Tag Archives: asset allocation

Diversification In Its Present Form Is For Suckers. So, Don’t Be A Sucker.

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“If you have large cap, mid-cap, and small-cap, and the market declines, you are going to have less cap.” – Martin Truax

The financial services sales forces as mass storytellers, have morphed once noble, efficient constructs into treacherous fairy tales.

red-riding-hood

Tenured financial concepts which define the core of advice in the brokerage industry go relatively unchallenged. Investors, due to lack of experience about such matters, have a difficult time challenging the status quo or ask the right questions.

The easiest way to convince investors to “stick with an asset allocation or investment plan” is to use the past as a pacifier, regardless of current market cycle. In other words, if it’s broken there’s no need to adjust the guidance.

The industry just needs to isolate and showcase a cycle where the old confines worked, push that specific period of time into the present and extrapolate the positive, perpetually into the future.

Hey, it’s what the industry does best.

I believe nothing changes in practice on financial front lines, as the priority remains pushing products. Brokerage firm margins are embattled by the profit-draining effects of lower-for-longer interest rates.

I don’t blame the mouthpieces as much as I do the senior management and compliance departments that channel, reward or benefit from the behavior.

As a regional manager at Charles Schwab told me:

“It’s always about shareholders first.”

There are Holy Grail concepts that are rarely revisited except by academics and a select few in the private sector and for their work, I’m grateful.

From experience I’ve experienced how somewhere between academia and implementation in the field, updates or improvements to dogmatic strategies` get lost or ignored, especially when they conflict with the short-term focus on shareholder and analyst expectations.

The insidious or naïve (take your pick) roads most selected are designed to mollify fears and at the same time, leave investor wealth exposed unnecessarily to danger.

An egregious stretch of the truth emboldens the heavily-protected sanctuary of diversification.

It’s a word that makes investors feel good.

It rolls sweet off the tongue. It represents warmth of a blanket fresh out of the dryer, the scent of fresh-baked cinnamon rolls.

cinnamon-rolls

However, don’t be duped. Today, diversification as pitched by your broker, is a wolf dressed as Red Riding Hood. Many financial professionals have fooled themselves regarding its effectiveness. At least the way it’s defined, currently.

You must understand what diversification is and most crucial, what it isn’t. Certainly, it’s not the panacea it’s communicated to be.

The outdated definition of diversification requires a tune up. There’s no ‘free lunch,’ here, although I continue to hear and read this dangerous adage in the media.

The word gets thrown around like a remedy for everything which ails a portfolio. It’s the industry’s ‘catch all’ that can lull investors into complacency, inaction.

So, who buys into this free lunch theory, again?

After all, what is free on Wall Street? Investors who let their guard down, buy in to the myth of free lunches on Wall Street, ostensibly find their money on the menu.

Due to unprecedented central bank intervention, there exists extreme distortion in stock and bond prices. Interest rates ‘lower for longer’ and in several cases, negative, have created a frenzied reach for yield in dividend stocks. Global risk-averse investors have purchased bonds with a voracious appetite.

A way to effectively manage risk has morphed into two disparate perceptions. The investor’s definition of diversification and that of the industry has parted, leaving an asset allocation plan increasingly vulnerable.

Today, the practice of diversification is Pablum. Watered down. Reduced to a dangerous buzzword.

First, what is the staid, mainstream definition of diversification?

According to Investopedia – An internet reference guide on money and investments:

  • Diversification strives to smooth out unsystematic riskevents in a portfolio so the positive performance of some investments neutralizes the negative performance of others. Therefore, the benefits of diversification hold only if the securities in the portfolio are not perfectly correlated.
  • Diversification benefits can be gained by investing in foreign securities because they tend to be less closely correlated with domestic investments. For example, an economic downturn in the U.S. economy may not affect Japan’s economy in the same way; therefore, having Japanese investments gives an investor a small cushion of protection against losses due to an American economic downturn.

Now let’s break down the lunch and examine how free it is.

 

Unsystematic risk – This is the risk the industry seeks to help you manage. It’s the risks related to failure of a specific business or underperformance of an industry.

To wit:

  • This is a company- or industry-specific hazard that is inherent in each investment. Unsystematic risk, also known as “nonsystematic risk,” “specific risk,” “diversifiable risk” or “residual risk,” can be reduced through diversification.
  • So, by owning stocks in different companies and in different industries, as well as by owning other types of securities such as Treasuries and municipal securities, investors will be less affected by an event or decision that has a strong impact on one company, industry or investment type.

So, think of it this way: A ‘diversified’ portfolio represents a blend of investments – stocks, bonds for example, that are designed to generate returns with less overall business risk.

While this information is absolutely valid, the financial industry encourages you to think of diversification as risk management, which it isn’t.

Here’s what you need to remember:

Ketchup (consumer staples) and oil (consumer cyclicals) all run down-hill, in the same direction in corrections or bear markets. 

Sure, ketchup may run behind, roll slower, but the direction is the one direction that destroys wealth – SOUTH.

Large, small, international stocks. Regardless of the risk within different industries, stocks move together (they connect in down markets).

Consider:

What are the odds of one or two companies in a balanced portfolio to go bust or face an industry-specific hazard at the same time?

What’s the greater risk to you? One company going out of business or underperforming or your entire stock portfolio suffers losses great enough to change your life, alter your financial plan.

You already know the answer.

Diversification is not risk management, it’s risk reduction.

  • When your broker preaches diversification as a risk management technique, what does he or she mean?
  • It’s not risk management the pros believe in, but risk dilution.
  • There’s a difference. The misunderstanding can be painful.

To you, as an investor, diversification is believed to be risk management where portfolio losses are controlled or minimized. Think of risk management as a technique to reduce portfolio losses through down or bear cycles and the establishment of price-sell or rebalancing targets to maintain portfolio allocations. Consider risk dilution as method to spread or combine different investments of various risk to minimize volatility.

Even the best financial professionals only consider half the equation.

Beware the lamb (risk management) in wolf’s clothing (risk dilution).

The goal of risk dilution is to “cover all bases.” It employs vehicles, usually mutual funds, to cover every asset class so business risk can be managed. The root of the process is to spread your dollars and risk widely across and within asset classes like stocks and bonds to reduce company-specific risk.

There’s a false sense of comfort in covering your bases. Diversification in its present form is not effective reduce the risk you care about as an individual investor – risk of loss.

Today, risk dilution has become a substitute for risk management, but it should be a compliment to it.

Risk dilution is a reduction of volatility or how a portfolio moves up or down in relation to the overall market.

Risk dilution works best during rising, or up markets as since most investments move together, especially stocks.Think about betting on every horse in a race.

  • In other words, a rising tide, raises all boats.

So, why is risk reduction but not risk management, the prevailing sentiment?

Sales Goals: Most financial pros are saddled with aggressive sales goals. Risk dilution is a set and forget strategy. Ongoing risk management is time consuming and takes time away from the selling process.

Diversification can be stronger than it is right now. Unfortunately, the financial industry as a whole, has watered it down and widened it so much, it’s become absolutely ineffective as a safeguard against losses. One reason is the sales targets that forces financial representatives to spend less time with client portfolios.

