instance, if you missed just the five best days during the ten year period ending December 31, 2006, your return would have dropped from 8.5% to 5.5%. If you miss the twenty best days, your return would be negative! The clincher is those days typically don't occur in the middle of a cycle but at the beginning or end when the market timer is sitting on the sidelines waiting for the new trend to be confirmed.

 

What to do about it: A fundamental truth about investing is that prices are random. Until you understand that, your brain is always going to be able to trick you into believing that you can predict the future direction of price. There are two things you have to do to avoid this mistake: 1) stay invested all the time - even when it feels bad and 2) tie the achievement of your investment objective to the amount invested, not the market value, which will fluctuate a lot during market cycles.

 

Staying in a bad investment until it gets back to break even

 

The guy I was talking to originally was really funny. At the end of the evening, after I had pointed out all these emotional mistakes, he laughed and said, "You are right. I guess emotions really do play a large part in our success or failure as investors." I was relieved. Finally I was making some headway. At which point he said, "I really like the sound of your program. But I wouldn't want to sell what I am in while it is down."

 

Perfect. Another teaching opportunity!

 

What I wanted him to understand was that this was yet another example of the mind playing tricks on us. Psychologists tell us the pain of loss is much stronger than the possibility of pleasure. As a result, we will often do harm by trying to avoid the pain of loss at the expense of a greater reward.

 

"Let’s imagine your portfolio was $500,000 but now it is down to $350,000. Let's assume that your current portfolio will average 5% return over the next thirty years, but some new investment you are considering would average 6%." I was just making up numbers for illustration purposes. "You can either sell the existing portfolio and put it all in the new investment or you can hold the old investment until it got back to $500,000, then sell it and put it in the new investment. Which will give you more money at the end of thirty years?"

  

He smiled. "Well, when you put it that way."

 

With perfect knowledge of the future, the obvious answer is to sell and purchase the better-performing investment. He will have more, over any timeframe, by putting it in the new investment sooner.  Of course, these are just made up numbers and we never really know how any two investments will do in the future.  But the point is, like so many of the decisions we make about money, this one is emotional – not rational.

 

What to do about it:  You chose your investments based on how likely they are to meet your stated investment objectives and tolerance for risk over a given time horizon. Whether to sell or hold an investment has nothing to do with the price you paid for it. That is done - in the past. The only thing that matters now is what is likely to happen in the future.

 

There are two more tricks our brain plays on us as investors. One is our propensity to buy high and sell low over and over again. The other is sticking with something that worked once even though the probabilities of it working long term are low. A sports analogy would be the six foot seven inch center in basketball who takes a long range, three point shot and makes it. He then spends the rest of the game shooting outside jump shots when his odds of repeating the feat are dismally small. It costs his team the game. In the interest of space, I think I will save these last two for the next newsletter.

 

In the meantime, if you would like to learn more, I encourage those of you in the Dallas Fort Worth area to attend the upcoming briefing on Thursday evening, November 13th. It’s called, What to Do When You Can't Trust Wall Street - or Washington.   I will discuss the recent trends making the job of the Family CFO so difficult and offer up my solutions. You can register on our website at snideradvisors.com.

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Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax or other advice and are provided for informational purposes only. This article is not a complete discussion of the benefits and risks of the Snider Investment Method®. For a complete discussion, read the Snider Investment Method® Owner's Manual, available by calling 888-6SNIDER. Please read and consider carefully before investing. All investments, including the Snider Investment Method® are subject to risk, including possible loss of principal. Income is objective and not a guarantee. Dollar cost averaging does not guarantee you will not experience capital losses.

Helping College Students Manage Their Money

I had the pleasure of getting up early yesterday morning to appear on Channel 4's "Good Day" show this morning. Host Tim Ryan and I discussed tips for helping college students manage their money. I know quite a few of you have kids in college, and it's never too late to teach your kids the right ways to handle their finances.

You can watch the interview here.

(By the way, if you'd like to order a copy of my book, How To Be The Family CFO, give us a call at the office: 214-220-0055 or 1-888-6SNIDER. We can send you a copy before they're even available in bookstores. Get one for yourself and for your kids!)

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Kim Snider is the President and Founder of Snider Advisors, an investment adviser registered with the SEC, focused on teaching individual investors a sensible, long-term investment approach focused on maximizing cash flow. For more information on Snider Advisors or the Snider Investment Method, please visit www.KimSnider.com.

