A Plan for 2012 That You'll Actually Follow

(from Carl Richard's New York Times' Bucks blog, 12/26/2011 - click here for the original post. Carl is a Certified Financial Planner in Park City, Utah. His sketches are archived on the Bucks blog and on his personal Web site, www.BehaviorGap.com.)  His new book The Behavior Gap, will be out in January.

For 2012, I have a challenge for you: make financial decisions on purpose. Too much of what we do is based on habits and assumptions instead of a thoughtful plan. During the next year, see what happens when you do these three things:

1) Define your current reality. I used to think this was the easy part. Turns out I was wrong. Most people don’t know where they actually stand financially.

After the last few years, it’s tough to face the reality of our situations. Even if you have a sense that things have gone well for you financially, building a personal balance sheet doesn’t rank very high on the fun meter, but it has to be done. It makes it hard to reach any goal if you have no idea where you are starting from.

2) Set some goals. This step hangs people up because often we have no idea what we will be doing in five days, let alone five years. Still, it’s really hard to get somewhere if you don’t know where you’re going.

Let go of the need for precision. These are guesses, so make the best guess you can and move on. How important is paying for college for your child or children (or grandchildren)? Define it a bit. How much will it cost, what can you save, when will it happen?

Be honest. Be realistic. Of course part of this process will involve making some assumption about rates of return you will earn. Be conservative and focus instead on having realistic goals and saving more. If you can’t save more, maybe spend some time trying to earn a bit on the side.

3) Commit to course corrections. Plan on them, in fact. Break down what you have to do into quarterly action steps, and then revisit the plan every three months.

If you are off course, make changes while you’re only a little bit off. If you leave Los Angeles on a flight to New York City and you’re a half inch off course, it’s much easier to adjust when you are over Nevada than it will be a few miles outside of Miami.

Planning for a better financial future is an continuing process, not a single event. It is also short-term boring but long-term exciting.

In 2012, commit to doing small, simple things consistently and over time. It will be the opposite of what we’ll hear in the news every day about making enormous changes, so part of the challenge will be to ignore the constant call for rash actions and sweeping reform.

Let’s make 2012 about subtle, small actions so we can make progress towards our goals over a long period of time.

Embracing Simplicity

Around the holidays, I find myself overcomplicating things.  From trying to find the perfect gifts and decorating the house just right, to making a spectacular meal consisting of recipes I’ve never tried.  Many times, this just ends up causing anxiety, and the end does not feel like it justifies the means.  Not because I have ungrateful friends or family, but because what is more important to them is the time spent together, not the hours spent preparing a “Martha Stewart” moment.

The irony is that I am not practicing what I preach.  I often tell clients that the less complicated an investment, often makes it better.  This usually means lower fees, which translates into better performance. 

It’s also true for the way people save.  It can be very easy for someone to reach their financial goals by creating a plan, reviewing it at least annually or as their life changes, and simply letting the power of compound interest do the rest.  Unfortunately, we live in a world where more complicated has become synonymous with more appealing.  It’s easy to get seduced by the notion that more time and effort will always result in a better outcome.

All you have to do is look at our government to see how well this works.  Most legislation that is passed is written on thousands of pages.  Chip recently attended a Dimensional (DFA) conference where one of the speakers suggested each government agency cut their annual budget by x% each year.  He mentioned this in his last blog post, FiscalStuff.    This simple move could meaningfully cut our country’s deficit with minimal pain shared by everyone.

So, as you gather with your family over the holidays, and talk ultimately turns to New Year’s resolutions, maybe yours could be to embrace simplicity.   This could be anything from setting up your 401(k) contributions to increase by 1% each year, to changing one dietary habit a month if you’re trying to lose weight,  to just being cognizant of the way we allow complication to sneak into our lives.  As with most things, once we create a plan of attack, our goals become easier to reach.

Enjoy the holidays!      

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

Is My Money Safe?

That’s the question a client asked me last week, after he watched Jon Corzine, former CEO of MF Global, testify to a Congressional committee about the $1.2 billion missing from MF Global client brokerage accounts. He wanted to know if his investment account at Fidelity was at risk.