Compliance Departments: A targeted diversification strategy places accountability on the advisor and poses risk to the firm. A wider approach makes it easier to vector responsibility to broad market ‘random walks’ so if a global crisis occurs and most assets move down together, an advisor and the compliance department, can “blame” everything outside their control.

  • “Hey it’s not our fault, it’s the market!”

Convenient excuse, isn’t it?

Diversification requires a shake-up, a smarter approach.

The Clarity team decided to go back to the drawing board. Consider how investors perceive diversification, then create a thoughtful definition which incorporates part of the old along with important enhancements.

My revised definition of diversification:

  • A targeted selection of investments designed to manage risk within an allocation that’s behaviorally connected to who you are and the goals you seek to achieve. An allocation that fits the macro-economic environment driven by specific investment buy and sell disciplines.

That’s diversification for the new world, post-great recession.

Revised diversification strategies require actionable rules.

The following guardrails should help you identify and avoid the pitfalls that define diversification as it’s practiced in the field of financial services.

Random Thoughts:

Watch for over-diversification. Too much of a good thing can increase risk. That’s not your objective. Do not allow your financial advisor to spread your investment dollars too thin: All you’ll do is create an expensive index fund alternative.The more investments you own, the more a portfolio may mirror or move in unison with the underlying markets (you can do that on your own in a less expensive manner).

Control the number of securities you own or add. Proper diversification can be achieved with as little as 5 to as much as 15 separate investment to represent stocks and fixed income options. You must understand the reasons behind every new investment. Is it additive to increase return or lower risk, or is it duplication of an investment you already own? Most likely it’s duplication.

You don’t need to own every asset class at all times to be diversified from a risk management perspective. For example, where is it written that a portfolio must always hold international stocks when most domestic or U.S.-based companies have formidable international revenue streams?

Why must small, mid, or large-cap stocks be eternally represented in a portfolio, never to be fully liquidated? An active approach to risk management may exclude several asset classes. Frankly, at times it may help returns and reduce risk.

Think outside the box for real diversification. For effective diversification consider passive income from rental real estate, development of human capital (your skill set) to increase earned income, perhaps fund a privately-held business (a riskier option). Remember ‘owning ketchup & oil’ through turbulent markets may not be an optimum risk management strategy.

And speaking of risk management…

Without a sell or rebalancing strategy, diversification can only go so far. This step is more work for your advisor, but that’s what he or she is paid for. To help minimize losses, a portfolio requires periodic rebalancing to take profits and a liquidation component to reduce losses that may be tough to recover from.

Beware the “lunch room effect.” You own 3 mutual funds from the same fund company, XYZ Financial. All have different names, different managers, and different objectives. Every day, the three fund managers have lunch. They discuss the weather, the hometown sports team, and their investment choices.

Manager # 2 based on the parameters of the mutual fund, likes what Manager # 3 has to say about Acme Corporation. She eventually decides, after further investigation, to add Acme Corporation to her fund holdings, too. This is stealth, industry-specific risk that destroyed tremendous wealth during the tech bubble. So the lesson here is to never own more than one mutual fund per fund group to avoid overlap.

The tendency is to perceive diversification a panacea, a Snuggie that allows portfolios to be forged then forgotten, as diversification is considered the ultimate free lunch (that’ll wind up eating your lunch).

Diversification today is a convenient cop-out or weak replacement for risk management.

Schedule a meeting with your financial partner to discuss your concerns.

Ask for a definition of diversification. See if you agree.

If not, it may be time to move on.

And save enough money through risk management to happily purchase your own lunches.

 

10 Questions to ask your Adviser. Right Now. Today.

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He was annoyed with me after a while. He said I asked too many questions.”

It’s tough for me to imagine speaking these words to a client or anyone seeking guidance.

I don’t have the guts. Or the hubris.

Or the stupidity.

I wonder about (and I’m thankful) for complacency among some advisers. It allows me to continue to gain thoughtful, inquisitive clients who never feel that I’m annoyed by a passion to learn.

The noblest efforts we undertake as trusted financial partners are to listen, answer questions, validate good behaviors, empower improvement and communicate effectively to our audience.

How does a prospective client – One who has a genuine curiosity in her finances, a successful saver and investor, ask “too many questions?”

If you’ve been with an adviser long enough to feel comfortable together, or maybe you’re exploring a new financial relationship, asking questions should be encouraged.

There’s no such concept as “asking too many questions.” You query enough to satisfy your need for information requested. I’ve noticed how the more self-aware an individual is about their financial situation, the more questions that arise.

There’s no reason to feel intimated or stifled.

You’ve earned the right (and the money).

Channel your inner Columbo.

Remember Columbo?

Columbo

The disheveled, inquisitive, seemingly frazzled (like a fox), detective was a master of detection. His questions on the surface were unassuming. Some appeared silly. However, underneath, there was a method to his madness.

Columbo knew the importance of questions no matter how insignificant they appeared

And when you were convinced he was done with the investigation.

There was always “just one more thing.”

It drove the perpetrators crazy.

Columbo was intrusive, occasionally annoying and he couldn’t care less. He was purposely oblivious. He felt he had the right to ask.

So do you. When it comes to your family’s financial well-being every question you have should be addressed.

Now’s the perfect time, too.

Why?

The market is complacent. Volatility is low.

Yet, dark clouds are forming on the horizon.

storm clouds

Political ill-wind is beginning to stir and capture the market’s attention, bond yields around the world are falling (some are negative). The 10-year U.S. Treasury yield is at it’s lowest close May 2013. A clear sign of economic distress. U.S. corporations are in their fifth quarter of negative earnings growth.

There’s never been a more perfect time to ask these ten questions: It would be a mistake not to.

Are you a registered investment adviser or a stock broker? There’s a difference.  A big difference. When people ask me I respond: “Well, I don’t really want to help you break anything. Most likely, I’m going to help you mend something a broker, broke.” You need to ask the question and comprehend the difference.

A registered investment advisor or “RIA” is held to a fiduciary standard. According to www.thefiduciarystandard.org, a committee of investment professionals and fiduciary experts who formed in June 2009 as advocates for fiduciary-level advice:

“Registered representatives of broker-dealers are subject to a suitability standard under the Securities Exchange Act of 1934, while investment advisers are regulated as fiduciaries under the Investment Advisers Act of 1940.”

What does that mean to you? Plenty.

Fiduciaries are held to a high standard of ethics and care which affects all the advice they provide. It’s a much stricter standard. There should be no conflict of interest and if one exists, it requires clear disclosure.

The Committee for the Fiduciary Standard outlines 5 core principles of a fiduciary:

  • Put the client’s best interests first;
    • Act with prudence, that is, with the skill, care, diligence and good judgment of a professional;
    • Do not mislead clients–provide conspicuous, full and fair disclosure of all important facts;
    • Avoid conflicts of interest;
    • Fully disclose and fairly manage, in the client’s favor, unavoidable conflicts.

 “Suitability” guides a broker to recommend an investment that is appropriates for your situation, is not held to the same standard. A broker is required to know your risk tolerance, tax bracket, and time frame for the money you seek to invest. All skeletal in nature. Yet legitimate. Well, it’s suitable.