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 888-6SNIDER to request the Snider Investment Method® Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method® are subject to risk, including possible loss of principal.

You May Be in Good Financial Shape and Not Know It

Yes, many people are staring retirement in the face and aren't even close to being prepared. Yes, our economy is in a funk right now. And yes, everyone is feeling the pinch of higher prices for gas and food. Don't you think it's time to turn away from all the gloom and doom and think something positive?

I'll start with this: You may very well be on your way to a secure financial future, no matter what you keep reading in the media. 

The press likes to focus on doom and gloom, and it likes to tell us time and time again that millions of Baby Boomers are heading toward retirement without nearly enough saved up. They'll emphasize the findings of the latest EBRI Retirement Confidence Survey, which says that most workers aren't confident they'll have enough to retire on. All this may be true, but by focusing solely on the unprepared, it strikes fear in the minds of everyone, including the millions of Baby Boomers who actually DO have plenty of resources to get them through retirement.

I'll admit; I'm just as guilty as the next guy. For the last several years, I've trotted out tons of statistics to try to scare people into shaping up their retirement portfolios. What I've found, however, is that I've been scaring the wrong people.

The fact that you read my articles tells me that you are trying to be on top of your financial situation. The ones who are truly ill-prepared aren't likely to be seeking advice from someone like me. They're probably blissfully ignorant of their financial situations.

I meet with people all the time to go over their individual circumstances, and I've found that most of them fall into three categories:

1. Those who have enough to retire comfortably on (sometimes a lot more than enough), but don't think they're in good shape. Most of them just need to learn how to structure their portfolios to target a sustainable income stream.
2. Those who could have enough, they just need to adjust their spending or their income, and sometimes both. They typically have enough time to get back on the right track; they just need someone to point them in the right direction.
3. Those who really don't have enough, but they think they do. They spend like they have lots of money to burn, when they really don't. They typically need a dose of tough love! They'll probably have to work longer, cut their expenses to the bare nub and save like crazy – not the advice they want to hear.

If you're worried about whether you're adequately prepared, then let's talk.  Let's have a conversation about your situation and your goals. I won't try to hard-sell you on Snider Advisors or the services we offer; I truly just want to help you and maybe calm your fears. The sooner you find out where you stand, the sooner you can make the necessary adjustments – and the less painful those adjustments will be. Give me a call at 214-245-5236, toll-free at 1-888-6-SNIDER, or shoot me an email. You might be better positioned than you think.

SOURCES:

1. Helman, Ruth, et al. “Americans Much More Worried About Retirement; Health Costs a Big Concern,” Issue Brief, Employee Benefits Research Institute, April 2008. [accessed 29 July 2008]
2. Hurt III, Harry. “Who Wants to Retire Later? (Don't Laugh)” The New York Times, 20 July 2008. [accessed 28 July 2008]

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Kim Snider is the President and Founder of Snider Advisors, an investment adviser registered with the SEC, focused on teaching individual investors a sensible, long-term investment approach focused on maximizing cash flow. For more information on Snider Advisors or the Snider Investment Method, please visit snideradvisors.com. Her book, How to Be the Family CFO: Four Simple Steps To Put Your Financial House in Order, will be in bookstores October 1, 2008.

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 888-6SNIDER to request the Snider Investment Method® Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

Time to Tackle Some Widespread Myths

I was going through my magazines the other day, and one little graphic jumped out at me. It showed the results of a survey of working 56-65 year-olds who were asked about their retirement plans. What it told me was that there are still a lot of misconceptions out there on how to plan, save and invest for the future.

The mainstream press doesn't do much to shatter these myths. So I'm going to go point-by-point through the survey results, and I hope I'll be able to set many people straight.

Finding: 43% of those surveyed believe they'll be able to withdraw 10% or more of retirement savings each year without exhausting their capital.

Reality: The widely accepted "safe" withdrawal rate is more like 4%-5% per year from a well-diversified portfolio of stocks and bonds, according to several studies. As with most of investing, the term "safe withdrawal rate" comes with a disclaimer: 4%-5% is merely a figure based on historical data that provides a high probability you won't outlive your money.

