September 22, 2014

Don’t get Investment Advice from the Experts on TV #FinancialPlanning #InvestmentAdvice

If you are confused about where to go for financial planning and investment advice, it is no wonder. There is so much information and misinformation about planning and investing that it has all become very confusing. You can’t pass a newsstand, a website, or a cable channel without someone offering you financial advice, most of which is irrelevant, if not downright harmful, to your financial condition. They all seem to tell you what stocks or mutual funds to buy as if everyone in America should be buying the same ones at the same time – and then a bunch of different ones the next month or year.

You might be able to find some answers on the Web. Every answer you need to find is probably out there somewhere, but how do you know which information is reliable? How do you even know you are asking all the right questions and including the relevant information on which to base an answer to your question?

Some of the financial newspapers and magazines are excellent, but others are not. The cable financial channels have up-to-the-minute news and data, ready and at your disposal. Just like the print media though, you need to learn to cull what is useful and disregard the rest. If you don’t make a living as a trader on Wall Street, most of the information is useless to you anyway.

Some portfolio manager touting his stock picks on CNBC will do little to further your financial goals. He is there to promote himself, his picks, and his investment vehicle. If he looks good on TV, he might be able to cut a better deal for himself with his employer or with someone else down the road. If he names the stocks in his funds on TV, some people might want to buy them. If enough people want to buy them, their share price could rise, making him look good. If he touts his funds on TV, more people may want to buy them. The more people that buy the fund, the more people that pay the fund’s management fee. The higher the fee collected by the fund company, the more money it will have on hand when it is time to pay out the hefty bonuses to its star portfolio managers who are always on TV. Whew! I think you get the idea. None of these things help secure your retirement.

Beware: Financial Plan Lure #FinancialPlanning #Investing

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Watch out for this come-on: Firms that use financial plans to sell more products or move your assets to them. While violating no law, this is questionable.

If advisors in the firm are Certified Financial Planner practitioners, odds are they don’t do this. But some advisory businesses still operate that way. Years ago, there were many more.

Playing this game are both stockbrokers, seeking to peddle products, and fee-only advisors, who want to pump up a client’s assets under management (AUM) so their fees (a percentage of AUM) are higher.

Often, the firm charges a very low price and pushes its employees to sell a certain number of plans each year. The cost does not come close to covering the cost to meet with the advisor, or for the advisor’s company to complete the plan. (The plan gets sent to the financial planning center for the data entry and printing.)

The financial plan might even be free if you deposit a minimum requirement or open an account. At my old firm, advisors had to sign up a given number of people for plans every year to qualify for bonuses and rewards. They were even allowed to buy a certain number and give them to their clients for free in order to meet those requirements.

Typically, the broker and the client get together to fill out a lengthy questionnaire. The broker sends it to their financial planning center for data entry and printing. A few weeks later, a big bound book or binder (100-plus pages) comes back with all sorts of facts and figures.

There is usually an action plan. One such plan details that the client needs more life insurance, preferably high-commission whole, variable or universal. The client’s mortgage interest is also too much, so he should refinance his mortgage, through the firm. The client is encouraged to add check-writing privileges on his stock account, and the client’s investment returns would be better and more consistent if he used one of the firm’s fee-based stock account platforms.

Oh, by the way, the advisor says you might as well simplify your life and consolidate all of your financial dealings under one roof. His. We all want to simplify things, right?

Firms also want their clients to become “sticky.” A “sticky” client is one who stays with the firm for a long time, usually because he has an extensive relationship with it.

If you have all of your financial accounts and dealings at one firm, it is a real pain to transfer your accounts somewhere else. Customers who maintain relationships with one firm for multiple products and services tend to be more loyal, and tend to keep their relationship going for a long time.

Moving a stock account is pretty easy, and people move them to different companies all of the time. You fill out some forms and it takes a few weeks, but it’s not that bad.

Other shifts are not so easy. Moving your checking account to a new bank is a hassle, especially now that most people have direct deposit of their paychecks and Social Security, and pay many of their bills with auto-debits.

Transferring a loan to a new lender means having to refinance it, and you only want to do that if you can get a better rate, or it will cost you money.

Moving life insurance is impossible. You would have to actually replace your current coverage with a new policy, and that may not be in your best interests or even a practical consideration at all.

