Time for a Reality Check

(from Dan Solin's Huffington Post blog, 10/28/2010 - click here for the original post)

As year-end approaches, this seems like a good time for a reality check.

On October 9, 2007, the Dow Jones Industrial Average closed at its all time high of 14,164. At that level, it had gained 94% over the preceding five years. The euphoria of the bulls was palpable.

On March 9, 2009, the index reached a new twelve-year low, closing at 6,547. The bears became the talk of Wall Street. Doom was in the air.

How you dealt with your investments during this period is indicative of everything that is wrong with the securities industry and why you need to fundamentally change the way you invest.

Few brokers predicted the greatest financial crisis since the Great Depression. Almost no one predicted both the meltdown and rapid recovery of the markets. Yet more than 90% of individual investors maintain brokerage accounts and rely on the flawed advice of their "investment professionals."

What if you didn't panic and did nothing from October 9, 2007 to date? I call it the Seinfeld approach to investing. You were in a globally diversified portfolio of low cost index or passively managed funds in an asset allocation (the division of your portfolio between stocks and bonds) appropriate for your tolerance for risk and investment objectives.

As of September 30, 2010, if your allocation to stocks was 50%, your portfolio has fully recovered. Investors with with an allocation of less than 50% to stocks have positive returns. If you were among the small percent of investors for whom an allocation of 100% stocks was appropriate, your total return is down almost 20%.

Check your portfolio returns. How do those results compare? Most likely, not well if you were listening to the financial pundits and "fled to safety" when the market crashed.

Almost all clients of brokers invest in actively managed funds, where the fund manager attempts to "beat the market." The use of these funds is another reason why investors typically underperform the market. If there is one compelling reason for terminating your relationship with your broker, it's the fact that recommendations of actively managed mutual funds are the way brokers make a living.

In a recent blog, Eugene Fama and Kenneth French, two of the most distinguished Professors of Finance in the country, explained the folly of investing in actively managed funds. They concluded that, when you factor luck into the equation, they expect 97% of actively managed funds to underperform a passive alternative.

Their conclusion is consistent with other studies that have shown over 99% of active fund managers have no genuine stock picking ability.

If your personal reality check persuades you to enter the New Year with a new investing approach, don't necessarily assume you can do it yourself. Studies over a 30 year period show that even those who pursue an indexing strategy on their own fail to capture 100% of market returns. They still do far better than investors in actively managed funds, but their failure to rebalance their portfolios and the lack of discipline to stay the course when times get rough, take a heavy toll.

A competent passive advisor, who focuses on your asset allocation and recommends investments only in index funds, passively managed funds or Exchange Traded Funds, can be a wise investment.

Lessons from "The Big Short"

So much has been written about the credit crisis caused by the real estate bubble and the government’s reaction to the resulting recession that it may be difficult to even consider reading a book on the subject, but “The Big Short” by Michael Lewis is worth the time.

Most books written on the subject provide a timeline of events and try to determine who was to blame. Instead, Mr. Lewis chose to focus on the few people who saw the crisis forming and bet against Wall Street, based on the strength of their convictions. The book isn’t a ‘get rich quick’ instruction manual, but it provides a fascinating look inside Wall Street thought the eyes of a few unusual people, and several important lessons for investors in the process:

Don’t believe that something is right just because so many people are doing it.

I know, it sounds like something your mother would say. But history is crowded with examples of investment booms and busts that were caused by the pressure of the crowd. In the last 40 years we’ve experienced energy tax shelters in the 80’s, the dot-com stocks of the late 90’s and the recent real estate boom. It’s easy to recognize how ridiculous prices were AFTER the fact, but in the height of a boom it’s tough to watch your brother-in-law get rich flipping Florida condos and your friends making money overnight without feeling you’re a sucker for staying out. But the last man standing when the music stops can lose it all.

Brokerage firms are rife with conflicts of interest that damage the wealth of individual investors.

In the credit boom leading up to the bust, brokerage firms made bets on bonds for their own accounts and created new investment vehicles by pooling together low quality mortgages. Bonds the firms no longer wanted to keep for themselves were dumped onto unsuspecting investors. We need to move to a fiduciary standard in the industry where all investment firms have to act in the best interest of their clients. Investors, in the meantime, need to pay attention to how their advisor is compensated and where his loyalty lies.

It takes guts to maintain your course of action when so many people tell you you’re wrong.