Feels like something is missing, doesn’t it?

My belief, based on how brokerage firm compliance departments operate and an unpleasant experience with a former employer, is that suitability has been misaligned to protect the financial organization from lawsuits or arbitrations and NOT designed to safeguard individuals seeking guidance.

The Fiduciary Standard is a high calling. It’s there to position the client front and center in the financial advice model, as it should be for every professional who assists consumers with their financial decisions.

 On April 6, 2016, the outdated foundation of financial services was slammed and cracked to make ground for hopefully, a safer, increasingly objective industry with the issuance of the Department of Labor’s Fiduciary Rule.

Mind you, it’s the genesis of a higher standard of care for brokers, so there’s much to be accomplished. I expect the Rule will be pushed, pulled, fine-tuned before it fully takes effect on April 10, 2017 and final policies put in place by January 1, 2018. My thought is this will be a continuous work in progress long after 2018. That’s ok. It’s a step in the right direction.

The new rule resurrects the definition of fiduciary from the 1974 ERISA – (Employee Retirement Income Security Act) and expands upon it. ERISA’s fiduciary standard outlines how a retirement plan fiduciary must act prudently and with undivided loyalty to the participants. Obviously, the retirement landscape in 1974 was very different. The 401(k) plan wasn’t in existence. Defined benefit plans, or pensions, were the most popular retirement vehicles.

Crucial elements of the rule – advice provided must be in a client’s “best interests,” full disclosure of conflicts of interest, and charge no more than “reasonable compensation,” for services. Generally, the fiduciary must sign a “Best Interests Contract” with the client that outlines how he or she will provide advice in the client’s best interest.

A broker’s financial institution will also be subject to the rule. Ostensibly, sales quotas, contests, awards or special compensation that may tempt an adviser to stray from his or her fiduciary responsibilities, will be prohibited.

The message is growing strong (there’s a long way to go), to an industry driven by sales pressure: Change your culture. In other words, those ads you run that give the appearance of fairness, caring and client first that not one consumer takes seriously? Make them reality, not fantasy.

Ethical employees who serve financial clients in publicly traded brokerage firms are torn between serving clients holistically for the long term and at the same time are up against the wall every quarter, starting from scratch, to meet outrageous quarterly sales goals and tremendous pressure to sell the hot product of the day (these tactics still exist). The internal friction can generate great turmoil and perhaps push an employee to make sales first and fail to responsibly counsel.

The mixed message from senior corporate puppets to do what’s right for a client and oh, meet big sales targets (or you’re out), builds conflict and distress. Talented workers become discouraged, burned out and move on. It’s an ancient business model. Change is required and it appears to be coming.

Slow is better than no.

Unfortunately, the recent ruling only covers retirement accounts. For now. The Security & Exchange Commission is expected to release a fiduciary standard in 2016 which would cover fiduciary responsibilities for taxable brokerage accounts. Although a uniform fiduciary standard (with the DOL), would be welcomed, it’s too early to draw any conclusion that this will occur. Nor is there any assurance that the SEC will adhere to an October release.

While the Feds work to figure it out, ask the question. Keep in mind, not every professional you engage will operate in a fiduciary capacity regardless of federal rulings. My suspicion is you’ll be hearing interesting, articulate, creative responses but not a clear “yes” or “no.”

Based on the answers received, you’ll gain valuable perspective about what’s best for you and your family’s finances.

Think fiduciary over suitability.

How much will I pay for your services?

 Simple question deserves a simple answer. Unfortunately, not so simple. People share with me their frustration as they’re unclear how their current financial professionals get paid or are compensated for selling investment products.

It’s especially perplexing for mutual fund investors sold multiple share classes and perpetually unclear of how charges are incurred. A clear comprehension of the class share alphabet (A, B, C), is as thick and jumbled as the inside of Campbell’s Soup can.

B &C share classes are popular selections on the product-push list. They represent the finest alchemy in financial marketing. As consumers are generally hesitant to pay up-front sales loads like in the case of A shares (even though when taking into account all internal fees and expenses, they’re the most cost-effective choice for long-term investors,) B & C shares were created to mollify the behavioral waters.

To avoid having a difficult conversation or facing reluctance about opening your wallet and shelling out 1-4% in front-end charges that reduce the principal amount invested, the path of least resistance is to offer share classes with internal fees, marketing charges and deferred sales charges. Either way you pay. With B & C shares generally, you pay more. However, big fees reduce returns, they’re stealth. Thus, they feel less painful to invest in (even though they’re not).

Frankly, the only funds worth considering are no-load mutual funds where you can purchase or sell anytime without a commission or sales charge. Avoid the A, B, C’s all together. Meet with an hourly-fee based Certified Financial Planner or a fiduciary to help you assess your current mutual fund holdings and for recommendations based on your personal situation.

A financial professional may be compensated hourly, by annual flat fee, a percentage based on assets under management, commissions or perhaps a combination. Regardless, to make an informed decision, you must understand how your adviser puts food on the table. If you can, get it in writing.

 There’s no ‘right way’ to be compensated as long as it’s fair and reasonable for services rendered. You also want to understand what motivates your broker or adviser to recommend investment vehicles. If you’re not getting straight answers, well you know what to do. Move on.

How do you incorporate my spouse, life partner and children when it comes to planning for me? You don’t exist in a vacuum. An adviser should maintain a holistic approach to financial planning and that includes communicating with loved ones and teaching children how to be strong stewards of money. The meetings, communication must be ongoing. At least annually.

Why did you select financial services as a career? I recall vividly how the stock market intrigued me through my teenage years. I never missed an episode of Wall Street Week. As early as 13 years-old I was fascinated with how markets worked.

In grade school I enjoyed helping classmates understand how our passbook savings accounts (and compound interest) worked. Every Wednesday, a bank representative from Lincoln Savings Bank would meet with our elementary school class and collect deposits and stamp our passbooks.

This question should be used to gauge a perspective financial partner’s penchant for helping others and passion for his or her role as a mission, not a job. How do you know whether a professional sincerely cares about your financial situation and goals? You’ll know it, intuitively.

 What are your outside interests? A successful life is about balance. This question gets to the weekend and evening person behind the financial professional you observe from behind a desk, charts, book, and computers. You may discover activities you have in common and develop rapport on a personal level.

To gain a complete picture of the kind of person you’re entrusting with your investments is a crucial element of your interviewing process. By the way, it’s not prying. It’s curiosity. Ostensibly, you should like the individual you and your family may be working with for decades.

Can you tell me about your firm’s service standards? You want to know how many times a year you’ll be meeting with your financial partner whether in person (preferably), over the phone or web meeting like Go To Meeting. Is it quarterly? Every six months? How would you like to work as a client? What are your preferences? Will you be receiving calls and e-mails throughout the year about topics important to your financial situation like the market, economic conditions, financial planning, and fiscal changes that may affect me?

What is your investment philosophy? Recently, I meet a couple who was upset how their broker placed a million bucks into the market in one day. They believed there would exist a more thoughtful strategy for implementation especially in the face of the second-highest stock market valuation levels since the tech bubble. But THEY DIDN’T ASK. Are you ‘buy and hold?’  You seek to discover  whether the adviser is merely towing the employer’s line or does outside research and shares his or her personal opinion based on research and study.

