A Christmas Carol

The Lord Mayor Would Have Spoiled

"A Christmas Carol"

Contributed by John David Marotta

 

        This insightful blog was composed by my colleague David John Marotta. He identifies the characters in Dickens’s The Christmas Carol according to their Money Personality matrix which I developed and is explained in my book ‘Why Smart People Do Stupid Things With Money” (pp.22-40). He uses this personality assessment to demonstrate classic behaviors around the Christmas theme, and pinpoint the impact the Christmas Spirit has on each one of us irrespective of our religious differences. His analysis of how our personality shapes our perceptions about money is a real masterpiece. Have a happy holiday! Bert Whitehead, M.B.A, J.D.



In his book "Why Smart People Do Stupid Things with Money," Bert Whitehead describes eight different financial personalities. For the past seven years I've taken a character from Dickens's A "Christmas Carol" and used them to illustrate one of these personalities.

Driven by fear and hoarding all he earns, Marley is a miser. Scrooge saves just as much, but he's greedier and reinvests his money to grow the business. Bob Crachit, on the opposite end of the spectrum, spends too much. He should be able to live on his income, but in modern terms would be called a shopaholic. These three personalities represent the extremes.

The characters in the middle of the continuum include Fezziwig, Scrooge's former boss. He is a nester, who tends toward savings and does better at balancing the extremes of greed and fear. He keeps his spending close to home, but includes his employees as part of his family. The two portly gentlemen tend toward greed, but they also solicit donations for the poor at Christmastime. They are entrepreneurial philanthropists.

Scrooge's nephew Fred represents a traveler who also balances greed and fear but tends toward spending. Indifferent about amassing wealth, he cares more for experiencing life to the fullest. Scrooge's former fiancée Belle is the bon vivant. She is driven largely by the desire to spend money on herself. She judges success by how it improves her own life.

These seven characters from "A Christmas Carol" represent all but one of the eight financial personalities. The final one is the gambler, motivated by greed and a desire to be associated with great power and wealth.

The character most closely aligned with the gambler personality in the story is the Lord Mayor. As Dickens described him, "The Lord Mayor, in the stronghold of the mighty Mansion House, gave orders to his fifty cooks and butlers to keep Christmas as a Lord Mayor's household should."

Politicians align well with the gambler personality. They tend toward greed and spending. They are incorrigible optimists. They mistakenly believe there are easy answers to financial problems.

Whitehead describes gamblers this way: "Gamblers are frequently embarrassed about the way they handle money. They get so good at lying to themselves and others that they actually believe it. They brag when they win, but seem to ignore and deny their losses. This makes it very hard for them to address their financial issues in a reasonable, logical way. Their warped view of financial logic often results in them viewing the casino or horse races as types of investments."

If that doesn't describe today's politicians, I'm not sure what does.

And when their schemes fail, politicians are susceptible to depression or embezzlement. In fact, studies suggest that both a gambling addiction and success in politics correlate with psychopathic behavior. Politicians tend toward lack of guilt, fearlessness and interpersonal dominance. And it is from this small minority of human beings with literally no conscience that we tend to choose our political leaders. This at least explains even if it does not condone their shameless deceit and manipulation of public opinion to extend their own political power and influence.

In their desire to be rich and powerful, politicians tend toward alcohol and drug abuse and sexual addictions, often despite a sham moral posturing for the voters. They also are generous to a fault with the public's money, all the while avoiding any significant private sacrifice from their own resources. This pomp with little circumstance was epitomized by the Lord Mayor's Show, an annual event that Dickens mocked in "The Public Life of Mr. Tulrumble."

Dickens wisely did not include a gambler personality in his Christmas story. Had he done so, the tale would have had an external villain. In Dickens's writings the gambler politician positions himself as a great benefactor to the city and yet turns out to be the "greatest forger and the greatest thief that ever cheated the gallows." The gambler would have assumed the role of antagonist and detracted from the heart of the story: Scrooge's inner struggle and his awakening conscience. Including the Lord Mayor's character would have made it a completely different story.

