Young Investors Key to Beating the Market

Want to know how to beat the market? “Sure,” you may say, “it’s possible. If I spent my every waking hour researching undervalued companies.”

But, what if I told you I had a fool proof way for those with time to spare to win against the market, without searching rummage shops for discarded crystal balls, or trusting in your uncle’s stock advice? And on top of that, even the most novice investor can use this strategy and win?

Impossible? Read on.

The way to beat the market isn’t by finding the next hot mutual fund manager or dedicating yourself to becoming the next Warren Buffett, it’s simply how you manage your tilt.

Your “tilt” is how your portfolio is invested in the market. You hopefully are diversified over the universe of stocks, but your tilt tells your holdings of large or mega companies versus small or medium sized firms. It also tells if you tend to invest in companies trading at premiums or discounts to the overall market.

More often than not, most retirement investors I meet are “top heavy,” investing in a mix that doesn’t stray too far from the market represented to a higher degree by largest companies, or a mix that resembles the S&P 500 (most people refer to this as the market). This is often the case if you’re investing in a Target Retirement Date fund, or any other fund or funds, or have a managed account.

However, is this the best mix when you’re young and have time to take risks?

By shifting the weights of your portfolio towards areas of the market that tend to have higher degrees of return (and volatility), you may supercharge your retirement accounts when starting out, specifically by using a greater share than the market of smaller companies with more room to grow, and stocks that are trading at a discount to the market (value stocks).

How much better can you do than the S&P 500 by including more small and value in your mix?
The S&P 500 averaged 9.5% per year since 1928. One can not invest in an index, but if you could and had invested $1 in the S&P 500 way back then, you would have had $3,530 at the end of 2012.

Using a similar strategy of owning the stock market, but by shifting the tilt to include more small, and more value, a portfolio that tracks Dimensional Fund Advisors US Adjusted Market Value Index would have averaged 11.7% during the same period. An investment of $1 would have grown to $11,998.

A strategy of tilting more towards small and value stocks will be more volatile than the market, so don’t think this approach will only lead to gains; you still have to master the skill of not watching your accounts rise and fall in the short run. However, while you’re accumulating and have a long time horizon, volatility can be your friend.

Robert Schmansky, CFP®
Financial Advisor
Clear Financial Advisors, LLC
Royal Oak, MI

How Accurate is Your Retirement Model?

I recently had the opportunity to revisit retirement modeling software. As one of my jobs, I teach a economics course, and one of the things I tell my students and financial advising clients is that models can provide us with ideas of how things may work, but with all of the independent variables that exist in the world, they aren’t likely to play out like we hope.

I was revisiting modeling software in part due to a recent critic of those that do not use “advanced” software to project hypothetical outcomes for clients. I used to. I’ve since given it up for many reasons. Mostly because I’ve seen life-changing decisions being made based on a model. “Mr. & Mrs. Client, you can take $50,000 out of your portfolio to buy that RV, and still feel secure in your retirement.”

That was 2007’s annual review of the model. After the market drop, the model was quite different, but the investor at least had a 2nd mobile home now.

Retirement models, like economic models or model trains, can show us a lot about the thing we’re modeling, but it is no substitute for ongoing advice and planning. And, modeling a few worst cases along with the normal case is the least you should do when making decisions based on models.

Of utmost importance however is that you understand the assumptions and factors being used. I can not begin to describe the number of retirement models I’ve seen that were so flawed with incorrect data and bogged down by assumptions. There are often static assumptions (I save $6,000 to my IRA every year), and variable assumptions (rate of investment return).

In my opinion the mixing of so many assumptions in one software package most often leads to incorrect projections. For example, most individuals savings can be variable. You may make a Roth IRA deposit this year, you may not. But, how you project for it makes a difference in the outcome. Are you taking Roth IRA contributions from one account and putting it into another, depleting your savings in order to do so? Does your modeling software know the difference? If you know enough to tell it to.

Do you own a business? How is that being treated? Investments? What assumptions are being used for rates of return, interest, inflation…?

A recent tread is to model various social security strategies that couples may be able to benefit from. One variable that many who do this on their own may forget is the life expectancy. If you just ran the model without thinking beyond the various scenarios, would it give you the right answer, or is this just a case of garbage in, garbage out?

For that reason I strongly recommend a second opinion on any retirement strategy. Retirement models do not take into account the complexities that exist with the individual choices that feed into your personal financial plan. FPA’s PlannerSearch tool can help you find local financial advisors to give feedback on your financial plans, and advice on the strengths, or weaknesses, of your retirement projections and plan.

