ACTIVELY MANAGE YOUR INVESTMENTS - INCLUDING 401K'S AND 403B'S
Most self-directed retirement plans I have reviewed contain an asset allocation that was fixed at some point in time and is now over-allocated to the securities that have done well due to failure to rebalance. Most are “buy and hold” portfolios and the balance reflects what the markets have delivered for any given time period. This works out well in a bull market, but can be devastating in a severe bear market, whether you are close to retirement or not.
“Buy and hold” is an investment philosophy built upon modern portfolio theory and a belief in efficient markets. In the simplest terms, the core belief is that the individual cannot do better than the market because at any moment in time the assets are priced efficiently; and if you are properly diversified, you will be protected from severe downturns due to holding a broad range of non-correlated assets. This makes for fascinating academic studies, and may be provable over very long periods of time, but that doesn’t make you feel any better when all asset classes crash at the same time, such as in 2008. “Stay the course” sounds good, but should you really? Does it make sense to ride your stock investments down 50% at the same time your bond investments are losing value as well?
A better solution is to have an exit strategy for each of your investments. Look at your 2007 year end balance and ask yourself “what if I had in place a 10% maximum loss from the high point and simply transferred to a money market fund at that point?” Most would be happy with that result. Don’t stop there. Try it with other periods like the tech-bubble of the late 1990’s.
Once you exit, you will need to have a re-entry strategy. There are many possible strategies. It doesn’t have to be too complex. Some use moving averages such as the 39 week or the 150 day. When the security price crosses above this line it is time to buy, at which point you will set another exit strategy. The rules you set should reflect your personal situation, risk tolerance, and the relative risk to your total net worth. The discipline is more important than the specific trigger points you choose.
If you don’t have the time or discipline, then hire a money manager. For about a 1% fee, you can hire a professional to do this for you. Some balk at paying these fees, but the markets routinely move this much each day. In 2008 you could have saved over 30% of your stock portfolio with a disciplined retreat to cash. There are not many active managers out there who are devoted to trend following, but they do exist. Your best bet is an advisor who will work on a fee basis. They do not have to be in your local neighborhood in this modern electronic world. For safety, you can grant only limited trading authority to the advisor so that they never have custody of your money.
The strategy works best in tax-deferred accounts, such as 401K’s, 403B, and IRA’s.
- JOSEPH LYONS -
USE ROTH'S FOR WEALTH CREATION AND TRANSFER
Roth retirement plans are one of the best wealth creation tools available. They are also one of the most underutilized. Simply stated, Roth's are accounts that are funded with after-tax money, which can grow tax-free as long as the accounts exist. The contribution limits are the same as for pre-tax accounts. They can take the form of IRA's, 401K's, or 403B's. There are AGI limits imposed at $116,000 for individuals and $169,000 for joint filers to contribute the full amount to a Roth IRA. Roth 401K's or 403B's have no limit, but must be offered through your employer.
Roth's have many advantages:
- Because the contribution limits are the same as pre-tax accounts, you can effectively save more in a Roth because the taxes have already been paid.
- Earnings in a Roth are never taxed. Think about making it your trading account if you make short-term equity trades. It is a great place for income investments that are taxed at your full marginal tax rate.
- There are no required minimum distributions at age 70.5, allowing many more years of tax-free growth.
- You are protected from future tax increases. Considering the current federal deficit, does anyone expect tax rates to decrease in their lifetime?
- Contributions can be withdrawn at any time without penalty. This is not true of earnings.
If you have sufficient resources for your own retirement, you should consider gifting Roth's to family members each year. This will help to reduce your estate and will be a powerful savings tool for your heirs, who may have many more years than you to accumulate the tax-free growth. Each of the recipients will need earned income at least equal to the Roth gift in order to do this. This is not as big a hurdle as you might think. Even small children can be paid for chores or helping out in the office. Imagine if someone had funded a $5000 Roth for you at age 15. At age 65 it could be worth $234,508 tax-free if it earned 8% per year!
Consider a Roth conversion if you have a traditional pre-tax IRA, or an after-tax traditional IRA. If your modified adjusted gross income is $100,000 or less, you qualify. If you make more than that, wait until 2010 when the limit is eliminated. You will pay tax when you convert, but never again. Pay the tax with other after-tax money so that you do not reduce the principal of the IRA. The decision to convert and how much to convert can be complex. You should work with your tax advisor to optimize your situation.
- JOSEPH LYONS -
COULD MADOFF HAPPEN TO YOU?
Let's start with the definition of a Ponzi scheme: a "Ponzi" scheme is an arrangement in which the perpetrator receives cash from investors and purports to earn income for them. The income turns out to be partially or wholly fictitious. Any amounts actually paid to investors, whether it is claimed to be income or a return of principal, is actually paid from funds provided by new investors. The perpetrator of the scheme criminally appropriates some or all of the investors' funds for their own purposes.