The MF Global collapse is similar to that of Lehman Brothers and Bear Stearns that occurred during 2008, when brokerage companies traded to make profits for themselves and made poor decisions that led to their undoing. During the same time we watched Bernie Madoff's long- term Ponzi scheme unravel, and read about other investor losses here in Greater Cincinnati. Taken together, it’s no wonder he’s worried. In my next blog, I’ll discuss the common elements of investor scams that have occurred nationally and locally. Today I’ll address brokerage account risk, and compare MF Global to Fidelity Institutional Wealth Services and the Charles Schwab Corporation, the two brokerage firms we use to custody our client accounts. There are four major differences in MF Global operations and those of Fidelity and Schwab:

Company Focus
MF Global’s core business was providing brokerage execution and clearing services for derivatives traded on global exchanges and over-the-counter markets, and many of their clients were hedge funds and institutional money managers. It was in the process of trying to diversify into other areas, but was not as diversified as Fidelity or Schwab. Both Fidelity and Schwab provide retail and institutional brokerage services for a broad variety of clients as well as mutual fund management. This diversification of revenue sources helps to make them stronger.

Financial Strength and Regulation
The Standard & Poor’s ratings analysis on MF Global published on December 13, 2010 assigned the company a –BBB rating (the 10th S&P rating level, almost ‘junk’ ). S&P pointed out that the company had suffered losses for the year 2010 and for every year going back to 2008. For the first six months of fiscal 2011 they reported a net loss of $29.9 million. At the time, the company held only $253 million in excess capital over the regulatory minimum. Fidelity and Schwab have much stronger financial profiles. Fidelity had equity of $2.4 billion as of June 30, 2011 and carried a rating of A+ (the 5th level) from S&P, while Schwab held $6.7 billion in equity capital and an A rating (6th level) for the same period.

Even though MF Global was also a registered broker-dealer, the company primarily held commodity accounts, not securities accounts, which are supervised by the Commodity Futures Trading Commission. The Securities Investor Protection Corporation (SIPC) offers $500,000 protection on securities accounts, like those held at Fidelity and Schwab, but there is no equivalent insurance for commodities accounts. In addition, both Schwab and Fidelity have private insurance coverage in excess of the SIPC limit.

Client Agreements
Commodity brokerage firms are permitted to use cash in client accounts for their own trading, subject to certain restrictions. In fact, MF Global’s standard client agreement permitted the firm to “borrow, pledge, repledge, transfer, hypothecate, rehypothecate, loan or invest any of the collateral” in customer accounts. This practice has been an additional source of revenue for the commodities industry for decades, but companies are supposed to segregate client money from company funds. In the final days of MF Global, when Mr. Corzine was scrambling to cover proprietary trades he had made on behalf of the company, his accounting apparently got sloppy.

Schwab and Fidelity client agreements do not permit them to borrow funds from client accounts.

Regulatory History and Character
According to the S&P financial report I referred to earlier, MF Global had more regulatory actions than other rated brokerage companies. In addition, in 2008 the company suffered an “unusual” loss due to unauthorized trading inside the company. They didn’t exactly have a stellar track record. Both Fidelity and Schwab have respected regulatory records.

John Corzine held the office of both Chairman and CEO at the company, and had lots of concentrated power with little oversight. He was CEO of Goldman Sachs in 1999 before he was pushed out, but had been out of the financial industry for 12 years while he worked in politics. He was anxious to make a name for himself and took increasing risks with the company’s proprietary trading to increase profits at the firm. As I wrote in my November 8th blog, that did not work out well.

It’s important to know the companies you do business with, and the people who stand behind them. No matter how sophisticated the world gets, it’s the strength of character of the people you work with that still matters most.

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

My Headline: Headline Risk Is a Lame Excuse for Active Managers

(from Dan Solin's Huffington Post blog, 12/6/2011 - click here for the original post)

A recent blog on CNBC almost made you feel sorry for active managers It referenced a study by Bank of America Merrill Lynch which found that active managers were having "a rough year." Only 23 percent of large-cap managers beat the S&P 500 index and only 27 percent topped the performance of the Russell 1000.