Robert Schmansky, CFP®
Financial Advisor
Clear Financial Advisors, LLC
Royal Oak, MI

Emergency Cash Reserves – Unloved yet Necessary

I met with a couple recently to deliver their financial plan, and throughout the first half of the meeting we laughed repeatedly as they seemed to have guessed my recommendations and either did or planned on doing exactly what I had written down.

They’ve been contributing 15% of their wages to their long-term retirement plan, have no debt other than a mortgage that will be paid off well before retirement, are able to pay a college tuition bill within their cash flow, and up until recently have been making it a point to contribute to Roth IRAs.

Aside from the validation from a professional, what possibly could this couple have needed with a financial advisor?

Admittedly, not as much as many clients I see, but one of the major observations was the excessive amount of importance on trying to be as efficient as possible. They put every available dollar towards the long-term retirement plan or into paying down their long-term mortgage debt, and in doing so they blew past step one in creating a solid financial foundation – having an adequate amount on hand for short-term emergencies and cash needs.

Our sample couple here came to me wondering how in the world they will be able to pay for a second tuition bill, or purchase new cars. They recently stretched their budget even further by refinancing their 30 year mortgage to a 15 year, and increased their monthly minimum payment. I also pointed out that they had no options to cover any other short-term emergencies that life may send their way other than to go into debt, or raiding a retirement fund.

In preparing their recommendations, I gave them a financial scorecard they would receive the following grades:

Long-term savings – A+

Credit and consumer debt – A+

Living within their means – A+

Having adequate liquidity – D

Overall financial health – B-

What this couple was lacking is cash on hand. Unlike most of your other financial priorities, holding cash is never the most efficient thing to do and so its importance is often overlooked. Compared with paying down a mortgage at 4%, or earning 5-10% in a long-term investment, cash earning next to nothing just isn’t an attractive idea!

But, having an emergency cash reserve is a critical piece of a financial plan. It acts like a moat around your financial castle. It protects you from the need to sabotage your long-term investment plan, or take on high interest debt in order to cover cash needs.

Having a minimum of three months of your net income in an emergency cash account is a requirement of any complete financial plan (Note: three months is a minimum. If you are self-employed, have rental properties, or other concerns about income remaining stable you may need to be at six or more). Even at the expense of not fully funding a retirement account or not paying extra on that student loan for some time. Make having emergency cash in a savings account or money market a priority now, and when the time comes to need it you won’t have to worry.

Robert Schmansky, CFP®
Financial Advisor
Clear Financial Advisors, LLC
Royal Oak, MI

I’ve Maxed Out My Retirement Plan… What Next?

First off, if this situation applies to you then let me say… “Congratulations!”

You’re doing a great job of saving for your future, and it will be well worth it down the road.

For many, saving to your employer plan may not be enough. You may have progressed in your career enough to where you need to catch-up, or you may just be a fantastic saver and need to find other places to invest.

Below are a few ideas for those that save:

• You can always contribute to an IRA. I meet with many who know they are outside of the contribution limits for a deductible IRA or Roth IRA. However, many are not aware that they can always contribute to an IRA and just not receive a deduction. The benefit of this approach is that your contributions will not be taxed when withdrawn. A strategy here may be to contribute to your IRA to convert that money to a Roth IRA later.

• Set-up a taxable brokerage account. If you are saving for goals 5+ years out, consider setting up a brokerage account to invest for higher returns. If this is saving for the long-run, you may want to consider revisiting your portfolio asset allocation decisions to determine if a tax-efficient stock mutual fund may be a good investment.

• Get aggressive with paying down your debt! Paying down debt will save you on interest costs more so than what you will earn on short-term savings, so make getting out of debt a priority.

• Improve your emergency and short-term savings. Many that save well for the long-run still suffer like the rest of us to have cash on hand for emergencies. Make sure to have at least three months worth of expenses on hand, and consider increasing that to between six and nine months. Next, figure out what large cash needs you will have that you may have traditionally financed like the need for a car or to replace something major around the home. Start to segregate these goals and figure out a monthly amount that can be saved towards them today. Having multiple bank accounts labeled for each goal can be a great way to keep track of your savings needs and goals. SmartyPig is a bank that takes this concept of goal-based saving and allows you to see your progress toward each of any number of savings goals you may have.

If you own your own business you have other options which may include setting up other tax-efficient accounts or pension plans.

