Archive for March, 2008
March 31st, 2008
John D. Schissel, QPA, CPC
The ability to make Roth 401(k) contributions became available to companies starting in 2006. The Pension Protection Act eliminated the original 2010 sunset provision and this benefit is now steadily picking up momentum as employers now regularly add this feature.
Roth 401(k) allows participants to tax their earnings when they are made to the plan. When Roth deferrals are withdrawn (assuming you meet certain minimal requirements) these deferrals and all of the earnings are received tax free.
On an economic basis, these two alternatives –Roth and Traditional- will work out exactly the same if the participant remains in the same tax bracket in retirement as they are when the deferrals are made.
Many selecting Roth contributions believe tax rates will increase based on recent government spending patterns; they anticipate being in a higher tax bracket in retirement and believe the solutions to Social Security and Medicare funding will raise the tax burden. Having the ability to pay the tax bill currently to allow investment earnings to compound over many years completely tax free is a great benefit. Assets in the Roth accounts are also not subject to minimum distributions of pre-tax contributions. So, you can gift all of the tax-free returns to your heirs. Generally, the longer investment period, the more advantageous the Roth is.
It is a good idea to do a sample calculation of the investment results of traditional vs. Roth 401(k’s). Some participants do both. If your current plan does not permit the Roth feature, consider asking your employer to add the feature.
March 28th, 2008
Thomas A. Muldowney, MSFS, ChFC, CLU, CFP®, CRC, CMP®, AIF®
This might be the worst of times for the typical boomer approaching retirement.
He has a continuing need for stocks because stocks grow. They do so for a cost…the cost is volatility. To mitigate the volatility, he should consider including some bonds. This combination of stocks and bonds is called “allocation” and such a portfolio is usually referred to as a “balanced portfolio.”
Revenue that can be drawn off a balanced portfolio (stocks and bonds) is usually higher than that which can be drawn off a portfolio of just bonds. The danger is this…since the stock market is so volatile, many folks will change their allocation to one that is heavier in bonds. A portfolio that is “just bonds” will probably freeze his income and his assets. Bonds are the very thing from which the term ‘fixed income’ in retirement comes.
There is little doubt that everything that anyone will do or will need to purchase in the future will cost more than it does today. Everything from apples to a trip to the zoo will cost more. This applies to the natural gas to heat his house to the gas that he needs to put in his car. Unless the retiree has financial assets that can grow and spin off sufficient cash flow, the only year in which a retiree will have enough retirement cash flow will be year number one. After that, for every single year of his retirement, his purchasing power will go down, owing it mostly to inflation.
Bonds suffer a second drawback. Everyone who borrows (a bond issue is the ultimate borrowing) will refinance if interest rates drop. This will cause bonds to deliver even less cash flow to the retiree. It is no wonder that so many households have been forced to consider the slow motion sale of their home in the form of a ‘reverse mortgage.’
This is toughest on the near term retirees because it will jade their perspective on stocks and do so, possibly, for the rest of their lives. That, by itself, may cause many “boomers” to make a decision that will move them toward bonds and thus set off the long slide to loss of purchase power.
The solution requires doing exactly the opposite of that which feels safe. Stocks have clearly been hammered lately but stocks are the heart that drives the pulse of the world’s economy. Stocks represent ownership and employment in the thousands of companies over the entire economic world. Stocks represent how you and I (we are the market) view the future economy. When stocks have low valuations (market is down) it represents that we, the owners of those companies think that the near term future is troubled. Often this only reflects the next several months! The long term is not only positive, but remarkably positive. It seems counterintuitive, but when stocks are down, it means that the costs of the assets that will produce your future income stream, your future income stream, are “on sale.”
So, where do you go from here? The answer is unpopular but direct - you should ‘stay the course!” and maintain your balanced stock/bond portfolio. This will help you preserve your long term retirement security and may be the very thing that keeps you in your house. Doing so may give you peace of mind to enjoy…“the best of times.”
March 26th, 2008
Brent A. Lindell, CTFA
You may not always consider what your investments and values have in common.
Why not?
It is possible to align your investment strategy to increase financial return and social good. This is called “socially responsible investing” (SRI) and it looks at the “bigger picture” when building a portfolio.