How can that number be so low if the stock market, on average, returns 10.4% a year? It's because the 4%-5% figure takes into account the fluctuations of the stock market as well as inflation -- an often overlooked piece of the retirement income puzzle.  First, the "safe" withdrawal rate assumes you aren't 100% invested in stocks; you have at least some assets in bonds and cash, which carry lower returns. Second, the average market return is an oversimplification of how the market really works. If the S&P 500 is up 10% one year and down 10% the next, the "average" return is 0, but you would end up with less money. Third, you have to take into account inflation. If you assume that the historical rate of inflation is 3.5% per year, your portfolio's returns have to grow that much just to keep up, and your withdrawals have to increase at the same rate so you don't lose purchasing power.

This is why I say that you have to target double-digit returns with your investments.* To be able to withdraw 4% a year, keep up with inflation (3.5%) and pay your taxes (assuming a 25% bracket), you'll need to aim for at least 10% a year -- more if you want to withdraw more, if inflation is higher than 3.5%, or you're in a higher tax bracket. I wrote an article on bonds a while back that explained the math behind this statement.

Remember, this is a target of at least 10% so you can potentially withdraw 4% a year. Most retirement portfolios aren't set up to target double-digit returns, which means withdrawing 10% is well beyond a pipe dream for most people.

Finding: 49% of those surveyed believe their income needs will drop by half after they retire.

Reality: I meet with retired clients all the time to go over their financial situations. Rarely do I see cases where their spending has declined in retirement. In fact, the opposite is true more often than not -- they typically spend more!

That's just from personal experience, but academics are finding similar results. Researchers at the University of Michigan found that in the aggregate, pre-retirement spending and post-retirement spending are about the same. Other studies suggest that spending initially goes up in retirement and doesn't begin to decline below pre-retirement levels until the retiree gets much older.

Although your job-related expenses may decrease and you may have paid off your mortgage, you have to take into account other expenses such as travel and healthcare. The cost of healthcare, and the cost of healthcare insurance, is rising at twice the rate of inflation.

Finding: 38% of those surveyed believe that long-term care is covered either by health insurance, Medicare or disability insurance.

Reality: Medicare covers few long-term care services, and people must meet strict income and asset requirements to qualify for Medicaid. Health insurance and disability insurance generally doesn't cover the cost of long-term care. And those costs can be huge.

A private room in a nursing home today costs about $70,000 a year.  Since 1990, the price has been increasing at an average of 5.8% a year. If you have enough millions in the bank to cover these kinds of costs, you probably don't need long-term care insurance. For everyone else, it's a different story.

Finding: 60% of those surveyed believe that at age 65 they will have a 25% chance or less of living beyond age 85.

Reality: The odds are more like 50%, and the expected joint life expectancy of a healthy 65-year-old couple is 30 years. That means there's a good chance that one member of the couple will live to age 95. Which brings us to the next point…

Finding: 56% of those surveyed say the greatest financial risk for retirees is longevity risk.

Reality: I'm glad to see they got this one right. But it tells me that a large number of people aren't connecting the dots: They think they can withdraw 10% or more per year and have much lower expenses, but they're still worried about outliving their money. They don't seem to realize how one affects the other.

But you aren't like that now, are you? You now know that to successfully make it through your golden years, you need to save prodigiously and invest wisely. And you need to plan. If you feel you're already on the right path, then congratulations! If not, it may not be too late. Email me or give me a call at 214-245-5236, and perhaps we can work together to get you back on track.

SOURCES:
1. "Taking a pass on financial reality," Investment News, 30 June, 2008.
2. Bengen, William P. "Determining Withdrawal Rates Using Historical Data," FPA Journal, [accessed 21 July 2008].
3.  Cooley, Philip L., Carl M. Hubbard and Daniel T. Walz. "Retirement Savings: Choosing a Withdrawal Rate That is Sustainable," AAII Journal, February 1998, Volume XX, No. 2, [accessed 21 July 2008].
4. Easterling, Ed. "Waiting For Average," Crestmont Research, [accessed 21 July 2008]
5. Hurd, Michael D. and Susann Rohwedder. "Changes in Consumption and Activities at Retirement," Michigan Retirement Research Center Research Brief, July 2005, [accessed 22 July 2008].
6. "Facts on Health Care Costs" (National Coalition on Health Care, 2007) [accessed 22 July 2008]
7. "The Importance of Personal Financial Protection" (American Society of Pension Professionals & Actuaries, 2006),[accessed 22 July 2008]

*Double-digit returns is an objective, not a guarantee

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Kim Snider is the President and Founder of Snider Advisors, an investment adviser registered with the SEC, focused on teaching individual investors a sensible, long-term investment approach focused on maximizing cash flow. For more information on Snider Advisors or the Snider Investment Method, please visit snideradvisors.com. Her book, How to Be the Family CFO: Four Simple Steps To Put Your Financial House in Order, will be in bookstores October 1, 2008.

