Kimmunications

Financial Advisor Red Flags - Part 2

Last week, I listed six red flags to watch out for when dealing with a financial advisor or broker. To recap, they were:

1. Invoking a dead relative in an effort to keep your account
2. Recommending variable annuities when they're not appropriate -- such as in an IRA
3. Recommending you move money out of your 401(k) or stop contributing. Also: recommending that you borrow from your 401(k)
4. Constructing a portfolio for you with an expected annual return of less than 10%
5. Recommending only mutual funds, especially those that are only available through his/her company
6. Accepting a commission from products they sell

The post was getting long, so I stopped there. This week, I'd like to continue where we left off with more red flags, some of which were suggested by readers like you. Again, these are in no particular order.

7.  Suggesting that you borrow from your home equity to invest

I am not an advocate of taking a loan for the specific purpose of investing. This includes taking out a home equity loan to play the arbitrage game many salesmen are suggesting these days.

An arbitrage is when you try to take advantage of a price or interest rate differential between two markets. For example, you take out a home equity loan at, say, 6 percent and invest the money in a mutual fund with an expected return of 10 percent.  If successful, you would profit from the 4 percent spread between the loan and the mutual fund.

Salesmen will claim that this strategy is low-risk or even risk-free, but it isn't. What happens if the mutual fund doesn't return 10 percent? What if it returns only 5 percent? Or if it loses money? Compound interest works against you and you stand to lose a lot more than you bargained for.

Also, you can't forget about the fees, commissions and taxes involved in such a strategy. Even if there's a positive spread, these can severely cut into your returns. For me, it doesn't seem worth it.

8. Assuring you that an investment cannot lose money.

An employee of mine showed me a postcard she received from a financial advisor near her neighborhood. He advertised a historical annual return of almost 15 percent with "no known history of loss." The implication is that he can deliver high returns with no risk. Sounds like the perfect investment, right?
RED FLAG! There is no such thing as a risk-free return above what is guaranteed by the U.S. government. It's a basic principle of economics: reward is the profit for risk. As an investor, your job is to manage the trade-offs between risk and reward. A risk-free investment such as a bond will give you about 4-5 percent. If you want more than that -- and most of us do -- you have to be willing to take on a little more risk.

9. Claiming he/she can turn a small amount into a large amount

I heard an advisor on the radio the other day claim he could get his clients a 500 percent return with very little risk. He suggested that he could get that return through a combination of techniques, including investing in real estate.

Is he saying that real estate is low risk? Millions of homeowners, particularly along the West Coast, would disagree! Since the recent housing bubble burst, home prices across the country have been declining steadily. In the top 10 metropolitan areas, home prices declined more than 13 percent since last year, according to the Case-Shiller Home Price Index. Different markets are performing differently, but nowhere are prices ratcheting higher right now. Common sense tells me this claim of a risk-free 500 percent return is simply bogus.

Another financial advisor-type is claiming that he can show you how to turn $10,000 into $3 million in just a couple of years and that he has a 30-year track record to prove it. I did a little math… if he started with $10,000 30 years ago and did what he says, he'd have billions of dollars by now. I haven't seen his name on the Forbes list of the world's richest people, so something tells me his claim doesn't hold water, either.

When someone makes outrageous claims like these, they're playing to your greed. Just remember that with higher returns comes much bigger risk, and if it sounds too good to be true, it probably is.

10. Claiming he/she can successfully and consistently time the market.

Some advisors love to claim that they can tell you when to get out of the market and when to get back in. They'll tell you they have the tools and the research staffs that nobody else has. What they won't tell you is that all the evidence says it can't be done successfully over the long term. Read my recent post on market timers.

11. Attempting to sell you on a fast-moving trend

A former criminal judge told me about numerous schemes that crossed his bench over the years. One of them involved an advisor who sold fractional shares of oil and gas royalties.

"They will lure an investor in with a higher-than-normal return, playing on your greed. Then they come back again several months later and want you to buy more of that share for an even higher return. The house of cards will ultimately fail, leaving the investor with nothing."
A guy called me up not too long ago and offered to sell me fractional shares in something like this, saying that because of rapidly rising energy prices, now is the time to invest. I told him, "If you're calling me, trying to get me to pitch your oil deals to my clients, this tells me that this is the top of the oil rush, not the bottom."

The more people who are calling you and taking out ads regarding a fast-moving trend, it probably means it's time to get out, not get in. To make money, you have to buy when everyone else is irrationally selling and sell when everyone else is irrationally buying. When the sales pitches are fast and furious, alarm bells should go off.

12.  Offering you professional services for free.

One reader told me he was suspicious when his CPA offered to do his taxes for free. What kind of a CPA does that? In this reader's case, it was because the accountant wanted him to open an investment account through him. The investment account would probably generate more in commissions and fees than he would charge for doing a tax return.

This isn't necessarily wrong, but it is something to be aware of. Look, people in the financial services business -- or any business, for that matter -- always get paid. None of us does this for free. As a customer, you need to know how they get paid. Would you rather pay them up front and know what you're paying for, or would you rather take your chances with hidden fees and commissions? Look for transparency in pricing.

There are, of course, many more red flags to watch out for. Keep emailing me your suggestions, and I'll keep adding to the list.

SOURCES:
1. Glink, Ilyce. "Homeowners react to falling real estate values." The Boston Globe, May 13, 2008 (accessed May 15, 2008).
2. "The World's Billionaires." Forbes, March 5, 2008 (accessed May 15, 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.

Can You Have Too Much Home Equity?

The conventional wisdom used to be: Pay off your mortgage as soon as you can. Retire with a paid for home. Some personal finance writers still believe that. I used to believe it too, but not any more.

 

No debt is as bad as too much debt. I used to be a zero-debt advocate, but now I think zero debt can create a diversification and liquidity problem. If I have too much of my net worth tied up in home equity, I am very sensitive to falling real estate prices, and I am going to find it very difficult to tap my equity if I need it.

 

The problem with home equity is that the more I need it, the harder it is to get to. What lender, for instance, is going to give me a home equity loan when I have just lost my job? What kind of bargaining power do I have in the sale of my home if a loved one is sick and needs hugely expensive out-of-pocket medical treatment?

 

In response to my previous posts on this topic, some have suggested that taking out a home equity line of credit (HELOC) and letting it sit there unused is the answer to freeing up the equity in your home in case you ever need it. Sunday's New York Times shows us why that is not necessarily the solution.

 

Apparently, lenders across the country are freezing HELOCs across the country, even if you have a perfect credit score. In the last month, lenders have sent hundreds of thousands of letters to consumers telling them those home equity lines of credit they paid money to secure, can no longer be tapped.

 

Most of us think of diversification in terms of asset classes. You also have to think in terms of diversifying liquidity. On the liquidity continuum, cash is obviously most liquid. Businesses and limited partnerships are probably least liquid. In between you have a broad range.

 

Having an emergency fund is key. I believe in at least a six month supply of cash on hand. Next comes cash flow. Interest, dividends, option premium, rent, and royalty payments are all forms of short term liquidity. After that are items that can be readily bought and sold in efficient markets. This would include stocks, bonds, options and futures. From there, liquidity becomes murkier.

 

Some investments have lock-up periods in which you cannot sell them or you will pay a big penalty to sell them. Others, like real estate, can be easy to sell at times, but almost impossible to sell at others. The more complex the asset, likely the less liquid it will be.

 

It is helpful to consider that most companies don't go bankrupt because they lose money, they go bankrupt because they don't have sufficient liquidity to meet their daily obligations. Think of Bear Sterns.

 

The same is true of individuals. Most individuals who file for bankruptcy have jobs and assets. It is just that their cash inflows don't properly match up to their cash outflows. When this happens, you have a liquidity problem.

 

Your job, as family CFO, is to structure your assets so that no matter what happens, your cash inflows match up to your cash outflows. In on other words, liquidity has to be a primary consideration.

 

As a general rule, I like to think of liquidity as being inverse to assets. The less resources you have, the more liquid you need to be. As your assets increase, you can afford to put more and more of them in less liquid assets.

 

If you haven't already, sit down and list out your assets. Stack rank them from most liquid to least liquid. Then ask my favorite question … "What if?" Ask yourself, what if I had no income coming in for two months? Where would the money come from? What about six months? A year? Two years? What if I was permanently disabled? What if I was sued or someone in my family became ill?

 

Asking these questions forces you to examine your resources in terms of liquidity. If you don't like the answers you come up with, it might be time to restructure your assets or get going on augmenting your savings.

 

SOURCES:

 

1. Morgenson, Gretchen, “You Thought You Had an Equity Line.” New York Times, April 13, 2008 http://www.nytimes.com/2008/04/13/business/13gret.html?_r=1&oref=slogin (accessed April 15, 2008,).

 

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Kim Snider is the President and Founder of Snider Advisors, a 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.

 

Your time horizon may be longer than you think

When choosing your investments, there are four things to consider:

 

1. Your investment objectives

2. Your risk tolerance

3. Your time horizon

4. Your temperament

 

Once you've chosen an investment that satisfies these criteria, you shouldn't make major changes to it unless one of those criteria changes. I've written a lot on my blog about several of these criteria, but today I want to focus on No. 3: your time horizon.

 

Many of us were taught that there are two phases to investing: The accumulation phase, when you can take more risk by investing primarily in equities, and the income phase, when you put more of your assets into lower risk investments such as bonds. The thinking is that your primary time horizon for investing is up until the day you retire; then you switch to living off what you've built.

 

This line of thinking is a bunch of bunk. Your time horizon for growth doesn't end when you retire; it continues for the rest of your life. (And income investing and growth investing don't have to be mutually exclusive; income reinvested is growth, but that's a topic for another day.)

 

I got to thinking again about our time horizon last week at one of our Snider Method information sessions. I had just described our investment method as a long-term approach when an audience member asked, "But I'm almost 70, and I'm already retired. Shouldn't I focus more on the short term?"

 

I told him that even 70-year-olds have a long-term investment horizon. The reason is life expectancy. If your goal is to sustain your standard of living for the rest of your life, you need to look at how long you can expect to live.

 

A recent article in USA Today detailed the life expectancy of men, women and couples who planned to retire this year at age 62. Citing data from the American Academy of Actuaries, the article said that the joint life expectancy for a 62-year-old couple is 90.7 years. There’s a 58% chance that one of them will live to age 90, and a 29% chance that one will reach 95.

 

This means that my 70-year-old guest has at about a 20-25 year time horizon for his investments -- maybe even longer. His challenge is to invest so his portfolio can sustain his standard of living for that long, taking into account inflation and the rising costs of health care.

 

Considering that the cost of living increases an average of 3.5% a year, and health care costs are rising at twice that rate, his rate of return needs to be higher than that obtained by the bond-heavy portfolio usually recommended to someone in his age group. The only way to generate that kind of return is to have a significant portion of his portfolio invested in stocks.

 

I'm sure most 70-year-olds would balk at the idea of being heavily invested in stocks. Too much risk, they'd say. But market risk is more of a concern in the short term. For the long-term investor holding a diversified portfolio, stock market risk is much less of a concern.

 

The stock market has historically been a great creator of wealth and protector of purchasing power for the investor holding a portfolio of America's greatest companies over long periods of time. Many investors don't realize that their time horizons are much longer than they think -- even my new 70-year-old friend who's already enjoying retirement.

 

SOURCE: Sandra Block, "Boomers' Eagerness to Retire Could Cost Them," USA Today, Jan. 14, 2008. http://www.usatoday.com/money/perfi/ retirement/2008-01-13-turning-62-cover_N.htm

 

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. 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. Growth refers to growth of portfolio income, not necessarily growth of net asset value. Growth assumes some portion of income is reinvested. Yields do not include unrealized losses or gains.

The Performance Paradox - Fear - (Part 1)

When the markets re-opened on September 17, 2001, the Dow was down, at one point, 850 points and the S&P lost 5% of its value. I remember remarking to my husband (boyfriend at the time) that I felt as if I was moving through Jell-O. Much of what we thought we knew about our world had just gone out the window. No one knew what was coming next. Would there be more attacks? Was this just the beginning? And even if there weren't, how would the economy withstand such an unprecedented disruption?

 

That week, a number of our clients called us. Some just wanted to talk. Others wanted to know what to do. Should they continue with the Snider Investment Method as if nothing has happened? Should they sell their Snider Method positions? Should they liquidate their other stock market holdings?

 

Our response, as it always is, was to stay the course. There was no reason to alter the strategy or do anything different. After all, our investment objectives, tolerance for risk or time horizon did not change when those airplanes slammed into the World Trade Center. I put together a 60 second radio spot that aired on local radio before the markets reopened which told people we would be buyers of stock when the markets reopened.

 

Many people, clients and otherwise, thought we were nuts. Some called to say they were dumping their portfolios. We advised strongly against it, but it was their money. They could do what they wanted.

 

Those who dumped their portfolios did so out of fear and are classic examples of one side of what I have come to call the Performance Paradox. The Performance Paradox is that the more we react to the short term performance of our portfolio, either out of fear or greed, the worse our long-term performance will be.

 

The person who invests from a base of fear, in other words is so afraid of market losses or is so obsessed with short term performance, that he sells every time an investment goes down creates a pattern of turning temporary losses in value into permanent losses of capital. Do this over and over again and you will continually turn winners into losers.

 

What is the answer?

 

To be a successful investor, you must be an optimist. You must recognize and internalize that we live in the greatest, most transparent economy in the world. There will be downturns and tough times - no question. All of us have a tendency, especially as we get older, to think the world is going to hell in a hand basket.

 

And yet, we also know that ten years after any economic disruption - whether it be the Great Depression, the 1987 crash, the currency crisis of the late 1990s, September 11th or whatever - we can look back and we will not wish we had sold. Instead we will wish we had invested everything we had at the time.

 

This is not to say that investing is risk-free and that even the most optimistic among us won't go through periods of doubt. By definition, we will experience severe declines periodically in the future. Investing in the stock market is a winning strategy, most of the time, but not all the time. And those down years can be hard to ignore.

 

If we could accurately predict when those down years would occur, this discussion would be moot. We would simply get in ahead of market upturns and get out ahead of the downturns. But of course, no one can accurately predict when the downturns will come or how long they will last. As Nobel Laureate Paul Samuelson said, "The stock market has forecast nine of the last five recessions."

 

What we can predict is, if you are an optimist who takes a long term view of the market, you will prosper over the years because you will have found a proven strategy for success. The investor who takes the opposite approach - who is bound up in fear and as a result monitors his portfolio constantly and reacts out of fear to short term declines in value, will not be successful over the long run.

 

This is the Performance Paradox. The more you want or need it, the more you try to get it, and the more you micromanage it, the worse it will be.

 

So which are you? Do you take an optimistic long-term view of the market? Or do you try to micromanage the short term performance of your portfolio?

 

Next week, I'll look at the flip side of the Performance Paradox - greed. Then we'll talk about the antidote. Stay tuned.

 

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.

Know Your Greatest Risk

What is your most valuable asset? Your business? Your house? Your investment portfolio? The pile of gold buried in your backyard? What would you guess?

 

If you guessed anything tangible, you guessed wrong. Your most valuable asset is what economists call your human capital. This is the sum total of the skills knowledge and wisdom you possess which you then trade with your employer or your customers for money.

 

When you are young, human capital represents the lion share of your total wealth. As you age and begin to accumulate other assets, human capital becomes a smaller proportion but still is your largest asset.

 

If that is so, and economists tell us it is, then your biggest risk is not being sued if someone slips and falls in your driveway, a protracted bear market or the cost of long-term healthcare. Your biggest risk is disability or obsolescence. Both have the potential to seriously disrupt your income.

 

Think of it. As long as my income stream keeps flowing, I can get through almost everything else. Suppose someone does slip and fall in my driveway. They sue me and the court awards them millions of dollars. I may file for bankruptcy but the court will allow me to keep enough of my income to keep a roof over my head and feed and clothe my family.

 

Imagine we experience a depression which takes thirty years for stock prices to recover from. As long as I don’t lose my job and I can still work, I can still eat. Imagine I work in a family business that continues to pay me long after I have become old and feeble. Long term healthcare is not a problem.

 

I am not saying life would be champagne and caviar. I am just saying it would be better than the alternative. A steady income solves many problems. Loss of one can wreak havoc.

 

Disability

 

We have two choices when it comes to risk. We can either hedge it or insure it. Insuring a risk is almost always more costly than hedging it because the intermediaries, namely insurance companies, have to make a profit over and above the cost of the hedge.

 

We can insure the risk of disability by purchasing disability insurance. Some employers offer disability insurance as an employee benefit. Disability policies can be either short term or long term.

 

Short term disability policies pay you a percentage of your salary if you are temporarily unable to work because of injury or illness. A typical policy will you anywhere from 50% to 65% of your pay for anywhere from two weeks to two years, depending on the policy you purchase. A period of 13 to 26 weeks is more common and then long-term disability kicks in if you have it.

 

Long-term disability replaces income for a much longer period of time. Policies usually limit benefits to five years or age 65, whichever comes first.

 

Of course, being the optimists that we are, no one likes to think about what happens if disaster strikes. But the question asked by a Family CFO most often has to be, “What if?”

 

Data from the American Council of Life Insurers tells us one in seven will experience a disability lasting more than five years. The odds increase to one in five for those of us between the ages of 35 and 65.28 It turns out the leading cause of disabilities is not freak accidents, as many people think, but instead is caused by devastating illnesses such as cancer or heart disease. The long-term loss of income is so disruptive that 46% of home foreclosures are due to medical disability.

 

Obsolescence

 

You cannot insure against obsolescence but you can hedge against the risk. How? By making constant upgrades to the software between your ears. The best hedge against being replaced by a 23 year old whiz kid is lifelong learning.

 

	Those who do not read are no better off than those who cannot.€ ~Proverb

 

Lifelong learning need not be formal to be effective. I had the pleasure of interviewing Dr. Benoit Mandlebrot for my radio show several years ago. Dr. Mandlebrot is a mathematician who is best known as the father of fractal geometry. Fractal geometry is what makes the stunning reality of modern day computer animation possible.

 

Dr. Mandlebrot'€™s accomplishments are unique in that he has been awarded major prizes not just in mathematics but also in physics, medicine, science and technology. His concepts have also been applied to economics, earth sciences and linguistics.

 

Dr. Mandlebrot credits his ability to think outside the traditional confines of a single branch of science to his unconventional education. He said in one interview, "€œTo tell the truth, and not to sound pretentious, but circumstances prevented me from acquiring a real college or university education in the traditional sense, so I am primarily self taught."

 

Passive income

 

Disability and obsolescence can both be hedged by building a portfolio which produces enough passive income to pay all the bills, as described in chapter 14. When passive income equals or exceeds day-to-day living expenses, work is no longer a necessity, it is a choice.

 

For my husband Jim and I, we use a combination of passive income and disability insurance to hedge our risk. Because I am the public face of our company, if I were to become disabled, our business would be seriously impacted. But we still have employees and bills to pay.

 

We have a disability policy on me which specifically covers the overhead of the business in the event I am disabled. We rely on the passive income from our investments to replace our income from the business.

 

Longevity

 

Americans' increasing longevity can be an economic blessing or a curse. Provided we remain healthy, increased longevity increases our human capital. If our mental and physical health declines as we age, our human capital is diminished.

 

Thus, there is one other thing you can do to increase your odds of financial success and it has nothing to do with saving or investing. Take care of your body and your mind. Quit smoking, eat right and exercise. These are as much a part of achieving lasting financial success as a sound investment strategy.

 

The preceding is an excerpt from Kim Snider's yet-to-be published - but getting closer book, "The Family CFO's Guide to Financial Success." This book should be available in bookstores everywhere (don't you agree?), but isn't - until Kim stops procrastinating on the second draft!

 

Kim Snider, Kim Snider Financial Communications 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.

It's All In How You Look At It

Look at the ballerina below. Is she turning clock-wise or counter-clockwise?

I see her turning clockwise, which is supposed to mean I am more right brain. Most people will see her turning counter-clockwise, which means you are more left-brain. But the cool thing is you can change which way she turns.

 

Focus on her turning the other way. Sometimes I have to look off the screen to get her to change. Sometimes it is really hard. Can you do it?

 

It just goes to show it is all in how you look at it. I had a caller on my radio show on Saturday who said he had pulled all of his money out of the stock market because he was afraid of terrorism. In other words, he was afraid of the risk. I, on the other hand, always have all of my money IN the stock market (by way of the Snider Investment Method™) because I too am afraid. Only I am afraid of running out of money.

 

Some people focus on short term risks that cause temporary market declines and opt for cash or bonds to manage risk. I focus on longer term risks like inflation and longevity and opt for generating cash flow from stocks to manage risk. Both of us see the same set of facts but interpret them differently.

 

Who is right? I guess it depends on how you look at it.

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. Diversification does not ensure a profit or protect against loss of in a declining market. 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.

Loss of principal may be the wrong dragon

A man is lying in his hospital bed, surrounded by friends and family, reflecting on his recent near death experience. "I always thought it'd be the ulcer that killed me. I did everything the doctors told me. I drank the cream, ate the butter, drank the milk. And now I have a heart attack!" This was a scene from a new original series on AMC, called "Mad Men", set on Madison Avenue in 1960.

 

It is also a scene playing itself out in the portfolios of millions of Americans. Like Don Draper's boss in Mad Men, many of us are fighting the wrong dragon - and killing ourselves in the process.

 

At each speaking engagement I do, I ask my audience, "When thinking about your investments, what worries you most?" One of the first answers offered is always losing money. Capital preservation is our ulcer. Inflation is our heart attack.

 

Think about the average Baby Boomer - someone born around 1952. For many of you, that won't be too tough. You are the average Baby Boomer. Assuming your parents were 25 when you were born, your parents would have been born right around 1927. How do you think that shaped the messages you got about money, and in particular about investing? How do those messages affect you today?

 

The dominant financial experience in the lives of most of our parents, and certainly our parents' parents, was the Stock Market Crash and ensuing Great Depression. As a result, Baby Boomers were imprinted with certain ideas about money, almost from birth: Don't put your money at risk, pay off your home, stock market losses are ruinous.

 

It is not just investors who are indoctrinated with this belief system. The ranks of financial advisors, financial journalists and government regulators are populated by this same demographic cohort, with the same belief system, stemming from the same seminal event.

 

As a result, as we accumulate assets, we become focused - obsessed in some cases - on avoiding capital losses. So, as we age, we put more and more of our money into fixed income securities like bonds. If capital preservation is the ulcer, fixed income portfolios paying 5% or 6% are the cream.

 

"How so", you ask? The first thing you have to understand is the fact from which all your investment decisions must emanate, assuming your objective is to someday be able to live off the proceeds of your portfolio, is your life expectancy.

 

The average retirement age for all Americans retiring in the year 2007 is 62. So let's consider the case of the average couple retiring this year. They are both 62 years old and non-smokers. I want you to take a guess as to the age at which the second death will occur. In other words, both are 62 years old today. According to the actuarial mortality tables, how old will the latter to die be, when he or she passes away?

 

Jot the number down or just fix it in your mind. Got it?

 

If you would like to dig for the answer, or verify the answer I am about to give, go to your insurance agent and ask to see the mortality tables for the joint life expectancy of a 62 year old man and a 62 year old woman who don't smoke. They will confirm for you the answer is 92 years old. Their joint life expectancy is 30 years.

 

This is the good news bad news joke. We are living longer, but that longevity is also one of our greatest risks.

 

Now I want you to consider this. In 1988, I was fresh out of college and I made $18,000 a year. I was single. I had my own one bedroom apartment in a reasonably nice apartment complex. I had a new Ford Probe Turbo, on which I made monthly payments. I paid my insurance and gas. I could afford to eat out, go out at night with friends and take a couple of vacations a year. I could do all that on $18,000 a year. Granted, I didn't save anything, but my lifestyle was pretty comfortable.

 

So imagine one of my grade school teachers who retired, in 1977, with a pension of $20,000 a year. They were probably able to live pretty comfortably too - for awhile. After all, the median income in 1977 was $13,572. In 1977, a gallon of regular gas cost $0.62. You could buy a Porsche 924 for $9395! The median price for a new home was $54,200.

 

But fast forward thirty years to 2007. How well do you think my grade school teacher is doing on that $20,000 a year pension now? Even with a Social Security check and a paid for house, I can promise you, her monthly income doesn't go far enough.

 

So here is where our inherited belief system clashes with our reality. The cost of living rises, in the United States, an average of 3.5% per year. That does not take into account health care, which is rising at least twice that rate. If you hold a portfolio which returns 6% a year, for example, your real rate of return, or the return left after inflation, is only 2.5%. This is not enough to sustain any reasonable standard of living over a period which will likely span 30 years of retirement.

 

The only way to sustain a reasonable standard of living over that long of a time period is to earn a real rate of return significantly higher than that paid by bonds. In short, your long-term standard of living is directly correlated to the percentage of your assets you place in what has traditionally been thought of as the riskier asset classes, like stocks.

 

And therein lies the conundrum. In order to live comfortably, you must do the thing that you fear, which is put your capital at risk - because profit is the reward for risk. Without risk, there is no risk premium. And you must earn the risk premium in order to be able to live when you no longer have a paycheck.

 

That is the bad news. Here is the good news. In spite of what you may think, in spite of what your gut might tell you, and in spite of the belief system passed on to you by your parents, there is, effectively, zero risk in the stock market for the long term investor holding a diversified portfolio. Market risk only exists in the short term.

 

To that end, we have to stop thinking of our investment time horizon as our retirement date. Our investment time horizon is as long as we will live. For almost everyone reading this, we are talking a minimum of twenty years. For most of you, much longer.

 

I am 44. For planning purposes, I assume my investment time horizon, for example, stretches to the age of 102. In other words, my investment time horizon is 58 years. If I plan to hold an equity based portfolio for that long, what risk do I have? Not much.

 

Will I experience temporary declines in my portfolio value? Of course. Markets are cyclical. They go up and down. But at the end of 58 years, how likely is it that my investment will not have grown at a rate that exceeds the total return on bonds? As my grandmother used to say, "Nothing's impossible, just highly improbable."

 

Therefore, your choices are really quite simple. In order that you not run out of money, or at least purchasing power, you must commit a substantial portion of your assets to equities and keep them there for the long term - through the ups and downs - all of the panic buying and selling. The only way to make the required return is to always be in the stock market. Not market timing. Not stock picking. Holding a portfolio of America's greatest companies over long periods of time.

 

For most of you, that is not easy. It will never be easy. It goes against programming imparted to you almost at birth. But you have to do it anyway. To do otherwise is to guarantee a heart attack by treating the ulcer.

 

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. Diversification does not ensure a profit or protect against loss of in a declining market. 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.