This unfortunate occurrence so far has a price tag of $65 billion. Yes, billion. It seems that not only the elite investing widows and "wanna be millionaires" were duped but so were a fair number of so called "smart & sophisticated advisors. Notice that these are social titles without any independent conferring authority other than just what was self acclaimed by society or by the individual themselves. There are a number of simple but important lessons to be learned fro this shell game that was performed right in front of regulators and the customers of the firm.
Madoff's scheme succeeded because of the following reasons. First, there was an obvious lack of transparency as regards to the trades that were occurring in most of the accounts. Not many of the buys & sells were traceable to any public exchange but rather some black box(s). Two, the foundation for many investors and advisors seeking out Madoff's magic were based on social connections. Three, every participant investor and advisor accepted the thesis that market-beating returns with no risk were the order of the day. Mind you that no academic theory anywhere makes this claim or even suggests that this is a worthy exercise for anyone other than a fool or crook. So much for these "smart & sophisticated" advisers who fed Madoff most of his assets. These are the "feeder" funds mentioned in the financial press commenting on the Madoff case.
Now you may be thinking well, it sounds like anyone could have been sucked into this ponzi scheme. I disagree! It is true that Madoff had a good resume being the former chairman of the NASDAQ, in business since 1960, and a highly regarded philanthropist with charities around the New York area. Oh, and he lived in a penthouse that was the envy of New Yorkers. Ok, but what did any of these facts have to do with his ability to manage other people's money? Did anyone ask that simple question? Yes, many did and they rejected his offer. So, not everyone was enthralled with the social accomplishments of Madoff. But he did capture well in excess of 60 billion dollars of social grave and magical hopes from people who knew or should have known that the stock market is not without extreme risks. Does anyone doubt that fact today? Sadly I see within the financial press today that some are trying to rebuild this thesis since after all, no one could possibly fall for this ponzi scheme again. Could they? Google Sir Stanford and read about this ponzi scheme.
I could be understanding of the weaknesses we all have when it comes to making clear and objective financial decisions but I'll not do that. While many believe they are the best judges when it comes to investing, those of us that teach and practice this art are evermore humbled by what the markets do and fail to do. After all, a market is simply a collection of financial decisions made by individuals who are primarily motivated by their own fear, greed & hope. Need I say more about the difficulty in gauging the long term effects of these three emotions?
- STANLEY HARGRAVE -
WHAT DO EXPERIENCED FINANCIAL ADVISORS LOOK LIKE?
The Wall Street Journal, April 13, 2009 edition, published a special report entitled, "Seven Questions to Ask When Picking a Financial Adviser." Hers's one financial adviser's reply to this article.
First, the term "financial adviser" is a code word for anything that you want it to be. It is meaningless unless a lot more information is provided. There is currently no legal limitation to the use of this word and hence it's not helpful to the process of finding one.
Forget sorting everyone by their acronyms, (i.e. CPA, CFP, CFA, CLU, ChFc, etc). This is not a practical way to approach this challenge. There are just too many variables in titles. My father was a doctor, can you tell what he did in relationship to his professional title? Not likely.
How the adviser gets paid is important. Unfortunately, commissions drive financial solutions in too many negative ways. If a well meaning adviser gets paid only by commissions he is doomed only to solutions that have built-in commissions. I like a system that allows for simple fee-for-service as a way to even out the conflicts that are almost always present. Most sale rewarding systems are too expensive and provide little legal protection to the buyer if the outcome is different than represented.
Adviser checks and balances are always a good thing to see in any financial intermediary relationship. An adviser who needs or has direct access to your money should be scrutinized, subject to a fidelity bond, and this is after a rigorous due diligence audit.
Almost every professional adviser I've known insists on putting representations in writing. As a matter of fact most of them insist on written engagement letters and written notes of conversations. This is to protect themselves and keep the client aware of what everyone agreed to. This is a consumer friendly and confidence building process. Consumers should insist on this type of process especially when one's personal wealth is on the line.
The client must stay involved in all aspects of the project and process. This is not to say that the client needs to do anything or everything. But you should stay informed and ask questions. Non-scheduled questions are best. Never hand over the the check writing or account control to anyone! If you give up on these controls you're only asking for someone to take advantage of your naivety and stupidity.
Experienced advisers have errors & omission (E&O) insurance. This is a rather tricky subject since this insurance does not pay if the insured commits a crime or steals money. It covers legitimate mistakes made in the normal course of an adviser's work. This is not the same as SIPC insurance which covers a broker's liability in holding securities and cash. Since Madoff had a company providing custody of client securities and cash there is up to $500,000 of financial insurance available per account. So why did so many Madoff clients have in excess of $500,000 in their respective accounts? In hindsight one can only cite irrational confidence and little regard for well designed rules of protection. This is but a painful example of consumer negligence. We need to say again, that the return of one's money is far more important than the return on one's money!
If your financial life is dependent on having experienced advisers you should always try and find advisers who have a "fiduciary" obligation in the advice they render. This advice is not generally available through financial institutions because of their own conflicts in gving you advice. Only a handful of those advisers mentioned earlier in this column would qualify. Always ask for fiduciary confirmation in writing and confirm through a third party which is typically a regulatory organization. You deserve no less.
- STANLEY HARGRAVE -
