All Things Financial Planning Blog


12 Comments

The 5 Biggest Changes in Personal Finance over the Last 20 Years


Personal-DebtMy son recently turned twenty and it inspired me to reflect on all of the changes in his life as well as in my professional life. My son’s progression has gone from being a baby, to a toddler, to a growing child, to a teenager, and finally to a young adult. He is now trying to figure out his professional place in life as he just finished his first year of college. During that same timeframe, I’ve seen personal-finance go through its own five stages of maturity. Twenty years ago it was more about buying a product, being transaction focused, little reliance on technology, running massive volume plans, and focusing just on the money aspects, not health and psychological aspects.

  1. Let’s face it, our culture must sell products and we’re pretty darn good at it. The problem is that the marketing and slick ads of all the things we buy in America today, don’t always match the quality and integrity. I think the biggest move that our industry has made in the last 20 years was to go from selling a product to following a process. The process includes a comprehensive financial plan. The financial plan not only talks about investments but also about understanding debt, figuring out a budget, understanding human capital (what we think of as our skills to make money for ourselves), reviewing your insurance for the major risks in life, and understanding that all of these things are linked together in order to get us all to the finish line.
  2. The transaction focus over the years has ebbed and flowed in terms of the hyperactivity in order to get better performance. Back in the olden days, it was about transactions because that’s how many advisers were paid. It was said that advisers are not in the storage business they’re in the moving business. Today the focus is on asset management for a fee, retainers, hourly fees, and project fees rather than commissions. Although I see a bit of a backlash happening in the last few years where it appears technology is getting ahead of the small investor. The advent of massive millisecond transactions have caused us to doubt the integrity of the system which the world of investments is built upon. We had multiple occasions like the “flash crash” and the search for algorithms giving institutions a major-league advantage over the average investor.
  3. For those who need help with their finances, the place to start your search is to ask a friend if they know somebody that’s good. Yet the next step is to get on the Internet and search for someone that appears to fit your standards. Even though it’s like trying to take a sip out of a fire hose every time you do a Google search people are finding most of their initial information on the internet. Today, I feel it’s much more of a collaborative effort between the adviser and the client. The adviser gathers the information needed to better help assist the client in making decisions. The best advisers these days are more of a librarian than a master of many disciplines.
  4. The financial plans that we put together over the years can be extremely comprehensive and lengthy. The problem with that is that planning by the pound doesn’t always get things done because most people are very busy these days and just want to get down to a summary version. I know that because I do a daily radio show commentary and 14 years ago I had 3 minutes to talk, today I have a minute and 10 seconds. A more modular approach works better because it talks about your specific problem at the moment and how you fix it. I feel that the best plan these days is to have one page versus 100.
  5. Probably the most important change that I’ve seen over the last 20 years is that financial planning has gotten much more holistic. It is about looking at the big picture and trying to incorporate wisdom, along with emotions, as we see the springing up of behavioral economics and why we do what we do. Reading a book like Daniel Kahneman’s Thinking, Fast and Slow (he was the first psychologist to win a Nobel Economic prize) should be mandatory for anybody who’s going to invest or put together a financial plan. It’s really critical to try and take health, wellness, happiness, human capital, emotions, relations, and wealth together as they are all part of the playing field.

The world of financial planning and investment advisory has moved steadily in the right direction over the last 20 years and I hope that it will continue to do so. There is certainly a lot of room for improvement yet I feel that some of the breakthroughs that we’ve seen in healthcare and technology over the last two decades are going to find their way into a simpler, more comprehensive blend of our money and life connections. Robbers used to say, “Your money or your life.” The next phase of financial planning is going to be “Your money and your life!”

Dave Caruso, CFP®
Certified Financial Planner™
Coastal Capital Group
Danvers, MA


3 Comments

We’re Married. Now What?


With six wedding ceremonies to attend this year, 2012 has been the year of marriage celebrations for me. It’s an exciting time in many of my friend’s lives and I couldn’t be happier for them! However, as the months after the ceremony roll on, questions have been popping up as to the best way to merge finances, what debt to pay down first, what steps to take to change names, and what else is out there that they haven’t even considered. In hopes of assisting my friends along with the many other newlywed couples out there, below are some items to consider in the days and weeks after your marriage:

Name Change: Post wedding, make sure you obtain at least 3 copies of your official marriage certificate from the county clerk, which is where your name change will be indicated. You’ll begin the name change process by first obtaining a new social security card (visit http://www.socialsecurity.gov for more information). From there, visit the DMV to update your driver’s license and then move on to your passport, employer, voter registration, bills, bank accounts, etc. It may be helpful to make a list of all the accounts you’ll need to update.

