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.

 

Wickedly Funny YouTube Subprime Video

In general, my articles tend to be fairly serious. But, I think every once in awhile some humor is in order. As Mignon McLaughlin said, "A sense of humor is a major defense against minor troubles."

 

There is far too much doom and gloom these days. I am as aware as anybody of the number of people losing their homes, the high price of oil, the falling dollar and the volatile stock market. But I think the press drives us to unhealthy extremes of sentiment, especially when it comes to the economy and the stock market.

 

It scares me, the extent to which the press, which is largely ignorant of economics or finance, takes a stand that is so transparently intended to sensationalize rather inform, influences the day-to-day sentiment of tens of millions of otherwise bright people.

 

Let me give you an example. A day or two ago, the press started putting out headlines suggesting markets were reacting to a "fear of stagflation." All of a sudden, my inbox was flooded with emails mentioning stagflation, as if it were an invading army amassing on our border. "Should I change my portfolio given we are about to go into a period of stagflation?" Aggghhh!

 

The popularity of so-called fake news shows, like The Daily Show or The Colbert Report, (I hope) show us that Americans are pretty fed up with what passes for journalism today. Or maybe that is just me projecting how fed up I am onto everyone else. Who knows.

 

Good satire turns the words of the subject against them, and simply by reformulating them, shows us the absurdity of the original statement. In keeping with that sentiment, I offer you a spot on version of recent financial events from John Bird and John Fortune from the South Bank Show.

 

At last, British humor I can relate to! Thanks to Joe Mikus for the heads up on this one. FYI - run time is about 8 minutes.

 

 

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 are subject to risk, including possible loss of principal. Individual results may vary.

Mortgage Mess

I am still traveling so this will be short and sweet. I'd like to point out an excellent article by Laura Rowley over on Yahoo Finance. It is titled, "Footing the Bill for the Subprime Fiasco."

And while we are on the topic of messes, you might also have a look at Scott Burns' article on the federal deficit. (Free registration required) According to government figures, the entire deficit problem boils down to unfunded liabilities in the Social Security and Medicare programs. He goes on to point out t"if the federal government confiscated all the land in the United States along with all of its improvements – buildings, highways, plants and equipment, and other durable assets built on it – and sold them at auction to foreign investors, it would still fall more than $20 trillion short in present value of the monies required to satisfy its future budget."

Give these a read and let me know what you think. Gotta go. I have a plane to catch!

 

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.

Business Week Needs Help With Story

Peter Coy, Economics Editor at Business Week, would like to interview someone with a subprime adjustable rate mortgage whose interest rate either reset upward recently, or is about to reset. He says: “Real people, please. Don’t need expert commentary. Please respond to the email or phone numbers below. Need this ASAP.”

If you would not mind talking to Peter for his story, contact him directly:

Peter Coy
Economics Editor
BusinessWeek
43rd floor
1221 Avenue of the Americas
New York, N.Y. 10020
phone 212-512-2626
peter_coy@businessweek.com

FYI - I don't know Peter. I'm just passing this on from Lauren Young, the Personal Business Editor

 

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.

February 2007 Family CFO Briefing

Investing

 

You gotta love this. In the same vein as the monkey's throwing darts and Rusty, the Longhorn steer that picks stocks by pooping on the stock pages: A subscription web site that provides its subscribers with stock picks for as much as $100 a month invites, in January, 10 Playboy models to participate in an investing contest. When results are tallied toward the end of the year, 40 percent of the bunnies deliver better returns than the S&P 500, compared with just 29 percent of actively managed mutual funds.

 

Investing for Retirement

 

Millions of American women face declining living standards in retirement. Like men, they'll feel the sting of cutbacks on corporate pensions. But women suffer more than men from the high rate of divorce, which can deprive them of savings and income when they need it most. Many also lose benefits and income when they leave work to care for children and they live longer than men. (Los Angeles Times, free registration required)

 

Some brokerage firms make more money on money market spreads than they do on commissions. Most money market sweeps are paying less than 2% in brokerage accounts while money market fund rates are averaging 4.75%. By reinvesting client funds on the open market, brokerage firms are pocketing the difference and making a tidy 2% to 2.5% profit on your money. (Wall Street Journal, subscription required)

 

The Employee Benefit Research Institute (EBRI) reports "IRA Assets Hit Record $3.67 Trillion" fueled by IRA rollovers. Total IRA assets are larger than those in either traditional pension or 401(k) type plans.

 

Another EBRI report, issued in February, reports that 401(k) type plans have become the dominant form of employer sponsored retirement plan. There has been a significant increase in the percentage of family heads with a defined contribution plan (typically a 401(k)-type plan). In 2004, almost 26 percent of family heads who participated in an employment-based retirement plan had a defined benefit (pension) plan only, while 56 percent had a defined contribution (401(k)-type) plan only, while the remaining 18 percent had both a defined benefit and defined contribution plan. This was a significant change from 1992, when 42.3 percent had a defined benefit plan only and 40.8 per-cent had a defined contribution plan only.

 

Big corporations announced 15% more layoffs in January than in December, but the total was down 39% from this time a year ago, according to an unscientific tally of job-cut announcements released Thursday by outplacement firm Challenger Gray & Christmas. (MarketWatch)

 

Congress and government regulators are planning an array of moves to strengthen oversight of 401(k) accounts, which have become the linchpin of retirement savings for millions of Americans but are often burdened by hidden fees that chip away at their value. (Baltimore Sun)

 

MSN Money lists five common blunders people make in their 401(k) plans. (WARNING: shameless self-promotion coming up.) Our new web-based program, How To Turn Your 401(k) Into A Million-Dollar Nest Egg goes much farther than pointing them out. It will tell you step-by-step how to properly manage the many different aspects of your plan so that it can someday provide enough income for you to live comfortably in retirement. Our unique paint-by-numbers approach will tell you exactly which funds available in your plan are the most likely to deliver the best results. It will show you how much to invest and where. We are very proud of this new product because we believe it will help a lot of people who are clueless when it comes to what to do with their 401(k). Stop by our web site for a free preview. (Now back to your regularly scheduled programming.)

 

Housing, Real Estate and Mortgages

 

If you are making accelerated mortgage payments and not contributing the maximum to tax-deferred retirement plans, you are making a big mistake according to a recent paper titled "The Tradeoff Between Mortgage Prepayment and Tax-Deferred Retirement Savings," published by the Federal Reserve Bank of Chicago.

 

In Dallas County, foreclosure postings are up 24 percent. In Tarrant County, they are up 17 percent. Denton County came up 15 percent and in Collin County they are up 61 percent over this time last year. Dallas and Fort Worth are in the top ten in the nation for foreclosures. Dallas ranks number 5 and Fort Worth is number 7. (CBS 11 local coverage)

 

Debt and Savings

 

• Only 17% stick to their New Year’s resolutions!
• 38% said that losing weight was #1 priority for 2007 followed by spending more time with loved ones
• 24% consider getting out of debt their second most important priority for 2007
• 31% answered that they currently have credit card debt of MORE than $8500 while 40% said they have less than $1000
• 60% said that they could live as they do now for less than 3 months or less if they lost their job tomorrow - while 31% said they could live longer than 6 months
• Nearly ½ of all surveyed don’t know their credit score!  (48%)
• 56% consider ‘viewing their online bank balance’ managing their personal finances
• Nearly ½ of all surveyed do NOT have an emergency fund stashed away (49%)

 

(Note: I don't have a link for this one. The information comes from a press release sent to me by Quicken's PR firm looking for interview opportunities. The firm must not have done a very good job because a Google search turns up zilch. Sorry! I'd give you a link if I could find you one!)

 

I found these statements, without attribution, when I was doing research for a project. Since sources weren’t cited, I can't vouch for their validity but they certainly ring true. Judge for yourself:

 

• Americans currently owe nearly $9 trillion in debt -- accumulating nearly 40% of it in the past five years.
• Over the past four years, Americans have borrowed more against their homes than they've invested.
• Forty percent of new-car buyers still owe money on their trade-in.

 

The previous rings especially true given the following: People once again spent everything they made and then some last year, pushing the personal savings rate to the lowest level since the Great Depression more than seven decades ago.

 

And finally, how's this for perspective? New research into the world's personal wealth finds assets of just $2,200 per adult placed a household in the top half of the world's wealthiest. $61,000 puts you in the top 10% and if you have more than $500,000, the United Nations Study says you are among the richest 1% in the world! Here is the terrifying number. Half the world - nearly 3 billion people - live on less than $2 a day. (MSN Money)

 

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.

Should You Pay Off Your Mortgage Early?

If you are making accelerated mortgage payments and not contributing the maximum to tax-deferred retirement plans, you may be making a big mistake, according to a recent paper titled "The Tradeoff Between Mortgage Prepayment and Tax-Deferred Retirement Savings," published by the Federal Reserve Bank of Chicago.

 

According to the authors, "a significant number of households can perform a tax arbitrage by cutting back on their additional mortgage payments and increasing their contributions to tax-deferred accounts." The average benefit is about 11 to 17 cents on the dollar over the term of the mortgage, depending on the choice of investments inside the tax-deferred account, they say.

 

It doesn't require a high risk portfolio to get the benefits from this strategy. The authors assumed the additional retirement assets were invested in either U.S. Treasuries or mortgage-backed securities. As long as the pretax returns on the retirement accounts are greater than the after-tax rates on the mortgage, "households are generally better off saving in a TDA [tax-deferred account] instead of prepaying their mortgage."

 

The study found 38% of households that prepay their mortgages could benefit from the proposed arbitrage strategy. It should be noted, for purposes of this study, a short-term mortgage (less than the standard 30 years) is considered the same as making prepayments on a regular mortgage. In both cases, the homeowner is paying down the mortgage faster than they normally would. The study assumes these extra payments could be saved in a retirement account instead.

 

"These misallocated savings are costing U.S. households as much as $1.5 billion per year." That leads to the question, why are we so prone to doing the wrong thing? The authors say this inefficient behavior can be explained by "self-reported debt aversion and risk aversion variables." In plain English, people who pre-pay mortgages don't like any debt.

 

I would suggest, as in all things, a balance is called for. No debt is as bad as too much debt. You have bad debt, which is debt used to buy things that depreciate in value -- and good debt, which is debt used to buy things that appreciate in value. Some good debt may not only be OK, but better than none at all, as long as you don't go overboard.

 

As I have said in previous posts, I have amended my position on this subject in recent months. 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 the more I need the harder it is to get to. Who is going to give me a home equity loan when I have 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 huge out-of-pocket medical treatment?

 

On the other hand, I am not an advocate of taking the money you would use to pay off mortgage and investing it in high risk investments. I would not, for example, recommend you play the arbitrage game between mortgage rates and mutual fund returns, as many salesmen are suggesting these days.

 

I also would never recommend taking a loan for the specific purpose of investing it. But my own investment method will borrow very small amounts on margin from time to time to take advantage of some extra leverage.

 

So there is definitely a line. Personally, I am still trying to define exactly where I draw it. It's sort of like pornography. I know it when I see it but have a hard time defining it. Studies like these from the Chicago Fed are very helpful in thinking through all the issues.

 

Thoughts? Where do you draw the line? I'd especially like to hear from anyone who is pre-paying a mortgage but not maxing out their retirement accounts? Does this information cause you to rethink what you are doing? Could you, or would you redirect those payments to your 401(k), 403(b), IRA or maybe a Health Savings Account (HAS)? Leave your comments below.

 

SOURCE:

 

1. Gene Amromin, Jennifer Huang, and Clemens Sialm. "The Tradeoff between Mortgage Prepayments and Tax-Deferred Retirement Savings." Federal Reserve Bank of Chicago August 2006.

http://www.chicagofed.org/publications/workingpapers/wp2006_05.pdf

 

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.