Maxing out your employer savings plan may not be the end of your options for investing for the long-run. What is best for you will depend on your personal goals, and creating a plan to meeting them.

Robert Schmansky, CFP®
Financial Advisor
Clear Financial Advisors, LLC
Royal Oak, MI

When to Rollover Your 401(k)

The financial industry wants to make sure you are fully aware you left something behind at your old employer. That retirement account that is “just sitting” there needs to be moved over to an IRA for you to invest in someone else’s mutual funds or investment products.

Generally speaking, it makes sense to rollover your 401(k), 403(b), or other retirement account to an IRA when you retire, or for any other reason are allowed to move your funds. The reasons to rollover a retirement account include:

• Control. You no longer have to live with the changes your investments that are dictated by your employer.
• Diversification. Most retirement accounts lack in their ability to diversify over all asset classes an investor may want. By rolling over your account, you can access the world of investment products. It used to be said that some (though definitely not all) retirement plans may provide institutional level pricing for investments that otherwise would require an investor have a significant amount to buy into a particular fund (hundreds of thousands of dollars, if not millions).

While that still may be true if you are concerned with having access to certain investment managers, most low-cost index funds today are available at reasonable minimum investment amounts.

However, there may be reasons to not rollover all or part of your account. They include:

• You need access to the money before age 59½. IRA accounts are subject to a 10% early withdrawal penalty before age 59½ whereas your retirement account may allow access without penalty as early as age 55.
• Have a significant amount of money in company stock that has appreciated above your purchases. There may be tax benefits to not rolling over company stock, if it has appreciated greatly and if you own a lot of it.
• Possibly better creditor protection. A 401(k) is protected from lawsuit, while state laws can vary on the protections provided to IRA accounts.
• If you expect to do a Roth Conversion with after-tax IRA accounts. If you have been accumulating after-tax IRA money, and plan to convert those funds in the future, it may be in your benefit to do so prior to rolling over a retirement plan.

Clearly every individual’s decision to rollover a retirement plan requires a review of their personal circumstances, so be sure to discuss your rollover potential with your financial and tax advisors before assuming a rollover is the best move for you.

Robert Schmansky, CFP®
Financial Advisor
Clear Financial Advisors, LLC
Royal Oak, M

But What If You Can’t Work?

I first met with Steven and Janice (names changed) a few years ago. They had always saved somewhere around 5% of their salary, but at times dipped into that amount when emergencies would pop-up.

Steven, a manager of services for a school district, is the family’s main income earner; Janice spent many years out of the workforce raising their four children, and took classes to improve her skills at various professions, but has had a hard time finding anything but part-time work.

During the good years instead of catching up on saving they purchased a cabin on a lake in northern Michigan at a price that was more than their main home. The plan was always to retire there one day, and have a spot in the meantime that the children and their families could enjoy.

As time went on, these plans just didn’t work out; the children moved after college across the country and not only did they not use the cottage, they didn’t have much interest in inheriting a property that they would have to be concerned about in a far away state. They had to take out loans to maintain and repair two homes, and the costs offset much of the benefits from saving.

When faced with the reality that this part of the plan was destroying their current lifestyle Steven’s response was predictable. “I’ll work as long as I have to.”

Many retirement plan projections are run out to age 65 or 70. But our plans don’t often consider what happens if you can’t work that long. Meanwhile a recent report from The Joint Center for Housing Studies of Harvard University found that more retirees are facing cost pressures, which is a trend that is expected to continue, especially for those that counted on home equity in one or more homes in retirement.

Over the last several years though many in Steven’s position have lost the ability to earn what they need to. Others have dealt with disability, loss of loved ones, and other tramatic events that limit their ability to work at the level they need to in order to work effectively.

Clearly there is a huge downside risk to the chance we may not be able to work as long as we need to. In addition to the risks of not being able to work, there are many other financial considerations and risks that grow as we work longer:

• Many deal with income shortages by taking Social Security benefits early. Locking in Social Security early causes a permanent reduction in earnings, and taking it while under full retirement age and working can cause a significant portion to be subject to tax.
• If you are not able to work you may you may have to draw down retirement accounts at an unsustainable pace. You may face paying for insurance, medical expenses, and other costs that can throw off your plans further.

Whatever your current age is, it’s important to make long-term savings the backbone of your plan. Don’t wait or count on earning more in the future, or being able to work forever. You may just not be able to.

Robert Schmansky, CFP®
Financial Advisor
Clear Financial Advisors, LLC
Royal Oak, MI

4 Ways for Graduates to Get onto Sound Financial Footing

As graduates seek to start their careers, many have high expectations, and many questions on how to get ahead. Below are four things I’ve learned over the course of my first decade in the working world.

1. Save. Save now. Savings will not only allow you to retire one day, but they will also let you take advantage of opportunities that may require you to take time off work, or to start your own business one day. Put aside 10% of your wages right away, and increase that every year by another 1-2% until you reach 20%. For ideas on where to save and how to save while paying off debt, read my past blog titled ‘Debt Payoff Strategies.’
2. Savings alone isn’t enough… you need to invest. Recent studies show that younger employees are the most interested in conservative, guaranteed income. Older (and wiser) participants had lower expectations that guarantees were the best way to maintain their wealth.
3. Think like an employer. Jobs like you might see in a movie like Office Space, where employees may do a few hours of work over the course of a weeks just won’t exist for you. To get ahead you have to think like you’re the boss if you ever want to become the boss (or, if you want to become your own boss).
4. Continue to learn. Perhaps the best way to use your savings may be to invest in yourself, which may mean going back to school. The payoff from investing in yourself and a new degree, or simply learning new skills on your own, may not lead to much now, but can open any number of doors over the long-run.

Robert Schmansky, CFP®
Financial Advisor
Clear Financial Advisors, LLC
Royal Oak, MI

What to Invest In Today

I meet with individuals on a daily basis that have different perceptions of the world, and how they should react with their portfolio:

•  I’m worried about what’s going on in the world, I want to sell out of international stocks.
• International stocks have been down more than domestic, I feel like it’s a great time to buy.

Both clients have valid reasons to think what they do. So, who is right and who is wrong?

I don’t know enough about the market to tell them what will happen with stocks over the next week, month, or year. I do know however that the above messages include underlying perceptions of investing that are rarely productive, and never consider an individuals goals.

In a recent TED talk titled Perspective is Everything (warning: an instance of foul language is used), advertising guru Rory Sutherland discussed this idea of perception, and specifically how economists (and likely the ones my above clients take their cues from) have the wrong perception of how to assist people in making the best decisions. He points to an often ignored school of economic thought (economics of the Austrian school) that instead of studying mathematical models, places its focus on psychology to determine why people act in order to find solutions to economic problems.

Most investors have bought into an investing paradigm that involves beating something or someone (neighbors, family, etc.), or maximizing yield. It makes sense why so many people equate this idea to investing since this is the exact paradigm they hear from so called ‘experts’ of investment management – “I best the markets.” The piece of their reasoning that doesn’t always translate is that they need to beat the markets to justify their jobs; that doesn’t mean what they offer is what you need.

As an advisor I rarely talk to clients about performance or winning investing as if it is a game. While it may be in an investment managers interests to take gambles with your money, it is not in yours.

Rather, I encourage investors to focus on the reasons for investing, and pick the best investments that meet those objectives, rather than starting with the objective of ‘winning.’ I use the acronym GPS to describe the starting point investors should have to qualify an investments usefulness.

Growth. All investors seek growth, and historically growth is best achieved by participating in the profits earned by successful businesses.

But, while most stock mutual funds fail to beat the markets, most investors with a ‘win at all costs’ mentality get burned, or waste countless hours jumping from one hot fund to the next in search of an extra percent return. The activity of buying into one hot fund at a high, and moving out of it after it falls on tough times often leads to a significantly lower portfolio returns than what would have been achieved by staying put.

Stability. Investors also want safety, but the question they rarely ask is – “How safe is this investment?” I hear far more often – “How much does it earn?”

The rule to remember here is don’t sacrifice safety for yield. Instead of thinking about what often amounts to a few extra dollars a year, ask yourself – “What are the chance of this money being there for me when I need it?”

Principal preservation is another goal of investors; to have their money not only stay stable, but increase as prices rise. I typically talk about it out of GPS order because a combination of Growth and Stable investments may provide the right mix to achieve a portfolio that keeps up with inflation. These may be real assets like real estate, precious metals, currency, or real goods. Think about these investments as providing diversification benefits first over providing winning returns.

Instead of pouring over funds and worrying about what fund or investment will outperform the others, a less stressful and far more productive strategy for individuals is to figure out how much you need to have invested for each category, select investments based on how well they match category criteria and not on returns, monitor those investments, and control the factors you can (avoid investing with companies with poor stewardship, poor performance, and excessive costs). This activity of determining how much you need in each category aligns your investment selection to your individual goals.

Invest today in a changed perception, from trying to win the highest return, to following a purposeful investment selection plan which will ease your stress, align your portfolio with your personal goals, and likely increase your returns.

Robert Schmansky, CFP®
Financial Advisor
Clear Financial Advisors, LLC
Royal Oak, MI

Invest in Your Company Stock Like an Executive

Have you ever worked at a job that gave you access to more of something than you could ever want?

You might be a pizza lover, but let me assure you from my own experience that a few weeks of full time work at a pizza shop will lessen that craving quite a bit. The same feeling can be had with any profession you may love from the outside, but find that having access to too much of whatever it is lessens the allure.

I imagine that this feeling can be the same with executives of corporations, though they tend to not only have a great job and perks in their businesses, but also have access to company stock in ways the average employee does not.

When I look at how successful executives invest in their own companies – these individuals that have stock options, stock grants, restricted stock, and a myriad of other plans that incentivize them to be owners and have a stake in the company’s success – it can be somewhat surprising to watch their behavior towards owning stock and how it can be different than the average employee.

They own stock (and often times lots of it), but perhaps it’s similar to having ‘too much’ of something that makes you appreciate what ‘it’ is in different ways.

I find executives who own stock in the many ways they do often exhibit the opposite behavior of regular employees when it comes to holding stock in the company they work for.

Regular employees often:

• Hold too much of their company stock as a percent of their investments,
• Have a tendency to think the stock will do better than other similar companies,
• Hold onto it based on emotion both during goods times and bad, and
• Generally want more rather than less.

While it’s true many executives have minimum stock ownership requirements that can result in their holding a substantial amount of company stock, they don’t often go out of their way to buy substantial amounts, or gamble on where the stock may or may not go. Many look for opportunities to sell and diversify their holdings. The first move many make at retirement is to sell stock they previously were restricted from doing so and creating a diversified portfolio. \

We want to feel like the stock of company that provides us with an income and our benefits will do well, but attaching those feelings to any stock can be a HUGE investing mistake! Investors who do this carry significant risk, as not only is their income and company benefits based on the company, but so is the success of their investment plans!

Executives that already have more company stock also seem to appreciate diversification over many companies other than just their own. While we often think we have great knowledge about how a new product will impact a company’s stock performance, business leaders that have been around know it’s not what they think they know that will determine the stock price, but it is what they don’t know about the event that can drive the stock price up or down.

If you are an investor in stock of the company who employs you, think as if you are investing like those that are successful and diversifying your risks, or if you have a tendency to invest in your company based on emotion.

A rule of thumb to invest by: Never allow any investment to be more than 10% of your total portfolio.

Robert Schmansky, CFP®
Financial Advisor
Clear Financial Advisors, LLC
Royal Oak, MI

Factors in Selecting a Power of Attorney Holder

When it comes to estate planning it is not only important to have the right documents, but it is crucial to have thought through the people who will be the beneficiaries, child custodians, and especially any individuals who will hold power of attorney over your affairs.

A power of attorney is a legal document that gives another person the authority to make specific decisions on your behalf, as well as to act on your behalf in regards to those powers. They may be created for financial or health matters to allow another person to act on specific items when you are not able to, for example in times where you may be incapacitated.

A financial power holder may pay your bills by accessing your bank accounts, file your taxes, or manage your investments. A health care power holder may make decisions regarding your personal care.

You may list the same person for all powers, but often the individual who is best at one may not be the best at another. You will want to have a list of several individuals to act in succession (known as contingent power holders) in case the individual in question can not act on your behalf.

For financial matters, consider if an individual is financially responsible. Do they file their taxes on time? Do they appear to pay their bills and not live beyond their means? Are there any warning signs in what they talk about that would lead you to believe otherwise?

Being financially responsible does not mean that one needs to be an expert at financial matters, but they do need to recognize the actions to take and be diligent about meeting deadlines and following through. If an individual is generally responsible in this way you can provide instructions for them to seek out help from advisors who are familiar with parts of your finances and your overall plan.

For health matters it is important to find someone who will stick up for your values and who is comfortable with making sure you receive the right care. This individual may be someone who is not afraid to stand up to authority when they know they are in the right, and who is good at gathering information, making complicated decisions based on your values, and making sure individuals follow through appropriately.

Robert Schmansky, CFP®
Financial Advisor
Clear Financial Advisors, LLC
Royal Oak, MI