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 888-6SNIDER to request the Snider Investment Method® Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

Who's watching your pack?

Last week, I was in Alaska with the Bora Bora Society, a great group of Snider Method workshop alumni who travel together once a year.  While there, I met an Iditarod racer and his dogs. The racer, called a "musher," explained to us just how grueling the race can be -- more than 1,150 miles through mountains, across frozen rivers, and into dense forest and desolate tundra. All this at sub-zero temperatures, gale-force winds and blinding blizzards. The wind chill was once recorded at -100 degrees Fahrenheit! 

To see the work and training involved in such an endeavor is truly amazing, and I think I could have spent my entire trip just learning about the dogs and the care it takes to cross the finish line.

It takes a steely resolve and a little insanity to even want to compete in this race, and the mushers ought to be admired. But the real athletes, the real stars are the sled dogs themselves, which the mushers treat like their own children.

They were training one young dog -- maybe a little over a year old --  who was obviously new to the game. All the dogs were hooked together and running, but the young one kept turning his head, looking at the scenery around him.

I noticed one of the older dogs, perhaps the oldest in the pack, was right beside him. Every time the young dog broke his concentration, the older one nipped at him to keep him in line.

"We don't really do much training," the musher said. "The dogs really train each other."

That got me thinking about how families treat investing and personal finance. Your family is like a team of sled dogs; you all must work together to navigate the rocky terrain through all sorts of weather. The older, more experienced members of your family need to make sure the younger ones learn how to run the race the right way.

So who's watching out for the young pups in your family? Are you teaching your children and grandchildren good money habits? They won't pick it up in school -- most high school graduates don't even know how to balance a checkbook!

Sure, the younger pups may not appreciate your nipping at them whenever they wander astray. They'll yelp and bite back… but you must keep at it. Your involvement in your family's financial education will serve your pack well.

(By the way, there are more photos from the trip on our Bora Bora Society page on Flickr.)

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Kim Snider is the President and Founder of Snider Advisors, an SEC Registered Investment Advisor, focused on teaching individual investors a sensible, long-term investment approach focused on maximizing cash flow. For more information on Snider Advisors or the Snider Investment Method and how to stop enriching your investment advisors at your expense, please visit snideradvisors.com. Her book, How to Be the Family CFO: Four Simple Steps To Put Your Financial House in Order, will be in bookstores October 1, 2008.

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 888-6SNIDER to request the Snider Investment Method® Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

Lack of a financial education hurts the super-rich, too

Conventional wisdom holds that the ultra-wealthy have many more investment advantages than you or I. After all, they have access to highly selective hedge funds. It’s an exclusive club where the stakes are high and the rewards are out of this world.

Or that’s what they want us to believe.

The big hedge funds claim to offer much higher returns than what the normal investor can get through mutual funds. That’s why the buy-in is so high. But it turns out, hedge fund performance isn’t much better than that of run-of-the-mill mutual funds. What’s more, the incentive programs given to the managers leave hedge funds open to fraud and chicanery.

As with so many problems on Wall Street, this has to do with the compensation system. The manager of an ordinary actively managed mutual fund may take a fee of 1-2%. That’s bad enough, but it’s chump change compared to what the hedge fund manager gets. The typical fee arrangement for a hedge fund manager is usually 1 or 2% of the assets PLUS 20 percent of the returns that exceed some benchmark. So let’s say a fund has $200 million in assets and has a benchmark rate of return of 7%. After the first year, the fund was up 10%, or worth $220 million. The manager would earn $4.4 million for the management fee, plus $1.3 million for beating his benchmark (20% of the 3% extra gain).

You can imagine how this incentive arrangement just invites manipulation – and leaves hedge fund investors exposed to tremendous risk.

According to a study from the University of Pennsylvania's Wharton School:

…[I]t is very hard to set up an incentive structure that rewards skilled hedge fund managers without at the same time rewarding unskilled managers and outright con artists. Furthermore, any incentive scheme that does not directly penalize underperformance can be gamed by the manager so that his expected fees are at least as high, relative to expected gross returns, as for the most skilled managers.

