Alternative Investments (“alts”) and The Flight to Safety – Part II

Jim Lorenzen, CFP®, AIF®

In my last post, a talked about how the financial planning profession has changed dramatically since I opened my first office in  1991; but, the financial services industry – not to be confused with the profession that operates alongside it – seems to have changed little, though it’s changed a lot.

I talked about how the financial product manufacturing, marketing, and sales channels represent an industry that exists alongside – not necessarily a part of – the financial planning profession.  It doesn’t help, of course, that anyone can call themselves a financial planner – but I digress.

Alternative investments (alts) represent one example, which I discussed in the last post.  Another alternative investment is deferred annuities.

People love guarantees.  Marketers know this and the use of the word virtually always gets investors’ attention – particularly those who’ve amassed significant assets and are contemplating retirement.

The media – always on the alert for something they can hype or bash for ratings and typically lazy – find it easy to highlight high costs and shady salespeople.   And, there’s some truth to that.  Guaranteed income or withdrawal riders and  equity indexed annuities do tend to have high costs.  Often the guarantees that are less attractive than those presented.

The cost-benefit argument could, and probably will, go on forever.   I have other issues.  The first is, does an annuity make sense at all?  – Any annuity.   There’s no tax-deferral benefit if used inside an IRA and it limits your investment choices.  They also often have surrender charges that enter into future decision-making; but, even when there are no surrender charges, the withdrawals can harm performance or even undermine the guarantees that were the focus of the sale.

For me, here’s the big issue:  the annuity creates something most of my clients no longer want any more of – deferred income (who know what future tax rates will look like in 10-15 years as government deficits climb?  Deferred income comes out first and is taxed at ordinary income tax rates.

Deferred income in non-qualified annuities (outside IRAs, etc., funded with normally taxable money) is income in respect of a decedent (IRD) and does not get a step-up in cost basis at the death of the holder – someone will pay taxes on the earnings and they may be in a higher tax bracket or the IRD may put them there.

There may be other ways to invest using alternative strategies.  Options can work, but they also carry additional costs and risk.

Talk to your advisor –  a real one would be a good idea – to see what your plan should be.

Jim


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Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and an ACCREDITED INVESTMENT FIDUCIARY® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Alternative Investments (“alts”) and The Flight to Safety.

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The more things change, the more they stay the same.

Jim Lorenzen, CFP®, AIF®

The financial planning profession has changed dramatically since I opened my first office in  1991; but, the financial services industry – not to be confused with the profession that operates alongside it – seems to have changed little, though it’s changed a lot.  What?  I’ll explain.

The industry, comprised largely of product manufacturers and their sales arms (these days it seems anyone can say their a ‘financial advisor’), has a long track-record of constantly packaging new products to take advantage of a demand among investors that the product manufacturers create through their marketing.   New ‘issues’ (created by marketing) give rise to new products to be sold to fill a marketing-driven demand.  Changes in product innovation to generate new sales is the constant that never changes.

This doesn’t mean it’s all bad; it’s just that it can be difficult for spectators to recognize the game without a program.

Alternative investments get a lot of press these days – especially if there’s a perceived risk of a down or bear market… a perception that’s  convenient to exploit at almost any point in time.  The media likes ratings, so profiling people that called a market  top or decline – and made money – is always good for attracting an audience.  And, since there’s  always someone on each side of a trade, finding someone on the right side  isn’t difficult.

I’ve always felt that many fund managers operate like baseball free agents.  Being on the right side of a call gets them on tv, which in turn attracts new assets, which in turn leads to bigger year-end bonuses.  I could be wrong, or not.

Many captive “advisors” are putting their clients into “alts” these days because their employer firms (the distribution arm for the product manufacturer) are emphasizing them.

My sales pitch for alternatives:   With alternatives, you can have higher costs, greater dependency on a fund manager’s clairvoyance, less transparency, low tax-efficiency, and limited access to your money!  What do you think?

Don’t get me wrong.  It’s not a black and white decision.  They can have a place in a well-designed portfolio; and, while many endowment funds and the ultra-wealthy do tend to own alts, most of us aren’t among the ultra-wealthy and risk mitigation is important.

What can you do?  What should you consider instead?  Well of course that depends on your situation – everyone’s different.   But, I’ll have a few thoughts you can chew on – and discuss with your advisor – in my next post.

Jim


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Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and an ACCREDITED INVESTMENT FIDUCIARY® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

College or Retirement: Does a 529 Plan Make Sense?