There is a certain irony in the fact that Bank of America Merrill Lynch is the source of this information. The merger of these two mega active managers was triggered by what the New York Times characterized as Merrill's "billions of dollars in mortgage-related mistakes." Merrill's active management of its own portfolio did little to inspire confidence in its investment expertise.

But I digress.

Active managers were quick to explain their underperformance. Mark Lamkin, the CEO and "chief investment strategist" at Lamkin Wealth Management, blamed his underperformance on "headline risk," noting: "Nine of the last 11 years my active strategies have beaten the market, and I'm underperforming this market. It's all headline risk."

"Headline risk" is the possibility that a negative news story will adversely affect the price of a stock.
I tried to verify Mr. Lamkin's claim that his active strategies have "beaten the market" in nine of the last eleven years and was unable to do so. His firm does not publish the results of its portfolios on its web page. I called his office and asked for additional information but received no response.

Analyzing the significance of claims that a fund manager or advisor "beat the markets" is not uncomplicated. You need to understand how much risk the manager took and whether the benchmark used for comparison is an appropriate benchmark, comprised of a proportionately weighted mix of stocks and bonds.

Mr. Lamkin's lament about "headline risk" is troublesome. Unexpected news is a reason for under performance by active managers, but it is not an excuse that active managers should use to explain their inability to "beat the markets." Tomorrow's news drives stock prices. Active managers don't know tomorrow's news. They can't anticipate what they don't know. "Headline risk" is one of many reasons why active managers historically have underperformed the markets and are likely to continue to do so in the future.

According to a mid-year 2011 study by Standard and Poors, Over the past three years, 63.96% of actively managed large-cap funds were outperformed by the S&P 500, 75.07% of mid-cap funds were outperformed by the S&P MidCap 400 and 63.08% of the small-cap funds were outperformed by the S&P SmallCap 600. Passive management trumped actively managed in nearly all major domestic and international stock categories.

The results for this year, while worse than in previous years, are not unexpected. The skill of active managers is not in "beating the markets." It's convincing you they are likely to do so in the future, and coming up with lame explanations for why they have not done so in the past.

That's my headline.


Dan Solin is a Senior Vice-President of Index Funds Advisors (ifa.com). He is the author of the New York Times best sellers The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, and The Smartest Retirement Book You'll Ever Read. His new book, The Smartest Portfolio You'll Ever Own, was released in September, 2011.The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.

Fiscal "Stuff"

As most of you know, we here at TAAG do not find much value in the exercise of trying to forecast the short or intermediate outlook of markets or the economy.  All of our brains are wired to constantly crave information that will give us some insight to help us make better decisions with our money.  Unfortunately, the name of the game when it comes to short term forecasting is uncertainty, despite the endless line of “experts” willing to line up and take their run at claiming to know what’s next.  Go with their suggestions over and over again and you’re bound to lose. 

That said, one of the best sessions at a recent conference I attended featured Ed Lazear.  One of the world’s most renowned labor economists, recipient of most awards having to do with economics, chair of the more recent President Bush’s Council of Economic Advisers, advisor to governments around the world and currently a graduate school professor splitting time at both Stanford and the University of Chicago, Ed is a smart guy and worth listening to when it comes to all things economics. 

I thought it would be worth passing along some of his thoughts on the current environment and all the “stuff” or noise surrounding our economy, what truly is cause for concern, and why we should be optimistic in the long run.

-          Ignore the Forecasts

o   When asked, Lazear estimated GDP will grow 2.5-3% in the next year, but that was just a guess.  He went on to say that listening to any prediction about what the economy is going to do over a particular month, quarter or even year is pretty much a stab in the dark.  While serving at the White House, his team would have all the economic data to generate the GDP growth rate for a given month.  They would hand off the data to the number crunchers and within a few hours, GDP would be reported.  Even with all of the data known and in their hands, Ed admitted their in-house advance estimates being off 0.75% or more, a pretty big margin of error for a number that’s historically in the 3-4% range annually.  There are simply too many drivers for any one person to truly claim they know what’s coming next, much less how markets might react as a result. 

