Financial Advisor and CFP - Independent Fee-Only Financial Planning, Salt Lake City, Utah

Are You Better Than The Average Investor?

2012-01-27T14:16:00.002-07:00

The latest study conducted by DALBAR shows that from 1991 through 2010, the average equity fund investor realized an average annual total return of 3.8%, while the S&P 500 Index provided an average annual total return of 9.1%. Similarly, over the same time period the average fixed-income investor obtained an annual rate of return of just 1.01%, while the Barclays Capital U.S. Aggregate Bond Index returned 6.89%.

Research indicates that investment decisions can be affected by a variety of issues, including "herd mentality," overconfidence, pride and regret. There is also a tendency to respond much more strongly to losses than to gains, a tendency that drives many investors out of the markets during acute declines. Thus, this difference in returns is largely attributable to investors getting in when times are good -- essentially buying high and selling low.

The lesson here is that a consistent financial plan helps investors focus on the long term and avoid the type of habits displayed by the average investor.

Are Social Security Benefits Taxed?

2012-01-23T16:42:00.002-07:00

Ever wondered if your Social Security benefit is subject to Federal tax? Well it depends on your annual household income. The following chart tells you how much of your Social Security benefit is taxed at various income levels:

Tax Rates - 2012 and Beyond

2012-01-23T16:36:00.003-07:00

The following chart illustrates the Federal tax rates that will be applied to various income levels in 2012:

Additionally, the following standard deduction levels and personal exemption will apply to all 2012 tax filings:

Finally, the following chart details the changes in tax law that are scheduled to occur in 2013. Notice the increase in the capital gains tax, that dividends will be taxed as ordinary income, and that the top tax rates are scheduled to rise:

Consequently, it may make sense for some investors to recognize certain long-term capital gains or ordinary income in 2012 while rates are low.

How Much Can You Save In Retirement Accounts in 2012?

2012-01-23T16:31:00.003-07:00

The following chart illustrates how much can be saved in various retirement accounts in 2012:

However, your ability to make deductible IRA contributions and to qualify to make Roth IRA contributions fades out after you exceed certain income levels:

Why Many Portfolios Seem To Have Under-Performed in 2011

2012-01-03T12:08:00.003-07:00

Investors will soon receive their year-end statements for 2011 and will be analyzing their returns for what has been a very volatile year. When comparing their portfolio’s returns to popular large-cap indexes, such as the Dow Jones Industrial Average or the Standard & Poor’s 500 Index, many investors may see that their portfolio produced a lower return. In 2011 few well-diversified portfolios matched, let alone exceeded the performance of large-cap stocks. Does this mean that your investment strategy failed last year?

Using exchange-traded funds, here’s a chart showing how various market sectors performed from 12/31/2010 through 12/31/2011:

ETF Name	Ticker	2011 Performance
iShares DJ US Financial Services	IYG	-20.45%
iShares MSCI Emerging Markets	EEM	-18.80%
iShares MSCI EAFE (international)	EFA	-12.23%
iShares Russell Microcap	IWC	-9.84%
iShares Russell 2000 (small cap)	IWM	-4.43%
iShares S&P Mid Cap 400	IJH	-2.17%
SPDR S&P 500 (large cap)	SPY	+ 0.00%
iShares DJ US Real Estate	IYR	+ 5.55%
SPDR Gold Shares	GLD	+ 9.57%
iShares Corporate Bonds	LQD	+9.74%
iShares Barclays 7-10 Year Treasury	IEF	+ 15.65%

As you can see, the S&P 500 was flat for the year. The chart includes six other equity sectors that had losses. Finally, four sectors had gains: real estate, gold, corporate bonds, and U.S. Treasurys. What happened?

The third year of a U.S. presidential term has historically been the best performing year for stocks within the four-year presidential cycle. Incumbent presidents have used the third year of their terms to push through economic stimuli in hopes of getting the votes necessary to be re-elected. The gridlock in Washington this year prevented that from happening. Other negative factors included slow domestic economic growth, Europe’s sovereign debt problems, the earthquake in Japan, and a potential decline in China’s economy.

The performance numbers in the above chart point out the importance of a fundamental investment concept: the need for allocating your investments among various market sectors. If you had some exposure to the asset categories that did well such as real estate, bonds, and gold, it helped your portfolio. However, even with exposure to these asset classes, most portfolios holding a majority proportion of stocks experienced an overall loss in 2011.

Another thing to note is that diversification worked quite well in 2011. Perhaps it didn’t work the way we wanted, but there was a definite variance in asset class performance. After the gruesome bear market in 2008 when virtually all asset classes declined in tandem, many investors claimed that diversification didn’t work anymore. The good news is that 2011 confirmed diversification does work and that when certain asset categories decline others are likely to increase in value.

The Callan Periodic Table of Investment Returns lists nine asset categories (or sectors) and their annual returns over a period of twenty years, ranked in order from the best-performing to the worst. This table is instructive in several ways.

Every year the best-performing asset category has been positive.
The nine categories’ rankings often change dramatically from year-to-year.
There is no identifiable pattern that can predict the best-performing sector going forward.

It can be tempting to abandon target allocation percentages that were established when a thoughtful diversification strategy was originally established. Investors are naturally drawn to higher-performing sectors. For example, from 1995 through 1999 large cap growth stocks led the pack by a substantial margin. Consequently, investors threw their money into this asset class with reckless abandon. Then this trend abruptly reversed as small cap value stocks were the #1 performers in 2000 and 2001.

Finally, we should keep in mind the importance of exercising discipline. As W. Scott O’Neil, President of MarketSmith, recently stated, “The trait most common among successful investors is not intelligence, experience or intuition. It’s discipline.”

At Net Worth Advisory Group, we don’t believe any investors who maintained their appropriate investment allocations failed in 2011. We believe that maintaining proper diversification has paid off over time and will continue to do so.

Is Your Financial Advisor Doing His/Her Job? Year-End Action Items

2011-11-29T14:06:00.000-07:00

Is your financial advisor doing his/her job? If not it could cost you thousands of dollars in taxes and penalties. Year-end is a good time to test your advisor’s dedication to your financial success. Prior to the end of the year there are three things that should be addressed: capital gains, required distributions, and Roth IRA conversions. If your advisor hasn’t reached out to you to address these issues it may be time to hire another advisor. Let’s talk about each action item.

Avoiding Capital Gains Taxes

First, you need to take a look at the investments in your non-retirement accounts to see if you have any capital gains that will add to your 2011 tax-burden. For example, let’s assume you bought a stock for $10,000 in 2009 and sold it in 2011 for $20,000; a gain of $10,000. You will have to pay a capital gains tax of $1,500 (15%) on your $10,000 profit. Even worse, if you owned the investment for less than one year the income will be counted as ordinary income, which can be taxed as high as 35% (creating a tax bill of $3,500!). However, you can avoid the tax by finding another stock/bond/mutual fund in your portfolio trading at a $10,000 loss. By selling the stock and incurring the loss it will cancel out the gain for tax purposes. In this example the strategy will save you $1,500 in taxes (or $3,500 if the profit is counted as short-term capital gains!). If you like the stock or fund you sold you can simply buy it back 31 days later. By reviewing your taxable account(s) your advisor can check your capital gains and look for ways to offset those gains. If this isn’t happening your advisor is not doing his/her job.

Avoid a 50% Penalty

Second, if you are over 70 ½ you are required to withdraw some money from your IRA. If you don’t take the required distribution you’ll have to pay a 50% penalty. For example, if you are a 72 year old with a $500,000 IRA you are required to withdraw $19,531 and pay income taxes on the distribution. If the distribution is not taken the penalty is 50% of the amount you were expected to withdraw. In the case of our example the penalty would equal $9,465! If you are over 70 ½ make sure you take your distribution. Again, if your advisor isn’t doing his/her job and overlooks required distributions it could cost you.