The authors show how an enterprising hedge fund manager can use the derivatives market to generate what look like above-average returns. By placing highly leveraged bets on unlikely events, the manager can generate enormous amounts of cash. If his bets are right, the fund investors are very happy. If he's wrong, the fund collapses and the investors lose almost everything. Either way, the manager stands to make a fortune regardless of how the fund performs. This is a process the authors call “piggy-backing.”

In mutual funds and hedge funds, the term “alpha” is used to explain the part of a fund's performance that isn't explained by market forces. In other words, it's the result of the manager's supposed skill. By piggy-backing, an unskilled manager can fake alpha. By writing a number of covered calls using his investors' money as collateral, “it allows an unskilled manager to mimic a target series of excess returns without having the slightest idea about how a skilled manager would actually generate them.” [emphasis in original]

Dean P. Foster, one of the authors of the study, gives an example of this strategy at work:

An enterprising man named Oz sets up a new fund with the stated aim of earning 10 percent in excess of some benchmark rate of return, say 4 percent. The fund will run for five years, and investors can cash out at the end of each year if they wish. The fee is the standard '2 and 20': 2 percent annually for funds under management, and a 20 percent incentive fee for returns that exceed the benchmark.

Although he has no investment track record, Oz has a smooth manner, a doctorate in physics and many rich acquaintances. He raises 100 million and opens shop. He then studies the derivatives market and finds an event on which the market places fairly long odds, say 9:1. In other words, it costs .10 to buy an option that pays 1 if the event occurs and 0 otherwise. The nature of the event is unimportant: it might be a large fall in the stock market, Florida getting hit by a Category 5 hurricane or Russian President Vladimir Putin dying before the end of the year.

Next Oz writes some covered options on this event and sells 110 million of them in the derivatives market. This obligates him to pay the option holders 110 million if the event does occur and nothing if it does not. He collects 11 million on the options. To cover his obligations in case the 'bad' event occurs, he uses the investors' money plus the proceeds from the options to buy 110 million in one-year Treasury bills yielding 4 percent, which he deposits in escrow. This leaves 1 million in "pocket money," which he uses to lease some computer terminals and hire a few geeks to sit in front of them, just in case his investors drop by.

The probability is ninety percent that the bad event does not occur and Oz owes nothing to the option holders. With a gross return (before expenses) of 15,400,000, the investors are thrilled, and so is Oz. He collects 2 million in management fees (of which he has only spent 1 million), plus a performance bonus equal to 20 percent of the 'excess return', namely, 20 percent of 11,400,000. All in all, Oz nets over 3 million for doing absolutely nothing.

Foster says Oz can repeat this scheme next year. If his bets continue to pay off, he'll attract more investors and pocket more money. If the fund collapses, Oz can simply close the fund early and start a new one next year.

This scheme is not illegal, but it is risky – risky for his investors, but not for himself. In no scenario will Oz actually lose money. Actually, the more risk he takes with this investors' money, the more he stands to profit. That's the way his incentive structure works. You may get screwed if the fund collapses, but he walks away with millions.

This is yet another example of how Wall Street’s compensation system puts the interest of brokers and fund managers ahead of the investor. No matter how much money you’re working with, unless you know what’s really going on, you’re just asking to be taken advantage of.

That’s why it pays to learn as much as you can about how Wall Street really works, and why you ultimately should be in control of your own investments. Wall Street is set up to take advantage of the little guy, even if that little guy has millions and millions of dollars.

SOURCES:

1. Foster, Dean P. and H. Peyton Young, “The Hedge Fund Game: Incentives, Excess Returns, and Piggy-Backing.” March 2008. http://www.brookings.edu/~/media/Files/rc/papers/2007/1114_hedge_fund_young/1114_hedge_fund_young.pdf (Accessed April 23, 2008).

2. Foster, Dean P. and H. Peyton Young, “Hedge Fund Wizards,” Washingtonpost.com, December 19, 2007. http://www.brookings.edu/opinions/2007/1219_hedgefunds_young.aspx (Accessed April 23, 2008).

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Kim Snider is the President and Founder of Snider Advisors, an SEC Registered Investment Advisor, focused on teaching individual investors a sensible, long-term investment approach focused on maximizing cash flow. For more information on Snider Advisors or the Snider Investment Method and how to stop enriching your investment advisors at your expense, please visit snideradvisors.com. Her book, How to Be the Family CFO: Four Simple Steps To Put Your Financial House in Order, will be in bookstores October 1, 2008.