Dickens started his writing career as a parliamentary reporter. He found politicians pompous rhetoricians who made promises they never kept. His experience is captured in David Copperfield's description: "I record predictions that never come to pass, professions that are never fulfilled, [and] explanations that are only meant to mystify."

Since Dickens's day, politicians have perfected the sound bite, which in essence is the antithesis of nuanced reasoning. It also makes it increasingly difficult to express the complex unintended consequences of economic systems.

Families can't afford gamblers running their personal financial affairs just as our country can't afford politicians assuming our corporate financial affairs. Ultimately Scrooge did what neither the Lord Mayor nor anyone else in the story could. Ebenezer developed the empathy to truly care about others. And then he gave of himself and his own resources to make a difference in their lives. And that is the true spirit of Christmas.


Attribution to David John Marotta
Posted 12/20/12 Online IndUS Business Journal

Five Ways to Get Poor

Bert Whitehead, M.B.A., J.D ©

 

1)  Stay in a Dysfunctional Relationship.  

I have often described divorce as "mutual impoverishment."  While many different relationships can have detrimental financial consequences, divorce in particular leaves both parties handicapped -- often for their lifetimes.  Our divorce laws are designed to protect the most vulnerable spouse, but seldom can the contribution of a high-earning mate be equalized.  So the dependent spouse who typically embraces the primary parent role at the expense of career development often faces a continuing downward spiral in living standard while the higher earner must start a new financial future from scratch. And while two people living together costs less than living in separate households, the reality is that the costs of living apart after a divorce can be financially devastating if both parties attempt to maintain the marital standard of living.

The lesson here is to be choosy about your mate at the outset! "Till death do us part" states a commitment that embraces the mutual support and teamwork that optimizes the marital relationship. But that is still no guarantee of financial prosperity.

Of course other dysfunctional and financially draining relationships can be non-marital. By definition a dysfunctional relationship is one where maintaining a commitment is detrimental to both parties. This can also include parents and children, abused spouses, and those who continue long-term relationship with an afflicted partner who will not take the steps necessary to achieve recovery.  Often the most committed spouse unwittingly aggravates the dysfunctional relationship through co-dependent support.
 

2)  Develop Some Bad Habits.  

No one is perfect; some are more imperfect than others.  The Seven Deadly Sins (Pride, Anger, Sloth, Greed, Lust, Gluttony, and Envy) are considered by many to be the roots of various addictions (hubris, chronic rage, procrastination, gambling, sexual obsession, compulsive spending, over-indulgence in food and drink, covetousness, etc.).  These bad habits are 'deadly' because they are often considered the origins of many other 'sins' or dysfunctional behaviors that are difficult to change.

My experience is that addiction of one type or other is often at the root of financial distress.  Addictions involve misuse of both personal and material assets, so they are often the harbingers of poverty.  Recovery from financial downfalls due to active addiction is seldom successful unless the addiction is directly addressed and dealt with effectively.

3)  Let Your Skills Atrophy. 

As our global economy grows increasingly complex and competitive, skills we develop in our youth become obsolete much sooner than in earlier cultures and societies.  For example, in the past a journeyman carpenter could be assured of a job for life with very simple tools.  This job today requires considerable computer knowledge and more advanced mathematical capability.  The knowledge of a financial planner and other complex professions is estimated to have a half-life of eighteen months.  Half of our knowledge relating to our profession becomes obsolete in just a year and a half.

It is not only more difficult to get a good job without advanced education, the education that qualified you for a job five years ago is likely to be insufficient in today's labor market.  Paradoxically, the more advanced an education required to get a job, the faster those skills and knowledge become obsolete.  Thus, most advanced professions require more continuing education to maintain licensing.

4)  Put Up a Good Front. 