I actually felt sorry for the man who made $100 million for himself and $700 million for the investors who stuck with him. Michael Burry created a hedge fund, Scion Capital, and began betting against the real estate bubble in 2003, before the rest of the world caught on. Because he was early, real estate and mortgage backed investments continued to go up in value, and his hedge fund suffered losses. In 2006, when the S&P 500 was up more than 13%, he lost 18.4% for his clients. He was physically threatened and harassed, and some of his investors organized to sue him in the fall of 2006. By June of 2007, the real estate house of cards began falling in the credit markets, and his bets paid off spectacularly. But Burry was so traumatized by all the years of harassment and doubt that he closed his fund.

If you have an investment plan in place to reach your goals, it’s emotionally difficult to stick with it when you feel the sky is falling or everyone is getting rich and you aren’t. But don’t allow CNBC’s Jim Cramer or a friend at a holiday party cause you to doubt yourself.

If you have some time over the holidays, I recommend you spend it with “The Big Short.” You might even walk away with a few more lessons of your own.

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

Running from the Bear

While walking my dogs in Symmes Park on Halloween morning I encountered a black bear. I knew the bear had been spotted in the area because signs have been posted for about two months. When the signs first went up, I did my due diligence by going to the websites for the township and Ohio Department of Natural Resources. I found out how you should react if you encounter a bear – make noise, don’t approach or feed the bear (really?) and don’t run away. I had my plan in place. In the unlikely event that I saw him for myself, I would slowly back away and change my route. Unfortunately, when staring my fuzzy black fear in the face, all of my planning went out the window and I did exactly the opposite of what you should do – I ran away as fast as I could!

As I have played this scene over in my head, I began searching for something that would have made my response different. Maybe if I wasn’t alone, and had my husband, or another person with me, I would have been able to respond more rationally. Even though I had done my research, maybe I should have created a different plan. I’ll never know…hopefully.

What does this have to do with investing? A lot, actually. My incident with the bear and my response is very similar to what investors face each day. Although you can put a plan in place by creating a portfolio based on your past tolerance for risk and discussing the best course of action when facing a bear market (now I understand where the name comes from!), your actual reaction may be far different than your plan.

With bear markets occurring about once every five years, what can you do to make sure you don’t run from the bear and endanger your goals? The first step is to ignore the media. They will typically make you feel as if you need to make a split second decision whether to flee or not- and you don’t. When staring the next bear market in the face and your inclination is to run, turn off the TV or computer, take a few deep breaths and call your advisor.

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

Preventing Identity Theft & Fraud

I recently had the priviliege of hearing Detective Jim Kelley of the Blue Ash Police Department give a presentation on preventing identity theft and fraud. There was great information shared in the session and well worth passing along in this week’s blog.

Perhaps the biggest surprise was how little most of the tips had to do with computer and internet security. That’s certainly something we’ll touch on, but in this rapidly growing digital age, it seems the easiest targets for crooks continue to be your mailbox, your phone and your garbage can. Yes, dumpster diving is alive and well in the world of fraud.

Some of the top tips from the sessions . . .

1. Buy a Shredder
Detective Kelley said that if he could buy each and every home in this country a gift, it would be a simple shredder. He recommends that any piece of mail, receipts or any other document that we are disposing of get shredded. Criminals are more than happy to root through your trash cans for any information that might help them. If your trash is full of shredded documents, they’re much more likely to move on to the next victim.

2. Mind Your Mailbox
Putting outgoing mail in your mailbox and putting up the red flag doesn’t just get the attention of the mailman. It’s also a literal “red flag” that you have mail with potentially sensitive information ready to steal. Whenever possible, use an alternative method to send any outgoing mail, especially when personal information is involved.

3. Hang Up
The older we are, the more likely we’re a part of a generation that was taught to be polite on the phone. This, however, was likely when the home phone was a tool for communicating with friends, neighbors and family and not a sales tool for every scam under the sun. Detective Kelley stressed to not be too polite to just hang up on stranger or unknown callers. Your bank, credit card company or other trusted institution will never ask for your account information or personal data over the phone unless you’ve called them to resolve an issue and are asking to verify your identity. If you think the call might be legitimate, hang up and call a number that you know connects you with the right entity to confirm.

4. Be Diligent
One of the biggest things criminals bank on is that you’ll be as lazy as they are. You need to be diligent in your affairs. Go over bank and credit card statements when they come to make sure nothing fishy is on the statement. It doesn’t require hours of time or a fine-tooth comb, just a basic review to make sure everything is legitimate. The same goes for your credit report. Visit http://www.annualcreditreport.com/ to review your free credit report and check for any potential errors. You’re entitled to one free report from each of the three major credit bureaus, so set up a reminder every four months to do this today.