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method® Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

The Marvelous Miss Mary

I was on the phone the other day with the nicest lady. Her name was Mary. She had called in to my radio program the previous Saturday. I had given her my number and told her to call me so I could give her the name of a good, fee-only financial planner because that was what she really needed.

 

Mary had worked hard her entire life. Her job wasn't glamorous. It didn't pay anywhere near the top of the pay scale, but you can tell she did it with pride. She started putting money in her employer's retirement plan back in the 1980s, when they first came out, and she had been contributing religiously ever since.

 

Her house is paid for and she has saved a hundred thousand dollars or so outside her 401(k). She will also get a small pension and Social Security. She is getting ready to retire at the end of the year. She told me she has always read as much as she could about personal finance. She wanted a financial planner who could help her, not tell her what to do. (You go girl!)

 

We chatted about mutual funds. Some of her friends, she said, were afraid of the stock market because they didn't want to lose money. But she understood, from watching her 401(k) all those years, that sometimes it goes up and sometimes it goes down, but over the time she has had it, it has gone up a lot! You just have to leave it be.

 

Unlike most of her generation, she understood intuitively that she had to focus on not outliving her money rather than the fear of losing it. She knew she had to keep investing in the stock market for her nest egg to keep up with inflation. She is the exception, not the rule in this regard.

 

Mary listens to me on the radio all the time, she says. The idea of that makes my heart skip a beat and brings a smile to the corners of my lips. I love the idea that I might have helped her in my own small way.

 

She brought up the Snider Investment Method™. She never graduated from high school, she told me, and she doesn't know how to use a computer - yet. She is thinking about taking some courses now she is retired.

 

"I just wish I was smart enough to do your Snider Method!"

 

"Miss Mary", I said, "I can tell you one thing for sure. After what you have told me today, what is holding you back is not lack of smarts. When it comes to your money, you have accomplished what only 20% of people ever do - financial success. If you ever set your mind to learning the computer well enough, I am CERTAIN you could do the Snider Method. Look what you have already learned on your own!"

 

As you can probably tell, I thought Miss Mary was just marvelous! I could have talked to her all day. It just goes to show, investing and personal finance is mostly common sense … and they don't teach you that in school or hand it out with your promotions!

 

What Miss Mary teaches us is anybody can be a good investor and a good steward of their money.

Kim Snider Financial Communications makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. All investments are subject to risk, including possible loss of principal. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing.

Not Your Average 12 Year Old

John-Paul Pigéon is not your average twelve year old. He is a Rich Dad, Poor Dad prodigy and the youngest graduate of the Snider Investment Method™ Workshop. John-Paul is an accomplished speaker on the subject of money, speaking to children and adults alike. In fact, he has shared the stage with the legendary Les Brown, which is more than I can say.

 

John-Paul has recently written his first book, called John-Paul's Secret Recipe. It is the story of his first business - a lemonade stand.

 

This tale of two brothers and a classic road-side lemonade stand illustrates in kid-friendly terms the basic underlying principle of finance, cash flow. Though John-Paul does have a secret lemonade ingredient the message of the book extends far beyond a tasty pitcher of ice-cold, refreshing lemonade.

 

An autobiographical account of John-Paul's first entrepreneurial venture designed for audiences ages 3 - 9. The book includes a classic recipe for homemade lemonade and space for children to write in their own recipe and 'secret' ingredient. This book's brightly colored illustrations, fun caricatures and brotherly camaraderie exude wholesome family values.

 

A third of the proceeds from John-Paul's book benefit the Les Brown Out of the Rain Autism Center. This book will teach your children about important financial concepts that will help them succeed in life.

 

It is a delightful book, filled with John-Paul's passion for financial literacy. Purchase copies for the little people in your life directly from John-Paul's website.

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

.2(S) + .8(M) = FS

There are two formulas that I apply to financial success. One is E + S + I = FS and the other is .2(S) + .8(M) = FS. For those of you who don't like math, I can picture your eyes starting to glaze over now, but stick with me. I am not about to get all nerdy on you.

 

The first is a formulaic expression of something you have heard me say many times before. Financial success comes from thinking like an entrepreneur (E), saving prodigiously (S), and investing wisely (I). Hence, E + S + I = FS. This basic formula for financial success is the subject of my first book, which I have finally started to make headway on after three years of swearing I was going to get it done!