This is essentially the motive for maintaining consumer debt, such as balances on credit cards.  Typically, someone who lives beyond their means is trying to be someone they're not.  Maintaining this illusion to impress others takes a huge psychological toll, which aggravates the guilt and fear.  Dampening those feelings requires more spending on props to maintain the false facade. The  person is sucked into a vortex of poverty.

There is a distinction between 'good debt' and 'bad debt.'  'Good debt' may include a home mortgage, an education loan, or a car loan for someone starting out.  These can be considered 'good' because they enable a person to get leverage, e.g., get a better job, so they can earn more.  This is relative to their ability to earn, so a $250,000 mortgage, or a $100,000 education loan, or a $50,000 car loan is not appropriate as a 'good debt' for a new college graduate who earns $35,000 per year.

 

5)  Don't Celebrate Thanksgiving. 

Getting poor, or rich, is more of an attitude than a measurement.  Relatively speaking, the poorest 10% in our society are richer than the richest 10% of humans in the world.  "Prosperity depends more on wanting what you have than having what you want." --(Geoffrey Alpert)

 

I appreciate the editorial review contributed by Chip Simon, CFP®, an ACA colleague in Poughkeepsie, NY

Are Financial Planning Fees Worth It?

Bert Whitehead, M.B.A., J.D. ©2012

Pssst. Wanna increase your investment portfolio’s returns by 1.82%?

Then get yourself a good financial planner.

Or so says Morningstar, a consumer-driven investment research firm, in a recent study that measured the value of financial planning to individual investors. Morningstar is considered credible because it isn’t paid by the funds and annuities that it rates. Of course, the end users of Morningstar data are generally investment advisors who earn large asset management fees and they greeted the study with enthusiasm. But the report describes certain factors apart from investment portfolio decisions that add incremental value to financial management -- a major point that lends credibility to the study.

Morningstar Describes the Benefits of Financial Planning

Measured together, these outside factors are called “Gamma” by Morningstar and include: asset allocation, “product allocation” (which seems redundant), tax efficiency, and then withdrawal strategy and “liability-driven investing” (which seems to be akin to withdrawal strategy). So it seems there are really three main factors: asset allocation, tax efficiency (in the portfolio), and withdrawal strategy.

Investment advisors primarily tout their “strategy” for buying and selling individual securities or shifting allocations based on their market timing approach. While they insist that this adds more value to a portfolio than they charge, using this approach alone has been debunked by numerous studies. Simplistic or complex hedged “buy high, sell-low” approaches have lower returns in the long run as taxes, trading costs, idle cash, and emotions undermine performance.

However, many investment advisors feel that the 1.82% Gamma advantage would more than cover the 1.0% fee that they charge. After all, they often consider themselves to be “Financial Planners” who advise clients on their "total" financial situation. Therefore, their services deliver value beyond portfolio management.

“Financial Planners” Usually Limit Their Advice to Investments

It’s my experience that most advisors who hold themselves out as “Financial Planners” are in truth “Investment Advisors.” While they pitch the “total” approach, they focus their marketing and advisory efforts almost exclusively on investments. They charge for “assets under management” (AUM), usually a percentage based on the amount of assets a client gives them to manage.

I find that many AUM clients don't reveal all their accounts (especially retirement accounts) to their advisor to avoid being charged a higher fee. So advisors who claim to manage total assets under this scenario are stretching it a bit. In addition, tax efficiency is a sham if the client’s tax return is never reviewed. And, typically, advisors don't know the important withdrawal details of retirement accounts, even when told about these accounts. As to the withdrawal strategy, it’s problematic when neither client nor advisor knows how much the client spends each month or their other sources of income!

Based on these realities, Gamma is tough to find for most financial planning or investment management clients. And the Morningstar researchers agree. They doubt that most financial plans ever go beyond investment selection to include the Gamma advantage.

Advisors May Understand and Advise Only about Investments

That means that most clients pay too much for AUM advice. A $2,000,000 portfolio brings in a $20,000 fee for the investment advisor who charges 1% of assets under management. And since the business is scalable, it’s pure profit. For that fee the client usually gets asset allocation and rebalancing. But where is the guidance about how much to save, when and how to refinance a mortgage, when to initiate a Roth conversion, insurance needs, and estate planning? Since most investment advisors are not trained or professionally certified to provide comprehensive financial advice, the client is told to obtain mortgage advice or Roth strategies from their tax advisor. The tax advisor however knows nothing about the client's investments or long-term goals so the client gets no advice on the issues that matter the most.

Flat Retainers Are More Cost Effective than AUM Fees

Dalbar, Inc., a leading financial services market research firm, consistently finds that clients want comprehensive financial advice. But how can they find it for a reasonable cost when so much of the industry is geared to “gather assets” for AUM?

It’s my contention that a flat annual retainer fee is the least expensive and best method to obtain unbiased, comprehensive financial advice. In fact, it focuses the relationship on the very same outside success factors cited by Morningstar. There are minimal conflicts of interest and the advisor is motivated to work with the client on a regular basis, handling financial issues as they arise.

Think of it this way…would you rather work with an advisor who is structured to put his arms around your money, or one who is structured to put his arms around your problems? Chances are, it’s the latter.

Many people think that annual retainers are too expensive since they are quoted as an annual dollar amount. In fact, a flat annual retainer fee is nearly always less than an AUM fee….and you know what you are paying for. Clients are generally unaware of AUM fee amounts since they are withdrawn directly from their account and buried in the investment reports.

The right professional advice is worth the price. But the only thing worse than paying an investment advisor 1% of your portfolio annually for investment advice, is paying that fee and expecting to get professional comprehensive advice that is not forthcoming.

Special thanks to those who collaborated on this post: Chip Simon, an ACA colleague from Poughkeepsie, N.Y., and Shari Cohen who was the copy editor.

Bi-Weekly Mortgage Payments

Smart Strategy or a Scam?

Bert Whitehead, M.B.A., J.D. © 2012

Most homeowners have been solicited by their mortgage company or another financial institution with an offer to convert to biweekly mortgage payments instead of monthly payments. The advantage touted for this strategy is saving a heap of interest over the years and reducing the time required to pay off your mortgage by several years. Clients often ask us whether this is a good idea or not. No, it is not smart; it is a scam.

If that is all you need to know, you're done: go on and read something else. If you want to understand why it's not smart, read on!

The math does work: paying half your monthly mortgage every two weeks does pay off your mortgage much faster and does save a substantial amount of interest. It may also be viewed as very convenient since most people are paid biweekly.

Investment Earnings Exceed Benefit of Interest Savings

It is not financially advantageous because it doesn't take into account the foregone investment earnings, which is more than the mortgage interest saved. The reason biweekly mortgage payments reduce interest and the length of the mortgage is that you end up paying an additional month's mortgage payments each year (26 payments divided by 2 = 13 Months). The correct comparison is not between biweekly mortgage payments and monthly mortgage payments. The correct comparison is between the interest expense you could save with biweekly payments and the amount of interest earned if you invest the additional amount you otherwise would be paying on your mortgage.

A Sample Mortgage Situation (or A Case Study)

Consider a 30-year, 4% fixed -rate mortgage taken out 5 years ago by a taxpayer in a 33% federal tax bracket. The taxpayer is offered a deal to switch to biweekly payments which would require a $500 “set up” fee plus half of a month's mortgage payment to start. The interest rate (4.0%) remains the same, but instead of a monthly payment of $763.86, the home owner would pay $381.93 biweekly. This would enable the homeowner to pay off the mortgage in 21 more years (instead of 25) and save the homeowner $42,572 in interest expense. This is the ”pitch.”

To correctly analyze this problem, there are five factors to consider:

1. Normally (but not always) the mortgage company charges a fee of about $500 to set this up for you. This is ridiculous because most mortgages permit prepayments with no additional fee or penalty. If you were to invest this $500 fee at 6.00% for the 21-year mortgage period, it would grow to about $815.

2. The terms of the biweekly arrangement actually require that the payments be made at the beginning of the period, whereas typical mortgages charge the €payments at month-end. If the homeowner invested only one month’s payment at 6% for 21 years, it would earn about $480 in interest.

3. Paying half of the monthly payment every two weeks is comparable to paying 13 monthly house payments a year. If the extra $764 was invested each year instead of being used to pay off the mortgage, it would grow to $30,548.

4. Since home mortgage interest is deductible, choosing to reduce interest by $42,572 over the next 21 years would increase federal income taxes by $12,024, plus the taxes saved would earn $ 7,575 over the 21 years.

5. In total, the $ 51,442 in additional investment earnings generated by investing the money instead of paying down the mortgage is sufficient to pay off the balance of the original 30- year mortgage in full in 21 years and still have $18,262 in cash remaining.

Additional Reasons Why Biweekly Mortgages Are Not Advantageous

In addition, if you were able to invest the surplus mortgage payments in an IRA or other pension each year, you would be able to defer an additional $17,981 in income taxes.

Consider also that mortgage providers generally charge a lower rate for shorter mortgages. So if you wanted to pay off your home in 25 years instead of 30, it would be wiser to arrange that at the outset when applying for a mortgage and take advantage of the lower rate.

In any event I advise clients to keep a longer mortgage on their home because it is your best hedge against inflation. If inflation increases in the next 5 or 10 years back to 5% or 10% as it did during the 70s and 80s, mortgage rates will soar to 9 to14%. You would be pleased to owe the bank a couple hundred thousand dollars at a 4% fixed rate as your money market account is paying 6% or more!

Special thanks to those who collaborated on this blog: Chip Simon, an ACA colleague from Poughkeepsie, N.Y., Al Hoefer, my technical consultant; and Shari Cohen who was the copy editor.

Finding "Real Returns" in the Bond Market

Bert Whitehead, M.B.A., J.D

Widespread consternation is erupting in the investment arena, particularly in Fixed Income Departments which handles bonds. Everyone wants to find the perfect investment with 'decent' yields like 5% to 8% which are our birthright. To accomplish this, many investment advisors devise complex allocation strategies, e.g. derivatives, collateralized mortgage obligations, annuities and whole life insurance, to justify the amount they charge investors.

I still have trouble believing that these ‘Professional Fixed Income Strategists’ can add any value for their retail clients. Surely if they had the foresight and analytic ability they claim, they would have been able to detect Collateralized Mortgage Collapse or Libor Rate scam. Their losses on these investments will exceed $100,000,000,000 (yes, 100 Billion)… and the scam had been ongoing since 2008!

The players include Schwab, BofA, JP Morgan, Citi Bank – plus virtually all the biggest bond dealers abroad. Their strategies in this area have been a continuous train wreck! Why would we conclude that they can make these kinds of fixed income strategies work for small investors in the retail market?

Rates Reflect Default Risk

The truth is this: if Treasuries are paying 2, and high-yield bonds are paying 6%, the 4% difference is entirely attributable to the higher risk (i.e. default rate) plus the outrageous fees bond dealers charge. That means that for every $1million invested in junk bonds, some retail customer(s) will lose $40,000 – net of everyone else’s gains. There is no free lunch.

In Las Vegas, the casinos set the ‘vig’ or the odds by adjusting the rules. In the financial world, the Gnomes of Zurich set the vig, based on their knowledge of the default rate of the debt. This is why subprime borrowers pay higher rates (currently 6.5%) than you and I do (3.5%). In aggregate, the higher amounts of interest the banks collect from subprime loans are offset by the higher losses and administrative costs except for a very small premium. If the ‘vig’ is set too low (as it was during the real estate/mortgage meltdown), the banks and investors in these bonds see their values plummet once the defaults start.

When these bonds are wrapped up in bond funds, closed funds, or sold to individuals through large institutions, the additional costs wipe out the small premium. These costs include underwriting costs, reporting costs, distribution costs, transaction costs, and other ‘monthly expenses’ that are added in. Then the institutions have to sell the bonds for substantially more than they bought them for, and the yield realized by the small investor is correspondingly less.

Essentially, especially at today’s rates, retail investors focus on the 6% yield, and have no idea that the correct odds, or risk premium, should mathematically be 8% on the world market. Investors take much greater risks than they think they are, and are paid less for the risk. Since the default rate is relatively small, an investor may never see the loss attributable to the higher risk of any one investment. But there are real losses when investors must take pennies on the dollar after a bond when there is a default (such as GM, Lehman Bros., etc.). In a bond fund, this loss is further obfuscated by the expenses of the bond fund, and its market value.

Interestingly, when bonds are sliding toward default their value drops and they can be bought at a sizeable discount. Since the coupon (i.e. the periodic income payment from the bond) is fixed, the bond's yield rises. So a $10,000 bond with a 6% coupon pays the investor $600/year. If the bond issuer (e.g. Greece) starts to look riskier, the bond value could drop on the open market. So if the price drops to $6,000 the yield increases to 10%! To amateur investors, this makes the bond look like an even better deal simply because it has a very high yield.

Yields Increase as Bonds Become Riskier

In truth, the bond becomes more risky as the price drops and yield rises, and is considered less risky as the price of the bond increases and the yield drops.
This is a fundamental truth about investing in bonds: there is no excess long-term profit in a bond investment. A higher rate of return is always accompanied by more risk. Unlike stocks, diversification in a bond portfolio does not provide protection -- only higher costs.
Bond dealers (who are paid more than stock brokers) have more latitude in pricing bonds because all bonds (except Treasuries) are very thinly traded. This is because bonds have many different variables: convertible, preferred, subordinated, call features, etc. Therefore, very few bonds are traded each day so bond dealers usually hold inventories themselves.

So when you sell the bond, it doesn't sell for the amount shown on your statement--that is the 'asked' price if you were buying. The 'bid' price is generally not provided because the bond dealer will buy ONLY at a significant discount. The difference between the bid price and the asked price is called the 'spread.' These spreads are common in the sales of assets in inefficient markets, like diamonds. If you buy a diamond today and go back to sell it back tomorrow, you would likely get back only about 60 cents on the dollar since the spread is about 40%.

Since the dealer is taking the risk of holding the diamond, he can set his own prices. Stock brokers are called 'brokers' because legally they don't take title to the stocks: they are only facilitating the transaction. Most stock markets are huge so the broker never actually owns the stock and must buy and sell at market values.

It is folly to think that the ABC bond you bought today at 8% yield is 'better' than the XYZ bond your friend bought with a 7% percent yield. At the end of the day, those who bought the XYZ bond will, in aggregate, have the same amount of money as the ABC bond buyers. The defaults and additional costs of ABC buyers will offset the extra 1% in yield.

These numbers are not just 'made up' any more than the casino odds (or vig) are haphazard. If you buy bonds with the belief that you can beat the market you are thinking like a casino gambler. You can no more outsmart the house with your system, than you can get an edge in a casino. You are facing an overwhelming disadvantage since the other side has much more information, analytic capacity and cash.

Bonds Are Useful for Cash Flow

That’s why I insist that ‘safety trumps yield.’ The function of bonds in a portfolio is to provide cash flow which is certain. Since bond yields only vary between about 2% and 20%, the only way to make money in the bond market is to be a market timer. Like trying to beat the casino, the bond dealers who are betting against you know more than you do, have more cash and, are more informed, so you are the chump.

The stock market, by contrast, can be a great investment because the risk of diversification only impacts the volatility. For 'real people' the wise choice is to dollar-cost-average by saving a certain amount every month over a lifetime into a low-cost diversified index fund. Cash and bonds are held to provide long term cash flow so stock investments don't have to be liquidated.

The more complex an investment is, the less suitable it is for individuals. Complicated investment products are really designed for banks, insurance companies, and other financial institutions which can vet them properly. This is especially true for bonds. Our financial institutions offer stripped down versions of complex strategies, add on a huge profit, and sell them to people who don't really know what they are buying.

People have lost more money by chasing yield than at the point of a gun!" -- Warren Buffett.

I appreciate the discussion with our client Ward Johnson which inspired this blog. I also appreciate the professional copy editing provided by Shari Cohen.

Our 'Lost Generation'

Bert Whitehead, M.B.A., J.D. and Chip Simon, CFP © 2012

Much political patter is spent discussing how to bring back our middle class. Globally, the middle class is doing quite well, thank you. In fact, it has burgeoned exponentially in China, India, and other emerging economies. Fifty years ago we were admonished that, “rather than giving a man a fish it is better to teach him to fish.” Now much of the globe is fishing in our pond.

Sometimes I worry that the U.S. middle class may be facing a ‘lost generation’. The term "Lost Generation" was originally used to define a sense of moral loss or aimlessness apparent in literary figures during the 1920s, a result of their experience in the First World War.

But rather than being demoralized by the shock of a major conflict, consider that nearly half of our youth today between 17 and 24 can’t even qualify to enlist in the Army. Either they have no high school degree, can’t pass the reading or math tests, are felons, or are obese. If they have trouble keeping up to these basic requirements of citizenship or health, how can they keep up to other changes and demands in the world? How do we expect them to be in the middle class 20-30 years from now?

Why might much of our youth be lost? After all, we spend more per student for education than any country in the world. Yet our students rank in the lower 50th percentile in math and science compared with 34 other developed countries. SAT scores have declined over the past 40 years. Colleges and employers are increasingly burdened with remedial courses. In a nutshell, our youth are not as smart as they were in the past, and much of the rest of the world’s youth are smarter, and hungrier, than ours. They’re ready to catch most of the fish…

We can’t pin our current problems on the government, or parenting, or schools, or the breakdown of the social contract. All of these play a part. But over time there is a remarkable capacity for many social and economic problems to ‘self-correct.’ As we adapt we eliminate solutions that don’t work anymore and embrace new approaches.

The New York Times recently ran an interesting summary of current sociological research about family structure and its effect on inequality. (http://www.nytimes.com/2012/07/15/us/two-classes-in-america-divided-by-i-do.html?_r=1/). Many of the hurdles that are created for our youth can start early. Over 40% of children are currently born out of wedlock, up from less than 10% in the '60's. This has an alarming correlation to poverty, high school dropout rates, shorter life spans -- and the decay of our middle class.

My generation in the 60's and 70's often pushed social boundaries, which expanded civil rights, generated the sexual revolution, empowered women, and changed our society in other important ways. We also tore down a lot of fences without understanding why the fences were there in the first place. Many of the fences were there to enable future generations to build sound financial foundations.

The most successful financial pattern for the development of young adults has a defined sequence of events:
• First, finish your education;
• Then establish a career;
• Then get married;
• Then buy a house;
• Then have children.

When the order of these life decisions is changed, there are often severe financial consequences for the individuals involved and for society. Decisions to have babies before a parent is able to support a family leads to a lifetime of poverty. Since couples living together without a marriage commitment are twice as likely to break up, their children are more limited growing up in poor single parent homes.

It is very difficult, particularly in our technologically advanced society, for young people with inadequate education and experience to find a path to prosper in the workplace. Early financial setbacks generally limit their potential and their children's potential.

Of course there are many successful families that don't share this developmental pattern. But the data is clear. These stepping-stones are important and many of our social ills stem from missteps and ill-advised decisions made by our youth. Providing our youth with sound financial direction, and cementing expectations of sound financial decision making, are critical.