Maybe there’s a better way to accomplish both!

Jim Lorenzen, CFP®, AIF®

Can’t afford to save for retirement because you need to accumulate money for your kids’ college expenses?   Sound familiar?

Most parents are willing to put their kids’ education ahead of their own retirement needs, according to a T. Rowe Price survey.   In fact, their research says it’s true of 74% of parents – all willing to prioritize college saving over their own retirement needs.

But, is that the smart thing to do?

529 plans tend to be the primary college savings vehicle, but parents could be, and often are, jeopardizing their own financial security.  529 plan do offer tax breaks for their depositors; but those tend to be low dollar amounts and then often limited to only state income taxes.   A 401(k) or IRA can cut their federal taxes up to 40% for every dollar they deposit!  –  And, it’s even more if the parent’s employer is matching contributions!  This isn’t rocket science.

As for investment choices, 401(k) and IRA menus still tend to offer greater flexibility and access to thousands of mutual funds, ETFs, even individual stocks, bonds, and certificates of deposit.

 The Liquidity Issue

While 529 plan assets can be withdrawn at any time, if it turns out you have no qualified higher education expenses to match the withdrawal amount, the earnings can be taxable income – and there could be an additional 10% penalty on the income portion.

There are, however, ways to tap retirement accounts with minimal impact from taxes, costs, or penalties:   You might be able to borrow from your retirement plan at work – maybe with no application and at low interest rates – and Roth IRAs allow withdrawals of contributions at any time for any reason with no taxes or penalties.  Earnings can be withdrawn after age 59-1/2 without taxes or penalties, as well.   Note:  Those under age 59-1/2 will be taxed on the earnings portion of a Roth IRA, or any part of a traditional IRA, as regular income.  However, a pre-59-1/2 IRA or Roth IRA owner may avoid the 10% penalty if the money is used for qualified higher education expenses.

Caution:  It’s worth noting that any distribution from a parent’s retirement account may be counted as income when calculating subsequent years’ financial aid and may reduce any needs-based benefits.

Speaking of needs-based awards and benefits, while no more than 5.64% of 529 plan account value will be considered each year before any needs-based money is awarded, retirement account assets usually aren’t counted at all!

Retirement should be your number one priority.  Structured properly, retirement funds can be arranged to provide solutions for multiple objectives and minimize Uncle Sam’s dip into your wallet, as well.


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Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and an ACCREDITED INVESTMENT FIDUCIARY® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Are All Financial Advisors “True” Fiduciaries?

Jim Lorenzen, CFP®, AIF®

The short answer is ‘no’.   Mark Tibergien, CEO of Pershing Advisor Solutions, is quoted in this month’s issue of Wealth Management saying, “When we look at those who are breaking away [from traditional brokerages] and forming their own firms, we recognize that they are making a fundamental change from being an employee to being a business owner, from being a broker to being a fiduciary advisor and from being a product advocate to being a client advocate.”

According to the article, written by Mindy Diamond, president of Diamond Consultants, a nationally-recognized boutique search and consulting firm in Morristown, N.J. specializing in the financial services industry, here are just a few of the things she mentions to look for:

  1. Ability to serve the client first. Captive advisors, she says, essentially serve as product advocates for the firm and are limited to the products and platforms approved by their firms.  Independent advisors, on the other hand, serve as client advocates with access to the whole of the market – the ability to ‘shop the street’ for products and solutions that best serve the client.
  2. Higher level of transparency. At an independent firm, safe asset custody is separate from the advisor’s business and product manufacturing, creating a process of checks and balances.
  3. A clearer payment structure. Unlike the wirehouses, independent advisors aren’t paid according to a grid – a performance measurement based on selling ability and not meeting the client’s needs.  Higher production levels result in a higher percentage commission payout from the firm to the advisor.   Independent advisors are business owners with fully disclosed compensation that’s easy to understand.
  4. Ability to select the technology and services that best suit their clients – not what the ‘house’ provides.

It’s worth noting that independent registered investment advisors (RIAs) have legal fiduciary status automatically.   This may not be true in all instances when the advisor is considered an RIA representative only for the planning stage but reverts to registered representative (RR) status for product selection and implementation.

It pays to know who you’re dealing with.

Jim


Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and an ACCREDITED INVESTMENT FIDUCIARY® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Are You Managing Money? Maybe you should be managing risk.

Jim Lorenzen, CFP®, AIF®

Markets are sensitive to risk.  We know that.  According to analysts at Lockwood Advisors, only 8% of global economies are now growing above recent averages; but, the U.S. is still the best; the G10 countries are the worst.   Headwinds do include politics:  Many market insiders are worried about a reversal of tax cuts and the anti-business stance of many incoming members of Congress.

Just like back in 1950 (remember?) the U.S. economy has been growing above recent potential, propelled by the growth spurt from major corporate and personal tax cuts; however these cuts just might have staying power since they’re not based on wealth redistribution.  The real headwinds just may be coming from two economic realities:  Demographics and the large U.S. government debt.

The aging population, increasing the percentage of the population in the decumulation stage, may apply downward pressure on growth for decades.  The Administration on Aging estimates that the population age 60 or older will increase by 21% between 2010 and 2020 and by 39% between 2010 and 2050.

Most people, it’s safe to say, think of future market returns using a frame of reference based on the past.  Indeed, most advisors – I’m guilty too – continually put-up mountain charts to show clients what’s happened before even as we tell them it’s no guarantee it will happen again.  But, the baby-boomers who remember the 1950s and 1960s – and especially the go-go 1990s – should be reminded the current is no longer flowing in the same direction.   Defensive allocations just might be the best defense going forward.

Hope you find this helpful!

Jim

 


Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and an ACCREDITED INVESTMENT FIDUCIARY® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Here’s Your 10-Point Financial Discussion Checklist!

Jim Lorenzen, CFP®, AIF®

How does your financial future look?  Your chances for financial freedom will depend on how well you’ve covered your bases!

Here’s a checklist for your kitchen table discussions:

  1. When do you plan to retire?  Your retirement age will impact how many years of spending your retirement assets will have to cover.  It will also likely affect just how much you may spend each year.
  2. What are your retirement goals?  Get them down in writing and sort them by needs, wants, and wishes – the prioritize each goal and put a dollar amount on each of them.  For those that are recurring, you’ll not only need to put a dollar amount on each event, but you’ll need to adjust for inflation, as well (car purchases are an example).
  3. When do you plan to file for and start Social Security payments?  How will this affect your tax picture when combined with other sources of income from retirement plans, etc.
  4. How will you design your investment portfolio to provide both income and inflation protection while mitigating downside risk?
  5. Will you need to reduce living expenses?  If so, where can you cut?  Not everyone will need to, but running out of money in your old age wouldn’t be a happy picture either.
  6. Should you get a reverse mortgage?  Does it really provide the security the commercials talk about or is it just a band-aid?
  7. Have you provided for the possible need for long-term care?  Long-term care policies are available, however many are concerned about not using the benefits after paying out high premiums for years.  Some policies also have many restrictions.  It’s worth reviewing the fine print.
  8. How will you protect yourself against financial fraud?  This can take many forms, from cyber threats to the Bernie Madoffs of the world.
  9. How can your spouse and children be protected when the main breadwinner is gone?
  10. Is creating a financial legacy important to you?   This can be accomplished for children and grandchildren, but they’re not the only ones.  Some people think giving is only for the rich; but affluent people often wish to do it, too.

Hope you find this helpful!

Jim

 


Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and an ACCREDITED INVESTMENT FIDUCIARY® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Should You Graduate From Mutual Funds?

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Jim Lorenzen, CFP®, AIF®

It’s probably a safe assumption that most individual investors began their investment programs with mutual funds and have built their 401(k)s, IRAs, and/or taxable accounts with mutual funds ever since.

While those mutual funds may have been appropriate for them in those early days, are they appropriate today?

If you’re one of those who’s built your retirement portfolio with mutual funds over the years and now have more than $500,000 invested in your long-term nest-egg, you may want to consider how much you may be losing to factors that have little to do with “the market”.   It begins with the Four Pillars of Investment Success.

 

For this post, we’ll talk about the bottom-left pillar, particularly as it relates to cost.

By now, most people are aware of the difference between ‘load’ and ‘no-load’ mutual funds.  Loads are basically sales charges that pay compensation to the selling registered representative of a broker -dealer.   They’re not necessarily bad.  A small investor can seldom be economically serviced by a fee-based registered investment advisor and this economic model provides that investor access to help that otherwise may not be available.   Either way, those charges aren’t hidden; they’re disclosed.   Here are some additional charges worth discussing:

Annual expense ratio

This is also disclosed in a mutual fund’s prospectus.  For example, assume a growth mutual fund has an expense ratio of 1.40%.   You’ll find it disclosed; but here’s what that 1.4% doesn’t include:

Turnover.  Turnover is an important factor in determining a fund’s true costs.  You see, turnover impacts other costs, as you’ll soon see.

Transaction/trading costs:  When a fund manager makes a trade on an exchange, that trade incurs a commission – just like your own trade would – and the fund manager receives a `confirm’ reflecting the net proceeds of the trade AFTER commissions have been taken… the same kind of ‘confirm’ you would receive.   They report the NET proceeds after the cost of the trade.

Look on your most recent mutual fund statement – any fund.  Do you see trading costs or any other fees or expenses disclosed on the statement… anywhere?  You might think it’s all in the annual expense ratio; but think again.  Transaction costs are NOT included in the fund’s annual expense ratio!

In the book, Bogle on Mutual Funds, the former Vanguard Fund chairman estimated trading costs generally average 0.6%  I don’t know the real number, so for illustration, I’ll use his.    If hypothetically a fund’s turnover is 120% – check the prospectus for your fund’s turnover – here’s what it means in calculating expenses:Trading Costs (use a low-end figure) x Turnover = Total trading costs.  So, 0.6% x 2.2  = 1.32%.

Why use the 2.2 factor for a 120% turnover?  Simple:  You have to establish a position in a security before you can turn it over; and, that’s true for each security in the portfolio.  The entire portfolio is established, then 120% is `turned over’ in a year.   If you used 1.2, you’d be computing only a 20% turnover, far from what’s really happening.  So, trading cost  times turnover gives us 1.32% in trading costs, to add to the fund’s annual expense ratio to get combined annual expenses plus trading costs.

According to Morningstar, the typical equity fund has annual expenses of 1.4% annually.   If we use that figure for illustration – remember to look at your own funds’ prospectuses to see what applies to you – 1.32% + 1.40% = 2.72% in annual costs.

Market impact costs:   When you or I sell 100 shares of a security, it doesn’t really impact the price.  But, when an institution buys or sells huge blocks of a security, the price can be affected.  How much?   Market impact costs can range between 0.15-0.25%.   And, of course, you would apply that figure to turnover, too.   We’ll use the lower number for our hypothetical illustration.0.15% x 2.2 = 0.33%.  So our hypothetical fund with a 1.4% annual expense ratio that experiences a 120% annual turnover could actually be costing the shareholder 3.03% annually.

Annual Expense Ratio                            1.40%
Turnover 2.2 x 0.6%                              1.32%
Market Impact Costs 2.2 x 0.15%          0.33%
Total                                                   3.05%

This means, according to this calculation of our fictitious fund – the one we assumed had an annual expense ratio of 1.40% –  the total real annual expenses to the shareholder are actually 3.05%, more than twice the annual expense ratio reflected in the prospectus; and those additional costs are nowhere to be found on the statement.

Okay, you now know what to look for.  Pull out your statements and prospectuses and do your own math.  You may have to make a guess for market impact and trading costs, or you can use Mr. Bogle’s – you probably won’t be far off.

Here’s another point worth remembering.   Using our hypothetical fund example, if you’re paying 3% all-in for a $100,000 investment, you’re paying about $3,000 per year; but, the percentages don’t drop as your assets increase!  If you have a $1 million dollar portfolio, you’re now paying $30,000 per year – and, that’s just for the fund!

As I said at the outset, if your portfolio is over $500,000, there’s probably a better way to get responsible management, a good investment allocation, and even professional guidance – all for less than you may be paying simply to be in mutual funds now.

You may want to check into it.   Naturally, I’d be happy to help.

Jim

 

If you have $500,000 or more and are looking for an independent fiduciary advisor, you can get started here.


Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and an ACCREDITED INVESTMENT FIDUCIARY® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Tax-Advantaged or Tax-Deferred? Do you know the difference?- copy

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Jim Lorenzen, CFP®, AIF®

Tax-deferred and tax-advantaged are two terms often used interchangeably and, as a result, often lead to a lot of confusion; but, the difference can be significant in planning how you will be drawing income from your nest-egg during your retirement years.  The key, of course, is to discover your options and do advance planning.

Tax-deferred investing is familiar to us.  Many employers match employee contributions up to a certain dollar amount to a company-sponsored retirement account, which usually offers tax-deferred growth.  Contributing to your account up to the employer match is a significant first step to retirement success.

However, many have found that their company-sponsored plan has proven inadequate due to contribution limits and other factors.  Most investors would likely be well served seeking out other sources of tax-advantaged retirement funds.  When used properly, tax-advantaged money is taxed up-front when earned, but not when withdrawn.  This approach may seem costly; but, that view may very well be short-sighted and far more costly.

Let’s take a look at a hypothetical example of tax-deferred and tax-advantaged money at work.  Our fictitious couple, Mitch and Laura, are starting retirement this year and will need $50,000 in addition to their Social Security benefits.  Assuming a 28% state and federal tax rate, they’ll actually need to draw $69,444 from their retirement account to meet their needs.*

Tax Deferred

Need = $50,000

Taxes = $19.444

Total Withdrawal required to meet spending need: $69,444

What if Mitch and Laura had balanced their portfolio with a tax-advantaged funding source?  What if they could pull the first $30,000 from the tax-advantaged source and the rest ($27,777) from the tax-deferred source?  What would that look like?

its-about-timeTax Deferred Combined with Tax Advantaged

Tax-Advantaged money = $30,000

Tax-Deferred money = $20,000

Taxes = $7,777

Total Withdrawal to meet needs and taxes = $57,777

Because Mitch and Laura balanced their portfolio, they saved $11,667 each year during retirement – almost 24% of their year’s living expenses each year!   Simple math reveals a savings of over $116,000 during ten years of retirement; and it they’re retired for 30 years, as many are, the savings is over $350,000, not counting what they could have made by leaving the money invested – which could be rather substantial:  At just 3.5% annualized, the total would come to over $600,000!

A Plan that Self-Completes

Most savings plans, including employer-sponsored retirement plans, are dependent upon someone actually continuing to work and actively contributing to the plan.   If work and contributions stop, the plan does not complete itself.    

It’s been my experience that relatively few individual investors have self-completing retirement plans, while a rather large percentage of high net-worth investors do.

What financial tool can accomplish the goal of being self-completing?  Not stocks, bonds, mutual funds, or even government-backed securities of any type.   There’s only ONE I know of – and, it’s tax-advantaged, too.   Believe it or not, it’s a “Swiss Army Knife” financial tool called life insurance.    It’s not your father’s life insurance; it’s specially designed

It can ‘self-complete’ a retirement plan – and it doesn’t matter if the individual dies early or lives a long life.  Few people realize they can win either way.    As I said, stocks, bonds, real estate, commodities, and company retirement accounts simply can’t match it; but, the design must be customized.

If you’d like to learn more about this and other smart retirement strategies, feel free to contact me.

————–

 

*This has always been a source of misunderstanding for many individual investors:  The fact is not all the money in Mitch and Laura’s retirement account belongs to them.  Their retirement account might show a $500,000 balance, for example, leading them to believe they have $500,000.  The truth is less comforting.  The truth is, given a 28% tax-bracket, that $140,000 of that money belongs to the government, not Mitch and Laura.  They’ll likely never see it.  Their real balance – the one the statement doesn’t show them – is $360,000; and, as we’ve seen, they’ll need to draw-down $69,444 each year to meet their needs.  How long do you think that money will last?

 

 

Disclosures

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

How Will Rising Interest Rates Affect Stocks?

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Jim Lorenzen, CFP®, AIF®

… and what do rising interest rates (and inflation) mean to your long-term success?

Maybe less than you think… or is it maybe more than you think.

We don’t really know, do we?   Planning isn’t about what we know; if it were, we’d all just go with our guts and get rich!  Planning is about what we don’t know.

But we do have indicators.   Past performance is no guarantee the future will repeat – we know that; but, maybe – just maybe – it can provide a little idea of how markets have reacted to rising interest rates in the past.  Here’s a chart from Bloomberg; I apologize for the fuzziness.

As you can see (I hope) since March of 1971, there have been 21 periods of rising interest rates.  Of those 21 periods, the S&P declined only 5 times and the largest decline was around 5.5%.   Comforting?  Well, good reading  anyway.

The problem, of course, is we’re dealing with real money and real people’s lives.

It pays to have a ‘back-up’ in your financial plan that can help ensure there’s a ‘late life income’ even if everything else falls victim to the incompetency of elected officials who’ve become self-anointed economic experts.

For that reason, I thought you might enjoy a report I’ve put together about how to create a ‘late life income’ by adding another component to your investment diversification strategy.