Convert to a Roth IRA

Finally, if you are in a low tax bracket in 2011, which may occur if you lost your job or recently retired, you should consider converting some of your traditional IRA money to a Roth IRA. Be aware that there are pros and a cons when you convert. The “pros” of converting is that once the money is in a Roth it will grow tax-free throughout retirement, and annual minimum distributions are not required. The “con” is that you will have to pay income taxes on the money you convert. However, if you are in a low tax bracket your tax bill will be small.

It may makes sense to convert to a Roth and pay the taxes now if you are in a lower tax bracket so you can avoid paying the taxes later when you may be in a higher tax bracket. This strategy could save you a lot of money over time. For those in a lower income tax bracket, you could very well benefit from a Roth conversion.

Now that we are closing in on the end of the year you can see how much income you’ve earned and determine at what rate you’ll be taxed. Your advisor should be aware of your annual income to help you determine whether a Roth conversion might be a good option. If your advisor isn’t aware of your annual income amount, you may want to look for an advisor who is a little more on top of things.

The Bottom Line

At Net Worth Advisory Group, we review all of our client’s accounts to see if there are capital gains issues, monitor distributions for our clients who are over age 70 ½, and make sure we are familiar with our clients income so we can help them decide if a Roth conversion makes sense. This is routine for us in November each year.

If your advisor is not talking to you about these cost saving strategies I’d recommend you contact them, have a frank discussion about why he/she hasn’t contacted you to discuss these three strategies, and consider hiring an advisor who won’t let things fall through the cracks.

Why Your 401(k) May Change Significantly

2011-11-29T14:00:00.002-07:00

Next year, 401(k) plan participants will see the true cost of their retirement accounts for the first time – and many will not be pleased. In April 2012, long-awaited Department of Labor rules designed to improve fee transparency in 401(k) plans will go into effect. Consequently, many employers are changing their 401(k) plan provider in an attempt to lower investment fees and provide stronger investment options.

There is an old myth that 401(k) plans are “free.” In fact, in a 2011 survey conducted by AARP, 71% of plan participants thought they paid no 401(k) fees. For this reason, expect to hear a collective gasp when investors open their quarterly 401(k) statements in April.

In reality, the fees charged by poorly-managed 401(k) plans can be quite extensive – record keeping, fiduciary services, direct or indirect compensation for service providers (not to mention the cost of the actual investments) just to name a few. Sharebuilder, a nationwide manager of 401(k) plans, estimates that total annual costs for the average 401(k) plan is approximately 2.25%. Further, many registered investment advisors estimate that some 401(k) plans, especially those of smaller firms, could be as high as 3.5% to 4.8% per year.

This certainly doesn’t suggest that 401(k) plans are poor retirement vehicles. The tax-deferral, automatic contributions, and employer-matching benefits are paramount and should be utilized by nearly everyone with access to a plan. Fortunately, the benefit of the new disclosure laws coming into effect in April is that it forces employers to take more responsibility in ensuring their 401(k) plans offer high-quality investments at a reasonable cost.

Although these new laws have not yet taken effect, they are already beginning to serve their purpose. In preparation for complying with disclosure requirements, many employers are already doing additional due diligence and have discovered that their employees have been paying unjustified and unreasonable fees. Consequently, many employers are already making modifications to their 401k plans, or even changing their 401(k) provider.

Look forward to April 2012. Minimizing investment fees is just as important as obtaining a satisfactory rate of return. Be sure to speak to a fee-only financial planner when you receive your first quarter statement to determine whether your 401(k) plan’s fees are appropriate and to identify responsible actions to be taken.

Ameriprise Workers Find a 401(k) Plan Unsatisfactory – Their Own!

2011-11-01T13:12:00.000-06:00

Late last month, a group of workers at Ameriprise Financial Inc. filed a lawsuit in federal court against their employer, accusing the company of stuffing its 401(k) plan with expensive, underperforming mutual funds that came from the company’s own investment management arm. According to the suit, the company placed 401(k) contributions in proprietary funds that charged plan participants $20 million in excess costs.

The workers allege that Ameriprise and its committees, as the plan’s overseers, violated their fiduciary duty to the retirement plan. Investments in the 401(k) plan included mutual funds from Ameriprise subsidiary RiverSource Investments LLC, which is now known as Columbia Management Investment Advisers LLC. (Ameriprise seems to be developing a history of changing the name of their funds frequently to avoid having mutual funds with negative reputations. For example, Ameriprise funds recently utilized the RiverSource name for only five years).

According to the suit, “Defendants chose more expensive funds with inferior performance histories in order to generate revenue for Ameriprise. An investigation would have revealed to a reasonably prudent fiduciary that the RiverSource investment managers investing in RiverSource mutual funds were imprudent.”

The lawsuit highlights several concerns many fee-only financial planners have about their industry. First, as the majority of financial advisors work on a commission basis, there is always concern that advisors will direct their client’s assets into investments that pay the largest commission, not the investments that are necessarily the best option for the client. According to Ron Lieber of the New York Times, since the vast majority of Ameriprise’s revenue comes from investments in the company’s in-house insurance, annuities, and mutual funds, the firm’s success depends on advisors steering client investments into those products.

Second, there is always the concern (and in many cases, plenty of documentation) that proprietary investment options are excessively expensive and provide performance that is under par. In this case, the RiverSource target date funds used by the 401(k) plan cost investors .84% - .94% each year in fees, while a Vanguard alternative charges .10% -.18% in annual fees. Further, workers claim that the RiverSource funds lagged their benchmarks and received poor performance ratings from Morningstar Inc.

The lawsuit provides further support for the contention that fee-only financial planners are in a unique position to focus on what is best for clients. As fee-only advisors never receive commissions from the products they recommend, their job as fiduciaries is to concentrate on recommending the investments with the best performance records and lowest fees at all times. If you haven’t spoken with a fee-only financial planner to confirm you have cost-efficient, high-performance investments in your portfolio, call our office to schedule a complimentary consultation.

The More Things Change....

2011-10-18T14:55:00.005-06:00

Considering the American debt ceiling fiasco, all the political turmoil, a European debt crises, and unemployment at 9 percent, there are plenty of reasons to be concerned about the stock market and the state of the global economy. Consequently, markets have moved downwards since April as all these factors have been digested by investors. Investments within all asset categories have experienced increased and alarming volatility over this period. Naturally, investors and those close to retirement are concerned.

I decided to look at my previous articles to find a way to reflect on recent events; I didn’t have to look for long. Here is an excerpt from the first newsletter I published back in March of 2009:

How volatile is this investment environment? As measured by the S&P 500, the market moved more than 3% in either direction during a single day only once between 2004 and 2007. By comparison, the market moved at least 3% in one day 40 times in 2008. Further, moves of 2% to 3% occurred 28 times during the calendar year.

For those who see no end in sight for this volatile market, remember -- we have been here before! Between 2001 and 2003, the market moved between 2% and 3% an average of 20 times per year, and that was over a three year period! We then moved on to enjoy a relatively stable and profitable period between 2004 and 2007. Thus, history indicates that the increased volatility we are currently seeing in the market is not the "new norm" and we should expect volatility to subside at some point, creating a more reasonable investment environment for all.

I researched the performance of the S&P 500 during 2011 and found that the market had moved 3% or more in either direction only 9 times this year, and 4 of those times the moves were positive. Additionally, moves of 2% to 3% have occurred only 14 times during the calendar year. Again, I can look back and say “we’ve been here before” and point to another example of moving on to more calm and profitable times -- 2009 and 2010. In addition, by comparison, the volatility we’ve recently experienced is actually quite tame compared to market fluctuations we’ve experienced even recently.

The human mind has a unique way of interpreting events relating to investing hard-earned money. We always convince ourselves that current times are unlike anything that’s been experienced before and that today’s problems are more difficult and numerous than yesterday’s problems. The present never seems like a good time to invest and save – we always want things to settle down and be more stable before investing. Unfortunately, these are the feelings that are present in the marketplace 75% of the time. Even worse, if you wait for the 25% of the time when investors feel comfortable you have likely already missed the boat and are likely to have invested immediately after the market has experienced a profitable run.

This is the reason having a well thought out and devised investment strategy teamed with a long term approach is so critical to investment success. The mind of an investor will never make things easy. There will always be a reason for heightened fear or concern, a reason to sell or not invest. Fortunately, investment advisors can add tremendous value in overcoming these obstacles. Do you have an investment strategy? Can you write on a piece of paper exactly the logic used to determine why you hold the investments you currently own? Have you documented which elements of your portfolio are designated to provide income during various periods of your life? Have you established safe measures that will prevent you from selling in the middle of a panic and ensure you don’t end up buying high and selling low? A financial planner can help you answer these questions.

Too often we wait until the market has had an impressive run to feel confident putting our money to work. This is why having a sound investment plan can help you avoid making investment decisions with only a short-term focus. It is also why having a financial planner on your side to ensure you stick to a well-defined strategy during both good and bad times will ultimately maximize your chance of achieving your investment goals.

Is A Roth Recharacterization Right For You?

2011-10-05T18:02:00.000-06:00

In 2010, many people took advantage of law changes enabling them to convert their traditional retirement accounts to a Roth IRA. The intention was to pay taxes on those retirement dollars in 2010 and enjoy tax-free growth going forward.

While this is likely still a sound strategy, the recent market downturn may provide a less expensive opportunity to do this. Consider the example of an individual in the 25% Federal tax bracket who converted $100,000 of retirement funds to a Roth IRA in 2010. In doing so, this investor paid $25,000 in taxes so that all future earnings in the Roth account would grow tax-free.

Now suppose this investor’s current account value has dropped to $80,000 during the volatile market we’ve experienced. An investor might argue that it was unfair to pay taxes on $100,000 of income when the asset is now only worth $80,000. Believe it or not, the IRS is willing to agree.

By recharacterizing the 2010 Roth conversion, both the investor and the IRS can pretend that the 2010 Roth conversion never took place. Essentially, the investor is converting the Roth dollars back into a traditional IRA account where taxes are again deferred and it’s like the Roth conversion never happened. This eliminates the tax bill that was created by the original Roth conversion.

As most people have already filed their 2010 tax returns, they will need to file an amended 2010 return in order to eliminate the reference to the Roth conversion and receive a refund of any unnecessary taxes paid.

What if the investor still prefers the tax-free treatment a Roth IRA provides? Amazingly, the IRS provides an opportunity to still take advantage of these great investment vehicles. After 30 days have passed since the individual recharacterizes his Roth account back to a Traditional IRA account, the investor can against convert the funds back to Roth dollars. What is the advantage of this? Now the investor is paying taxes on $80,000 of income rather than $100,000. Assuming the taxpayer is still in the 25% Federal bracket, the tax bill would now be $20,000. Thus, by recharacterizing and re-converting, the individual lowered their tax bill by $5,000!

The small hassle of this process may not be worth it if the tax savings will only be a couple hundred dollars. However, if you’re due to lower your cost by thousands of dollars, it is definitely something you should look into.

If you converted retirement funds to a Roth IRA last year, speak to your financial advisor to determine if you might be able to reclaim any unnecessary taxes you have paid. Notice: applications for Roth recharacterizations are due October 17th.

The 8 Most Common Investor Mistakes

2011-09-13T14:49:00.004-06:00

Yesterday we reviewed a study by DALBAR that concluded the average stock investor had received a 3.83% annualized return from 1991-2010, while the S&P 500 generated a 9.14% annual return over the same period. The study concluded that investor behavior tends to cause investors to underachieve the market. Today we'll look at the top eight mistakes the average investor makes.

Mistake 1: Excessive Buying and Selling
A study of more than 66,000 households found that investors who traded most frequently underperformed those who traded the least. For the study, investors were split into five groups based on their trading activity. The returns achieved by the 20 percent of investors who traded the most lagged the least active group of investors by 5.5% annually. Another study showed that men trade 45 percent more than women, and consequently, women outperformed men.

Mistake 2: Information Overload
Those who monitor the market too closely have a tendency to undermine their portfolios with self-destructive behavior. Richard Thaler, a professor at the University of Chicago, conducted a 25-year study where he divided investors into three groups: one group who checked their investment performance every month, one that checked performance once per year, and one that checked performance every five years. The study concluded that individuals who check performance the most obtain the lowest investment return and are most likely to sell an investment immediately after a loss. Of course, selling low is not a good strategy for making money.

Mistake 3: Market Timing
History has shown that the market rises about 70 percent of the time. Market timers tend to find themselves out of the market during the 70 percent of the time it's going up because they are trying to avoid the 30 percent of the time the market is falling.

Market timing is typically driven by emotion. Investors tend to buy stocks when they feel good and sell when they feel bad. Unfortunately, investors tend to feel good once the market has run up 20 percent and feel bad when their portfolio is down 20 percent. With the "feel good/bad" strategy, investors will always buy after the market has already gone up and sell when the market has already fallen.

Mistake 4: Chasing Returns
Guess which mutual funds attract the most new money each year? Money flows into mutual funds that have just enjoyed the greatest performance in the previous year. Unfortunately, investors are often late to the party with this strategy. For instance, in 1999 the Nicholas-Applegate Global Tech I fund posted an unbelievable 494 percent return, and investors saw instant riches parading before their eyes. Yet, an individual investing in this fund at the start of 2000 experienced the follwing returns: -36.37% in 2000, -49.26% in 2001, and -44.96% in 2002.

It shouldn't be surprising that chasing returns is a very common mistake. The entire financial media industry is built around a common theme: "Don't Miss Out on the Ten Hottest Stocks." When the fine print says "past investment performance is no guarantee of future returns," believe it!

Mistake 5: Poor Diversification
You may have seen this mistake coming. Investors tend to be concentrated in one or two companies or sectors of the market. Over-concentration can hurt a portfolio, whether the market is performing well or poorly. Poor diversification leads to excessive volatility, and excessive volatility causes investors to make hasty, poor decisions.

Mistake 6: Lack of Patience
Most mutual fund investors hold their funds for only two or three years before impatience gets the best of them. Individual stock investors are even less patient, turning over about 70 percent of their portfolios each year. It's difficult to realize good returns from the stock market if you invest for only weeks, months, or even a couple of years. When investing in stocks or stock funds, investors must learn to set their investment sights on five and ten-year periods.

Mistake 7: Not Understanding the Downside
When you buy an investment, you should plan on worst-case scenarios occurring when you invest. It is true that past performance isn't guaranteed to repeat, but it does give us an indication of what to expect on the downside. Know how your investments performed during recessions, wars, terrorist attacks, and elections. If you don't understand the risks at the outset, you are more likely to react poorly during periodic market setbacks and get scared out of the market.

Mistake 8: Focusing on Individual Investment Performance Rather than Your Portfolio as a Whole
Ray Levitre, author of The 20 Retirement Decisions You Need To Make Right Now, said "One way to know you are diversified is that you will always dislike a portion of your portfolio." If you are properly diversified, I can guarantee you that each year some of your investments will lag behind others in your portfolio. If you look at investments in isolation rather in context of your overall portfolio, you will be tempted to make poor decisions. You can get yourself into trouble by getting rid of investments when they're low in value and replacing them with those that just experienced a nice run.

Conclusion
Most of these mistakes can be avoided by having a clearly defined, long term investment strategy. Before investing, develop a proper diversification strategy, a system for evaluating the performance of investments, and solidify your long term investment goals. Then, turn off CNBC and refer back to the systems and principles of your strategy when it is time to make investment decisions.

Are You An Average Investor? (Hint: Hope You're Not!)

2011-09-13T12:59:00.002-06:00

DALBAR, an independent research firm, recently published a 20-year study that illustrates how the average investor has fared compared to the market as a whole. According to the study, the average stock-fund investor has achieved an annualized return of only 3.83% from 1991 through 2010. Had these investors simply invested their money in the S&P 500 (composed of large U.S. company stocks) and forgotten all about it, they would have achieved a 9.14% annualized gain.

Keep in mind that investing solely in the S&P 500 isn't maximizing the diversification in an investor's portfolio. After all, the S&P 500 doesn't include small and mid sized companies, or international stocks. History tells us that over long periods of time, a diversified portfolio should outperform a non-diversified portfolio.

Even a simply buy-and forget strategy with bonds would have achieved greater returns than what the average stock fund investor achieved over the last 20 years. An investor who simply held the Barclays Aggregate Bond Index since 1991 achieved an annualized return of 6.89%, and encountered much less volatility and risk than the average stock investor was exposed to.

Consider the difference between an investor earning an average annual return of 3.83% as opposed to 6.89% or 9.14%:

$100,000 Invested At Different Growth Rates
Rate of Return	3.83%	6.89%	9.14%
10 Years	$145,622	$194,702	$239,794
20 Years	$212,059	$379,089	$575,014
30 Years	$308,805	$738,095	$1,378,854

Notice the growth in the funds invested at the 3.83% return that the average investor achieves. It should be readily apparent that a 3.83% return is simply not enough growth to provide most of us with anything near the retirement we strive for. So how do we avoid being "an average investor?"

This study illustrates that investor behavior is the biggest culprit causing individuals to achieve below average performance. No single mistake explains this poor performance. Rather, there are a combination of errors repeated over and over - mistakes that can be overcome by simply implementing and adhering to a disciplined investment strategy.

Tomorrow we'll review a list of some of the most common, hurtful mistakes that the average investor makes. Beware: you'll see that the majority of these mistakes are encouraged by CNBC and some of your favorite websites.

Are 401(k) Loans A Good Solution?

2011-08-26T11:58:00.001-06:00

According to Bankrate.com, 19% of Americans tapped their retirement savings last year to cover the cost of an emergency. Most people need to borrow money at some point, but is borrowing from a 401(k) plan the best solution?

Before you consider borrowing from a 401(k) plan, it’s a good idea to weigh the benefits versus the costs. Additionally, be aware that not all 401(k) plans allow employees to borrow from their accounts. Check with your H.R. department before you even begin to consider a loan.

On the surface it may look very attractive to borrow from your 401(k) plan. You can borrow up to 50% of your account value up to a maximum of $50,000. Further, borrowing from a 401k plan is unique in that you’re borrowing from yourself instead of from a third party. The interest and principal that you pay goes back into your plan.

Here’s a simple example that illustrates what you’re essentially doing by borrowing from your 401(k) plan. Assume that you place ten $10 bills in your right pocket. You then transfer the bills to your left pocket and place an IOU for $100 in your right pocket. Every month you return one $10 bill to your right pocket, and you utilize fifty cents from your piggy bank to pay the required interest.

As the example illustrates, the cost of borrowing from a 401(k) can be minimal. However, the individual in our example isn’t exactly getting ahead either. The problem is that you’re just shifting your own money around. You are missing the opportunity to build your 401(k) from an outside source in the form of new contributions, employer matches, growth, interest and dividends.

Taking a loan from your 401(k) has other costs. Most plan administrators charge a fee to prepare loan documents. A large administrator in Utah charges $75 to set up an employee loan. Worse, some employers won’t let you continue contributing to your 401(k) plan until the loan is fully repaid. Thus, you could forgo matching contributions – one of the greatest benefits of an employee retirement plan.

To pay back the money, you must set up a strict repayment schedule. The payback period cannot last more than five years (except for funds withdrawn for a home purchase), and you will typically make monthly payments using a reasonable interest rate – commonly the prime rate plus 1%. Many employers automatically deduct the loan repayment from the employee’s paycheck – with after tax dollars! Of course, this negates another one of the greatest benefits of a 401(k) plan in that you no longer get tax deferral.

If you leave an employer while you have a loan balance, you have to repay the entire outstanding loan balance. If you default on repayment, the IRS will treat the loan as a distribution. You will then be subject to income taxes and, if you are under 59 ½ years old, will have to pay a 10% penalty.

Before taking a loan from your 401(k), ask yourself why you want to borrow money. Reasons for borrowing money run the gamut from truly important things, such as medical expenses or buying a house, to things that merely feed our egos, such as hot new cars or exotic vacations. If you’re borrowing to buy something nonessential, you should consider a different source than a 401(k) plan. It’s not a good idea to replace appreciating assets (your 401(k)) with assets that depreciate.

Generally, I feel that a 401(k) loan should be considered only if it’s essential and all other financial resources have been exhausted. However, there are instances when a 401(k) loan can be a fantastic solution. For instance, I have a client who expects to receive an inheritance within the next few months. However, this client would like to purchase a new home immediately and needs funds for a down payment. It makes sense for this client to borrow from his 401(k) plan in order to cover the initial cost of the home loan and repay the loan in full once the inheritance is received. This enables this individual to borrow funds inexpensively but then not forfeit the great benefits provided by his retirement plan.

Stock Market Craziness

2011-08-05T16:32:00.002-06:00

Dear Clients,

I wanted to share my thoughts given the craziness in the stock market over the past week and hopefully provide some perspective which the press fails to report. Let's look at the market drop from some other angles:

BONDS

Almost all of your portfolios have bonds in them. When you hear news that stocks are down remember that stocks only represent a piece of your portfolio. Further, if stocks are down, most likely bonds are up. This holds true during the past week -- bonds have been up.

STOCK MARKET PERFORMANCE

The stock market is up 8.59% as measured by the S&P 500 over the past 12-months (as of 8/4/11). So, while it's true that stocks have been beat up over the past week, they are still in positive territory for the past 12-months. Year-to-date the stock market is down 3.50%. Longer term the stock market is up significantly. Since March 9, 2009, just about two and a half years ago, the stock market is up 86.31%. Thus, even though the market is down recently it is up significantly over the past two and a half years.

BALANCED PORTFOLIO COMPARISON

By comparison, our portfolios that are comprised of 50% stocks and 50% bonds are up 8.29% over the past 12-months, and are up 0.53% year-to-date. Longer term our 50/50 mix portfolios are up 54.49% since March 9, 2009.

BUY LOW SELL HIGH

It's funny, if I were to ask you how to make money in stocks you'd likely say, "buy low and sell high." However, while this is easy to say it's very counterintuitive. If you buy low you are buying something that is down in price, that nobody wants, that CNBC is saying is awful. Buying low is buying stocks now. Buying high is buying gold now. The average person buys high once an investment has gone up in value and the investor feels good. They generally sell after an investment drops and the individual feels bad. Of course, this is the opposite of what they should do. This emotional investing is the ticket to poor returns.

REBALANCE - BUYING LOW

A good way to take advantage of the recent stock market drop is to rebalance your portfolio. Since stocks have done poorly recently your stock allocation may be lower and your bond allocation may be higher than the targets we've set. For example, a portfolio that was 50% stocks and 50% bonds in January may be 45% stocks and 55% bonds now. My recommendation is to rebalance. This means, in this example, to sell 5% of the bond portfolio and add the money to the stock portfolio, bringing the portfolio back to the target weighting of 50/50. Please let me know if you would like to rebalance your portfolio.

BUCKET INVESTING

We typically position portfolios using a bucket strategy. "Bucket One" consists of the money you'll spend in the next year or two. This money is in money markets or equivalents. "Bucket Two" consist of money that will be spent in years three to ten years. This is our bond money. "Bucket Three" contains the money that won't be spent for ten years or more. With this methodology the money you have invested in stocks is money that we won't begin spending for ten years. This means that if there is a stock market drop we have ten years to rebound. Time is on our side.

APPLE COMPUTER

Do you think Apple will be profitable over the next 1-3 years? In other words, do you think Apple will sell ipads, ipods, iphones, and computers? If the answer is yes and they are profitable, their stock will likely increase. Stock prices, while swayed by the noise of recent events, eventually reflect their true value based on a company's profitability/earnings. I believe companies will figure out a way to be profitable even given the current craziness. If this is true then stock values will go up.

EXPENSIVE WORDS

The most expensive words on Wall Street are, "This time it's different." When we have stock market drops people - even the pros on Wall Street - tend to let their emotions get the best of them, and begin to believe that this market drop is different from previous market drops. We have always rebounded from stock market losses. Corporations have figured out a way to be profitable even when economic conditions have seemed insurmountable. I believe that this will continue to be the case. I believe that capitalism works and will continue to do so. If this is the case, then stocks will increase over time.

HOLD THE COURSE

As you might expect by now, I am bullish on the long-term, and believe that the best action to take right now it to stay the course.

I hope this was helpful as you battle the negative sentiment created by illogical volatility and sensational news reporting.

Retiree's Healthcare and Medicare Basics

2011-08-01T16:03:00.002-06:00

Finding affordable medical insurance is a critical part of your retirement planning. Most retirees ultimately receive health insurance through Medicare. However, early retirees don't have access to Medicare until the age of 65. Thus, individuals retiring early must temporarily obtain coverage either via a continuation of their employer-provided coverage or through private insurance.

Continued Group Coverage
In today's corporate world, you are fortunate if you have continued employer coverage when retiring before the age of 65. However, if you don't, there are legal requirements that prevent employers from completely eliminating health coverage for a period of time after an employee retires. Under the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA), employers with twenty or more employees are required to provide access to continued health insurance coverage to former workers for up to 18 months.

Remember that COBRA only requires the employer to provide access to coverage; the cost of the coverage is assigned to the individual. Unfortunately, coverage under COBRA can be extremely expensive - in some cases as much as seven times what the employee paid for coverage while employed. Because coverage under COBRA must be identical to the coverage the employee had while working, a retiree is unable to choose a less-expensive plan to save money.

Private Insurance
Many early retirees will need private insurance, and it's a tough market for people ages 50 to 64. This age group is largely unprotected by government programs and is most likely to be denied coverage or hit with high premiums. If you have serious health problems, you may want to continue working to keep your employer-sponsored health coverage.

For healthy people ages 62 to 64, private health insurance costs $500 to $1,000 per month. If you are planning to retire before age 65, evaluate your health insurance options as soon as possible. Visit www.insure.com to get an instant online health insurance quote. If you can't obtain coverage, you may have no option other than to continue working until you qualify for Medicare.

Medicare
Last month, Steve Vernon put together some great information regarding Medicare. Following is a summary of Mr. Vernon's article, or you can view the full article here.

Enrolling and choosing a Medicare plan can most easily be thought of as a seven-step process. But first, you'll want to understand the four major parts of Medicare:

Medicare Part A: Hospital Insurance - helps pay for inpatient hospital care, skilled nursing facilities, hospice care, and some home healthcare.
Medicare Part B: Physician and Outpatient Coverage - helps pay for doctors' services, outpatient hospital care, and some other medical services such as blood work, lab tests, and preventive services.
Medicare Part C: Medicare Advantage (MA) Plans - include Medicare Health Maintenance Organizations (HMOs), Preferred Provider Organizations (PPOs), Private Fee-for Service Plans, and Special Needs Plans. Coverage can also include prescription drugs. These plans include Medicare Part A and B.
Medicare Part D: Prescription Drugs - necessary to obtain prescription drug coverage through Medicare. The coverage is offered through private health insurance companies.

Step 1: Check Your Eligibility
Eligibility for Medicare is similar to that of Social Security. You or your spouse must have worked 40 quarters (ten years) in Medicare-covered employment to receive free Medicare Part A coverage. Additionally, you must be 65 and a citizen or permanent resident of the United States. If you or your spouse hasn't worked 40 quarters, your monthly premium for Part A coverage could be as high as $450 per month.

Step 2: Determine When You Should Enroll
If you start your Social Security income benefits before age 65, you'll automatically be enrolled in Medicare Parts A and B upon turning 65. If you haven't started your Social Security benefits by age 65, you'll want to enroll in Parts A and B within three months of your 65th birthday. You'll also want to enroll in Part D at this time unless you're getting prescription drug coverage elsewhere.

If you delay signing up there might be a penalty applied to your premiums. Even if you're covered by an employer-sponsored plan, your employer may still require you to enroll in Medicare Part A at age 65. Ask your HR department for more information. If you don't enroll in Parts B and D because you're covered by your employer's plan, the late enrollment penalty won't apply.

If you decide you'd rather be covered by a Medicare Advantage (MA) plan than by Medicare Parts A and B separately, you'll want to enroll before your 65th birthday to avoid penalties. However, you won't want to elect a MA plan while you're covered by your employer's plan since you'd be duplicating coverage. In this instance, you may want to apply for Medicare Part A coverage at age 65 and then switch to a MA plan after retiring.

Step 3: Choose Between a Medicare Advantage (MA) Plan or Enrolling in Medicare Parts A and B
Medicare Advantage Plans combine Medicare Parts A and B, often cover Part D and may cover some of the amounts you might normally pay for Part A's deductibles and copayments.

The advantages of MA plans are:

All coverage comes from one source.
MA plans may have lower premiums when compared to premiums for Medicare Parts B, D and Medigap.
Some MA plans provide benefits not covered by Medicare, such as dental, vision and wellness.

The disadvantages of MA plans are:

You may be restricted to doctors in the plan's network.
You may need to cover 100 percent of the cost to visit a doctor outside your network.
You may need to pay a co-payment each visit.

Compare features and premiums of the MA plans in your area to enrolling in Medicare Parts A and B separately. Check to see if your preferred doctors or specialists participate in the MA plans you consider. Also, check out this tool offered by Medicare to help determine whether to take traditional Medicare Parts A and B, or enroll in a MA plan that offers coverage for both.

Step 4: Determine Whether You Should Purchase Parts B and D
The basic premium for Medicare Part B (generally $115.40 per month) only covers about one-fourth of the cost; the federal government pays for the rest. For high-income individuals, the monthly premium for Part B can be as high as $369.10. Part D benefits provide essential coverage since most retirees take prescription drugs. Monthly premiums generally range from $20 to $50. Both Parts B and D are good deals for most individuals.

Step 5: Shop For Part D Coverage
Medicare Part D, covering prescription drugs, is insurance you typically buy from an insurance company. You can select among many companies that offer Part D benefits. Mr. Vernon emphasizes that when choosing a provider, consider the plan's formulary - the list of drugs that the plan covers. There are plenty of tools offered by nonprofit organizations that can help you identify the provider that is right for you.

Be aware that Medicare Part D includes the dreaded donut hole. For example, if your total drug costs exceed $2,840 in 2011, you might be paying 100 percent of the costs until your total out-of-pocket costs for drugs reaches $4,550; at that point, you'll be eligible for catastrophic coverage and you'll only pay a small part of the remaining costs.

Step 6: Evaluate Medigap Insurance
Medicare has substantial deductibles and copayments which can lead to thousands of dollars each year in out-of-pocket expenses. Medigap insurance provides coverage for these gaps in your Medicare coverage. Monthly costs for Medigap plans generally range from $50 to several hundred dollars, depending on the type of Medigap coverage chosen.

Medigap plans come in 10 standardized policies, lettered A, B, C, all the way up to N. Each Medigap Plan A has the same features, each Medigap Plan B has the same features, and so on. Once you select the type of Medigap plan you need, you can easily compare the costs among different insurance companies. View a list of the different policies here.

Note: if you enroll in a MA plan you won't need Medigap insurance because that would duplicate coverage.

Step 7: Dealing With Expenses Not Covered By Medicare
Medicare Parts A and B and most Medigap plans don't typically pay for long-term care, vision, dental, hearing aids, or eyeglasses. If you need hearing aids or eyeglasses, you'll want to determine if either your Medigap or Medicare Advantage plan covers these expenses. This can be an item to consider when deciding between Medicare Parts A and B or a MA plan. If the plan you choose doesn't cover these expenses, you'll want to factor these costs into your budget.

Final Thoughts

Mr. Vernon estimates that by the time you add up all the costs involved, you should expect monthly expenditure of $500 or more per person for medical costs. Factoring these costs into your monthly budget can help you decide when you can afford to retire.

Finally, when you see how much money you could be spending on medical insurance and out-of-pocket costs, you might get really motivated to take care of your health to potentially reduce the amount of money needed. Wouldn't you rather spend your money doing fun things than on medicine or trips to the doctor?

What's the Guaranteed Rate on Your Variable Annuity Really Worth?

2011-06-27T13:46:00.012-06:00

Have you heard of an investment that will guarantee a 5, 6, or even 7 percent return, and can return more if the market performs well? Actually, these claims are quite common in the variable annuity world. However, it is critical to realize that the guaranteed return is only half the story, and that the withdrawal rate attached to the annuity dramatically impacts the actual return achieved by the investment.

Moshe Milevsky has done some great work determining "the catch" of these investments. His entire report can be viewed here, but the following is a summary of his findings:

Growth Rates Aren’t The Whole Story

These products are called "guaranteed lifetime income benefit" variable annuities (GLIB VAs). The annual guaranteed growth rate, which is the rate touted by annuity firms to attract consumers, applies only to an income base. The income base is usually the equivalent of your original investment, plus the interest derived from the invested dollars at the annual guaranteed growth rate. This value is completely separate from the actual market value of the account, which fluctuates with the market. At set periods, an investor can choose to withdraw the actual market value from their account or annuitize the income base. If the investor decides he wants to annuitize the value of the income base rather than cash in the actual value of the account, he will receive a set dollar amount annually for the rest of his life. The dollar amount is determined by the withdrawal rate assigned to the contract. Withdrawal rates frequently range from 4 to 7 percent, and this figure is usually not made as clear and apparent as the annual guaranteed growth rate by insurance firms. Yet, it is crucial to understand that the withdrawal rate is different from the annual guaranteed growth rate, and every GLIB VA has both.

In order to take advantage of the annual guaranteed growth rate of as much as 7 percent, investors must first sacrifice the liquidity of their investment. After annuitizing, investors will never be able to access the lump sum of their investment -- they will only receive annual payments for the rest of their life. Second, whether annuitizing is a good option depends on the withdrawal rate and how long the investor lives. If the withdrawal rate is low, which essentially limits the speed in which you can access your invested funds, the annuity’s actual return is lowered.

Not as Good as it Sounds

Let's look at an example. Suppose a 55 year old invests $100,000 in a product offering a 7 percent guaranteed growth rate and annuitizes this product in ten years. The guarantee assures this investor he will have at least $196,715 by the age of 65. This number sounds great, but this is where the potential problem arises.

When you refinance your home, do you simply work with the bank that offers the lowest mortgage rate? Recently, banks started utilizing a trick where they offer obscenely low mortgage rates but charge a high amount of fees to process the loan. Homeowners are beginning to realize that when financing their home, they need to consider total costs, or a combination of the mortgage interest rate and the fees to generate the loan.

Similarly, a high annual guaranteed growth rate of return doesn't do an investor any good if they are restricted by a low withdrawal rate. Suppose our hypothetical product stipulates a withdrawal rate of 5 percent. Thus, at age 65, the investor will receive 5 percent of $196,715, or $9,836 for the rest of his life. Again, this figure doesn't sound too bad, but what rate of return is he actually achieving assuming he lives to his natural life expectancy? Following is a chart containing cash-equivalent returns for GLIB VAs with various guaranteed growth and withdrawal rates.

As you can see, our 65 year old investor whose annuity has grown 7 percent annually during the past ten years but is restricted to a 5 percent withdrawal rate will only earn 2.09 percent annually over the life of the investment. Don’t forget that these guaranteed income riders come with an additional cost – commonly 1 percent per year. Of course, this makes our actual achieved return even lower. Varying the investor's age and the investment's growth and withdrawal rates will produce a range of implied returns, but the actual return is always less than the growth rate highlighted in the policy. Why? As Mr. Milevsky puts it, "marketing materials speak the language of 'investment Celsius' to human beings who are hard-wired to understand 'economic Fahrenheit.' The numbers sound similar, but the scales are completely different."

Do your homework when analyzing any annuity product. Speak to a fee-only financial planner who can provide you with objective advice. You may hear a different side of the story than what you hear from the commissioned sales agent promoting the product.

The Square Dilemma

2011-06-01T11:52:00.002-06:00

Take fifteen seconds and count the number of squares you see in this image.

Do you believe that if you show this illustration to two other people, the probability that all three individuals will come up with a different answer is quite high?

There are actually 30 squares within the illustration: 16 individual squares, 9 squares made up of 2 x 2 individual squares, 4 squares made up of 3 x 3 individual squares, and the entire image itself is the last square.

What’s the point of this exercise? Even seemingly the most simplistic situations can be surprisingly complex, and a second opinion can shed new light on an old topic.

Net Worth Advisory Group offers complimentary consultations. Even if you are confident in your retirement planning efforts and your ability to design a top-level investment portfolio, speaking to a fee-only Certified Financial Planner may provide a new perspective to your situation and reveal ways to improve your financial future. Call to schedule an appointment.

More Than Money

2011-06-01T10:43:00.002-06:00

People often focus their retirement planning efforts on meeting financial goals while neglecting other equally important issues. Relevant questions involve not just what financial resources you will have available, but how you will use your time during retirement.

Katherine Schlaerth, an associate professor emeritus at the USC School of Medicine, recently wrote an article for the Los Angeles Times called “Early Retirement is Hazardous to Your Health.” As a geriatrician, Dr. Schlaerth believes that working longer is generally a good thing. She has observed that patients who quit working are likely to gain weight, become hypertensive, and even develop depression. Her observations have been substantiated by several research studies: the Whitehall II study of British civil servants, a recent joint study by the Rand Corporation and the University of Michigan, and an Israeli study. These studies include the following conclusions:

Continuing to work reduces the risk of cognitive decline.
Both men and women in countries where people work longer have better memories.
Those who work longer have better health and are more independent.

To illustrate these conclusions, try solving this simple problem. If five people win the lottery and the prize of $ 2 million is divided evenly, how much will each winner get? In a recent study, half of Americans over age 50 gave an incorrect answer. Further, three-fourths of people over age 85 and almost everyone over age 90 answered incorrectly.

How can we apply the lessons from these experiments to retirement?

Maintain an activity retirement plan. If possible, keep working. Some people can continue to work part time in their occupations. Retired people can serve as volunteers in various capacities. Pursing hobbies can be rewarding, but some are personal activities that don't include essential interactions with other people.
Avoid too much leisure. We can strengthen and lengthen our cognitive skills by keeping active.
Aging will eventually decrease our reasoning ability, no matter how long we may be able to defer it. Designate a financial advisor or trusted family member to assist in handling financial matters while you are still able to make good decisions. This will not only benefit you immediately, but will also benefit a surviving spouse.

While I enjoyed lunch at the recent National Association of Personal Financial Advisors Conference in Salt Lake City, I met Jim from Fort Collins, Colorado. I discovered that Jim is eighty years old and still practices as a financial advisor. He is slim, trim, and mentally sharp. I'm sure him would agree with these three lessons.

Social Security Benefit Statements No Longer Mailed

2011-05-26T14:06:00.002-06:00

Since 1999, American workers have automatically received an annual Social Security projected benefit statement in the mail. In an effort to save money, these statements will no longer be mailed, at least for the period from April through September 2011. The Social Security Administration predicts that in October it will resume mailing annual statements, but only to those who are age 60 or older and not receiving benefits.

Individuals can still access their benefit statement online. You can get a personalized estimate of your future retirement benefits at www.ssa.gov/estimator, but it won't contain as much detail as the physical document you have been receiving.

The agency estimates that it will save $30 million by suspending mailing for the remainder of the government's fiscal year.

What Kind of "Financial Planner" Do You Have?

2011-04-27T15:09:00.004-06:00

More and more, the term "financial planner" is being overused and misunderstood. When is the last time you heard anyone introduce themselves as an insurance salesman, stockbroker, or annuity salesman? Those terms are increasingly rare because the individuals in those professions now refer to themselves as "financial advisors" or "financial planners." Yet, what financial planning do these people provide? If you speak to someone who generates their living from selling annuities, they are likely to suggest an annuity is perfect for you, regardless of your situation.

Consequently, the title "financial planner" has been diluted to the point that most consumers don't really know what a financial planner does. In fact, many "financial planners" don't even know what a true financial planner does.

Last night I attended a webinar hosted by a "financial planner" who promised his services were one-of-a-kind. This individual stated that 99.9% of financial planners spend 100% of their time managing their clients' portfolios, and that he was unique because not only did he manage investments, but he worked with clients to lower their costs of living. This individual promised he would examine ways to lower clients' insurance bills, taxes, and mortgage payments. He also promised he would educate his clients about opportunity costs, inflation, and retirement planning. Is the wide range of services offered by this individual beneficial? Absolutely.

However, the statement that 99.9% of financial planners spend all their time on investments is entirely false. I believe this individual was confusing the titles "financial planner" with "product salesman" or even "investment advisor." In fact, all true comprehensive financial planners provide the type of benefits discussed by this individual.

True financial planners help their clients determine where they are in relation to their financial goals, plot a strategy to help their clients obtain those goals, and monitor their clients progress to maximize their probability of success. This includes providing advice on all elements of a true financial plan: retirement planning, insurance coverage, estate planning, investment analysis, education planning, and other topics. Additionally, true financial planners educate their clients about the process of making wise financial choices and provide them with the tools to understand the implications of the decisions they make.

So what type of financial planner do you work with? First and foremost, do you have a financial plan? If not, how much planning can your advisor be providing? Also, if you meet with your advisor less than once per year, consider the possibility that he is more a product salesman than a financial planner. Additionally, research how your advisor is compensated - do you pay him directly to represent your best interests, or is he paid by the products he "recommends" to you. Finally, how much advice does your advisor actually provide? Does he simply recommend investments that should make you money, or does he help you identify your goals, teach you strong financial habits, and guide you towards the life you've imagined.

National CFO Survey Results

2011-04-20T11:59:00.002-06:00

Today Grant Thornton LLP released the results of a national survey of U.S. Chief Financial Officers (CFOs) and senior comptrollers. The study concluded there is growing optimism about the U.S. economy as 48% say it will improve over the next six months (up from 30% six months earlier).

While still tepid, 39% intend to increase head count (up from 28% six months earlier), and 54% are optimistic about their own company's outlook over the next six months (up from 46% six months earlier).

Regarding the disaster in Japan, 94% say it will at least be somewhat impact the U.S. economy. Meanwhile, the majority believe that Japan will not fully recover for at least 3-5 years.

Although probably expected, it is interesting how concerns seem to be growing over inflation. 50% of survey respondents say their company intends to raise prices for its goods over the next six months. That figure is up from 31% six months ago and 24% one year ago.

Is Your Home Included In Your Trust?

2011-04-08T11:47:00.002-06:00

My fee-only associate Michael Chamberlain brought up a great point concerning your estate plan. I thought it was worth re-posting:

Having a living trust allows your appointed trustee to control your assets if you become incapacitated. This trust also enables you to avoid probate upon your passing.

When you establish your trust, your attorney will prepare a quit claim deed that transfers your home to your trust. No problem, all is good…until you refinance.

Most lenders want to place the mortgage onto the property when the home is not in trust. The lender instructs the title company to take the home out of trust and then completes the mortgage. There is no problem with this, but you must instruct the title company to transfer the home back into your trust immediately after the refinance.

When interest rates hit a recent low late last year, many people refinanced and the majority failed to put their home back into their trust!

If you have a trust and you own a home, check with your county recorder to verify that it is in the name of your trust. If you are uncertain, check with your estate planning attorney. Be particularly vigilant if you have refinanced since your trust was established.

An ounce of prevention can save tens of thousands in probate fees and prevent delays in estate closure.

A Moment To Focus On The Good

2011-03-30T11:15:00.002-06:00

One of my favorite economists, Jeff Thredgold, pointed out in his recent newsletter that society tends to focus on negative information. Consequently, he dedicated some time to focusing on the positive developments within the U.S. Here is a sampling of the information he mentioned:

The 0.9% decline in the nation’s unemployment rate during the past three months was the sharpest three-month fall in 28 years.
U.S. economic growth has now been positive for seven consecutive quarters.
Productivity of U.S. workers rose an average of 2.6% annually during the past 10 years, the largest gain in 40 years. Rising productivity is a long-term key to higher standards of living.
The number of people who have quit smoking (46 million) now exceeds the number who still smoke (45 million). Less than 21% of adults smoke today, versus nearly half in the early 1950s.
Substantiated cases of childhood sexual abuse have fallen 49% since 1990. Physical abuse of children is down 43%.
Economic output of the average American worker is 10-12 times that in China. Americans won 30 Nobel prizes in science and economics during the past five years. China? Just one.
A record 30% of men have earned a bachelor's degree or higher, versus 29% of women, also a record. This compares to a combined 7.7% in 1960. A record 85% of adults over age 25 now have at least a high school diploma, versus 24% in 1940.

To view Jeff's entire newsletter, visit www.thredgold.com/tea-leaf.

Should We Fear Global Uncertainty?

2011-03-29T11:13:00.003-06:00

Recent “cataclysmic” events will be approximately the fifteenth time the world was supposed to end since 1981, when some individuals at Net Worth Advisory Group began their careers as financial advisors. Think about all the crises that have happened and been predicted over the years. Thirty years ago, a Utah man became popular by predicting an earthquake that would devastate the entire earth. He had it nailed down to the very year. Hundreds of his followers in Utah added earthquake coverage to their homeowner’s policies. The earthquake never came. At least insurance companies did well.

With the one-day decline in the stock market on October 19, 1987, again, the world was coming to an end. Three months later it had totally recovered. Other crises occurred in 1982 (global credit crunch), 1989 (junk bond collapse), 1994 (bond market massacre), 1998 (Russian currency crisis), 2000 (Y2K), 2001 (tech bubble), 2008 (sub-prime loan crisis), and 2010 (foreign debt crisis), just to name a few. During the last thirty years, many Cassandras have regularly issued their dismal prognostications. Sometimes an event occurred that temporarily fulfilled their dire predictions. Yet, the economy and market always recovered. The world continues to turn and function. It can be very dangerous to follow the advice of doomsayers. If you had been out of the stock market the last 30 years, you would have paid a very high price. The S&P 500 closed at 122.55 on December 31, 1981. It’s now above 1300.

If we have learned anything about the stock market during the last thirty years, it is that the greatest risk doesn’t occur when fear is rampant. The most dangerous environment is exactly the opposite: when people are wildly optimistic and buying any investment in sight. Those are the times when risk is the greatest. The building of the tech bubble in 1998 and 1999 is a prime example of this infectious group mentality.

The challenge for investors is to step aside and develop the ability to view world events and market activity apart from the crowd of human sheep. Granted, this is easily said but very difficult to do. Remember that your feelings are most likely the same as everyone else’s. Unless you develop the skill of isolating your emotions from those of the vast majority, you will become a market timer who buys high and sells low – not a good strategy for making money.

The recent events in the Middle East and the earthquake in Japan may have triggered a “correction” in the market that was long overdue. A correction always has a triggering event, but we should remember that the “event” is an excuse, not a cause. What was the market psychology that existed when Middle East tensions erupted? Were investors buying any and every stock with reckless abandon? Was the market greatly overvalued? No -- none of these conditions existed. By answering these simple questions, we can conclude that recent events didn’t signal the emergence of the bear from his hibernation. Last year, we had the “PIIGS” European debt crisis. Despite that event, the market did very well in 2010.

History has shown that human beings have remarkable resilience and an amazing ability to overcome catastrophe. People pull together and solve problems. The Chinese character for crisis contains two parts: one is danger, the other is opportunity. People deal very well with poverty and trials. What they can’t handle well is success and wealth. A patient, long-term view is the price investors must pay to profit from the stock market’s attractive returns.

At Net Worth Advisory Group, we believe that our clients should accumulate a reasonable supply of resources, including cash, to prepare for a disaster -- be it natural, man-made, or personal. But anyone who sincerely believes that capitalism is dead and that all human creativity and technological advances have come to an end should sell all his/her financial assets. Then go buy farmland, weapons, ammunition, gas masks, and all the other survivalist paraphernalia. Sit on the porch of your farmhouse in a rocking chair, shotgun cradled in your arms, and wait for the end. It may be a long time coming -- and that will take a lot of patience as well.

How Do Equity Indexed Annuities Stack Up?

2011-03-17T22:05:00.011-06:00

Sales of equity indexed annuities (EIAs) have grown considerably in recent years. These products are positioned as simple investment vehicles that enable the investor to participate in market gains but offer protection from market losses. In reality, these are complex investments and because salespeople are paid large commissions for promoting these products, it’s difficult to get an objective opinion on whether they are right for you.

How Do Equity Indexed Annuities Work?

EIAs produce an investment return that is tied to a market index, most commonly the S&P 500. Each product has a minimum guaranteed return (currently, 1% is common) and a cap rate, which is the highest annual return the investment can generate (currently, 8% is common).Consequently, an EIA with these common parameters would generate the same return as the S&P 500 of that return was between 1% and 8%. If the S&P 500 produced an annual return of less than 1%, the EIA would guarantee 1%. Similarly, if the index produced a return greater than 8%, the annuity would be capped at an 8% return.

Further, EIAs have participation rates that commonly range from 70% to 100%. For instance, if the index increased in value by 10% during the year, an EIA with an 80% participation rate would produce an 8% return (80% of the index’s 10% return). Also, it is important to note that minimum guarantees, cap rates, and participation rates can change at the whim of the insurance company.

Other Important Factors

As mentioned previously, salespeople are handsomely compensated for selling EIAs. To protect the insurance firm from paying a large commission to a salesperson only to have the investor sell the annuity, these products have a surrender charge if the investors sells within a certain time frame, which can be as long as 10 years. This surrender penalty can be as much as 10%. Thus, liquidity is severely limited with these investments.

EIAs offer tax-deferral, meaning an investor doesn’t pay taxes on investment gains until the annuity is sold. This tax-deferral is similar to the benefit offered by a 401(k) or IRA. However, unlike investments in a 401(k) or IRA, investments in an EIA don’t reduce your current income or tax bill when the investment is made. For this reason, many financial planners encourage their clients to maximize contributions to other tax-deferred vehicles before considering an annuity.

It’s important to note that most EIAs only count equity index gains from market price changes, and exclude any gains from dividends. Since you're not earning dividends, you won't earn as much as if you invested directly in the market. For example, the S&P 500 earned 15.1% in 2010, but 2.3% of that return came from dividends which would not be included in an EIA.

Lastly, the guaranteed return on an EIA is only as good as the insurance company that gives it. While it is not a common occurrence that a life insurance company is unable to meet its obligations, it happens. Information about the financial strength of insurance companies can be found on the SEC's website.

Investment Return

Suppose a 45 year old with a 40 year investment horizon was looking for an investment that offered impressive returns with relative safety. Would an EIA be a good choice? Let’s consider a $10,000 investment in three unique options: an investment in the S&P 500, an investment in a conservative diversified portfolio* consisting of 75% bonds and 25% stocks, and an investment in an equity indexed annuity tied to the S&P 500. For illustration purposes, let’s assume the annuity has extremely favorable conditions: a 100% participation rate, a 3% minimum guarantee, and a 10% cap rate. Further, let’s give the EIA the benefit of the doubt and assume it includes the portion of the S&P 500’s return due to dividends, which few EIAs do. All and all, this annuity is significantly more favorable than any real product you are likely to find. Since the investor intends to live another 40 years, let’s look at what would have happened to these three $10,000 investments during the last 40 years, starting in 1970.

As you would expect, the $10,000 investment in the S&P 500 grew the most over 40 years, to $495,551. However, this investment endured significant volatility, losing as much as -37% in one year. Clearly, this investment is too risky for an investor willing to endure only a small amount of risk. Alternatively, the $10,000 investment in the diversified 75% bond, 25% stock portfolio grew to $433,838 -- still an impressive return. However, the largest loss this portfolio suffered in a calendar year was -6% (1974), which might be tolerable to an investor with a low risk tolerance. Finally, while the equity indexed annuity with unrealistically favorable terms never gained less than 3% per year, our $10,000 investment only grew to $195,479. What if we consider an EIA with more realistic terms: 100% participation rate, 1% guarantee, and an 8% cap rate? Our $10,000 investment would have grown to only $103,767. Clearly, when comparing an EIA to investing in a diversified portfolio with a conservative ratio of bonds to stocks, an investor benefited of accepting a small amount of volatility in their portfolio.

Did you recently purchase an equity indexed annuity without full knowledge of the product? Annuities have a “30-day free look” that enables you to surrender the product free of charge within 30 days of signing the contract. If you recently purchased an EIA, speak to a fee-only financial planner immediately to ensure the product was right for you. If you decide the annuity wasn’t what you thought, a fee-only financial planner can help you exercise your free look provision and find an alternative investment that is more appropriate.

* Model portfolio returns were derived using the following allocation and indexes; STOCKS: 25% DJ Wilshire Large Company Growth Index, 25% DJ Wilshire Large Company Value Index, 10% DJ Wilshire Midcap Growth Index, 10% DJ Wilshire Midcap Value Index, 5% DJ Wilshire Small Company Growth Index, 5% DJ Wilshire Small Company Value Index, 20% Morgan Stanley EAFE Index NR USD; BONDS: 40% Lehman Bros. Long-Credit, 40% Lehman Bros. Long-Term Govt. Bond Index, 20% Citigroup Non-$ World Gov. Bond Index;