-          The Bad News

o   Our unemployment rate remains tremendously high and is trending more in line with France’s than Germany’s which, historically, is not a comparison we want to aspire to.  The real long term concern lies with our deficit and debt.  The ratio of our deficit to GDP is entirely too high and rising.  In the long run, allowing some of our entitlement programs to continue without any reform is what will truly cause our debt to skyrocket even further.  It will take tough solutions to help get these trends moving in the right direction again.  Moving in the direction we are today is simply not an option.  The world took a pretty big hit over the last several years, but the U.S. is climbing back, albeit at a snail’s pace

-          The Upside

o   Lazear closed the session by mentioning that despite all of the doom and gloom, this is likely to go down as one of the healthiest turning points in our country’s economic history.  For the first time in a long time, the national budget and the size of our government is front page news and front of mind for many citizens.  This, in his mind, is hugely positive and will push us to innovate and develop solutions.  The arguing and posturing in Washington, while extremely frustrating, is the nature of politics and will turn as constituents demand.  All parties involved know they have to deal with this in the relatively near future.  Not dealing with it is a “death sentence”.   

o   Ultimately, he sees an agreement being reached.  He personally likes the idea of cutting the budget across the board at “X” percent per year for a number of years as an approach.  It creates a disciplined process that allows groups to plan for without causing any one area more than their share of pain.      

The point of this update is not to give you yet another person’s opinion on what’s to come, but to give you a long term, measured look at how one of the smartest guys in any room sees what can, at times, appear to be an overwhelmingly impossible situation.  There’s no doubt there are major challenges in this world, but, as with investing, that creates more opportunities and higher expected returns for markets and society in the long run.

Have a great week!

Chip Workman, CFP®

cworkman@taaginc.com

www.taaginc.com

Happy Thanksgiving!

As we head full steam into Black Friday and all the hustle and bustle of the holiday season, we wanted to pause a moment this Thanksgiving Eve and encourage everyone to really take time tomorrow to enjoy all the family traditions, the time together and to truly give thanks for all that we have and enjoy in this world. 

Wherever you are this Thursday, we hope you have a wonderful holiday and know that we are thankful for the work we get to do with and for our clients and their families each and every day.

Happy Thanksgiving to all of our readers, clients and their families!

The Asset Advisory Group
www.taaginc.com

Resetting Expectations

I am an avid Cincinnati Bearcats fan. It was heartbreaking on Saturday to lose our first string quarterback, Zach Collaros, to a broken ankle. Although the players did a great job in the second half of the game adjusting to a new quarterback, we still lost to West Virginia. Zach’s out for the season and now four other teams are only one game behind our first place standing in the Big East. The Bearcats are still eligible for a bowl bid, but getting to a game like the Orange Bowl may be more challenging. I may need to adjust my expectations for post-season play.

This happens all the time in financial planning. We set goals, encounter obstacles, and need to adjust our plan when we face new challenges. This might be the loss of a job, an unexpected illness, or a precipitous drop in the stock market. While all of these events are beyond our control, how we prepare for them in advance and readjust along the way can minimize their impact on our ability to reach our goals.

Over the past 21 years, I have worked with many clients who have had to alter the original picture they had of their retirement. There were those who planned to retire from Procter & Gamble in March, 2000 when the stock tumbled from $87.44 to $61.00 in one day. Or the client going through a divorce only to learn that her husband had spent all of their savings, and they were living on credit cards. In each situation, what at first seems insurmountable is actually a temporary setback. The sooner you face a difficult situation, the less devastating its impact will be.

As we have worked through challenges, and my clients have made adjustments to their original course, they have still been able to achieve a fulfilling retirement. As we’ve often said in this blog, it’s not what happens to you, but how you respond to it that will dictate the success or failure of your plan.

While the Bearcat’s initial response to losing their quarterback seemed to be fear and panic, once they were able to regroup at halftime and adjust their game play, they came a lot closer to winning their game. Maybe I’ll need that hotel reservation in Miami after all…

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