Taxes: You and your spouse may begin to file your taxes as “Married Filing Jointly” in the year that you are married. Be sure to check in with your accountant as to if that is the best route for you two and update your withholding elections through your Human Resources department if appropriate.

Money Mergers: Hopefully you and your spouse had more than just one conversation about money pre-nuptials. Some things to consider in the days ahead are whether or not to open a joint account. If you decide to go this route, also discuss if you will maintain separate accounts or if everything going forward will be deposited into your joint account. Work out a detailed spending and savings plan and ensure the two of you are on the same page with how your money is being managed and spent.

Assets & Liabilities: Create a list of all of your accounts, including Roth IRAs, 401(k)s, checking, savings, and any other personal cash or investment accounts. Decide if any accounts (aside from retirement) should be consolidated and if you’d like to add each other to titles of cars, property, or any other assets. In addition, review your investments and take some time to adjust your allocations so that it is appropriate based on your combined goals. Also create a list of any outstanding debts such as: credit cards, student loans, mortgages, and car loans. Prioritize your debt re-payment plan by focusing on those balances with the highest interest rates first – likely your credit cards.

Insurance Needs: For items like car and health insurance, evaluate each of your plans and pick the better of the two. Your car insurance should provide the best coverage for the most reasonable price. For health insurance, ensure that your current doctors are available under your spouse’s plan or that you’re okay with making a change if necessary. With life insurance, first determine the amount of coverage needed by considering outstanding debt and the loss of household income that would occur should something happen to either you or your spouse. For young couples just starting out, look into term coverage, which should provide coverage at the most reasonable rate.

Beneficiary Update: An item that is commonly overlooked by newlyweds is the updating of beneficiary information. If you and your spouse determine that you’d like to name each other as beneficiaries, be sure to contact your HR department at work and any companies that hold a life insurance policy or retirement account for you to make necessary updates.

Estate Planning: In the months ahead, consider establishing Durable Power of Attorneys for finances and health care and creating a Will that addresses your combined assets and wishes.

The list above won’t address all of your financial concerns as newlyweds, but by taking the time to go through each item together and consulting your accountant, financial planner, or attorney, you will start your new marriage on a financially healthy road to success.

Mary Beth Storjohann, CFP®, CDFA
Senior Financial Planner
HoyleCohen
San Diego, CA


2 Comments

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.

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


Leave a comment

Location, location, location


You have probably heard the old real estate adage – location, location, location – meaning the location of your house has a great impact on price. The same theory holds true for other investments. Where you hold your assets is almost as important as the assets themselves. Investments grow through interest, dividends, and/or capital gains. In general, interest is paid on bonds and savings accounts; dividends are paid on stocks; and capital gain is the profit you earn when you sell an asset for more than you paid for it. Unfortunately, interest, dividends, and capital gains are each taxed differently, so ensuring investments are held in the proper accounts can maximize your after-tax return. In short, interest earning assets should be in tax-efficient accounts while capital assets in taxable accounts.

Take Control of Your Tax
Currently, long-term capital gains are taxed at a maximum rate of 15 percent for the highest tax brackets and zero for the lowest two tax brackets. Conversely, interest and some dividends are taxed at ordinary tax rates which are higher. You cannot control when a bond pays interest or when a stock pays a dividend, so the tax liability is out of your control; however, you do choose when to sell a stock and thus incur capital gains. Therefore, you can control your tax liability by holding capital assets such as non-dividend paying stocks in your taxable accounts and income producing assets, such as bonds and dividend paying stocks, in your retirement accounts.

Keep It Simple
If you own commodities, as any well diversified investor should, you most likely own them through a mutual fund or ETF; if you own physical commodities, see section on Make Your Gold Shine. Most commodity funds are structured as partnerships, which means that at the end of the year, you will receive a K-1 statement from the partnership showing your share of the partnership’s profits/losses. The K-1 must be entered into your tax returns and can increase your tax preparation costs and complication. One way to avoid having to report a K-1 and still own commodities is to buy them in your retirement accounts. You will still get a K-1 at the end of the year, but there will be no tax ramifications.