I think you might enjoy it -it’s based on an actual case study.  You can access your Late Life Income report here.

Enjoy!

If you would like help, of course, we can always visit by phone.

Jim


Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Why Do Individual Investors Seem to Always Lag Behind Market Returns?

Jim Lorenzen, CFP®, AIF®

A recent study by Morningstar, a leading mutual fund research firm, compared mutual fund returns with the gains individual investors actually received. The study found that investor returns typically lagged fund returns.  The reason: Investors tended to move cash in and out as markets would rise and fall, often buying high and selling low.[1]

The study covered 10 years through the end of 2012, and found that funds posted an average annualized return of 7.05%, compared with a 6.1% average return realized by investors. (The returns factor in all stock and bond funds that Morningstar tracks. Investor returns are weighted based on asset owes into and out of all share classes of open-end mutual funds tracked by Morningstar.  [To learn more on why many individual investors have trouble reaching goals, see your report, Why Most Financial Planning Will Probably Fail.

Although a gap of a single percentage point may not seem like a big difference, it can make a significant impact over the long term, thanks to compounding. In fact, a hypothetical $10,000 investment returning an average of 7.05% annually would produce a total of $19,856 over 10 years compared with $18,078 for an average annual return of 6.1% over the same period. Over 30 years, the gap becomes even wider: $78,286 for the 7.05% return vs. $59,082 for the 6.1% return.[2]

The findings in the Morningstar study are apparently no fluke.  Similar findings were discovered in a study by Dalbar back in 2010 (see graph).

What’s the reason for this?  While I have admittedly not conducted a back-tested analysis on this, I do have what could be considered an informed opinion.   It’s investor behavior – to be sure not a ground-breaking epiphany.

When investors buy in good markets and sell in bad ones, they generally lose – no news there.  What is worth consideration is something Warren Buffett said years ago:  If you think investing is fun, you’re doing something wrong.  Real investing is boring; what you see on tv is financial porn.   However, if you’re investing properly, you will virtually always be buying low and selling high.

Why?  It’s as simple as having a properly constructed portfolio, designed to implement your formal financial plan, and adhering to a disciplined rebalancing process.  Not all financial plans are sound, however.  See our report.

Rebalancing is key.  Regardless of your rebalancing schedule,[3] it helps ensure you will be selling high and buying low.  Important:  Rebalancing does not guarantee gains nor does it guarantee against loss; but, it sure beats trying to ‘call’ markets.

Let’s use a simple hypothetical example using a simple stock and bond portfolio.   If your financial plan indicates the best balance for you is 60% bond and 40% stocks and your investment portfolio is valued at $500,000, you’d be allocating $300,000 to bonds and $200,000 to stocks.

Using easy to grasp numbers, let’s assume that when it’s time to rebalance, based on a schedule you and your advisor have chosen, your bonds have lost 10% in value, due to rising interest rates while your stocks have gained 20%.

Your bonds are now valued at $270,000 (down by $30,000) and your stocks are now valued at $240,000 (up by $40,000).  Your total portfolio is now valued at $510,000.  Not bad, but our schedule says it’s time to rebalance and we do believe in investment discipline.

40% of $510,000 would indicate a stock allocation of $204,000; but the current value of that portfolio is $240,000 due to the run-up.  That means trimming our stock exposure by $36,000 – we’re automatically “selling high”.

Our bond portfolio, now valued at $270,000 is down $30,000 due to rising interest rates.  At a 60% allocation, we should have $306,000 (60% of $510,000) in bonds.  Obviously, that’s where the $36,000 from our stock sales will go.  We’re “buying low” into a rising interest rate market.

In the real world, portfolios aren’t quite so elementary.  There are investment styles within each asset class and there are sectors within each style.  It can get rather sophisticated, but technology helps.

You may have heard it a thousand times; it still bears repeating:  It begins with a plan.  If you don’t have one, you’re lost – and if you think you have your plan in your head, your heirs will be helpless, even if you aren’t already.

[1] Russel Kinnel, “Mind the Gap: Why Investors Lag Funds,” Morningstar, February 4, 2013.

[2] Results are for illustrative purposes only and in no way represent the actual results of a specific investment.

[3] Transaction costs and tax implications should not be ignored.

As I noted earlier, many plans will likely fail.  See our report.  Hope you find this helpful.

If you would like help, of course, we can always visit by phone.


Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.