A different perspective on market volatility

It is my experience that you have three primary concerns when it comes to your investments: 1) Catastrophic losses of principal; 2) Outliving your money; and 3) Knowing who to trust. Am I right? Talking to people just like you, day in and day out, I know those fears are heightened by extreme market movements like we have experienced in the last few weeks. True?

 

So I thought it might be helpful to give you some perspective on market volatility from various authors who I know and respect. From Dr. Benoit Mandelbrot¹, in The (Mis)behavior of Markets:

 

From 1916 to 2003, the daily index movements of the Dow Jones Industrial Average do not spread out on a graph paper like a simple bell curve. The far edges flare too high: too many big changes. Theory suggests that over time, there should be fifty-five days when the Dow moved more than 3.4 percent; in fact there were 1001. Theory predicts six days of index swings of more than 4.5 percent; in fact, there were 366. And index swings of more than 7 percent should come once every 300,000 years; in fact, the twentieth century saw forty-eight such days.

 

In other words, there is far more volatility in the markets than most people realize. That is Dr. Mandelbrot's central message. Rather than ignore this risk, I think we should be teaching people how to make it work to their advantage.

 

From Nassim Nicholas Taleb², in Fooled by Randomness:

 

Prices swing more than the fundamentals they are supposed to reflect, they visibly overreact by being too high at times (when their price overshoots good news and when they go up without any marked reason) and too low at others. The volatility differential between prices and information meant that something about 'rational expectation' did not work.

 

Prices swing more than the underlying fundamentals because markets are driven by the human emotions of fear and greed. Neither of these have anything whatsoever to do with the underlying fundamentals.

 

From Ed Easterling³, in Unexpected Returns:

 

The average annual change for the Dow Jones Industrials Average stock market index, as a simple average, is just over 7% over the past century, 1901-2003... Over that period, what percentage of the years would you expect the annual change would occur in the range of -10% to +10%? Most investors seem to guess a number between 60 to 70 percent—that a clear majority of the years would be inside the range. What range would be required to include half of the years inside that range? … It is very surprising to most investors that the yearly range in the stock market has been inside the range of -10% to +10% only 30 percent of the years. Remarkably, to include half the years inside the range, it has to be expanded to -16% to +16%.

 

Of course, that also means that 50% of the years had a return of greater than ±16%, too. For an investor who looks at his or her portfolio value as a gauge of success, those swings would be pretty scary. For a cash flow investor, who gauges success by the amount of income a portfolio can generate, and by extension, the sort of lifestyle the portfolio can sustain, those market swings should be irrelevant.

 

Finally, there is this from Peter Bernstein⁴ in, Against the Gods: The Remarkable Story of Risk, who I tried to get on the show but could not:

 

For true long-term investors—that small group like Warren Buffet who shut their eyes to short-term fluctuations and that have no doubt that what goes down will come back up—volatility represent opportunity rather than risk, at least to the extent that volatile securities tend to provide higher returns than more placid securities.

 

This is the approach I take to volatility. Volatility is my friend, not the enemy. I love, love, love volatility. To me, the last month or so has been the absolute ideal!

 

How do you feel about big market moves? Do they scare you? Make money for you? Or not affect you at all? Do any of these perspectives surprise you? Do you agree? Disagree? Feel free to leave your thoughts and comments below.

 

We have taught 3009 investors how to:

 

• Manage their emotions
• Preserve capital
• Get growth even as markets decline
• To generate enough portfolio income to do what they want, when they want, without worrying about market ups and downs.

 

If you have over $25K to invest, register today for our free introductory class on cash-flow investing and the Snider Investment Method™.

 

 

 

 

1. I first interviewed Dr. Mandelbrot in 2004 for my radio show. Dr. Mandelbrot is the father of fractal geometry, which in case you are interested, is what makes all of today's amazing computer animation so lifelike. He is also the Sterling Professor of Mathematics at Yale and a Fellow Emeritus at IBM's Thomas J. Watson Laboratory.

 

2. I first interviewed Nassim Taleb for my radio show in August, 2004. (You can listen to the podcast of that interview here.) In fact, it was Nassim Taleb who introduced me to both Dr. Mandelbrot and Terry Burnham. In addition to Fooled by Randomness, Nassim Taleb is also the author of the recent best-seller, The Black Swan. Dr. Taleb is a fellow at the Courant Institute of Mathematics of New York University.

 

3. I first interviewed Ed Easterling for my radio show in April, 2005. We have had him on several times since. (You can listen to the podcasts of our interviews here and here.) Ed is the founder of Crestmont Research and Adjunct Professor at SMU's COX School of Management where teaches a graduate course on hedge funds. Ed's website, crestmontresearch.com, is a wealth of wonderful primary research on market cycles.

 

4. Peter Bernstein is the one author on this list who I do not know. I talked to his assistant about getting an interview on my radio show some years ago and he declined. Peter Bernstein is the author of the semimonthly analysis Economics and Portfolio Strategy. He has authored six books on economics and finance. He was the first editor of The Journal of Portfolio Management.

 

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.

Do You Deserve Financial Success?

I saw an article in MarketWatch the other day that made me sad. Apparently, 50% of Americans believe a secure retirement is an impossible dream. It makes me sad because self-defeating beliefs like this become self-fulfilling prophecies. There is absolutely no reason this has to be true.

 

Financial success requires three things: save prodigiously, invest wisely, and act like an entrepreneur. These things are simple. They are doable. But they are obviously not easy or we would all be millionaires.

 

In The Millionaire Next Door, Drs. Thomas Stanley and William Danko tackle the question of quantifying how wealthy you should be. They use a formula I have find quite useful. Multiply your age times your realized pretax annual household income from all sources except inheritances. Divide by ten. This, less any inherited wealth, is what your net worth should be.

 

If your net worth is more than twice this number, you are a PAW - a prodigious accumulator of wealth. If it is less than 50% of this number, you are a UAW - an under-accumulator of wealth. In between and you are average - an AAW.

 

At the age of 28, I was wealthy, by any measure. I didn't inherit it. But it was a stroke of luck. The company I worked for went public and my stock options were suddenly worth a lot of money.

 

By age 30, I was dead broke. I didn't have a penny to my name and I was in debt up to my eyeballs. All my cool toys were re-possessed. I sold my beautiful Uptown condo at a terrible loss just to stay out of foreclosure. My credit was wrecked and I had no job.

 

Today I am 43 - I'll turn 44 in May. I am again wealthy - by any measure. This time it wasn't a stroke of luck. It was damn hard work. And let me tell you something. It is far more gratifying than the first time.

 

There are many lessons to be learned in how and why I lost all that money the first go around. I'll save that for another day. I prefer to focus on how I got from the there to here - and to ask you a question? What can you learn from my experience?

 

One of the most useful exercises for me has been finding people who had what I wanted, figuring out what they were doing that got them the result I was after and then doing the same thing. That is why I found the Millionaire Next Door to be so helpful. It gave me a shortcut. I didn't have to talk with all these people, the author's already had.

 

Financial success starts with a simple principle. If you earn $100 and spend $110 you will always be poor - it doesn't matter how much money you earn. If you earn $100 and spend $90, you will always have money - it doesn't matter how little you earn. If you want to be financially successful, you must spend less than you earn.

 

Once you have put away enough to cover emergencies start investing your savings. The key to investing wisely is knowledge. I believe a financial education is one of the best investments you can possibly make.

 

Investing is simply a trade-off between risk and reward. You cannot have one without the other. That law is as fundamental as gravity - it cannot be suspended. The investor who manages that trade-off well will do well. If you don't, you won't. Too much risk or too little can be equally detrimental to achieving financial success. Your job is to always maintain a happy medium.

 

Risk is connected with financial success in many ways. For example, two-thirds of high net worth (HNW) individuals are entrepreneurs even though the self-employed only make up 20% of the workers in America. That makes sense given that profit is the reward for risk. The entrepreneur takes the risk to start and sustain a business and therefore makes more, when successful, than the person who works for someone else and has less risk. But he or she also stands to lose more if the business fails, which it often does.

 

So it is not surprising that HNW individuals are predominantly entrepreneurs. I am an entrepreneur. Not because I set out to make a lot of money but because I have a passion that burns deep inside my core - to make a profound difference in the financial lives of others by teaching them what I had to learn the hard way.

 

But the good news is that you don't have to be an entrepreneur to be financially successful - you just have to act like one. Most successful entrepreneurs I know have three traits you need to be financially successful: 1) commitment and determination; 2) creativity, self-reliance and ability to adapt; and 3) believing in yourself.

 

People sometimes ask me how I went from broke, to not, in thirteen years. I tell them I decided to. That is the truth. Without commitment and determination, you probably won't get there, because financial success requires making hard choices - usually involving giving up what you want now for the opportunity to have something better down the road. That is hard.

 

It is also hard not to get caught up in what everyone else is doing or to not keep doing the same thing over and over and expecting a different result. When the traditional Wall Street offering didn't meet my objectives, I created my own. If what you're doing isn't working, change what you're doing. Otherwise, you shouldn't be surprised when you keep getting what you've always gotten.

 

50% of Americans don't believe they can create a secure retirement. Sadly, they are right. Because if you don't believe you will, then you most assuredly won't.

 

Why do so many people doubt their ability to achieve financial success? Is it because they are afraid to try? Is it because too many people have told them they can't do it? Is it because we are a gluttonous, consumer goods oriented society where no one knows the value of delayed gratification any more? Maybe.

 

I saw an old beater car driving down Stemmons Freeway yesterday with a big screen plasma TV tied in the trunk. The driver was pretty obviously on the lowest rungs of the economic ladder. Yet there he was with his big screen, which by the looks of it, was worth more than the car!

 

But maybe, just maybe, it is because we do not believe we are deserving of financial success. One thing I know for sure, anything I believe I am unworthy of - love, money, respect, friendship - will elude me until I can say with certainty, "I deserve this!". Do you deserve financial success?

 

	TAKEAWAYS:   1. To be financially successful you must: save prodigiously, invest wisely, and act like an entrepreneur.   2. If you don't believe you are capable of financial success, figure out why.

 

So now you know what I think. How about you? What do you think? Feel free to leave your thoughts and comments below.

 

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.

The Road to Financial Success Is Well Marked

Do you ever look at people who are more financially successful than you are and wonder how they got there? There are only three ways to become rich: inherit it, marry it, or earn it.

 

Most of us aren't heirs to a fortune and unless your parents are in the minority, they are going to need all they have just to live out their power years. Some may be fortunate enough to marry into wealth but I certainly wouldn't recommend it as a wealth-building strategy. It reminds me of the line in Pretty Woman, "Meet the Olson sisters. They have made marrying well an art form."

 

So that leaves earning it. The good news is the road to financial success is well-travelled and those who have gone before you have left it pretty well marked. The only thing required from you is the discipline to make it happen. Here's how:

 

Forget about appearances. I bet you know someone who makes a lot of money, lives in a fancy house, drives fancy cars, and lives paycheck to paycheck. I know a lot of people like that. But I bet you also know someone who lives in an average house, drives the same paid-for car for ten years, and has a net worth of several million dollars. Thomas Stanley and William Danko call these people "The Millionaire Next Door." If you haven't read the book, get it.

 

Don't buy things you cannot afford. My grandmother is 88 years old. She was ten years old, living on a farm in East Texas in 1929 when the stock market crashed. She grew up, like so many of her generation, believing that you didn't buy something you couldn't pay cash for. When you have the discipline to save for the things you want, it gives you the time to decide if they are really important. If they are, they'll mean more for having saved to buy them.

 

Kick your bad habits. Do you smoke, drink, gamble or live on junk food? Our bad habits rob us in many ways. Let's take the difference between eating breakfast at home or grabbing a McDonalds on your way to work each morning. My breakfast every morning is a bowl of oatmeal and Crystal Light. I am guessing that meal probably costs me about $0.75. Compare that to $3.00 for an Egg McMuffin, hash browns and a soda (I don't drink coffee). Do that five days a week, 52 weeks a year, that's almost $600 a year. $600 compounded at 10% for twenty years is $4000. Do that every year for ten years and you have cost yourself a years worth of living expenses. That doesn't take into consideration the extra cost of insurance and healthcare if you are a high risk.

 

I am not suggesting you have to live in abject poverty or deny yourself a splurge once in awhile. I like a Whataburger as much as anyone. But you have to admit bad habits are expensive. If financial success is a priority for you, then kicking bad habits is one way to get there.

 

Visualize your goals. There is a tendency to become what you imagine yourself as being. So how do you attain your goals in life? By having a goal and knowing what it is! I, for example, have had a goal for almost ten years of owning a polo farm in Aiken, SC. Not a day has gone by that I didn't picture in my mind what the house would look like, how the barns and pastures would be laid out, and me playing polo on my own field. Today, that goal is a reality.

 

It is not enough to say I have a goal. The trick is to imagine exactly what that looks like, in excruciating detail, and hold that thought doggedly in your mind. The one thing we know is that our minds can't stand to have the inside not match the outside. If you are persistent with the visualization, and you have full faith in you ability to achieve your goal, your mind will, over time, make your outside world congruent with your inside world. I don't know why it works that way. I only know that it does.

 

Manage risk. Shit happens. Make sure you have six months of living expenses in a bank account. Insure any risk you cannot afford and update your insurance as your situation changes. The paradox is, the more at risk we are, the more likely we are to skip this step. When money is tight, it is easy to raid the emergency fund or cancel the insurance policy and hope lightening doesn't strike. But Murphy's law says that is just when it will and if it does, the financial setback may be too drastic for you to ever recover from.

 

Abolish get rich quick fantasies. Wealth is built one dollar at a time. I like the quote by Theodore Roosevelt. He said, "The things that will destroy America are prosperity-at-any-price, peace-at-any-price, safety-first instead of duty-first, the love of soft living, and the get-rich-quick theory of life."

 

Manage your own money. Imagine a broker has two mutual funds he can sell you. One is a low cost index fund that will match the market's performance exactly but pays him no commission. The other will under-perform the market two-thirds of the time but will pay him all sorts of money. Which do you think he is going to recommend? The only person who has no conflict of interest when it comes to taking care of your money is you. That makes you uniquely qualified to manage your own financial affairs.

 

Stop chasing the herd. The person who chases the latest hot idea, whether it is internet stocks, real estate, or commodities, is condemned to repeatedly buy high and sell low. The key to wealth is to buy when everyone else is irrationally selling and sell when others are irrationally buying.

 

Think of your money as a tool. Your money is no different than a carpenter's hammer or a truck driver's truck. It is a tool. Every day you put its little coveralls on, hand it its lunch pail and send it off to work. If, at the end of the day, it doesn't come back with four buddies in tow, your money isn't working hard enough. You need to find it a different job.

 

Be the Family CFO. You are your family’s chief financial officer and it is arguably the most important job you will ever hold. The CFO of a company is responsible for that company’s financial health. You are responsible for the financial health of your family. What separates the good CFO’s from the bad is knowledge. A good CFO works to be as educated about financial matters as possible. The more you know, the better you’re able to distinguish between a great investment opportunity and a cleverly disguised sales pitch.

 

	TAKEAWAYS:   1. There are only three ways to become wealthy: inherit it, marry it, or earn it. The last one is the most reliable.   2. Get started today. Tackle the items on this list one at a time. Make a plan for implementing these ideas. Let us know how you are doing.

 

Care to share? Which of these needs to be your highest priority? Leave your thoughts and comments below.

 

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.

Options Find a Place in Retirement Accounts

The traditional view of options can best be summed up in one word - risky. That has always frustrated me, mainly because it is such a persistent myth. Options can be risky, particularly when they are used to place a bet on the future direction of price. If that's what you want to do, why don't you just go to Las Vegas?

 

Increasingly though, options are being used in the way I believe they ought to be used, which is to manage risk and create portfolio income. Even more specifically, they are being used to generate portfolio income for retirement portfolios.

 

Charles Schwab did a survey of some of its options customers and were pleasantly surprised to find most of them were using options in this very conservative way. The Wall Street Journal reports:

 

The survey showed that 61% of them consider themselves to be risk takers, but only 40% think there are more gains to be made with options than with stocks and bonds, and only 31% agree that they like trying to outsmart the market with their option trades.