Make Your Gold Shine
If you invest in gold, silver, or other similar assets (i.e., stamps, wine, rugs, etc.), the IRS considers these collectible items. The tax rate for these collectibles is a flat 28 percent if held long term and at your ordinary rate if held less than a year. These unique tax rates still apply even if you hold these investments in an ETF. Since such investments have less favorable tax rates, it would be wise to hold them in an IRA instead of a taxable account.

Be Tax Efficient
REITs are required to distribute 90 percent of their taxable income to shareholders, which means they generate a high yield; therefore, REITs are more appropriate in a retirement account. In addition, some interest, like those on certain municipal bonds, are exempt from state and federal income taxes, thus making them ideal to hold in a taxable account. Recognizing the type of income received (interest, dividends, or capital gains) and how it is taxed will help you determine where to hold those investments to ensure the most tax efficiency.

Ara OghoorianAra Oghoorian, CFP®, CFA
Founder and President
ACap Asset Management
Los Angeles, CA


3 Comments

Defining Diversification


In the top few responses most people give when you ask what they know about investing, “it’s important to be diversified” is right up there with “buy low, sell high”. Both statements are true and very important components of investing. My concern is that we hear and say these things so often, we lose sight of what they actually mean.

Investopedia.com defines Diversification as “a risk management technique that mixes a wide variety of investments within a portfolio.” True, but what the heck does that mean? Can it be any mix of investments? What does it really hope to accomplish? Is my portfolio diverse?

Today my goal is not to sell you on a particular investment strategy or convince you that there is any one way to properly diversify. My hope is to provide some key educational points to enhance your understanding of this important rule of thumb.

As the last several years have shown, investing in the stock market can be a volatile experience. If you invest in stock in one or even a small handful of companies, the value of your portfolio can shift wildly, often it seems for no logical reason. The primary purpose to diversify your investments is to decrease these and other risks.

How does one increase a portfolio’s diversity? Let’s look at a portfolio strictly invested in stocks. The simple answer is to buy a higher number of stocks. The better answer is to buy a higher number of different kinds of stocks. Suppose you own General Motors. Buying Ford might technically make you more diverse, but only slightly so. You still own just two companies, both large, US automakers. Instead, you should look at a vast array of companies differing in size, location and type.

This means expanding your portfolio to large and small companies of all types (often called sectors) all across the globe, avoiding the urge to own more companies in the U.S. than in other parts of the world. U.S. companies make up just 40-50% of global market share. By focusing solely on the U.S., you cut off the opportunity to better diversify and participate in the opportunity for growth in more than 50% of the world’s companies.

I want to stress that none of this is a blueprint for any type of investment strategy. It is simply an effort to help you understand what diversification means. How much diversification, in what areas, and the blend or allocation of different types of assets is a decision that should be made with careful thought and, in most cases, professional advice based on your goals and ability to tolerate risk.

As you approach your personal financial planning and goals, it’s important to obtain at least a basic grasp on the essentials in order to make the most educated decisions possible. There are lots of trusted professionals there to help, but knowledge is always a worthwhile investment.

Chip Workman, CFP®, MBA
Lead Advisor
The Asset Advisory Group
Cincinnati, OH


15 Comments

6 Tips for a Better Financial Future


Summer is upon us and in full swing. While you (hopefully) have some well-deserved time off, take the necessary steps to get your financial life back on track. No matter what stage of your life you are currently in, these simple but valuable financial planning tips may help you do so.

  1. Take 5 minutes to check your beneficiary designations– Young or old, chances are you have some type of life insurance policy or retirement plan. And chances are, you have not taken a look at who will inherit these funds/accounts since you opened the account several years ago. Countless times I have seen clients shocked when I uncover their beneficiary designations to be an ex-spouse, a deceased family member, or even worse – a big blank line. Take the time now to check to ensure that you have the appropriate beneficiary designations in place on all retirement accounts and insurance policies. Your financial professional can help you with the tax and estate planning advantages to certain beneficiary designations for each type of account.Tip: The most common (and basic) type of life insurance most employees have is an employer-paid policy with a $50,000 death benefit (this is the most common type because the IRS requires you to be taxed on the value of employer-provided group term life insurance over this amount). More often than not, when employees go through their first-day-of-work orientation and elect their new benefits, they leave the beneficiary designation for this standard policy (and probably their 401(k) account) blank. Check it out now and make sure you have elected a primary AND contingent beneficiary.
  2. If you don’t know how to do taxes; it may not be a great idea to do your own taxes– It’s really as simple as that. Oftentimes, we attempt to do our own income taxes in order to save some money, but have no real knowledge of our complicated tax system. This may be a costly mistake if you are not aware of many important and ever-changing tax laws. Are you aware of all of the various deductions and credits you are entitled to? Are you aware of the rules for claiming dependents? Do you know how to properly calculate your charitable contribution deductions? Do-it-yourself tax software has made it very convenient to complete your own taxes, but tax planning is not simple and the decision to do your own taxes should not be taken lightly.Tip: One of the most common mistakes people make when they attempt to do their own taxes is failing to utilize carry-forwards from prior tax years. For example, you can carry unused capital losses (say, from a bad investment loss) forward for your lifetime. Your capital losses will offset other capital gains, and if there’s still a loss remaining, you can deduct $3,000 p/year from other taxable income. If you do not keep track of your carry-forward balances or look at your previous returns for guidance (assuming these prior returns are correct), you may miss this valuable deduction, costing you hundreds or thousands of dollars in tax savings. If you are not confident in your ability to prepare your return, consider having a professional complete them this time around.
  3. Can you name three investments in your 401(k) account?– If someone asked you if your car had leather seats and air conditioning, would you be able to tell them? Absolutely. Then why shouldn’t you know what your biggest retirement asset is made up of? Take the time to understand your 401(k) account as it will be an important savings vehicle for your retirement years. Explore your available investment options, know the deferral percentage rate you need to elect in order to take advantage of your employer match (if any), and ensure that your investment allocation is appropriate for your risk tolerance, time horizon and retirement goals.Tip: Some 401(k) plans allow you to automatically increase your deferral percentage each year by a desired increment. This will allow you to gradually increase your contributions effortlessly and systematically without dramatically impacting your cash flow. Consider the following example which shows the difference in ending account values between keeping a constant deferral rate compared to increasing it incrementally over the years. Both examples assume a starting account balance of $20,000 and a beginning gross salary of $65,000 p/year:

    Constant 3% p/year deferral rate: $1,576,264*

    Starting at 3% deferral and increasing by 2% p/year until 10%: $2,693,714*

    *Assumes 3% raises p/year, 7% annual return, and a 3% employer match, for 40 years.

     

  4. Do you know what will happen to you, your children and your assets when you pass away or become incapacitated?Estate laws are complicated, ever-changing and mostly misunderstood by the average American. Not having a basic estate plan in place is like showing up to a job fair without a resume. Did you know that in 2011, over 70% of Americans did not have a basic will in place? This is one area of your life that you do not want to risk being unprepared. At the very minimum, you will want to have a will, guardianship provisions (if you have children or legal dependents), and power of attorney documents. A revocable living trust is also an important estate planning tool you will want to consider, depending on your situation, estate planning goals and objectives.Tip: Many people believe that only the very wealthy need estate planning. This is simply not true. Basic estate planning documents are important to ensure you have control of your assets and well-being during your lifetime and after your death. Do not let the state decide how your assets will be distributed or who will care for your loved ones.
  5. Planning for educational expenses begins at birth– Far too many parents begin to plan for their children’s college expenses when it’s far too late – when the college-bound child is sitting in their driver’s education course. At this point, the tax advantages and compounding advantages of a 529 college savings plan are greatly diminished, and the impending expenses are likely to be paid out of any cash flow and lots and lots of debt.According to the College Board, the increase in college tuition at a public four-year school was 8.3 percent between the 2010-11 and 2011-12 school years. That’s over twice the inflation rate over the same period! Take actions as soon as possible to begin planning for your child’s education. All things being equal, the earlier you start saving, the longer you have for your savings to grow and compound.

    Tip: Once a college savings vehicle is established, try to increase the amount you contribute each year. Aim to increase the total amount you save each year by at least 6%. For example, if you save $100 a month this year, you should save at least $106 a month next year. This will help your savings keep up with the high college inflation rate.

  6. Do you know what your risk tolerance is?– The old adage that says you should hold your age in bonds (as a percentage of your overall portfolio allocation) may no longer be appropriate for today’s investor, especially in today’s economy. Don’t know what your risk tolerance is? Think about the following scenario. You are given a choice between two cars to take on a cross country vacation. Option 1 is a fast, attractive, high risk sports car with very bad crash ratings. Option 2 is a slower, unattractive, safe sedan with excellent crash ratings. Which do you choose and why?Consider another scenario in which you have the option to stay in one of two resort hotel rooms. Option 1 is a suite on the 25th floor with great panoramic ocean views. Option 2 is the same sized suite, but on the first floor with convenient emergency exits. Which do you choose and why?

    The amount of risk you are willing to assume for a chance at receiving a desired return can help you begin to design your overall investment portfolio. Among the various factors to consider when deciding on an appropriate allocation are: your proximity to retirement, how comfortable you are with investing, your other available income streams, liquidity needs, and your general comfort level with the financial markets.

    Tip: Your risk tolerance (once you determine it) should help you and your financial professional design an appropriate and diversified investment portfolio that will help you achieve your goals and objectives. It is important that you are comfortable, knowledgeable and confident in your investment plan, or else it may be very difficult to stay on course.

By FPA member Grant Webster, MSBA, CFP®
AKT Wealth Advisors
Special to FPA

 


2 Comments

How Sharpe is Your Portfolio?


Whenever I meet with prospective clients, I usually hear the following comment “I want my portfolio to outperform the overall market, but I don’t want to take any risk.” It’s understandable; individuals want their investments to do well when the market is up, but they also don’t want to lose any money when the market is down. Unfortunately, risk and return have a positive relationship: the higher the expected return, the greater the risk. The optimal portfolio earns the maximum return with the least amount of risk, but how does someone create that optimal portfolio? One method used by professional money managers is the eponymous Sharpe Ratio. Created by Nobel Laureate William Sharpe, the Sharpe ratio is a measure of risk-adjusted returns or how good is your investment return given the amount of risk taken. The higher the Sharpe ratio for an investment, the better the risk-adjusted return.

What is Risk
The Sharpe Ratio is simple to compute and is comprised of only three variables: expected return, risk-free rate, and standard deviation. Standard deviation is the most widely used measure for risk in portfolios because it shows the variation of returns from the average return. The greater the standard deviation, the greater the risk. The risk-free rate is a theoretical investment with no-risk and typical proxy is a short-term government bond yield. The Sharpe Ratio is calculated using the formula below.

(Expected Return of Portfolio – Risk Free Rate) / Portfolio Standard Deviation of Portfolio

Apples and Oranges
Assume your portfolio had a 15 percent rate of return last year while the overall market earned only 10 percent. Your initial thought would be that your portfolio is better than the overall market because of your added return. However, even though your return was greater than the overall market, if you take into consideration the risk of your portfolio, calculated using the Sharpe Ratio, you may have assumed much more risk than you thought. Hence, your portfolio was not optimal. Let’s assume that your portfolio had a standard deviation of 13 percent versus 6 percent for the overall market, and the risk-free rate was 2 percent.

Sharpe Ratio for your portfolio: (15 – 2) / 13 = 1.00
Sharpe Ratio for the overall market: (10 – 2) / 6 = 1.33

In this example, we see that while your portfolio earned more than the market, your Sharpe Ratio was significantly less. The market portfolio with a higher Sharpe Ratio was a more optimal portfolio even though the return was less. Therefore, you assumed excess risk without additional compensation. Conversely, the overall market, with the higher Sharpe Ratio, had a higher risk-adjusted return.

Not Everyone Is Normal
One of the biggest advantages of the Sharpe Ratio is also its biggest weakness. The Sharpe Ratio relies on the standard deviation as a measure of risk, however, the standard deviation assumes a normal (bell shaped) distribution whereby the mean, mode, and median are all equal. Recent history has shown us that market returns are not normally distributed in the short-term and that they are actually skewed. In a skewed distribution, the standard deviation becomes meaningless because the mean can be either greater than or less than other measures of central tendency. In addition, when short-term volatility spikes as it has in the last 3 years with large swings in both directions, the standard deviation rises and causes the Sharpe Ratio to be lower.

Why Diversification Matters
Constructing a diversified portfolio actually improves expected returns without increasing risk. The standard deviation of an individual asset is based on that asset’s variability from the mean. Standard deviation of a portfolio (multiple assets combined) is calculated using each asset’s standard deviation, the asset’s weight in the portfolio, and the correlation coefficient among the assets. When two assets have low correlations and they are combined to form a portfolio, the portfolio standard deviation is lower than the sum of the two standard deviations. As a result, the Sharpe Ratio tends to be higher because the denominator of the ratio is lower.

Ara OghoorianAra Oghoorian, CFP®, CFA
Founder and President
ACap Asset Management
Los Angeles, CA