If you have all of these different accounts, products, and services through your advisor, it will make your relationship very sticky. Someone would have to really disappoint you, or make you pretty angry to end the relationship.

Be mindful that some advisors are not necessarily out to protect your best interests.

Don’t rely on a Straight-Line Model for your Retirement Planning #RetirementPlanning #PersonalFinance

You might have a hard time believing this is actually out there, but make sure you don’t use a straight-line model in retirement planning when you try to determine the appropriate amount of withdrawals you can take from a portfolio without running out of money. Using the straight-line method, the software will assume that you earn the average return every year on your asset allocation and that you are taking a fixed dollar amount out every year, adjusting it annually for inflation.

Assuming that your portfolio is half in stocks and half in bonds, the software may assume that you will earn 6% per year, every year. It will further assume that any withdrawal amount less than that will work forever, without you ever running out of money.
Using this type of software and this scenario shows you accumulating money ad infinitum. For example, if you have $500,000, any withdrawal amount under $30,000 (6% of $500,000) will work out fine, and the excess amount will be added back to your principal over and over again. It’s a nice theory. It just doesn’t work often enough to rely on it.

If you were to retire at the beginning of a bear market, commonly defined as a time when stocks in general go down 20% from their previous highs, you would run out of money much faster than the straight-line method would predict. And as you can probably guess, running out of money is the worst financial planning error you can make.

Let‘s go through a couple of examples to show what can happen. In a year when things go well, using the straight-line method, starting with $500,000, expecting and getting an 6% return, and using a 5% withdrawal rate, at the end of the first year you would expect to have $505,000, or $5,000 more than you started with, even factoring a large withdrawal of 5% of your portfolio. $500,000 [Initial Amount] + (6% or $30,000) [Investment Returns] – (5% or $25,000) [Withdrawals] = $505,000.

However, what if bonds provided their expected 4% return, but stocks went down 20%, and you still took out $25,000? Your portfolio would have suffered an 8% loss [.50 x .04] + [.50 x -.20] = .02 + (-.10) = -.08, and you would have compounded the decline even further by taking the 5% of the starting value. You would have ended the year at $435,000. $500,000 [Initial Amount] – (5% or $25,000) [Investment Returns] – (8% or $40,000) [Withdrawal Amount] = $435,000 [Ending Value].

Now, after just one bad year you have about 13.8% ($70,000) less than you thought you would. (You have $435,000 instead of $505,000.) Even if your year 2 returns are flat, meaning not up or down, by the end of year 2 you would have $410,000 in your account ($435,000-$25,000 = $410,000). Well, what if one bad year turns into two, or three, or more bad years, similar to the ones we had just a few years ago? And these were bad just for stocks. Most bonds did well during the recent bear market in stocks. If you were properly allocated, it did a lot to cushion the blow.

What if, like many people, you did not have enough money in bonds during the bear market years? What if both stocks and bonds did poorly at the same time for a few years? It certainly has happened before, and it will happen again. Straight-line is clearly not the way to go.

Don’t Let Financial Planning Software give you a False Sense of Security #FinancialPlanningSoftware

In many instances I think that financial planning software gives clients a false sense of security.  The problem with this software is that you will always have to make assumptions about the future, and many of them will be wrong.

For example, the other day a relatively young person asked me to run a projection to see if he could retire in fifteen years.  Despite my misgivings, I started to input his information into the planning software.

One of the first things it asked for was an assumption of future inflation for the time period, which covered fifty years.  Most economists have a pretty poor track record guessing what inflation was last quarter, let alone what it will be next year, or for the next fifty years.  I think it is a mistake to make guesses that you know will be wrong.

After inputting that somewhat dubious information, the software provides reams of data and projections based on earning some average estimated return over a long period of time, and we really have no idea what his real return is going to be.  It could be much higher than the software assumed, but that wouldn’t be a problem.

What if it was much lower?  What if he saved less than he could have because he figured that he didn’t need to save much have because the financial planning software told him his retirement was already secure? That would be a real problem and one he might not realize until it is too late to do much about it.

I’m not saying you can’t use software or that you can’t make estimates about the future in financial planning.  I’m saying that the further out you go, the more likely your estimates will be wrong and you need to realize that.