Is there a portfolio sell discipline? What is it? Frankly, if the word no, or something like it comes up, excuse yourself politely and find another adviser. This investigation is over.

The dirty little secret in financial services is that ‘sell’ is a four-letter word. I’m certain you’ve heard about missing the 10 best days in the market (brokers preach this ad nauseam). How detrimental it is to portfolio return. And it is. But what about the other side of the coin? What about the math of loss?

Math-Of-Loss-122115.png

Per Lance Roberts, Clarity Financial’s Chief Investment Strategist:

Clearly, avoiding major drawdowns in the market is key to long-term investment success. If I am not spending the bulk of my time making up previous losses in my portfolio, I spend more time growing my invested dollars towards my long term goals.

Markets can’t be timed. That’s true. However, risk management is about controlling the math of loss which can be devastating compared to possible gains. Your broker or adviser should have a strategy you believe in to guard against market storms.

Whether it’s a conservative portfolio or asset allocation right from the beginning, or a specific sell and re-entry discipline to minimize portfolio damage, a sell strategy is crucial.

Academics and influential financial service providers are on the band wagon when it comes to sell disciplines. Whether it’s Dalbar, the nation’s leading financial services market research firm, or MIT Professor of Finance Andrew Lo, there’s a growing body of work that shows how investors spend most of their investment life (20-30 years), making up for losses, playing catch up.

Investing, closing your eyes and hoping for the best is not a wise strategy especially in a market propped up by central bank intervention and a P/E 10 ratio at 25.7, the second-highest level since the tech bubble at 44.2. The historic average is 16.7. Real price/earnings over 10 year averages are not going to drive market returns in the short term. However, as an investor, you must be aware of the environment you’re dealing with. Placing 100% of your stock allocation into the market at these levels should be a strategy you avoid, especially if you’re 5-7 years from retirement.

How will I have access to you and your team? A caring adviser will make sure you have the ability to text, access to a cell phone number, the phone contacts and e-mails of support staff and make you feel comfortable to reach out at any time. You should also expect a prompt response to voice mails within 24 hours or less.

When can I meet your clients? Advisory clients possess knowledge and intellectual gifts they love to share with others. Intimate client gatherings provide clients opportunities to communicate, generate business, form friendships. It’s rewarding to witness. The ability of clients to gather and know each other also helps new retirees transition to their next life adventures easier by hearing the life stories from people who have been there already.

Questions are an integral part of any relationship. As a friend recently taught me – not asking them in a timely fashion can create resentment and anger.

You’re not being nosy.

You’re not a nag.

You’re seeking information to make an informed decision.

About a topic close to your heart.

Financial well-being.

No questions asked.

Unless you’re Columbo.

Then keep asking.

Six Ways The Living Are Dead With Their Money.

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A version of this writing appears in Nerdwallet, NASDAQ.com & YahooFinance.com.

Zombies have gone mainstream in pop-culture due primarily to the popular cable television show – AMC’s The Walking Dead.

Wandering corpses are scary. Financial dead zones are equally frightening.

wandering zombies

There are situations that corner money in a dangerous place.

The habits are so stealth you may never calculate how many dollars were bled or lost.

There are indeed occasions when the living are dead with their cash.

Random Thoughts on how to protect yourself and avoid financial ‘zombie traps.’

Bank fees can chip away at the flesh and blood of net worth – Moebs Services a leading economic research firm in a recent study discovered that overdraft revenue for banks, credit unions and Thrifts was an astounding $32.5 billion for the year ending June 2015. That’s the highest level since June 2010.

The Consumer Financial Protection Bureau registered approximately 410,000 complaints from December 2011 to June 2015. What’s amazing is that out of them only 1.6% were attributed to overdrafts. Consumers lost billions in fees by overdrawing accounts, but rarely took issue with a median $27 dollar fee for protection. Talk about bleeding dollars!

To avoid or minimize this zombie trap link-up a savings account or credit card to your checking. For an average charge of $5, money will transfer automatically to cover.  You can actively opt-out of a bank’s automatic overdraft program, too. Even better – Consider institutions with no overdraft fees. Google Nerdwallet and check their list of banks that won’t bloody you with overdraft charges.

Don’t ignore 401K allocations.  Your company retirement account is a potential dead zone. Once money is invested, there are two potential, lethal bites to net worth. First, there’s a tendency to build a stealth overweight in company stock whether it’s through payroll contributions or employer match.

The danger arises when 15% or more of your liquid assets are tied up in one investment and it underperforms or worse – drops dramatically in price, as witnessed in the energy sector over the last year. To manage risk, once (if) the stock allocation becomes monstrous, or 15-20% of the total value of a retirement account, protect yourself and trim it back to less than 15%.

Second, there’s a tendency to invest and forget: In other words, employees rarely review, alter or rebalance holdings. Money requires attention to deflect a zombie pitfall. Set aside 30 minutes every 3 months to ensure investment selections still fit your tolerance for risk, sell (take profits) from what’s performed the best, and determine whether you’re comfortable with your overall mix or asset allocation. Consider using the services of a Certified Financial Planner to provide an objective analysis of current investments and specific recommendation changes.

Minimum credit card payments. According to Nerdwallet, as of October 2015, U.S. household average credit card debt is $16,140. In zombie environs, this balance would be considered a herd. A group of living dead that moves as one, like waves. They overwhelm everything in their path.

So, if the minimum payment is roughly 5% of the balance (plus interest) at an interest rate of 15% (U.S. median), it would take close to 11 years to pay off the balance (assuming you stop using the card). Yikes. Talk about dead money!

In addition, you would incur $5,327 in interest charges. Minimum payments are not adequate weapons against herds. You’re going to need more firepower. Consider special deals that come with balance transfer offers, use liquid savings (which currently pay close to zero), or call the credit card company and ask for a lower rate – I’ve witnessed people negotiate attractive rates and save thousands.

Stealth, recurring charges. They are the most horrific. They’re like zombies in the fog. You won’t notice until it’s too late. Recently, after a close examination of my credit card statements, I discovered a quarterly payment of $9 dollars to a forgotten newsletter. I’m ashamed to say this had been going on for TWO YEARS. I bled money for 8 quarters!

Think about the recurrent payments you haven’t cleaned up because they’re a nuisance or frankly, you don’t remember. Debits for subscription periodicals you no longer read or membership fees for services you rarely use. This living dead walks among your credit balances. Just look.

PRINT (no online review) and closely examine your credit card and checking account statements at the minimum on a quarterly basis. Be proactive to battle the fog zombies. Call vendors to not only stop future debits but to reimburse you for services you haven’t used. I did. They rebated four quarters of charges.

Paying extra on a mortgage. Borrowers love to pay extra on their mortgages. It feels good. Like a cure that protects against lethal zombie bites. It isn’t. Most homeowners will stay in their residences for 5 years (not 30). Making larger payments is money taken from the life blood of liquidity. The additional cash has the potential for greater and higher uses like reducing high-interest debts, building emergency liquid reserves, bolstering investments that will be needed to generate retirement income. Unless you plan to remain in a house for 10 years or longer, paying extra only makes sense if you have adequately funded investments or completely paid off debts.