 

Where Fools Rush In

Regular readers will be intimately familiar with my theme of buying when everyone else is selling and selling when everyone else is buying. This is a cornerstone of the way I invest. Another cornerstone is that no one can consistently time the market or pick stocks. That means finding a long-term investment strategy and sticking to it irrespective of short term events.

 

An article by Michael Mauboussin, Chief Investment Strategist for Legg Mason and author of the book "More Than You Know: Finding Financial Wisdom in Unconventional Places" in the December issue of Time discusses our proclivity for buying at highs and selling at lows.

 

That proclivity is best illustrated by Dalbar's Quantitative Analysis of Investor Behavior which I quote often. According to Dalbar (Mauboussin attributes it to Jack Bogle but he is quoting Dalbar) in the 20 years ending in 2005, the S&P 500 index rose 11.9% annually and the average mutual fund 9.7%, but the average investor realized only a 6.9% return. (See update at the bottom of the page for more on this.)

 

Mauboussin points to two concepts to explain our behavior. The first is recency bias. Recency bias causes us to put more empahsis on what has happened most recently and minimize, or even ignore, facts and long-term data.

 

He also suggests that we pay little attention to nagging details but instead let the stories spun by Wall Street or the financial press capture our attention. He cites the recent run-ups in real estate and energy as examples saying, "More often than not, once a sizzling sector comes to the attention of an individual investor, the opportunity is gone."

 

We are hard-wired to be poor investors. That is the gist of behavioral finance. But what you have to be aware of is that Wall Street uses that to its advantage. Quoting Mauboussin:

 

If you think the investment industry is there to protect you, think again. Many firms see a hot sector as an opportunity to gather assets. Before the tech-stock peak in 2000, the industry marketed nearly 500 technology, telecom and Internet funds. It's the same story now, only the actors have changed. In October 2004, 180 hedge funds were dedicated to energy and commodity investments. Today there are 525.

 

There's nothing new about bad timing and Wall Street's willingness to accommodate it. In fact, poor timing may be one of the most systematic and predictable errors investors make. Famed portfolio manager Bill Miller has dubbed it the "five-year psychological cycle." Investors want to own today what they should have owned five years ago. Currently, investors are pining for energy and commodities, but they should have owned them in the early 2000s, when they were cheap and unloved. Instead, investors coveted the high-flying tech and telecom stocks, which would have been smart purchases in the mid-1990s--except that investors were busy chasing bank stocks, which would have been shrewd purchases in 1990. You get the idea.

 

People not only do this with hot sectors and hot stocks, they also do it with asset classes. The time to jump in the stock market is not after it has risen 20%. And the time to sell stocks and buy bonds or go to cash isn't after it has fallen 20%.

 

This is the idea behind portfolio rebalancing, a simple but fundamental aspect of portfolio management that very few individual investors do.

 

I am curious what your thoughts are on this topic. Are you inspired to agree? Disagree? Do you have an example? Feel free to share. Comments are welcome in the comment section below.

 

UPDATE: (11/29/06) I received an email from Michael Mauboussin. I said the numbers in the second paragraph should be attributed to Dalbar, not to Jack Bogle. I was wrong. He tells me he WAS quoting Bogle, not Dalbar. Apparently they come up with different numbers. Although the message in them is the same I think. Sorry Michael for the mistake. Thanks for taking the time to set me straight on that one.

 

SOURCE:

 

1. Michael Mauboussin. "Where Fools Rush In." Time 6 November 2006, A44.

http://www.time.com/time/insidebiz/article/0,9171,1552055-1,00.html

 

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.

 

What is dead money?

