Three Steps to Wealth & Financial Security
Page 9
Recommended reading: “Social Security’s Role in Your Retirement Portfolio” by Walter Updegrave, CNN Money, February 20, 2013;
“When Interest Rates Rise, Watch Out” by Andy Kessler, The Wall Street Journal, February 21, 2013; “Low Interest Rates Force Creative Choices” by Anand Shefali, The Wall Street Journal, March 1, 2013; “What Are CDs Good For?” by Liam Pleven, Wall Street Journal, March 15, 2013; “The Dark Side of Bonds” in the Appendices.
A note about interest rates: Interest rates today (2013) are at historically low levels. When interest rates go up, bond prices, especially long term bond funds, will fall. Warren Buffet has been quoted as saying that he does not like owning bonds “right now”, and he does not think average investors should either. His recommendation for individual investors (as of May 2013) is to keep cash on hand if the unexpected happens. See “Warren Buffett: Buy Stocks; Beware Bonds” USA Today, May 6, 2013.
Depending on interest rates, as an alternative to Vanguard’s Total U.S. Bond Market Index Fund which invests in all maturities – short, intermediate and long term bonds - one might consider a short term bond fund that would be less vulnerable to interest rate risk. Vanguard’s Short Term Bond Fund offers maturities from one to five years. Another option would be to use a money market fund in lieu of a bond fund. Vanguard’s Prime Money Market Fund seeks to provide current income and preserve a shareholders’ principal investment by maintaining a share price of $1.00. The fund invests in short-term, high-quality securities. The amount of income that a shareholder may receive will be largely dependent on the prevailing interest-rate environment.
Recommended reading: “Hidden Danger Lurks in Long-Term Bond Funds” John Waggoner, USA Today, April 26, 2013; and”Making Sense of Money Market Funds”, vanguard.com.
But shop and compare. Suggested brokerages to contact: Vanguard: vanguard.com – 877-662-7447
T. Rowe Price: troweprice.com – 800-541-6066
Schwab: schwab.com – 866-855-9102
Keep Your Portfolio Tuned Up
If you let your portfolio roam free for too long, you could become too heavily invested in stocks, risking large losses if the market were to go down.
How do you rebalance? Buy or sell securities to get back to your preferred asset mix. Vanguard will rebalance automatically for you if you give them the authority to do so.
Recommended reading: “Asset Allocation and Disciplined Rebalancing” Vanguard.com, April 15, 2013; “Keeping Your Investments in Balance”, Carolyn T. Geer, Wall Street Journal, June 8, 2013.
For Some, Asset Mix May Not Be Significant
Center for Retirement Research, Boston College Study
According to the Boston College study, few in United States have enough money invested in their accounts to make a difference. Improved investment returns by asset allocation and rebalancing for these people may not significant.
The following variables would be more important for most people: (1) continue to work: for every year worked, it is a year you can add to your retirement portfolio and not take money from it; and (2) cut spending and increase savings.
g. Seven: Keep Your Portfolio Simple
“When it comes to your portfolio and investing practice, more isn’t always better”. Anna Prior, Wall Street Journal
When it comes to investments, we have many options. “Some investors think they are diversified because they have money in 10 different places, only to find there’s a lot of overlap”. Scott Halliwell, certified financial planner, USAA.
Sometimes we are overwhelmed by the options available to us. One person who called me to consult said, “My financial planner has me in over a dozen actively managed mutual funds. I am overwhelmed so I let him manage my portfolio and decide what to buy and sell”. Not smart! Recommendations and guidelines: First: Do not use the same financial adviser to counsel you on a financial plan and also buy investment products. Such an adviser has a conflict of interest. You are now a part of his/her financial plan.
Second: Switch to low cost index funds.
Three: You only need a few funds. For example, if you are in your teens, twenties or even thirties you may be comfortable with one fund: a total U. S. stock market index fund or a small- cap growth index fund. If you are more conservative, you may want to add a total bond market index fund or a money market fund for income and as a hedge against the volatility of stocks. As the years go on, most investors add a bond fund to their portfolio. To add diversity, some/many will add a total international stock index fund and possibly a REIT index fund. In some cases a single fund can take the place of several funds. The classic example is a target-date fund discussed earlier in this section. The fund company automatically adjusts your mix of stocks and bonds to get more conservative as you near retirement.
Four: Put investing on auto pilot via monthly auto deductions from your bank and then monitor your portfolio; rebalance on an annual basis if necessary.
Recommended reading: “Keep Your Portfolio Simple” Anna Prior, Wall Street Journal, May 2, 2013.
f. Eight: Stay Married
“The most important decision you make in life is who you marry”. Warren Buffet
If you are married, stay married. The average married couple saves ten times more than the average single person. Why the huge disparity? The answer: divorce. Couples who divorce typically spend a great deal on attorneys and must also obtain new housing. It is cheaper for two to live than one. See the April 21, 2013, Wall Street Journal video on personal finance, captioned “Stay Married and You’ll Retire with More Savings”. Also see “Couples Need More Than Love” in the Appendices.