Overlooking important employer benefits. Benefits enrollment season is about to begin. Annually, I observe employees make mistakes that leave their futures up to chance. For example, they fail to take medical coverage or feel disability insurance isn’t required since “nothing bad is going to happen.”

There are hazards that have potential to wield long-term damage. A serious illness or a disability without adequate insurance coverage leaves you exposed to unrecoverable financial shocks. It would be like fending off a bunch of ravenous zombies with a plastic teaspoon.

It’s smart to accept when you’re outnumbered. To survive, transferring risk to a fighter with great resources (like an insurance company), is a money-smart way to live.

The dead can devour money.

They have an appetite for poor financial decisions.

Now you know how to detect and destroy them.

And live a zombie-free, financially less-frightening life.

zombie comic

4 Reasons To Embrace An Imperfect Retirement Plan.

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A version of this writing appears in MarketWatch.

The recent downturn in the stock market has placed an important decision on the back burner.

It’s not strange to change direction through a storm of uncertainty. Through a volatile period it’s not unusual to move a retirement date out, continue to collect a paycheck, bolster savings and reduce debts.

I hear it often – “I’ll work just one more year.”

The working dead

On the surface, it feels right to wait.

I call it ‘failure to launch.’

There’s never an opportune time to retire, regardless of the preparation and the formal financial planning undertaken to ensure lift-off. Frankly, even when the stock market is on solid footing people tend to find reasons to delay the next step.

It’s perfectly understandable. It’s human to feel vulnerable at the crossroad of a life-changing moment especially when the moment has arrived.

The financial planning process can inadvertently exacerbate “launch dysfunction.” It’s also in a planner’s nature to be conservative and advocate a decision to wait for a better time (whenever that is).

I’ve discovered after hundreds of retirement discussions and volumes of plans delivered, that the decision to wait is rooted in an overdependence on the successful outcomes of formal retirement plans designed to predict the survivability of assets to meet lifestyle expenses for three decades or longer.

But is that practical?

No.

Before you decide to undergo retirement planning, you must make peace with the fact that the entire process is extraordinarily imperfect, like you and me.

Retirement plans are 20% science and 80% forecast (or art).

Unfortunately, there are elements you will never be able to predict with complete accuracy. You may not live to 95 even though you believe it to be true.  Future market returns are an educated guess at best.

Instead of waiting for every financial star to align before retirement, consider the following random thoughts:

You’re better off with formal retirement planning, than not. People who begin formal planning early on, five to ten years before retirement, increase the odds of a successful launch date compared to those who begin late or not at all.

A plan which includes a complete inventory of assets, liabilities and future goals coupled with assumptions for inflation and realistic future investment return simulations helps you gain invaluable intelligence early that can be used to create an ongoing action plan to validate positive financial habits and minimize the impact of weaknesses.

A plan is not right or wrong, successful or unsuccessful. It’s not a threat, or a reason to be chastised for poor fiscal behavior. The first iteration is the start of a long-term educational process, an awareness and ongoing tuning of financial strengths that apex at a launch point I call ‘escape velocity.’

Consider escape velocity a financial trajectory that launches a retiree successfully through the first decade of expenses and withdrawals with minimal negative impact to investment assets. Academic studies outline how the first ten years of asset drawdowns is crucial to the survival of a portfolio over the next twenty.

Within a plan, your financial life is run through a simulation to determine probabilities of success which comes down to your money lasting as long as you do (or longer if you wish to leave assets behind for others).

You’ll see, how in the face of withdrawals and changing market returns, your asset values ebb and flow. Through great bull markets (best case), bear markets (worst case hope not) and somewhere in between.

If your assets can make it through the first ten years successfully. And I mean at a 75% or greater probability of success, you are ready to launch into imperfect retirement mode as long as expenses are monitored annually and changes are made to reduce lifestyle expenses.

I’m not saying it’ll be clear sailing. Or you won’t need to adjust mid-flight: Work part-time, cut costs, downsize.

Most likely, you will.

I’m saying there’s a delicate balance at stake. A point of no return to consider.

Either retire early enough to enjoy the experience, forsake a perfect planning outcome, take a leap of faith, or wait until your probabilities of success through the worst market cycle is 95% or greater. By then it may be too late due to health issues and aging. The retirement you hoped for may be one you regret.

You see, this is the art part. When you’re planning to travel a path three decades long, science fades into the dark pitch of road and creativity and faith take over, more often than not.

Mentally, you must let go of perfection and consider multiple detours to navigate the imperfect.

Be overly (insanely) cautious the first five years.  Academic work by financial planner, speaker and educator Michael Kitces and Professor Wade Pfau outlines how your asset allocation should be conservative in the early stages of retirement, especially in the face of lofty stock valuations.

Generally, I have retirees reduce equity exposure by 20% at the beginning of retirement and I’m not opposed to holding 2-5 years’ worth of cash or cash equivalents for withdrawals and to eventually purchase stocks at lower prices.

You’re thinking cash doesn’t earn anything. Well, it doesn’t lose anything, either. You can make up losses due to inflation. Principal erosion due to market losses is an entirely different story.

What most investors do not realize currently is that they could hold cash today and in five years will likely be better off. However, since making such a suggestion is strictly “taboo” because one might “miss some upside,” it becomes extremely important for measures to be put into place to protect investment capital from downturns.

Friend and business partner Lance Roberts provides the following chart which outlines the inflation adjusted return of $100 invested in the S&P 500 (using data provided by Dr. Robert Shiller).

The chart also shows Dr. Shiller’s CAPE ratio. We capped the CAPE ratio at 23x earnings which has historically been the peak of secular bull markets in the past. Lastly, we calculated a simple cash/stock switching model which buys stocks at a CAPE ratio of 6x or less and moves to cash at a ratio of 23x.

The value of holding cash has been adjusted for the annual inflation rate which is why during the sharp rise in inflation in the 1970’s there is a downward slope in the value of cash.

However, while the value of cash is adjusted for purchasing power in terms of acquiring goods or services in the future, the impact of inflation on cash as an asset with respect to reinvestment may be different since asset prices are negatively impacted by spiking inflation. In such an event, cash gains purchasing power parity in the future if assets prices fall more than inflation rises.

The importance of “cash” as an asset class is revealed.

While the cash did lose relative purchasing power, due to inflation, the benefits of having capital to invest at low valuations produced substantial outperformance over waiting for previously destroyed investment capital to recover.

While we can debate over methodologies, allocations, etc., the point here is that “time frames” are crucial in the discussion of cash as an asset class. If an individual is “literally” burying cash in their backyard, then the discussion of loss of purchasing power is appropriate. However, if the holding of cash is a “tactical” holding to avoid short-term destruction of capital, then the protection afforded outweighs the loss of purchasing power in the distant future.

Cash is not exciting. However, the excitement at the beginning of retirement should be about the memories you build, not the money you can potentially lose in stocks.

Real value of cash

Cover as much fixed expenses as possible with income you can’t outlive. Maximizing Social Security payouts and minimizing taxes on those payments by coordinating benefits received with withdrawals from investment assets, can add thousands to your household cash flow over a lifetime.