Instead of just identifying profitability, socially responsible investors look for companies that bolster environmental responsibility, diversity in the workplace, product safety, and quality. Likewise, a socially responsible investor may opt to avoid investing in businesses that are involved in alcohol, tobacco, gambling, weapons and other military industries, pornography, and/or pro-choice.
SRI is far from a radical idea. According to a 2005 report by the Washington-based Social Investment Forum, $2.29 trillion is invested in SRI strategies. This is 9.4% of the $24.4 trillion total assets under its management. Morningstar calculated that assets in the 20 green mutual funds and exchange traded funds (ETF) it tracks had hit $9.5 billion by June 2007.
Making Green by Being Green?
The big question is whether it’s possible to build an entirely green portfolio. It is no easy task and there are tradeoffs.
The biggest compromise is whether or not you are willing to give up the total return on your investments to get to a green portfolio. You may want to be green but also meet your financial goals. Remember that being green may mean excluding large chunks of the market. Furthermore, what may be “bright green” to one investor may be murkier to another. For some, SRI may mean not having alcohol, tobacco, gambling, or weapons in a portfolio. For others, it means just investing in green industries such as cleaner power.
In fact, how energy fits into SRI is debatable. For a large majority of environmentally-concerned investors, owning shares in gas and oil production, exploration, or service companies is forbidden – however, the investment returns that these companies have had in the past few years have been significant.
Think about nuclear energy. To many investors it is harmful because of the radioactive waste produced as a by-product. To other “green” investors, it may be acceptable as a viable, cleaner-burning alternative to fossil fuels. Ethanol can be taken in the same context. Then there’s wind power – it does not pollute but can be a noisy eyesore and have an impact on local birdlife.
To some, a company’s carbon emissions (contributing to global warming) are enough to remove it from consideration - even though what the company produces doesn’t disturb the green mentality.
The more purist the green investor, the harder it is to craft a diversified portfolio that meets his or her financial and social objective. These portfolios may be highly concentrated and therefore affected when that sector really lags behind the rest of the market.
Thou Shall Not…
Investing in accordance with religious beliefs is also difficult. For example, certain protestant religions do not believe in tobacco, alcohol, gambling, or weapons but think contraception is okay. In contrast, the Catholic religion does not have issue with tobacco, alcohol, gambling, or weapons (except weapons of mass destruction) but does prefer to exclude contraception and abortion. Thus, it is clear that the definition of a sin stock varies significantly by religion and investor.
Finding your Place
Everyone has their own values and knows what’s important to them. Identifying your concerns and if (and to what level) you’re willing to compromise is vital to building an SRI portfolio.
For some, a middle ground would be: instead of screening out “bad” stocks, seek companies that follow environmentally sound companies, regardless of the industry they’re in. Today, investors can access a more targeted approach to SRI (because Wall Street is listening) by buying into specific subsectors (like alternative energy and clean water) through a few mutual funds and ETFs.
When building a green portfolio for his or her client, a good financial advisor should spend the time to determine exactly what he or she “means” by green, sustainable, or environmentally sensitive investing. Remember, these phrases can have different definitions to different individuals. By knowing your concerns, an advisor can build a portfolio that’s an acceptable solution for you.
March 24th, 2008
Brent A. Lindell, CTFA
In my last entry, I spent time on a few savvy tricks that parents can use to educate their younger kids to be smarter about money. The idea is not so much to turn them into money-saving automatons, but to start a learning curve. This time we are going to move up the ladder to older kids (middle and high school age).
In a 2006, the JumpStart Coalition for Personal Financial Literacy surveyed 5,000 high school seniors; the survey tested their ability to manage financial resources such as credit cards, insurance, retirement funds, and savings accounts. The average score was 52.4% - not so great on any bell-curve. This as we’re ready to push our kids out the door to college and, according to Nellie Mae (the nation’s largest maker of student loans); the average undergrad has $2,200 in credit card debt.
There is no doubt we are in an “interesting” time with the sub-prime issue continuing to plague our economy. I just heard a statistic that in the
U.S., we now have less than 50% equity in our homes for the first time since the 1940’s. It seems to me that we see the government trying to aggressively fix the consequences of the sub-prime problem, but maybe we should spend some time on the idea of prevention; to me the issue is what we can do to teach our young people about how to use money wisely and grow into adults that understand the principles of basic personal finance.
When I was in high school (I graduated in 1986 to put perspective on this), the only exposure I got to personal finance was picking and tracking some individual stocks in my Economics class - that was it. In my thought process, it is the responsibility of schools to prepare students for the real world. I am not proposing that we replace core academic classes – but imagine if students left high school with a strong grasp on: how to balance a checkbook, student loans, credit cards (and the debt issue associated with them), and taxes. You could take this concept past what you need to know in college and also give them an education on investing, good debt vs. bad debt, financing a car, insurance needs, how to get a mortgage, credit scores, tracking expenses, and how to set up a budget.
We know that as we send our kids off to college, they are bombarded with temptation which can lead to financial hardship that can chase them their entire life. I also know that there are middle schools and high schools that do embrace personal financial literacy. I just believe, as I look around at the economy, that we could do more on the front end to help prevent bad decisions and integrate this idea of financial literacy into our education system.
As a sidebar, there is an excellent website, www.moneyinstructor.com that hits this concept square on the head with a tutorial approach.
March 21st, 2008
Brent A. Lindell, CTFA
I have three sons, ages 8, 6, and 4. Long ago, my wife and I agreed on trying to impart to them sound building blocks for their future. Like most parents, we want polite, well-mannered kids that have good study habits, play sports, go to college, etc. Another important aspect (since it just happens to be my vocation) is the understanding of personal finance and making sound decisions about money. I truly think that a curriculum of personal finance is lacking from our kid’s middle and high school educations, and needs to be addressed. However, parents can start that education at an even younger age than middle school. One of my favorite writers , Jonathan Clements of the Wall Street Journal, recently wrote about trying four financial tricks to make kids money savvy and I think the ideas are worth repeating.
1) Try to get them out of the habit of the immediate gratification of a dollar today. Let’s say you give your kids $5 a week in pocket money. When the next time comes around to fork over their allowance, offer them a choice: They can have the usual $5 right away – or they can have $7 (40% more), if they’re willing to wait a week. You can probably guess that the immediate gratification is taking the $5 up front – this gives parents a great venue to explain the value of waiting for the $7.
2) Slow down spending by giving them larger denominations. You will likely find that kids are more inclined to spend five $1 bills than they are to spend a single $5 bill. By the way, adults do this too. Research has found that people are less inclined to spend if they had say, a $50 bill rather than ten $5 bills, and it has been proven time and again that we are more careful with our spending, if we are paying with cold cash as opposed to a credit card.
3) Make a wish list to deter impulse purchases. When your child wants something, add it to his wish list. Let a few days or even a couple of weeks go by and go over the list with your kids. You probably wouldn’t be surprised to learn that they sometimes can’t even remember what it was they wanted.
4) Let your kids keep the change. If you give your kids $5, tell them they can buy something and that you want the change back – chances are they’re going to spend the entire $5 (or as close to it as they can get). Instead, try giving them the $5 and tell them they can keep the change. Often you’ll see them end up with the entire $5 unspent. Again, this gives a parent another venue to discuss money and how best to handle it.
March 19th, 2008
Thomas A. Muldowney, MSFS, ChFC, CLU, CFP®, CRC, CMP®, AIF®
Many of you reading this missive have done some traveling. Whatever the trip, you want to get to your destination, safely. Some of you will travel by air. All travel is safer in this modern age, but air travel is particularly safe.
As you are rolling down the tarmac, before you take off, the flight attendant will say, “in the event that something bad happens, the airbags will fall out of the ceiling. Place the airbag over your face and breathe normally.” Now I have to be honest with you, if I have to place a bag over my face, it’s going to be really hard to ‘breathe normally!’
But, the modern day airplane is engineered to handle “in flight” stress. For example the landing gear can support the plane, hold together and land it upright…even when it lands at 440 feet per second, fully loaded. While not in flight, the wings sag. But in order to gain the lift necessary to go airborne, the wings, at the tips, rise several feet
On almost every flight, you are likely to encounter turbulence. Turbulence only counts for about 10% or so of the time that you’ll spend in the air but it is scary, it may make you sick and when you land you’ll probably say…’I’m glad that’s over.’
The volatility in the marketplace today shows up in your portfolio…kind of like air turbulence. Remember, you cannot get from here to there without traveling. Today, I met with Mike. Mike was particularly anxious about the volatility in the marketplace. Among a variety of questions, he wanted to know if the market volatility was going to last forever.