Dead money is money that is earning its owner nothing. Examples of dead money include:

 

1. Money buried in your backyard or stuffed under your mattress

2. Equity in your home

3. Money invested in an asset that is under water and produces no cash flow

 

The opposite of dead money is money that is actively working. Examples include:

 

1. Interest bearing investments - CDs, money market funds, bonds

2. Cash flow investments - rental properties, dividend stocks, REITs, royalty trusts, etc.

3. Money invested in an asset worth more than you paid for it and still rising

 

I believe a fundamental rule of managing money is to avoid dead money like the plague. Your money is a tool. It has to work for you every single day. In this day and age, it has to work harder than ever because you face more risks than ever before.

 

Look at the first list up above. The old way of thinking about money encourages dead money.

 

The old way of thinking says to buy a house and put as much money down as possible. Make extra mortgage payments if you can. Get your mortgage paid off before you retire.

 

Today's reality is you cannot afford to have hundreds of thousands of dollars tied up in a mortgage. You are very likely going to need that money at some point along the way. Mortgages, home equity lines of credit and reverse mortgages have to be used as a strategic tool for financial planning today.

 

The old way of thinking says buy and hold. Stock prices go up over the long run.

 

But what about the short run? The new highs in the Dow notwithstanding, money invested in stock has been dead as a doorknob since 2001. It may still be dead. Dollars to doughnuts says if you remove any contributions you have made in the interim and add back any distributions, your portfolio value is less than it was.

 

Sorry to burst your bubble, but it's true.

 

The new way of thinking says losses in market value are unavoidable. Markets are cyclical and can't be timed. Cash flow is king. The only way to make money work consistently in the short run is for it to generate cash flow.

 

As long as I have sufficient cash flow, I can afford to hold for the long run because in the short run I have the income to deal with the unexpected without selling assets while they are down.

 

Many smart people believe these market highs are very temporary. They predict a recession is approaching. A lot of other really smart people say this is just the beginning of a new period of prosperity. I am just smart enough to know none of them know for sure. Flip a coin. It could go either way.

 

I always ask "what if?" I think a family CFO must plan for the unexpected. The way you do that is by asking "what if?"

 

What if I became ill and couldn't work. What if I lost my job or my business went under? What if housing prices fall - a lot? What if I can't flip this real estate investment I bought? What if 2007 is the start of another recession? What if the market loses 35% of its value over the next few years and takes another five to get back to current levels?

 

What if? And then -- what next?

 

The time to buy is when everyone else is selling and the time to sell is when everyone else is buying, not the other way around. These new highs are an opportunity to cash out and move to investments that will work for you even if "what if" happens. The key is to always plan so that no matter what happens, you'll still be OK.

 

Agree? Disagree? Leave your 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.

Mortgages Causing Financial Planners To Rethink Old Rule of Thumb

Financial planners have long used a rule of thumb that said retirees need retirement cash flow of 70% - 80% of their pre-retirement income in order to maintain a comparable standard of living. But that rule of thumb assumes a paid off mortgage going into retirement.

 

Studies show that is no longer a good assumption. The latest one, published in the September issue of Journal of Financial Planning, found that an increasing number of older Americans are carrying larger first and second mortgages into retirement for longer periods.

 

They found, for example, that 45% of people in their sixties have a first mortgage—up from 34% in 1980. Second mortgages and the percentage of income consumed by mortgages among 60 and 70 year olds is also rising.

 

“This new, increased and continuing debt load may suggest that the traditional rules of thumb for determining appropriate levels of retirement income are outdated,” wrote the authors.

 

Do you expect to carry a mortgage through retirement? Or two? Or will you retire mortgage-free? Was that a conscious decision on your part or did it just work out that way? Can you live comfortably on 70% - 80% of your pre-retirement income? Leave your thoughts and comments below.

 

SOURCE:

 

1. "Frontline News." Financial Advisor October 2006.

http://www.fa-mag.com/past_issues.php?id_content=3&idPastIssue=114&show=fronline

 

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.