Social Security is an income stream you can’t outlive and should not be discounted in your retirement analysis. It needs to be a crucial element of your written plan.

Creating a pension through the use of deferred income or single-premium annuities can supplement social security and bolster your income for life.

Investors fear annuities. Financial pundits on the radio and in print advise how annuities “are bad.” If you’re purchasing annuities, you’re most likely taking money away from them as advisors. Understand the motives behind negative blanket statements about annuities.

Not all annuities are the same.

Consider the word annuity means “a fixed sum of money paid to someone each year, typically for life.”

Social Security is an annuity, right?

The combination of Social Security plus income annuities can be employed to cover expenses you must pay – think rent, food and insurance. Leaving your variable assets like stocks as supplements to your income requirements.

Avoid variable annuities. They are unnecessary and expensive. When you think negatively about annuities, it’s the variable ones you’re most likely referencing.

Decrease cash outflow throughout retirement.  The first two years of retirement is a soul-searching expedition. It’s also a period where I witness retirees highly sensitive to stress and anguish from having too much ‘stuff,’ large homes and big overhead.

Reducing financial pressure by going smaller generates great emotional benefits. Monetary bandwidth can be built into your budget. If you’re prepared to reduce portfolio withdrawal rates through rough market periods without seriously inhibiting your lifestyle, then an imperfect retirement mindset can work.

An imperfect retirement strategy is not “set it and forget it.”

Throughout, you must be willing to regularly meet with your financial partner to analyze withdrawals market cycles and adjust accordingly. In addition, you need to be receptive to change and flexibility. Even be open to part-time employment to increase household income.

Because waiting for perfection is not practical or realistic.

And a life is at stake.

Yours.

imperfect striving

Gold is Not a Safe Haven – Don’t Be Fooled.

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It’s indeed a shining moment. Oh, not for you. For them.

The gold bugs.

gold bug

The zealots who over the last three years have been advising investors to purchase gold. They’ve been correct for roughly two weeks. There’s been a stealth bounce in gold prices.

Frankly, gold investors appear to be in a perpetual frenzy. Pundits who preach gold are steadfast in their conviction, recommending gold no matter how low it goes. Sooner or later, they were destined to be right.

Well, here is their moment in the golden sun (for now:)

It turns out gold is relatively risky in terms of standard deviation (a measure of risk), and the largest negative returns of gold are close to the ones of stocks. Per the author “gold is generally not a safe haven for bonds in any market. Gold only functions as a safe haven for a limited time, around 15 trading days.”

Now, we’re not saying gold can’t outperform for periods. We just don’t want you to fall for the impression that the metal is some sort of hard-commodity Snuggie, or offers protection for the long term.

The lives of your investments, the heart of them, are designed to be warm and connected — to sales, to services, products, countries. What is gold connected to? Nothing. You can’t even use it to purchase toothpaste. I tried.

Once I attempted to pay for a subscription to a gold newsletter with gold. I created mass confusion. Enough for an operator to disconnect me. Before rudely dismissed, I was notified by a manager that the writers of this monthly periodical (very popular) would happily accept any of my major credit cards. Or a personal check. Which of course, is backed by the dollar balance in my bank account. Not gold.

Remember: Gold newsletter marketers bank dollars (not gold). Some prey on your fear and paranoia.

Gold’s relevance ebbs and flows based on our fear of the unknown or circumstances beyond our control. How did something of the earth become a store of wealth? Why not apples? At least you can eat apples. If the end of the world does come, you’ll seek apples over rock.

In the apocalyptic science fiction movie “The Book of Eli,” Denzel Washington’s character uses Wet Wipes as a medium of exchange. I’d even take them over gold. Our dollars aren’t going away as a medium of exchange and will be backed by the full faith and credit of the U.S. government. We are not returning to a gold standard as much as Rand Paul would like to think.

Following a doomsday scenario, think of it this way: If gold is winning, then for the most part, you are losing. So pray it continues to be a lousy long-term investment. If gold is rising, most of everything else you own is falling. Not good. It’s in your best interest that gold fails.

There does not exist an academic study nor empirical data which proves gold as an effective inflation hedge. None. The pattern is random at best. Again, owning gold may provide a level of emotional comfort. That’s fine. More often gold prospers when there is instability or lack of confidence in a fiat currency. Could be inflation, also deflation. Regardless, the relationship to inflation or the dollar, is random at best:

Gold is portfolio protection — you’ve heard that one. The message is pervasive on television and radio. No. It has been and continues to be plain old U.S. Treasury securities. Want real diversification or protection? Cash and U.S. bonds do the job:

So you still want to own gold? If you must, keep your allocation limited to 5% of invested assets. There are several methods to consider. Obviously, you may own the medal directly — jewelry, coins, bars. You can investigate gold prices through goldprice.org.

The more efficient and liquid methods are through low-cost exchange-traded funds like SPDR Gold Shares GLD, -0.32%   or no-load mutual funds. The Vanguard Precious Metals and Mining Fund, VGPMX, -1.45%   which is inclusive of other precious metals in addition to miners, has an expense ratio of .29%. Regardless, you’ll require tremendous patience as an investor in this category. Be prepared for long periods of under- as well as over-performance.

True wealth comes from achieving more household cash inflow vs. outflow, combining assets that diversify, managing portfolio risk by preserving capital through market drawdowns, and managing emotions through good and bad market cycles.

Performance of gold compared with the S&P 500 SPX, -1.53% :

Richard M. Rosso is a senior financial adviser with Clarity Financial in Houston. Lance Roberts is a general partner and CEO of STA Wealth Management in Houston.

 

Four Words To Better Retirement Planning.

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As originally posted on http://www.nerdwallet.com. 

What are the obstacles that cause you to veer off course when it comes to retirement planning?

Increasing your odds of planning success shouldn’t be so complicated.

Solutions are obvious. There’s no magic.

Small changes in perspective or actions can lead to better results.

Hey, it’s never perfect either.

Remember the two main goals of the financial services industry:

1). To baffle you enough to sell you something you don’t need.

2). To force-feed you long-term bull market Kool-Aid to make you think stocks are a panacea (30% portfolio losses: Hey, no big deal. You have time on your side).

But you’re smarter than that, right?

Right? 

My former employer’s retirement simulation is so happy-go-lucky and optimistic (because every market is a bull market), it reminds me of Homer Simpson’s happy dream romp through chocolate town.

It’s toilet paper.

Don’t fall for the hype. Don’t even wipe with it: You’ll get a rash.

homer simpson chocolate dream

Maybe it comes down to simplicity.

Let’s start with four words.

Random Thoughts:

1). NO. Recall the habit of lending money to friends and relatives who rarely make efforts to repay. It’s time to make your retirement strategy a priority and use the word “no” often. You don’t need to explain. It’s an uncomfortable but necessary perspective. At the least, you’ll need to be selective, perhaps formal in your agreements going forward. The health of your retirement plan is at stake.

If you’re passionate about helping, consider the support provided, a gift. Set rules at first if saying “no” is difficult. For example, establish a specific dollar amount in the budget for purposes of lending. Never lend to the same borrower twice in the same year. Decrease the allotment by ten percent every year until eventually it’s so insignificant you’ll feel too embarrassed to say anything but “no.”

“No” is personal empowerment. Think of the word as a boundary – A verbal line in the sand that deepens the territory you’re clear won’t be crossed. “No” is a confidence builder. It allows greater focus on the “yes” you need to succeed.

Consider how postponing or decreasing saving for retirement by placing priority on education savings plans or by taking on excessive debt to assist children with college funding deserves a “no.”

Naturally, you want your children to prosper however, when the time comes to retire, there’s no loan, financial aid or scholarship opportunities available to you. The kids have options for funding. You don’t. A hardline “no” isn’t necessary; a change in perspective followed by action may be good enough.

Understanding when a “no” is necessary to avoid a derail of your plan is art and science.  A set of rules and setting expectations can help clarify when a “no” needs to surface. Perhaps you can partially subsidize education costs or seek compromise (a public, in-state option vs. the private university cost).

In eight out every ten plans I’ve designed, retirement is postponed by at least six years when parents decide to foot the entire education bill.  Saying “no” to full boat means your retirement boat floats sooner. I’ve witnessed retirement postponed a couple of years in most cases when compromises are made – a big improvement over waiting six years.

Mitch Anthony, author of the book “The New Retirementality” describes the modern retiree as trying to strike a perfect balance between vacation and vocation. In other words, maybe the perfect retirement plan is to say “no” to retirement. The traditional perception of retirement is indeed dying.

I work with a large number of part-time retirees who consult or are employed a few days a week to keep their minds active and say “yes” to continued contributions to the workforce. Meaningful engagement in a work environment is important to this group however, those retirees who do work are ready to say “no” at a moment’s notice if their employment situation grows unenjoyable or less meaningful. They have much to offer and their experiences and skills are valuable.

As best-selling author and good friend James Altucher told me:

“Never say no to something you love, so you never retire.”

His new book co-written with Claudia Azula Altucher, “The Power of No: Because One Little Word Can Bring Health, Abundance and Happiness,” will be necessary reading and provided to those I assist with retirement planning.

Ponder the “no” opportunities. Start with the actions you believe postpone or negatively affect what I call “retirement plan flow” which is anything that prevents your plan from firing on all cylinders.

A client recently said – “I even stand straighter when I say no. It makes me feel good.”

no

2). WAIT: The most common mistake I encounter are retirees who look to take Social Security retirement benefits before full retirement age when waiting as long as possible can add thousands in additional dollars to a retirement plan.

I’ve had to say “no” to clients seeking to retire at age 62. And I’m not ashamed. What’s three more years? It goes fast. And waiting can be lucrative. According to a 2008 study by T. Rowe Price, working three years longer, waiting until full retirement age, and saving 15% of your annual salary could increase annual income from an investment portfolio by 22%. If you can handle five more working years and save 25% of your annual salary through that period (takes some work), then expect a surprising 50% more income in retirement.

Delaying Social Security benefits from full retirement age to age 70 will result in an 8% increase plus cost-of-living adjustments. Where else can you gain a guaranteed 8% a year? Of course, nobody knows how long they’re going to live but if you’re healthy at 62 and there’s a history of longevity in the family, it’s worth the risk to wait until at least full retirement age.

3). SELL: Based on a recent paper written by Michael Kitces, publisher of The Kitces Report and Wade D. Pfau, professor of retirement income at the American College, reducing stock exposure at the beginning of retirement then increasing over time  is an effective strategy for reaching lifetime spending and portfolio survival goals.

The heart of the research is “Plan U” (for unorthodox in my opinion) — a “U-shaped” allocation where stocks are a greater share of the portfolio through the accumulation/increasing human capital stage (makes sense), decrease at the beginning of retirement, and then increase again throughout the retirement period.

The concept of reducing stock exposure early in retirement and increasing it later sounds highly counterintuitive – although from a market and emotional perspective it’s plausible, especially now.

First, be sensitive to your mindset as shifting from a portfolio accumulation to distribution strategy can be stressful. Focus on financial issues to allay uncertainty like (don’t let greater stock exposure add to stress), household cash flow and retirement portfolio withdrawal strategy. Gain and monitor progress with a financial partner or objective third party at least every quarter for validation and adjustment. The first year of retirement is an opportune time to step back from stocks especially as you feel uncertain and occupied with what I believe are more immediate concerns.

Second, stocks are not cheap based on several long-term price/earnings valuation metrics. Selling if you’re close to, or at retirement can be an effective strategy. Regardless, you may need to rebalance to free up enough cash to begin retirement account withdrawals by trimming profits in the face of lofty valuations.

Not a bad idea. Yes – sell, not buy.

As of the end of May, the P/E 10 which is based on the ten-year average of actual corporate earnings stands at 24.9. Since the historic P/E 10 average is 16.5, the current bull indicates an extreme overvalued condition.

Last, even though the key word is “sell” don’t forget to periodically add back to your stock allocation. Get the topic on your radar and continue the “U” formation after two years in retirement have passed. By then, you should have greater confidence in your overall plan and settled into a lifestyle pattern that suits your well-being.

4). SHIFT: Be open-minded and willing to alter plans as required. After two devastating stock market selloffs since 2000 and structural changes to employment including the permanent loss of jobs, we are growing accustomed to dealing with financial adversity – shifting our thinking to adjust to present conditions. Actions outside your control – poor interest rates on conservative vehicles like certificates of deposit, can disrupt retirement savings and cash flow. On average, the Great Recession has motivated out of necessity or fear, the desire for pre-retirees to work longer and continue to carefully monitor their debt burdens.

In addition, shift your thinking about continuing to save aggressively in retirement accounts as you get closer to retirement. If 80% or more of your investments are in tax-deferred plans, and you’re five years or less from your retirement date, I would consider meeting the employer match in retirement plans and saving the rest in taxable brokerage accounts. This strategy affords greater flexibility with tax planning during the withdrawal phase as generally, capital gains are taxed at lower rates than the ordinary income distributed from retirement accounts.

A qualified financial and tax professional can create a hybrid process where funds are withdrawn both from tax-deferred and after-tax assets. The goal is to gain tax control by not ending up in a situation where ultimately all distributions are in retirement accounts which will ostensibly be taxed as ordinary income. Your strategy requires close examination of how to blend all investment account distributions to minimize tax impact.

Shift your attitude about annuities. Look beyond the bad press and overarching negative generalizations you hear from financial personalities in the media – “Annuities are bad.” Are all annuities bad? No.

Several types of annuities exist. Some come with overwhelming add-on features and are difficult to understand.  You’ll know when to step away. Others are expensive and should be avoided. For example, variable annuities with layers of fees are a bad deal.  I find little benefit to them in retirement planning.

The greatest purpose of an annuity is to provide an income you cannot outlive. In its purest form, an income annuity whether immediate or deferred can be used to bolster the lifetime income from Social Security.

As you budget, total how much is required to meet household essential expenses, indexed for inflation: Rent, mortgage, utility bills, real estate taxes, food, gas, automobile payments (you get the picture). From there, work with an insurance representative (could be your financial partner), to calculate the investment required in a deferred income or immediate annuity to cover mandatory expenses along with Social Security.

An annuity investment takes over some of the burden of funding retirement; it shifts risk to an insurance company which increases the odds of portfolio longevity and or having the money you seek for fun stuff like travel and hobbies.

Retirement planning satisfaction can happen.

Occasionally, we create obstacles by accident.

Simple words can be powerful tools to cut away the confusion and settle your mind.

What other words will you consider?

Hey!

Not that one!

oh shit

 

Seven Facts Your Broker Won’t Tell You About The Fed and Your Finances.

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Don’t kid yourself. The Fed affects everything when it comes to your money. 

As I wrote previously, it was highly unlikely the Fed was going to pull back on purchasing $85 billion in Treasury and Mortgage bonds in September.

Because:

girl cry “Mom, I just saw Ben Bernanke!”

Have you checked the volatility in mortgage rates lately? The 30-year fixed breached 5% and now has backed off. How about activity? New-home sales are nowhere near pre-crisis recovery levels.

Wall Street and large investors have swallowed up existing homes which has spiked housing inflation, making them less affordable for home buyers like you and me. Ben Bernanke is clearly concerned about the overall state of the housing market which leaves him frozen to move away from the great experiment.

How would you feel about a higher interest rate on an auto loan or credit card? We’ve seen anywhere from a 4-10% decrease in median real incomes since 2008, for American families. Part-time employment is the new full time job. Anyone believe the Fed wants to weaken your shaky household balance sheet by creating monetary uncertainty in the face of inept fiscal policy? 

Have you checked the anemic interest you receive on savings accounts and money markets? It’s a bad joke. And what about the portfolio? There’s an impact due to interest rate policy.

There’s a big ka-pow  to the pocket and economic activity if rates continue to increase rapidly too, as they’ve done recently.

Brett Arends’ article about rising interest rates for MarketWatch was an eye-opener. Don’t blink: Click to read:

How the Fed can cause another 1987 crash.

As a student of the Great Depression, the last thing Ben Bernanke wants to do is create a 1937 like Fed hubris-induced market crash.

Higher rates matter. You’re smart enough to know that. So, what won’t your broker tell you about what looks like an imminent conclusion to the Federal Reserve’s grandiose bond-buying experiment? And what if the Fed puts off a taper as far out as 2015? It could happen. How will investors deal with the volatility?

Bonds are supposed to be the “safe” money, but is it?

What do you need to know to make you a smarter investor?

1). Cash is an asset class. No, it is. Really. Cash doesn’t gyrate. It provides protection when stocks and bonds are both heading south. Like now. Cash is a stabilizer. Think of it as the foundation under your house. Just because it’s not pretty and doesn’t feel like it’s doing much, realize it has an important job: To provide stability. Cash is a good diversification tool. It doesn’t zig, zag. It just sits there. Like an anchor. Think of cash as an anchor. Or a Snuggie.

Remember the Snuggie?

snuggie They “jumped the shark” with the doggie Snuggie.

Your broker would prefer all your money is invested regardless of prices paid for the investments. Having cash takes discipline. A portfolio strategy would be nice so there’s an ongoing  plan to put cash to work. Having cash won’t burn a hole in the portfolio. Eventually you’ll invest it. What’s the rush? Well, maybe you won’t since there’s nothing wrong with maintaining a targeted amount of cash in your asset allocation at all times.

From my own past experience I was advised by a “concerned” branch manager, that I held “too much cash” in client portfolios. I had ten percent across the board. You would have thought I committed murder. Ask your financial person: How much cash should I maintain?” Let me know when you get the blank stare, open mouth. Drooling.

2). I don’t have time to help you rebalance, I have a sales quota. Your broker’s main job is to sell. Then it’s pack you up and move you on to a place I call “no-rebalance land.”

Rebalancing is important at all times and especially important now. It’s a strategy to sell high, buy low. It’s also effective at managing portfolio risk over time.

Ask your broker – “What kind of rebalancing process is right for me now that interest rates are rising and stocks are off their highs?” I expect you to be met with more glazed eyeballs.

3). I’m relationship on the surface, transactions underneath. I was warm and fuzzy months ago when I sold you that fixed income investment. I’ve been out to lunch ever since.

Have you received a call from your broker to talk it out, gain knowledge about the current environment? Perhaps there’s nothing you need to change when it comes to your bond or fixed income allocations. It would be nice to know, wouldn’t it? A little reassurance and education can go a long way.

Leave a message. Your broker will get back to you.

4). I stink at understanding you from a behavioral perspective. I’m not a shrink, I’m a sales person. So many studies exist which outline how humans are not wired to place money into bonds, stocks, gold, widgets. Our brains are like primal beasts when it comes to investing. We are prone to emotional reaction (or overreaction), fear & greed, selling low, buying high.

We are our own worst financial enemies. Can your broker provide perspective? Odds are not good. It’s time for a good read. From Wall Street Journal writer Jason Zweig. He’s smart about this psychological money conundrum we all face. Here you go:

Your Money & Your Brain.

5). I don’t study on my own. I depend on a corporate think tank to feed me thoughts. This isn’t all bad. There are smart investment strategists out there. However, it would be refreshing if your broker had his or her own opinion about a macroeconomic event even if it conflicts with the corporate brain feeder.

A good broker will lay out the risks, rewards, pros and cons. Try this: “Forget what your company thinks about this interest rate train-wreck – What are YOUR thoughts?” I’m really setting you up for disappointment. I’m sorry.

6). I have no idea how Fed actions affect your portfolio long term. If you hear these words, keep your broker. He or she is a gem. Frankly, even during the Great Depression, interest rates were never this low for so long.

7). I have no thought-out rules to manage risk the Fed has created. First, to manage risk in your bond portfolio, shorten what’s called your bond portfolio duration (a measure of interest rate sensitivity) now. As prices have recovered in the face of a Fed “fakeout” or no taper, you now have an opportunity to re-position your fixed income allocation.

Currently, our portfolios are roughly 3-4 years in duration making them less sensitive to future increases to interest rates. We hold a targeted amount of risk in emerging markets bonds which possess attractive yields (4-5%). Municipal bonds are also priced attractively even for those in lower tax brackets.

Second, we are in the process of liquidating all GNMA investments – if interest rates increase again, refinancing activity will drop off which can lengthen a GNMA bond’s time frame to payoff or maturity. Longer time frames can result in greater principal risk or lower returns to current bondholders.

Third, we have created a series of duration-reduction rules based on our study of the long-term trends in Treasury yields. Currently, a 10-year Treasury yield of 3.15-3.25% would warrant attention and perhaps a reduction of bond durations to 2-3 years.

The unwind from this Fed experiment is beyond comprehension – there’s no historical precedent.

Make sure your adviser is at least searching for, inquiring about, gaining information from others who are smarter. Your financial partner needs to be flexible enough to change up your fixed income strategy if warranted.

Honesty, study and communication are the keys to make it through this period.

My thought? The Fed will not taper in 2013. However, the volatility in yields will remain as all of us cling to every word, each media bite out of Federal Reserve officials and then take action.

Overreactions will be the norm.

And you thought bonds were supposed to be the “boring” slice of your portfolio.

Don’t panic. Keep your cool.

Oh, and call your broker.