Interestingly, Mike is an airline pilot with one of the major airlines. After a particular turbulent flight, I asked Mike “Aren’t you pilots trained to handle turbulence?” “Sure” he said. “Wherever possible we avoid the turbulence. But, since it is not always possible to ‘see’ the weather, occasionally, you’ll find your self in a pocket of turbulence. The first priority is to navigate through the turbulence, safely. Another primary safety issue for the passengers…make sure the passengers are safe while traveling and that they arrive at their destination safely.”
That’s why the pilot will tell you to go back to your seat and buckle your seatbelt…It will keep you from hurting yourself.
If you are on a plane and it encounters turbulence…you might become a bit frightened. But, you probably won’t ask for a parachute or try to change planes in mid-flight. Even if you tried, you’d be told to sit down and buckle up – for your safety! Get it? For your safety.
Of course, a well diversified portfolio should be designed to handle the turbulence of the market. It won’t stop it, but it is designed for safety. Now, what do you think that you should do regarding the turbulence in the financial markets? Go ahead…it’s OK to ask.
March 17th, 2008
Thomas J. Ptacin, MBA, CFP®
Each year in late January, the Beloit International Film Festival is held just a few miles up the Rock River. The BIFF showcases over 100 films at multiple venues and includes a variety of silent films, documentaries and full length feature films. It is definitely a good way spend a cold January weekend.
One of the films featured this year was titled “The Ultimate Gift.” It is a movie about an extremely wealthy Texas oilman, Red Stephens. Played by James Garner, Red was an extremely successful businessman and active philanthropist. Unfortunately, he failed miserably at teaching his family the important lessons about responsibility, values, handling money, and being productive members of society. Terminally ill and sensing one last chance with his grandson, he designs a series of tasks referred to as “gifts”, which are meant to teach the young man many of these important life lessons. Once this series of gifts are completed, his grandson will be eligible for the large inheritance.
While most of us will never be encumbered by the amount of wealth portrayed in this movie, the messages of the film can still be applied to more real life situations. No matter how much money is involved, gifts or inheritance falling into the wrong hands at the wrong times can do significant harm to those the benefactor is trying to help.
For most people, some of these problems can be addressed with proper estate planning and legal documents. This type of planning is a must. However, an even more powerful way to start is by teaching kids about money and having discussions about the values for which you feel strongly. Once these lessons are engrained, your legacy has the opportunity to grow long after you are gone.
March 14th, 2008
Thomas J. Ptacin, MBA, CFP®
In my previous blog entry, I discussed some basic principles of asset allocation. You now have selected the appropriate assets classes and have purchased the right mix of investment vehicles to meet your targets. However, once you’ve implemented your portfolio, the effects of the market will begin to alter the composition of the portfolio you worked so hard to create.
Let’s use an investor with $200,000 who builds a moderate portfolio of 70% equities and 30% fixed income. Assuming equities average 10% growth per year and fixed income averages 5%, the investor’s initial equity allocation of $140,000 grows to $363,000 over a 10 year period. Over that same period of time, the fixed income portion of the portfolio also fulfilled its job description and the 5% average rate of return on the $60,000 initial allocation to fixed income is now $98,000.
The good news for our investor is that his initial investment of $200,000 has now grown to $461,000. It is, however, important to note that the investor’s allocation is now almost 80% in equities because the strategy worked as planned. The risk profile of this investor’s portfolio has now changed and the potential volatility of this “heavier in stock” mix of assets may no longer be appropriate.
One important, but often overlooked, element of managing a diversified portfolio is having a periodic rebalancing process in place. The concept is simple, on a periodic basis review the actual value of each asset class in your portfolio versus the target weightings. If the current value of the assets in a particular class is higher than the target, trim the excess amount by selling investments in the overweight class. Follow this by purchasing investments in the underweight asset classes to reconstitute your portfolio.
The equity to fixed income ratio is probably the most common segment to be measured. Though it is prudent to monitor your portfolio on several levels; International to Domestic, Large Caps to Small Caps, Growth to Value.
How often you need to monitor your portfolio depends on its complexity, but in most cases quarterly or even annually is acceptable. The critical part is that it is done consistently. Allow for some deviation from your targets to reduce the amount of transaction costs and taxes generated from rebalancing.
By following this type of process, you can be assured that your portfolio maintains risk characteristics that you are comfortable with. Systematic rebalancing also removes much of the emotion from your investment decisions, helping you sell high and buy low.
March 12th, 2008
Thomas J. Ptacin, MBA, CFP®
The term Asset Allocation is not new to the field of personal finance. Prudent investors seeking to diversify the risk in their portfolio divide investment dollars into a broad array of asset classes. While the concept is simple, the construction and implementation of a properly diversified portfolio is not. Below I will discuss some issues that need to be considered when allocating your investment assets.
In previous blogs last week, Amy Barrett shared some ideas for determining investor risk tolerance and a proper ratio of equities to fixed income. Generally speaking, those with a long time horizon until retirement can and should consider to be heavier in equities. As the investor ages and gets closer to retirement years, the need for preservation and stability emerges and increasing the allocation to fixed income typically makes sense. However, don’t overdo it. People are living longer and many retirements last in excess of 30 years. The risk of your portfolio eroding from inflation needs to be mitigated by maintaining some degree of exposure to equities in your portfolio.
Once you’ve chosen a mix of equities and fixed income that you are comfortable with, the next step is to determine the breakdown of the equity and fixed income components. When determining your asset allocation mix you should consider the following:
Invest in our Friends Overseas: By concentrating solely in the United States, you are ignoring over half of the global stock market capitalization. A mixture of domestic and international equities provides greater opportunities for diversification.
Don’t Forget about the Little Guys: Small Cap stocks actually have a higher expected return than Large Cap stocks. Furthermore, small companies have a low correlation to their big brothers. This means that oftentimes when Large Cap stocks are struggling, the small cap stocks are performing well. Healthy allocations to small cap stocks offer a great complement to the large caps in your portfolio, both in the US and Internationally.
Include the Tortoise along with the Hare: Growth stocks (the hare) can be exciting, but surprisingly value stocks (the tortoise) have historically come out ahead more often. Having a combination of growth and value stocks is important. Either is capable of winning the race in any given year. Unfortunately it is impossible to know the winner ahead of time.
Short isn’t so Bad: Try to limit the maturities on your bond portfolio to short and intermediate lengths. While long-term bonds typically offer slightly higher yields, they also come with more risk. Reducing portfolio risk on the bond side can allow you to spend more risk on the equities, which have a higher expected return.
March 10th, 2008
Amy L. Barrett, MBA, CFA, CFP®, CDFA™
My previous blog discussed the importance of identifying investment goals. A carefully planned goal is similar to the destination on a trip: the place that we want to reach. On a road trip, the car is the tool to get us there while in the financial world, the tool is the investments.
The most important financial decision affecting long-term investment results is the choice of stock-to-bond ratio of a portfolio. A simple example will help to illustrate the stock-to-bond ratio concept. An investor with $100,000 can choose to purchase $100, 000 of stocks or $100,000 of bonds. Alternatively, the investor could hold a percentage of stocks and bonds. For example, he could buy 50% of each: $50,000 stocks and $50,000 bonds. The percentage of stocks to bonds (50% stocks to 50% bonds) is known as asset allocation. The ratio is the most critical long-term influence on portfolio results because of the return difference between stocks and bonds. Where a bulldozer (think of bonds) could get to your destination, the trip might be slow and steady. On the other hand, the racecar (stocks), will get your there sooner. Historically, stocks (S&P 500) have had an investment return of 10.4% per year while bonds (U.S. Long-term Treasuries) had returned 8.5% per year. The implication is that the greater percentage of stocks, the higher expected ending wealth. Bonds lower the potential return of the portfolio.
How do to you choose the ratio of stocks-to-bonds? At Savant, we like to think of the stock-to-bond ratio choice as an eat more/sleep more choice. The more stocks in the portfolio, the higher the expected return, thus you can eat more in the end. The sleep more choice is one of physiological comfort where you are OK with the losses in bad times. One of the advantages of working with a financial advisor is their skill in helping identify your portfolio choice. Just as a good car salesperson can help you get the best auto for your cross-country trip, a skilled advisor can assist with the asset allocation choice.
Amy L. Barrett MBA, CFA, CFP®, CDFA™ is a financial advisor, specializing in investment and divorce planning issues, with Savant Capital Management, Inc., Rockford, IL 815-227-0300
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John D. Schissel, QPA, CPC 