11. FINANCIAL PLANNERS AND OTHER ADVISERS
a. Do You Need a Financial Adviser?
“Many people need a financial planner”. Larry Branton, Esq., tax, estate planning and employee benefits attorney
Jane Bryant Quinn, author, “Making the Most of Your Money,” gives this advice: Financial planning is not that hard. You do not need a financial planner.
You do need a list of objectives, a few simple financial products (such as index funds), a timeframe to give investments time, reasonable expectations, and the ability to avoid sales pitches—that is, avoid pitches from individuals in the financial services industry who sell actively-managed mutual funds and individual stocks.
Ms. Quinn gives sound advice. We have seen first- hand, however, that it is difficult for people to make wise judgments about their financial situations. So, we believe that “many” people, as Mr. Branton states, could benefit from a financial adviser.
But be careful: Hire a planner or adviser to review and/or assist with your financial plan. Do not allow the planner to sell investment products to you.
Recommendation: Buy low cost index funds directly from a large discount broker such as Vanguard, Schwab, or T. Rowe Price. See our discussion immediately below.
b. Is Your Adviser a Fiduciary or a Salesperson?
“There is no federal requirement for financial brokers who give advice and earn commissions to act in the best interest of their clients”. “Investors Beware”, New York Times, February 15, 2013
A RAND Corporation study revealed that investors have little understanding of whether their financial planner is a fiduciary or salesperson or how their planner is paid, that is, commission based, an hourly rate, or a percentage of the client’s portfolio.
Allan Roth, CPA and Financial Planner, “The Two Faces of Your Financial Planner,” AARP Magazine, April/May 2012, offers the following advice: Do not use planners to buy investment products.
Planners who sell investment products are not fiduciaries; they in fact have a conflict of interest with clients.
Andrew Haigney, a registered investment advisor, offers these insights: “Investment advisers and planners effectively have a license to steal.
“One needs to understand that the financial services industry’s planning-based sales techniques were developed by the marketing folks on Wall Street. Years ago trad
itional stockbrokers struggled to get a handle on the true nature of their client’s assets. Very often their most wealthy clients would maintain small accounts with the brokers.
“By offering their customers planning-based products and services, the customers became more forthright about revealing the true nature of their assets. The more details clients reveal about their financial station, the more sales opportunities for the financial services firms.
“When your financial plan comes with a financial planner or an investment adviser, you actually handicap your chances of achieving your goals. Investors seeking help putting together a financial plan end up becoming a part of the financial planner’s financial plan”.
Haigney’s article, “Your Financial Planner Will Probably Handicap Every Investment You Make,” can be read at http://www.businessinsider.com/a-license-to-steal-2012-8#ixzz25RfXccF3.
c. Our Recommendations
Retain a tax adviser to review your investment plan. S/he can ensure that your money is invested in the “correct” accounts, that is, taxable or tax deferred. The goal is to decrease taxes and increase savings. See Chapter 12 immediately below.
Retain estate-planning counsel to create a living trust to ensure that your assets pass directly to your beneficiaries, thus avoiding probate. Equally important, a living trust will allow your heirs to manage your estate in the event you become incapacitated.
Retain a trusted fiduciary to review your financial plan. A fiduciary can evaluate your plan and give you an opinion as to whether your plan is reasonable and wise. Your adviser could be a CPA, an economist, an MBA in Finance, or a financial planner. The rules of engagement should include the following: Understand how this adviser will be paid. Ensure s/he is a fiduciary who represents your interests.
Do not allow this person to sell you financial products such as actively-managed mutual funds, stocks or annuities.
Ensure that the person you select understands money management, financial planning, and wealth building.
If you need help constructing your portfolio or managing your investments, a fee-only planner who charges by the hour may be located at garrettplanningnetwork.com.
Recommended reading: “How to Find Low Cost Investment Help,” by Michael Pollock, Wall Street Journal, May 31, 2012; “A New Era for Do-It-Yourself Investing”, WSJ, May 6, 2013
12. TAX EFFICIENT INVESTING
“Improper tax management can cost you more than 25 percent of your long- term return, severely impacting your spending power in retirement”. Brendan Erne, financial writer
“The two most common tax missteps are failing to use a 401(k) or IRA and using tax inefficient investment vehicles such as actively managed mutual funds.” Brendan Erne
“While it is probably a poor idea to own actively-managed mutual funds, it is a terrible idea to own them in taxable accounts. Taxes are a drag on performance of up to four percentage points each year. Many low cost index funds allow your capital gains to grow largely undisturbed until you sell.” William Bernstein, author of The Four Pillars of Investing Note the managers of actively-managed funds, attempting to beat the overall market, typically sell or turn over the stocks in their funds on a regular basis, thus triggering short-term capital gains. Taxes paid by investors, as stated by Dr. Bernstein, are a significant drag on the fund’s performance.