 

The second refers to my belief that financial success is only 20% skill-set (S) and 80% mindset (M). That is true at the broad level and it applies to each of the three areas of financial success mentioned above.

 

When I say think like an entrepreneur, you don't have to have years of management experience to benefit from that perspective. You just need to be educated on some basic management tools, like personal financial statements. That is the easy part. Anyone can learn those. The hard part is the mind set side of the equation.

 

The traits of successful entrepreneurs are the same traits you should bring to your personal finances in order to be successful. Those are 1) commitment and determination; 2) creativity, self-reliance and the ability to adapt; and 3) believing in yourself and that you are worthy of financial success.

 

Saving money doesn't take all that much knowledge. I think it is fair to say anyone can do it. With proper financial literacy education, like that provided by Money Camp, even kids can grasp the concept of saving for what you want and different wallets for spending, saving and charitable contributions.

 

Having the discipline to save is another matter altogether. It has been said, "The reason most people fail instead of succeed is they trade what they want most for what they want at that moment."

 

I know in my own life, if left to my unconscious, I tend to be a spender rather than a saver. I didn't really become a saver until I met my husband, who is a natural saver. But once I started doing it, I realized I got a lot of satisfaction from seeing my net worth grow. Who knew the number on the bottom of personal balance sheet could bring more deep and lasting satisfaction than some gee-gaw I bought?

 

Don’t get me wrong. I still like nice things. But now whether I spend or save is a very conscious decision rather than an unconscious one.

 

Finally, you have investing. No where is my 80%/20% formula more pronounced than here. When it comes to skill set, it helps to understand that many of the most powerful concepts in investing are the simplest ones. It does not take complex investment strategies to build wealth through investing. In fact, the opposite is true. The more time you spend on it, and the more complicated your investment schemes, the less likely you are to get your desired result.

 

For years now, women who have just completed the Snider Investment Method™ workshop come up to me with incredulous voices and say, "I can do this!" In my mind I think, "Well, duh!"

 

Often they will say something like, "My husband has always taken care of our money", or "I am an artist. I didn't think I would understand investing", or "I didn't know anything about investing when I walked in and I was sure I would be totally lost."

 

(By the way - I am pretty sure there are men who think the same thing but I just don't think they are as willing to admit it to me!)

 

Anyone can learn to invest. It has nothing to do with whether you are an artist or an engineer. In fact, academic research says it has nothing to do with how smart you are.

 

Jay Zagorsky, a researcher from Ohio State University has studied the relationship between IQ and wealth. "Smarter people tend to get paid more on the job, but there's no relationship between intelligence and net worth when holding other factors constant," says Zagorsky, whose report was published in the journal, Intelligence.

 

(Just as another aside, we have scheduled an interview with Jay Zagorsky. So listen for my interview with him in the coming weeks on my radio show, Saturdays at noon CT on 1080 AM KRLD in the Dallas Fort Worth area and in our Financial Success Coaching podcast available from iTunes, Odeo and right here on the Kimmunications blog.)

 

So what does account for your ability to build net worth through investing? It is your ability to control your emotional responses to meaningless, short term price movements. It is your ability to avoid extreme states of fear or greed. It is your ability to do the right thing every single day even though it often feels wrong.

 

In short, investing is almost totally a mind game. That is why hedge funds hire psychologists to work with their traders in the same way professional sports team hire sports psychologists to work with athletes. I know because one of them was one of my mentors. Investing is 20% skill and 80% in your head. That is one of the very first things he said to me when we started working together and I know it is as true as the sky is blue.

 

That is why the way I invest my own money is a system that tells me what to do in every single circumstance. It leaves nothing to my discretion because I worked it all out based on probabilities beforehand. Then I follow it religiously to take the game out of my head and make it all about knowledge. That is a game I can win and in my opinion the only way you can win it.

 

So follow my convoluted algebra here. If E + S + I = FS and .2(S) + .8(M) = FS then E + S + I = .2(S) + .8(M). In other words, in order to achieve financial success, you must be educated on the nuts and bolts. That is important. But more important is your mental approach to money.

 

If that is true, then doesn't it also follow that the people you need to surround yourself with are not just salesmen who make their living by selling you annuities and mutual funds, but rather a mentor who will help you with both sides of the equation?

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.