5. Don’t Trust E-mail
Yes, your computer is still a concern, too. Use virus protection software and be diligent in what you do online. Be especially careful with your e-mail. More and more, your e-mail contact list is the prime target. If you get a strange e-mail from a known friend or family member’s address asking for money or encouraging you to click on a link that seems out of character, just hit delete. Detective Kelley gave examples of dear friends sending an e-mail that they’re overseas, mugged and desperately need money wired, or the famous lottery that you’ve won that you just need to send a check to cover the taxes. These sound like obvious scams, but those that wish to separate you from your money will continue to get more and more sophisticated in how they go about reaching out to their victims.

6. Quick Tips
- Soak your prescription bottles and peel off the labels and shred. Labels carry a lot of personal information, and you don’t want a potential burglar to know that you’re using Ambien on a nightly basis.
- Use gel pens exclusively to write checks to avoid a fraud known as “check washing”.
- Keep personal information locked up and out of reach if you have cleaning people, home health care or other services in the home where subcontractors might be used from time to time.
- Carry around only what you need on a day to day basis. There is almost never a reason to carry your social security card, little used credit cards or other information besides the basics.

7. Listen to the Experts
Detective Kelley provided excellent information from the National Crime Prevention Council. They have a well-done brochure called “Preventing Identity Theft: A Guide for Consumers”.

The bottom line is there is still no such thing as a free lunch. No one out there wants to give you money for nothing and there’s no reason for you to send anybody money so that they can send you more money. Be vigilant, take the necessary precautions within reason and when something seems too good to be true, take a pass. If there’s any question of legitimacy when it comes to these issues, don’t be ashamed or have too much pride to ask for help. If you have been victimized in some way, report it quickly. Especially when it comes to credit card fraud, if you don’t report it quickly after discovering the discrepancy, you could be liable for the loss. Call the bank, credit card or other company first, then the authorities.

Chip Workman, CFP®
cworkman@taaginc.com
http://www.taaginc.com/

Seduced By Complexity

(from Carl Richards' newsletter Behavior Gap, 10/28/2010 - click here to link to the original post)

Why do we say we want simplicity and then chose complexity? It often starts when we get caught in the trap of two competing stories. In the first one, we tell ourselves we want to simplify, simplify, simplify. In the second story, we tell ourselves that the solution to an important problem has to be complex. The reality is that getting something simplified is the ultimate form of sophistication, so why don’t we choose simplicity when it comes to financial planning? Even though people list simplicity as their number goal on survey after survey, we still seem to opt for the more complex solution because complexity can appear easier on the surface.

Too many times, I’ve seen people disappointed when I’ve proposed a simple solution to their investment or financial planning problems. Often the solution can be reduced to a simple calculation on the back of a napkin, but clients somehow take comfort from a 100-page paperweight packed with a thousand calculations. Logically they know that complexity isn’t a guarantee, but it seems to make people happy.

Pleasure in complexity even shows up in emergency rooms, too. According to a physician friend, patients are often disappointed when the diagnosis is relatively simple like, “Go home and get some rest,” or “Stop smoking and eat a little less junk food.” The patients appear to hope for a terminal disease because it’s “easier” than going home and following simple, but hard, health rules.

We spend $40 billion a year on weight-loss programs and products even though we know that for most of us the answer is simple, but difficult. It comes down to either consuming fewer calories, burning more calories with exercise, or both. But it’s tempting and far more interesting to look for complex solutions that appear easier, but aren’t effective.

What part of human nature attracts us to complexity instead of a simple solution? Maybe we’re counting on a magic bullet, something to save us from the simple, but often hard work. Maybe debating complexity is more fun than the day after day grind of just getting the work done. We even have a tendency to believe that complexity is a sign of intelligence. In reality, the simplest solution almost always turns out to be the most effective, but also the most difficult.

One example in a recent Reuters article highlighted a family that put their kids through college with no debt. They managed it on a modest family income by driving the same car for 10 years and putting money away month after month. The author asks, “Is this a fairytale?” If it is, then we’ve forgotten the basic tenants of financial success. Based on my experience boring, simple things like saving money, avoiding speculative investments, and repeating that process over and over isn’t sexy or appealing.

We need to understand our attraction to complexity because it impacts the way we approach our financial goals. The reality is that the simple options with the largest impact on your financial success can be difficult to implement. They require discipline, patience, and hard work. And they require that we apply those basic, fundamentals over and over for years. It's much easier to entertain ourselves with the thought of finding an investment that will give us a fantastic return than to save a little bit more money each month.