“Index funds are tax friendly, allowing investors to defer capital gains or avoid them completely if the shares are later bequeathed (that is, left to heirs). Taxes are an important financial consideration because the earlier realization of capital gains will substantially reduce net returns.” Dr. Burton Malkiel, author of A Random Walk Down Wall Street and Princeton professor
Recommended reading: “How to Be Smarter About Taxes” By Michael A. Pollock, The Wall Street Journal, February 2, 2013
13. WILL YOUR MONEY LAST YOUR LIFETIME?
“For many retirees, the big risk isn’t that they will run out of money before they turn 70 but after 85”. Brett Arends, Wall Street Journal
Many of us now live into our eighties, nineties, and even to one hundred. Perhaps the biggest challenge will be to ensure that our savings will last our lifetime. How can we ensure that it does? First, be careful before moving to all cash, certificates of deposit, or bonds, which may not keep up with inflation. You must invest some of your portfolio in stocks.
How then should you allocate among stocks, bonds, CDs, cash or money market funds? How much can you withdraw each year and ensure your money will last as long as you need it? “In the 1990’s California financial planner William Bengen analyzed historical returns of stocks and bonds and found that portfolios with 60% of their holdings in large company stocks and 40% in intermediate term U. S. bonds could sustain withdrawal rates starting at 4.15% and adjusted each year for inflation for every 30 -year span going back to 1926 - 1955”. Kelly Greene, Wall Street Journal. Can you rely on the 4% rule today? See citation to Ms. Greene’s article below.
“If you want reasonable assurance your savings will support you at least 30 years, the single most important thing you can do is to start with a modest withdrawal rate – say 4% or, given today’s interest rates, perhaps even less”. Walter Updegrave, CNN Money
“To avoid running out of money too soon – or ending up with a big stash late in retirement, along with regrets you hadn’t spent more freely early on – you’ve got to remain flexible, cutting back when returns are lean and perhaps spending more if your portfolio’s done especially well.” See “Make Your Retirement Savings Last into Your 90’s” by Walter Updegrave, CNN Money, March 15, 2013.
Recommended: Pick up a financial calculator. MSN.com,Bloomberg.com and bankrate.com, among others, have on line calculators if you do not own one. Put in the amount you have saved to date and then run a number of scenarios with different withdrawal rates and different stock/bond allocations to get an idea of how long your money will last. If you are uncomfortable using a calculator, you may want to consult a financial adviser or a friend who is comfortable using one. See Chapter 11 where we discuss how to locate and select a competent adviser to assist you.
Recommended reading: See “Say Goodbye to the 4% Rule” by Kelly Green, Wall Street Journal, March 1, 2013. Ms. Green suggests three alternative approaches that retirement specialists opine may work better than the 4% rule: 1.) Use annuities in your portfolio instead of bonds; 2.) Follow the minimum IRS rules for IRA withdrawals; 3.) Peg withdrawals to stock valuations.
One final question: Is it possible to be a conservative investor and not outlive your money? The challenge: you must be an aggressive saver. “Save half of what you make; live on the other half,” Mark Twain.
Good news: conservative investors who save aggressively can do OK. Gary’s dad invested in government bonds and a four unit apartment building, and his nest egg that lasted years beyond his lifetime. It is now being used to take care of our step mother who is well into her 90’s.
Today, consider the following facts: Government I Bonds pay a fixed interest rate, (0 currently) and a variable rate that keeps pace with inflation.
TIPS–Treasury Inflation-Protected Securities pay a fixed interest rate plus their principal is adjusted by the Consumer Price Index.
The returns on TIPS and I Bonds are about the same as inflation.
Recommended reading: “The Experts: Finding Income Despite Low Interest Rates”, Wall Street Journal, March 6, 2013
Part 4
Investing in Houses:
Pros & Cons, Biggest Mistakes, Guidelines for Investors
1. INTRODUCTORY COMMENTS
“Investing in a rental home isn’t as safe as it may seem”.
Tara Siegel Bernard, New York Times, March 30, 2013
“Buying real estate is the largest, most complicated and riskiest purchase you will ever make”. Leonard Baron, investor and author
Investing in real estate is elective not mandatory. Warren Buffet, America’s most successful investor, for example, does just fine buying
companies. Because many people want to be real estate investors we have included this section. The opinions we express are based on our experiences buying, owning and managing single family houses for the last thirty years, as well as counseling real estate investors for the last ten years. The opinions expressed are also based on my experiences as an attorney, mediator, and arbitrator resolving real estate disputes.
Both real estate and stock market investing require knowledge, commitment, and patience. Investing in low cost index funds is not complicated. In fact, as we have seen, it is pretty simple. If you invest by auto deduction month after month, year after year, you can build a nest egg, take advantage of compounding, and achieve wealth and financial security.
Real estate investing, on the other hand, is hard work and not so simple. We have seen many people try to be real estate investors. We have seen many fail.
If you want to be a real estate investor, learn as much as you can before you get started. In addition to reading this part of our book, read Part 3, in particular Chapters 2 and 3, “Compare and Contrast Asset Classes” and “Houses Versus the Stock Market.”
Some of our favorite real estate investment books are listed in the Appendices. See Amazon.com for further information about each book. A few comments about the books and their authors: