Ignore Cost at Your Own Risk

When selecting investments or investment advisors, people get caught up in mutual fund star ratings and performance track records. Cost of investing is only briefly considered, regardless of the sophistication of the investor, until they start to realize they aren’t making much headway. I was reminded of this by a phone call today.

A client’s relative sits on a foundation board, and he’s concerned about the lack of communication and reporting he receives from the company that manages the foundation’s endowment fund. During our conversation I learned they’re being charged 1.25% on the entire balance of the fund each year. This is a HUGE fee for that size of investment. I calculated our management fee using the Asset Advisory Group’s schedule - only .35%. If the endowment grows by 6% per year, over a ten year period the savings would be $2.3 million – which doesn’t even include the fees charged by the mutual funds or sub-managers they use.

This same trap catches people trying to invest on their own. Index annuities are being recommended as a solution for investors afraid of the market – a way to experience stock market gains without the risk. I won’t address all the problems with these investment vehicles (you don’t want to read a 10 page blog) but they’re one of the most expensive investments you can make. The Florida Department of Financial Services describes them as “extremely complex investment products that contain many detrimental features such as hidden penalties, costs, fees, and massive, multi-year surrender charges.” Market value adjustments, administrative ‘spreads’ and internal costs of the mutual funds inside the contract run as high as 25% each year.

When selecting a mutual fund in their 401(k) plan, most investors look at past (especially recent) investment performance to choose. But cost, not an investment’s track record, is a better predictor of whether you will make money in a fund in the future. Morningstar, the company that provides mutual fund scorecards, published a report in August 2010 that concluded the best predictor of a mutual fund’s future results isn’t the genius of the investment manager; it’s the expense burden the fund carries. According to Russel Kinnel, director of mutual fund research at Morningstar, “In every single time period and data point tested, low-cost funds beat high-cost funds.”

If you don’t know what you are paying to invest, find out. Cost is important, and if you ignore it you do so at your own financial risk.

Jeannette A. Jones, CPA, CFP®
jjones@taaginc.com
http://www.taaginc.com/

The Danger of Stock Market Forecasts

(from Carl Richard's New York Times' Bucks blog, 1/10/2011 - click here for the original post)

Carl Richards is a certified financial planner in Park City, Utah. His sketches are archived here on the Bucks blog, and other drawings are available on his personal Web site, BehaviorGap.com.

January marks the time of year where gurus come out of the woodwork with their stock market forecasts.

I thought it would be valuable to review a few of them and try to understand what they might mean to real people investing in the real world. I’ll cover two recent forecasts and one from a few months ago, too.

Let’s begin with Robert Prechter. In July, 2010, he said that based on his version of something called the Elliott Wave principle, “the Dow, which now stands at 9,686.48, is likely to fall well below 1,000 over perhaps five or six years as a grand market cycle comes to an end.” Since then, the Dow has been up sharply.

Then we have Robert Shiller of Yale. He recently put his price target for the Standard &Poor’s 500-stock index at 1,430. (At this writing, the index is currently about 1,280.) Before you get too excited, note that Mr. Shiller says that his prediction is for 2020. That works out to less than a 1.5 percent increase a year for the next decade!

Finally, there’s Laszlo Birinyi. According to a recent Bloomberg Businessweek article, Mr. Birinyi believes the S.&P. can hit 2,854. And in an amazing display of precision, he predicts this will happen on Sept. 4, 2013.

So there we have it. Three market gurus with three wildly divergent forecasts that were all covered and reported by reputable, mainstream news outlets.

What’s a real investor to think or do?

The problem with gurus and their guesses is not that they’re always wrong. Part of what makes these forecasts so tempting is that the gurus are right just often enough for us to believe that there’s merit in listening. Unfortunately, it’s incredibly difficult to identify which forecast will be right.

So what does a real person do with this information? I suggest you use it as kindling, as a starting point. I know it’s fun to chat with friends or colleagues about your opinion of the stock market. I also know it can feel like the duty of any self-respecting American to have an opinion about the market and the economy.

Having an opinion is fine. But acting on it with real money is often incredibly damaging. To move beyond opinion you can start by doing the following:

• Realize that investing is a means to an end and not the end in and of itself. Take the time to define the end (your goals), and realize that good investment decisions are only made within the context of your life.
• Once you define your goals, figure out what it will take to get you there. Part of that will obviously include a rate of return that you need to achieve. If that rate of return is unrealistic, then make adjustments to your goals. For example, you can try to save more, you can spend less or you can delay goals like retirement.
• Once you have a realistic set of goals, build the most conservative investment strategy you can to get you there.

You need to realize that no one can tell you with any sense of precision where the stock market (or any market) is going. If you’ve learned nothing else during the last 10 years, I hope you remember that the stock market won’t perform in a set way indefinitely. At some point the market will go down, and it may be for a long period of time.

Just as likely, the market will often go up a lot over a long period. So for the real investors who are investing real money in the real world, take note that you should build your investment strategy around your life and your goals and not the annual guesses of gurus.

Resolutions - Part I

Brad Steinman, Director of the Canadian arm of Dimensional Fund Advisors, offered up 10 important investment resolutions to start off the new year. Brad’s goal was to warn investors away from “ill-advised practices that are detrimental to their wealth” and hopes that “a set of New Year’s Investment resolutions, along with an advisor capable of helping investors adhere to them, will lead to a more prosperous future.”

Rather than rattle them off in what would be a rather lengthy blog post, we’ve decided to take a few resolutions at a time and provide some commentary on each periodically over the next several weeks.

Resolution #1: I will not confuse entertainment with advice. I will acknowledge that the financial media is in the entertainment business and their message can compromise my long-term focus and discipline, leading me to make poor investment decisions. If necessary I will turn off CNBC and turn on ESPN.

TAAG Thoughts: This is a topic we’ve covered at length in this space. There’s no question that what once passed as tabloid journalism has become “the news” across all fronts. Be it Jim Cramer, Brett Favre or the Kardashians, it can be difficult to differentiate between the evening news, CNBC and TMZ. The line between entertainment and information has been severely blurred if not erased altogether. We fully agree with Mr. Steinman that the best media to listen to when it comes to long term investment strategies is no media whatsoever.

Resolution #2: I will stop searching for tomorrow's star money manager, as there are no gurus. Capitalism will be my guru because with capitalism there is a positive expected return on capital, and it is there for the taking. And for me to succeed, someone else doesn't have to fail.

TAAG Thoughts: This touches on several of our firms core values, most notably the notion that gurus, much like the media, are to be ignored. Those who “get it right” are impossible to identify in advance, rarely repeat their success and the actual return investors receive in chasing these soothsayers after the fact pales in comparison to the returns as advertised. For more on the obstacles and dangers related to this manner of investing, see Dan Solin’s blog from last year.

The thoughts on capitalism and the long term expected return on capital ring true as well. In the long term, the only bet an investor needs to place is that the companies of the world will continue to grow. There will be lots of bumps in the road, some wild successes and some companies that cease to be, but, in the long run, the world will continue to develop new innovations and grow its collective balance sheet as it always has. You can participate in that growth by holding a globally diversified portfolio that seeks not to beat or outthink a market that, in the short term, will almost always disappoint.

These resolutions may seem like simple ideas, but we see time and time again that it is so easy to get caught up in the media hype or the promise of something out there that will allow investors to hit that home run without taking the required risk. Neither is an accurate depiction of real life or where our expectations should lie when it comes to our portfolios.
We hope you enjoy these and the other resolutions to come.

Chip Workman, CFP®
cworkman@taaginc.com
www.taaginc.com

Planning Your Philanthropy

At year’s end, many people find themselves rushing to make last minute charitable contributions. Often, the intent of helping out an organization is lost when a deadline looms. Since we’re just beginning the year, it is a good time to create a charitable giving plan so that your gifts will have the most impact.

There are many ways to support a charitable or non-profit organization other than simply writing a check. You can gift shares of stock which have a low cost basis. You will receive a tax deduction for the market value of the shares but do not have to pay tax on the gain from the sale. Many of our clients do this by transferring stock directly from their Fidelity or Schwab account to their church, alma mater or other organizations they wish to support.

Another way to gift highly appreciated assets is a Charitable Remainder Trust (CRT). With a CRT you can receive an income for your life (and your spouse’s) and a charity will receive what is left. You get to choose the amount of income you will receive annually (typically 5-10%). You can maintain control over how the assets are invested, receive a tax deduction in the year you make the transfer of assets to the trust and no capital gains are due on asset sales because you are benefitting a charity.

To make an impact without a personal financial contribution, there are many organizations that hold marathons, triathlons, bike races or walks in which you can take part and raise money. I have personally raised over $6,000 in the past two years for the Leukemia and Lymphoma Society by participating in two half marathons through their Team in Training program. This is a great way to get in shape and support a cause close to your heart.

If you would like to support our local community, The Greater Cincinnati Foundation provides several ways to do this by making grants in arts and culture, community and economic development, education, environment, health, and human services.

An alternative if you want to make a contribution in a certain year for tax reasons but do not have a specific cause in mind is a Donor Advised Fund. Both Schwab and Fidelity have Donor Advised Funds. They allow you to make a contribution, take an immediate tax deduction, direct how the assets are invested for tax-free growth and then recommend which non-profit organization(s) receive funds either today or in the future.

After retirement, a great way to give back to your community and stay active and healthy is volunteering. We have clients who contribute their talents to build houses through Habitat for Humanity, visit hospitals with their therapy dog, have gone on mission trips to do dozens of daily surgeries on animals in need, have traveled with Operation Smile to restore the smiles of children with cleft lips and palates , and are active in Kindervelt, which supports Children’s Hospital Medical Center. If you want to volunteer but do not have a particular organization in mind, a good place to start is www.volunteermatch.org.

No matter what organization you support with your time or money, you should do the research to ensure they are good stewards of their money. Charity Navigator is an independent source to research a charity’s financial health and how their funds are allocated.

I’ve touched on only a few of the ways you can support non-profit organizations. And, as you can see, being philanthropic does not have to involve vast sums of money. There are ways that everyone can give back. We are happy to help you determine your best avenue for giving, based on your charitable intentions.

Christine L. Carleton, CFP®
clcarleton@taaginc.com
http://taaginc.com/

Planning Ahead

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 that was signed into law on December 17th clears up the uncertainty hanging over tax and financial planning decisions – but only until the end of 2012. Here are a few things to think about as you plan for the next two years:

• Income tax rates will hold at their current levels for 2011 and 2012, and tax rates for long-term capital gains and qualifying dividends will remain the same as well. You now have two more years to sell appreciated investments at the current 15% maximum long-term capital gains rate, and if you are able to manage your income into the 10% or 15% marginal income tax bracket, the special 0% rate will apply to you. If you have stock options to exercise, you can do so at the maximum federal income tax rate of 35%. Now may be a good time to review your cash flows over the next 24 months to see if anything should be changed in your diversification or income recognition plans.

• Social Security taxes will be 2% lower in 2011, reduced from the current 6.2% to 4.2%. If your earnings are over the $106,800 wage base limit this translates into a $2,136 savings. Self-employed individuals will owe 10.4% vs. 12.4%, so if you plan on doing consulting work in retirement 2011 is the year to recognize as much income as you can! The tax-free distribution to charitable organizations from IRAs was retroactively reinstated for 2010 and extended through 2011. If you are over 70½ (and therefore must take a Required Minimum Distribution or RMD) you can transfer up to $100,000 from your IRA to a charity and not pay income taxes on the distribution. If you have other resources for your income needs, want to benefit a charity, and don’t want to pay income taxes on your RMD you should consider paying your RMD to a charity versus taking it as income. Because the change took place so late in the year, you can treat distributions made from an IRA to a charity in January 2011 as if it were made in 2010.

• The federal estate tax went through some major changes, but those are all temporary too. The estate tax exemption amount is now $5 million per person and the top estate tax and gift rates are 35% until the end of 2012. For the next two years, if one spouse dies, any unused portion of that spouse’s estate tax exemption amount may be transferred to the surviving spouse. All these changes are a huge benefit to families, but there is no guarantee that they will be extended beyond the current two year term. Many people have delayed updating their estate plans until the new rules were set. I think this is as good as it is going to get, so it’s time to set an appointment to get your documents updated if they are over five years old. We’re happy to help with a referral to an attorney if you need one, and will attend the meeting with you as well if you think it will help overcome procrastination.

Remember, we are always here to work with you to determine the best plan of action to reach your goals. If you have any questions or want to meet to review your situation, don’t hesitate to contact us.

Jeannette A. Jones, CPA, CFP®
jjones@taaginc.com
http://www.taaginc.com/