Money Savvy Pig

If you think back to your childhood, what were the biggest influences on how your view of money developed?  If you’re anything like me, this question triggers memories of the struggle between saving my hard-earned allowance and spending it on the newest pack of baseball cards in hopes of obtaining the rare 1989 Ken Griffey Jr. Upper Deck rookie card.

Since my wife and I just welcomed our first child into the world, I thought I would share some of the conversations that have been taking place at our house regarding how we plan to teach our daughter about money.  We’ve both heard and read over the years that teaching kids about how to handle money is one of the bigger challenges parents face.  Whether it is rewards for good grades or allowances for mowing the grass, the ability to spend that income develops quite naturally with young children.  So what are the key points to teach our children about the importance of saving vs. spending more than they earn?  Here’s a few we plan to employ…

Somebody’s Watching Me

This was not just a creepy 1980’s song by Rockwell, it’s really a phrase that describes how your kids are likely that somebody.  They are learning from our actions whether we like it or not. One of the best ways to teach sound money management is by actually using a budget to manage the family finances.  In addition to keeping the numbers updated, making a point to openly discuss where we are spending our money demonstrates how to be accountable for our decisions.  Using a budget also teaches how to delay gratification if money is not yet earned.   By communicating openly and explaining the why behind our money decisions, children can pick up lessons along the way.  Several examples include pointing out the unit cost of items in the grocery store, explaining your net pay vs. your gross pay and discussing the percentages you are giving and saving. Volunteer work can be a great way to demonstrate the benefits of giving your time while also validating that rewards that aren’t monetary can be just as fulfilling.

Value vs. Quantity

Other lessons that get lost in the money conversations is teaching our children the true value of an item.  By taking care of the things they already have, children can prolong the life of a toy decreasing the extra purchase to replace due to wear and tear.  Kids also can learn by making things instead of purchasing them.  Going through this exercise teaches young children how to use their imaginations and also how to be resourceful with the things they already have.

Experiences = Life Lessons

One of the best ways for anyone to learn a truth is by making a mistake.  Kids need to have the freedom to make mistakes because of their own decisions so that it creates teachable moments for parents.  One tool, that does a nice job of creating these situations is the Money Savvy Pig.  By putting this tool to use, kids learn about the opportunity cost of a dollar.  They can place money in the save, spend, donate or invest section of the bank.  Therefore, if they choose to save a dollar, that dollar can no longer be spent, given or invested.

We’d love to hear your input.  What are some of the successful methods you’ve used to teach your children about how to handle money?

Certified Financial Planner

Have you seen the new CFP® TV commercial yet (take a look here)? Pretty Interesting.  The commercial is currently airing on stations that include History Channel, Travel Channel, HGTV, ESPN, MSNBC, CNN and Fox News.

The CFP Board, who issues the CFP® designation, is making a new effort to help define what being a CERTIFIED FINANCIAL PLANNER™ really means.  There are a lot of people that call themselves “Financial Planners,” but only those that have the CFP® designation have satisfied a rigorous set of standards to use the mark.  This includes extensive education, years of experience and a 2-day 10-hour examination covering insurance, investments, retirement, taxes and estate planning.  The CFP Board has also launched a website, www.letsmakeaplan.org,  to help bring clarity to how a CFP® professional can help bring all your individual financial pieces together.  They do a nice job of explaining what you can expect when meeting with a CERTIFIED FINANCIAL PLANNER™ and how you might benefit.

Mail piling up?

This is one of the more common questions we hear about the amount of prospectuses, annual reports, etc. that our clients receive from their investment companies.  Would you believe that this much disclosure could actually be bad for you?  Especially when it comes to the financial services industry, more disclosure is a benefit to the client, right?

Disclosure Debate

With all the hub-bub in Washington of who should police the financial planning industry of late, the debate about the effectiveness of disclosure is heating up.  At a recent industry meeting last fall, discussions centered around the idea that the more disclosure a company unleashes on the public the more confused they become in case after case.  Daylian Cain, assistant professor of organizational behavior at the Yale School of Management, discussed his findings of how heavy disclosure can actually harm an investor.  The standard example in these cases being the more pages in a disclosure document the less likely the investor is to read it.  Read more about this interesting discussion here.

Plain-English Descriptions

Last July, the SEC changed financial companies requirements for disclosure so that it will now be in a plain English narrative form with the hopes of making it easier to compare between different companies.  Reading the article above describes how several firms will look to drown their clients with pages and pages of disclosure.  We’ve been working hard over the last few months to make our disclosure form (Form ADV) to be more concise and meaningful to our business activities.  We’ll be sending out new copies of this document in the next few weeks.

Photo Credit: luxomedia

In Jeremy Grantham’s latest quarterly letter, he profiled a story about Sir Isaac Newton in which one of the most highly regarded intellects in human history was lucky enough to enter the South Sea stock bubble rather early.  He stayed in long enough to make some money and then, most likely feeling good about himself, sold his holdings at a nice profit.  After the stock continued to rapidly appreciate, his friends began to brag more and more about how rich they were becoming from investing in South Sea stock.  Kicking himself for having made such a foolish mistake by cashing out at such a paltry profit, Sir Isaac dumped much more than he had invested the first time into the stock.  Of course, this time the bubble was perilously close to the top and he made the fateful mistake of riding the bubble burst all the way down before selling out on three separate occasions with hardly anything left to show for his original investment.

Gravity in the Stock Market

There are several lessons in this story.

1. Don’t get carried away no matter what type of circumstances surround an investment.
2. Remember that even smart people get burned by stock bubbles.

For these reasons, we’ve designed our strategy to help fight these feelings.  The stock ranges we establish for each of our clients (and ourselves) act as a discipline, helping to control those visceral responses to booms and busts in the markets.  Making calls of where we should be at a given time within those ranges is a large part of our research process.  So the next time your emotions make you feel like you want to act, remember Mr. Newton’s experience. With a sound and solid investment strategy, you can fight these very human urges that are born out of the fear and greed that dominate the average investor’s decisions.

Taking Advantage of your Roth 401k?

It’s very possible that you could be saving more money tax-free.  If your company offers a Roth 401k option, then this could be your ticket.  In recent weeks, the question we’ve heard most from clients is “should I be taking advantage of a Roth 401k?”  To help you make a decision we’ve answered the most common questions that people consider when weighing the benefits of using a Roth 401k.

1.       What will my tax picture look like in retirement? If you think your tax rate will be higher than it is now when you retire, then it might make sense to be making contributions to your Roth 401k option.  As you grow older, you will likely pay down your mortgage and have children move out, leaving you with lower itemized deductions, thus increasing your taxable income.  Similarly, if you plan to have an increased spending pattern in your golden years, then higher taxes will most likely be a reality you will be facing.  Some would argue that given our current state in the tax history of this country, we’re very likely to see taxes increase at some point down the line as well.

2.       Will my paycheck be lower? If you choose the Roth 401k, your paycheck will be lower than when you were making traditional 401k contributions.  This is because your deposits are being taxed before they go into the account.  This is in direct contrast to the 401k you may have already been contributing to.  Those contributions were deposited before they were taxed.  Therefore, less comes out of your paycheck with traditional 401k contributions.

3.       I’m not sure I have enough time before retirement? The time before retirement could make or break your decision.  If you have a 30 year time span in which to invest, the tax-free growth during that time would be hard to beat.  On the other hand, if you are in your late 50’s with retirement no more than 5 years away, the tax-free growth may not be enough to make the switch.

4.       What if I make too much money? There are no income restraints to participate in the Roth 401k.  In order to contribute to Roth IRA’s your income needs to be south of $167k to make the full $5000 ($6,000 if you’re 50 or over in 2010) per year contribution.  By using the Roth 401k, you will be able to deposit $16,500 ($22,000 if you’re over 50) into a tax-free account.

5.       Does my match grow tax-free as well? Even if you decide to fund the Roth 401k, your employer’s match (assuming you receive one) will be funneled to the traditional 401k in pre-tax deposits like it normally would.

Also, as of this year, you are now able to convert a portion of your current 401k to a Roth 401k.  Keep in mind, that each situation is different and you can only truly know if a Roth 401k is right for you by evaluating your own personal situation.

Photo Credit: o5com

Understand Your Risk

In today’s economic environment, safety is at a premium but bank account rates remain at historical lows.  This has persuaded many investors to look for higher yields with their safe money.  In some of these situations, they are finding products that are advertising a 7-9% return.

We found a real-world example described in this Bloomberg article that should make you think twice about higher-yielding “fixed” investments.  The article provides a clear picture of how stretching for yield in a bond investment can leave you wondering why you just took a 30% loss.

Many of these so called “safe, high-yielding” investments are made up of Structured Notes, Derivatives, and CMS curve notes.  As explained in the article, these are all complicated derivative type investments being pitched as safe alternatives to bond investments.  Many retirees now are being seduced into purchasing these products without fully understanding the risks involved.  Structured note sells alone are up 58% from last year as people look for ways to earn more than what they would earn in their bank account because of the rock bottom bank account rates.

Another area of these products to investigate is the increased fees being charged by those who sell them.  One of the products described in the write-up earned a fee of 5.1% in which half was used to compensate the brokers selling the convertible bond.  This is nearly 5 times the average expense ratio of your average mutual fund.

Make sure you ask questions about any investment you are considering and remember if it sounds too good to be true…it probably is.

Photo Credit: im pastor rick

We spotted a story in the WSJ recently, which described how the Dow’s performance in May was the worst May since 1940.  So we thought it might be helpful to take a trip back to the 1940’s and investigate what the general mood of investors might have looked like during that time.  Most investor’s confidence in the stock market had to be incredibly shaken due to the erratic volatility at that time.  The decade they had just lived through, the 1930’s, saw the Dow register eight calendar months in which it rose or fell by more than 20%. They also had to withstand three stock market drops of 30% or more (with the 1929 crash falling 89%) during that period. Now entering the 1940’s, a pervasive attitude of gloom had spread across our nation.  Many of the messages in the media characterized the build-up of a country preparing for war.

From a 1935 edition of Modern Mechanix

Headlines and News of the 1940’s

• Germans invade Western Europe, France and Great Britain; London suffering bombing attacks daily for almost 2 months
  
• Unemployment drops but is still over 14%; “Union Closes Plant” 200 Men Reported Discharged by Boeing Company; Retaliation Suspected
  
• FDR signs legislation requiring US men Register for Draft
  
• Automobile Production Ceased in 1942 due to need for steel

War on the Horizon

It’s not a far stretch to say that people then were probably even more fearful about economic conditions than they are today.  While fear continued to escalate, U.S. federal debt expanded rapidly, t- bills were near 0% and war savings bonds with a guaranteed 2.9% annual interest rate over 10 years became one of the more popular investments.  However, the investors who were able to put aside their emotions and continue to invest in stocks fared much better.  Dollars invested in the stock market from 1940-1949 averaged more than 9% per year over that decade.  In fact, for the three decades beginning in January of 1941-1943, the annual returns were even stronger averaging in a range from 12% – 15.5%.

That means if you had invested $100K each in stocks, bonds and cash on January 1, 1940 and left it alone through December 31, 1949 your $100k would have grown to the following totals identified by asset class:

What You’ve Seen Often Isn’t What You Get

As the graph clearly shows the price you pay for safety in the short-term could likely be a costly one over the long-term.   By many accounts, at the end of the 1940’s, Americans never had it so good.  The war was over, jobs were plentiful, housing was affordable and the American Dream was in reach for more people than ever before.   How truly valuable this knowledge could have been for an investor at the beginning of 1940.

For many investors in 2010, the strain of watching their investments swing on the roller coaster ride we’ve had since late 2007 has left them fatigued and ready to give up.  However, as much as it goes against our psyche, a negative return for an entire decade is a powerful reason as to why we should be excited about the prospects for the next 10 years.

The Dreaded Check Engine Light

Check that Engine!

One of the more standard ways your car will alert you of a problem is by triggering the check engine light.  Usually once illuminated, the check engine light can be decoded by running a diagnostic test on the car.  When we first meet with clients, we’ll often hear the statement, “I want to make sure I’m doing all I can with my investments.”  By running our version of the diagnostic test each quarter, we spot tune-ups and efficiencies that otherwise may be missed.  Our checklist includes:

• Handling required minimum distributions
• Identifying opportunities to fund more tax advantaged accounts (Roth IRA’s, IRA’s or qualified plans)
• Verifying funds will be available for short-term cash needs
• Minimizing transaction fees
• Evaluating if a lower cost investment could fill the role of a current one
• Determining if any accounts can be transferred for cheaper or better investment options
• Considering if any other account openings or transfers would be beneficial (college planning accounts/life insurance/1035 exchanges/annuities)
• Keeping investment allocations in line with your risk capacity and our investment themes

Some of these items occur every year and some every quarter.  Staying on top of each one keeps your portfolio in good working order.

Photo Credit: Robert Couse-Baker

This is the third and final installment of our “Behind the Scenes” series.  It is our hope that this series gave our clients a more transparent look at our business so they can better understand the diligence we employ with each client review.

Watch Out For Potholes

Photo Credit : me and the sysop

Unfortunately, with an investment portfolio we don’t always hit a pothole or get a steering wheel shake to let us know it’s time for realignment.  In fact, when investors do begin seeing bad returns, it often leads them to make bad choices with their investments resulting in costly mistakes. We have become well aware of this natural human tendency which is why we rely heavily on our research themes.  By conducting our investment review process quarterly, we can review client portfolios and realign according to our research themes if necessary. During our analysis, we monitor how closely the client’s current investment mix matches our long-term investment strategy.  We also measure the level at which our clients’ stocks are positioned within the allocation ranges we establish during our initial planning work.  If the stock percentage is above or below the range, we know an adjustment should be made.

Mental Accounting

Photo Credit: gutter

Many investors have a tendency to bucket their investment accounts.  They assign different purposes for their accounts which in turn require different investment strategies for each account.  For an investor to reach their optimal portfolio return, we feel it’s vital to have a coordinated investment strategy across all investment accounts.  Qualified plans give us the best example of this philosophy.  Many investment choices offered in 401k’s and 403b’s are limited compared to what you might be able to access in other accounts.  In a 401k, there may be a great international fund choice but only average domestic choices.  In this scenario, we may want to use the attractive international investment for all the funds in the 401k and surround it with more quality choices in other accounts where we have more investment selection.

I’ll Owe More in Taxes?!?

Photo Credit: krossbow

Don’t let the tax tail wag the investment dog.  In other words, there are times when heavy realized gains in a holding could lower the motivation to sell if you were strictly looking at the scenario from a tax perspective.  However, if this same security represented 75% of the portfolio and was comprised of one individual stock, the concentration risk would most likely outweigh the desire to hold on to the stock to avoid incurring a large capital gain.  Decisions such as these take careful evaluation and can only truly be assessed by taking the “big picture” into consideration.

Other Factors

Our investment review process allows us to assure our client’s portfolio is in good working order. To accomplish this, we also consider specific factors such as a client’s age, family relationships, tax considerations, risk levels, and the latest notes and communications with the client to assure we are not missing any potential improvements that could be made to their overall investment situation.  Our investment review process helps us take great care in assuring our client’s investment mix matches their risk preferences. Do you have a review process for your investments?

This is the second part of a 3-part series we’re calling “Behind the Scenes.” It is our hope that this series will give our clients a more transparent look at our business so they can better understand the diligence we employ with each client review.

Photo credit to Michael (mx5tx)

UNDER THE HOOD

In order for a car to stay in good working order, regular maintenance is required.  For investments, our routine maintenance checks occur regularly as we apply our review process to client portfolios on a quarterly basis.  If you popped the hood on our system, you would first notice the engine, our unique research process.  To keep this engine running at a high level, each member of our investment team spends time uncovering their own individual research in order to keep the bearings well-oiled.

We regularly conduct monthly meetings in which we discuss and debate our opinions to develop overarching economic themes and strategies.  These strategies are derived from multiple thought-provoking writers, money managers, and trusted economic researchers.  We also employ several statistical models of our own which are the basis for our estimate of the markets fair value.  After running through likely scenarios and or debunking biased theories, we craft our own strategic calls that we feel hold the most potential for future returns.  Several examples of questions we investigate while making these assumptions include:

• What is a healthy balance for splitting assets between US/Foreign holdings?
• Based on market valuations, which position should we be targeting in your allocation ranges?
• What specific sectors are likely to benefit going forward?
• How long of a maturity and what grade of quality should we be targeting with our bond holdings?
• Do large or small companies possess more potential return?
• Is any particular asset class over or undervalued?

AVOID IMITATIONS

When you encounter a maintenance issue with your car, there can often be ancillary problems that crop up if you try and make the fix with an imitation part.  To have the most confidence, you would prefer to replace with a part made by the manufacturer of the car for the best performance long-term.

The second leg of our unique research process is very similar as we are searching for specific funds to make a client’s portfolio run more efficiently. We run multiple screens in hopes of discovering quality funds that could potentially earn their way into our preferred fund rotation.  These funds go through a rigorous 18-point qualification test which helps us to judge if they deserve the right to be discussed in our Security Selection meetings.  These meetings, which also take place once a month, are where we peel the onion on funds we are considering for usage in our client portfolios.  We do our best to put a fund through the ringer, by evaluating everything from how the manager is compensated, to judging the culture of the mutual fund business.  Once a fund makes the initial cut, we try to find reasons why not to include it in our preferred list.  Several questions usually develop at this stage that gives us a reason to interview someone at the fund company.  Only after this type of meticulous analysis do we upgrade a fund to be used in our client portfolios.

This is the first part of a 3-part series we’re calling “Behind the Scenes.” It is our hope that this series will give our clients a more transparent look at our business so they can better understand the diligence we employ with each client review.