 

11-1-2006 - Items of Interest to Family CFOs

Saving and Budgeting

 

Money Magazine gives us 25 Rules To Grow Rich By. These cover the gamut -- from what remodeling will give you the biggest return when you sell your house, to how much company stock you should hold, to extended warranties. Each has its own calculator or resource box to go with it. While I don't agree with every one of them, they are good food for thought. (CNNMoney)

 

The Economy

 

The AP reports the median new home price fell 9.7 percent in September -- the largest amount in 35 years. That doesn't mean they fell everywhere, of course. The median is the midpoint. Half sell for more and half sell for less. Some areas, particularly those that have been hot in recent years, are harder hit than others. (Yahoo Finance)

 

Here is some more information, courtesy of Barry Barnitz, about falling home prices. "For two years running the S&P/Case-Shiller Home Price Composite Index has steadily shown tapering annual returns from its peak in July 2004. Not only do we continue to see shrinking gains but actual declines in most cities." (Financial Page)

 

The Wall Street Journal suggests the Goldilocks Economic scenario being suggested by many just got eaten. Eight days ago, the markets were pricing in a pretty rosy scenario. A slew of reports has (including the two above) changed all that. "It's prodded [the market] further into saying a slowdown of some magnitude is coming," says Mr. Ader. "People are thinking about a harder landing than they thought about two weeks ago." (The Big Picture)

 

Investing And Retirement

 

The vast majority of homeowners with adjustable-rate mortgages are worried their interest rates will rise, according to a Wells Fargo & Co. survey. But more than half think they'll be able to avoid a painful rise in their monthly payments by refinancing before things get too bad. 72 percent of homeowners said their home equity was their most important investment. That makes falling home prices and rising interest rates a bigger concern than ever before. (AP in Yahoo! Finance)

 

New numbers from S&P confirm what academics preach all the time: indexing continues to beat stock picking and market timing. Over the five years through the end of the third quarter only 29.1 percent of large-cap funds beat the S.& P. 500. 16.4 percent of mid-cap funds beat the S.& P. 400 index of mid-cap stocks, and 19.5 percent of small-cap funds beat their benchmark, the S.& P. 600 index of small-company shares. (New York Times, The Big Picture and Barry Barnitz)

 

John Markese, president of The American Association of Individual Investors, was interviewed by MarketWatch about creating portfolio income for retirement. He discusses maximum sustainable rates of withdrawal, a major shortcoming in my opinion, of the traditional asset allocation model. (MarketWatch)

 

Thoughts on any of these? Feel free to leave your 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.

10-25-2006 - Items of Interest to Family CFOs

This short paper, "Will Reverse Mortgages Rescue the Baby Boomers?", from the Center for Retirement Research, gives a wonderful explanation of reverse mortgages and how they can be used to tap equity in your home without selling it. It also explains the limitations and the risks. The best part is, the CRR is totally unbiased. They are academics looking at the problem of creating enough cash flow to rescue a generation unprepared for retirement. We are working to get one of the authors on the radio show very soon. (http://www.bc.edu/centers/crr/issues/ib_54.pdf)

 

Barry Ritholtz, offers this from The Big Picture. The chart is originally from the New York Times. Lest we are tempted to forget, in the short run, markets don't always go up. When they go down, they create long periods of dead money for the capital appreciation investors. That is why I chose to invest my money for cash flow in the short run and growth as a secondary objective over the long run.

 

 

 

The average Wall Street employee made close to $300,000 last year. That is about 5X what the average person in this country makes. According to the CNN Money article, top traders and investment bankers are commanding compensation in the tens of millions per year. Wall Street is making more than ever while your portfolio has made little or nothing for the last five years. (See the chart above.) Do you feel they earned what you paid them? http://money.cnn.com/2006/10/17/news/newsmakers/bc.financial.wallstreet.pay.reut/index.htm?section=money_topstories

 

It is impossible to continue indefinitely with your cash outflows exceeding your inflows. There is only so much home equity to be tapped and so much credit to be had. Yahoo columnist Laura Rowley has a good piece on the rising gap between income and expenses in this country. She offers five suggestions for averting the disaster that always comes eventually when you live above your means.

http://finance.yahoo.com/columnist/article/moneyhappy/11094

 

Thoughts on any of these? Feel free to leave your 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.

How Will the Housing Bubble Affect Retirement Savings?

It seems pretty evident to me that large portions of the country, especially on the two coasts, have experienced a housing bubble and that it is beginning to burst. The big question in my mind is how far will the bubble set Boomers back?

 

Why do I say there was a bubble? Look at sentiment. A survey by RBC Capital got the following responses:

 

• 75.6% see the value of their home rising over the next few years
• 46% expect a gain of 5% or more annually
• 30% expect a rise of 10% to 15% a year

 

Why do I say it is coming to an end? There are hundreds of data points that suggest a slowing housing market. I don't have the time or space to detail all of them. All you have to do is read to find a growing mountain of data. Here is one of the more recent ones from Moody's Economy.com:

 

The West Chester, Pa., forecasting firm projects that the median sales price for an existing home will decline in 2007 by 3.6 percent, which would be the first decline for an entire year in home prices since the Great Depression of the 1930s.

 

The forecast is included in a 195-page report, "Housing at the Tipping Point," which The Associated Press obtained before its general release on Wednesday.

 

The report projected that 133 of the nation's 279 metropolitan areas would suffer price declines. That is quite a contrast from the past five years when low mortgage rates pushed sales to five consecutive annual records and prices in the hottest sales areas skyrocketed.

 

Most of the Midwest, including Dallas, where I live, didn't experience a boom in prices to begin with. So we are likely to be unaffected. Not so for other parts of the country:

 

The 133 areas with slumping prices are concentrated in the states of California and Florida and the Northeast corridor from southern Maine to just south of Washington, D.C., as well as boom areas of Nevada and Arizona and some depressed sections of the Midwest such as Detroit.

 

And there is bound to be an effect. People who are complacent spend money. People who are scared, do not. What happens when all that home equity begins to melt?

 

The report described the current environment as a "correction" and not a "crash" but it cautioned that there were downside risks that could make the slowdown more serious.

A big threat is that the fall in home prices could have a significant impact on consumer spending patterns. The so-called wealth effect pushed consumer spending higher during the housing boom as soaring home prices made homeowners feel more wealthy and thus more inclined to spend money. But falling home prices could have the reverse effect and depress consumer spending.

 

I have a theory. My theory is that people in cities, like say Phoenix, that have experienced rapidly rising real estate prices are not as worried about their lack of retirement savings as people in say Dallas, where real estate gains haven't added much to the family coffers.

 

My experience in both cities tells me there is an urgency among Baby Boomers in Dallas that just doesn't exist in Phoenix. My fear, of course, is that those with big real estate gains are experiencing a false sense of security and have been lulled into complacency. When the bubble bursts, those people will find themselves even further behind than those that never experienced paper gains in their real estate holdings to begin with.

 

What do you think about my theory? Agree? Disagree? Leave your thoughts and comments below.

 

SOURCES:

 

1. "Majority Of Americans Still Optimistic About Home Values Over Next Few Years, According to RBC Capital Markets Survey." RBC Capital Markets Press Release 27 September 2006.

http://biz.yahoo.com/prnews/060927/to496.html?.v=5

 

2. Martin Crutsinger, "Housing Slowdown May Cause Price Drops." The Boston Globe Online 3 October 2006.

http://www.boston.com/business/articles/2006/10/03/housing_slowdown_may_cause_price_drops/

 

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 Housing Whammy

I have been trying to fashion a cohesive post about the potential aftermath of the housing bubble and refinancing frenzy. I have played with it for about two days now. So far I have failed. So instead, let me just give you a sampling of the issues and the impact we are already seeing.

 

A January, 2005 report from Dēmos, House of Cards, details the extent to which families have come to depend on credit to finance their life-style, much of it by depleting their home equity with loans that will likely come back to haunt them in the face of rising interest rates and falling home values:

http://www.demos-usa.org/pubs/AHouseofCards.pdf