I believe that, ultimately, the changes that will avert our current social trajectory will develop from these ‘endogenous’ factors that we can control in our lives. We can’t predicate our lives on ‘exogenous’ changes or expect the government or other forces beyond our control to determine our fate.

Reverend Ike, the popular black prosperity preacher in the 60's and 70's often exhorted "The best thing you can do for poor people is not be one of them!" More recently Hillary Clinton's observation that "It takes a village to raise a child" reinforces the reality that bringing up the next generation must be an endogenous process, not an exogenous government activity. If we are to reenergize our middle class, I believe that a key driver will be providing personal attention to show our youth positive ways to make sound financial decisions.

Sitting around and playing 'ain't it awful!' with like-minded friends only induces frustration, hopelessness and depression. It’s also nothing new. We all want our children to have a better life than we have enjoyed. It is our responsibility to give them a sound financial track to follow in making adult decisions.

Rebuilding our middle class is not the provenance of politicians, but of parents. It is up to us to help our lost generation to find its footing.

Our 'New' Investment Reality

Bert Whitehead, M.B.A., J.D. and Charles “Chip” Simon, CFP® © 2012


Can we realistically expect returns on our investments to be on a par with those enjoyed by past generations? Long-term historical stock market returns over a 20-year period in the U.S. have remained relatively stable at about 7-9% appreciation + 2% dividends over the past 80 years. When combined with intermediate bonds, a portfolio with 50% stocks and 50% bonds would reliably average a 7-8% return over a 20-year period.

However, the recent historic decline in interest rates has hurt total returns. Unless we see a marked increase in the stock market in the next 3-4 years, which would be a ‘reversion to the mean’, the 20-year historical average used for projections will have to be revised.

In this environment, near-term inflation is not likely to be much of a concern. The challenge will be to adapt to possible lower total portfolio returns.

There would be several sobering results from this economic revision. One is that clients will either need to work longer to accumulate a larger investment retirement portfolio, or they will have to plan to downsize. This is particularly true for the ‘echo-boom’ generations born in the late 1960's and later. They are not likely to have reliable social security benefits, and guaranteed pension benefits are becoming a relic of the past.

It’s also likely that children will not inherit as much wealth from their parents, as parents will use up those assets in their old age. Our youth will be paying a high price for increasing life expectancy.

To round out this scenario, we have to remember that governments are inclined to rescue every segment of society by increasing the money supply. Printing more money is a long-term inflationary strategy that is likely to compound the financial stress on at least the next two generations.

There is no easy way out of this if the economic duress continues and is exacerbated by public resistance to austerity. As a result, it becomes imperative that we teach our children these important basics to survive in the new reality:
1) Each family must produce more than they consume.
2) Our futures depend on saving at least 10% of our earnings through our lifetime to support us in old age.
3) Future citizens will have to recognize that life expectancy will determine their retirement age.

Now you might be nodding your head and saying 'ain't it awful!' with like-minded friends. But if you present these three points to your grandparents they are likely to look at you and say “DUH!” Wasn’t it commonplace for families to lead productive lives? Wasn’t it known that living below your means rather than beyond your means was bound to put you on a better financial firmament? And weren’t pensions originally keyed to life expectancies? (Yes, even in the late 1800s in Bismarck’s Germany)

The point is that the important changes have to be ‘endogenous’ and start with the factors we control in our lives. We can’t really wait for our lives to be dictated by ‘exogenous’ changes, whether they be Republican, Democrat, policy-based, Supreme Court sanctioned or anything else beyond our immediate control.

What can you do now? We don't advise immediate and precipitous portfolio revamping. Retired clients who have experienced the benefits of completed bond ladders already know that they are well protected financially for the next 15-20 years.

For clients who are still accumulating assets and building their bond ladders, a reduction in the total portfolio return will likely have an impact on retirement planning. During regular investment review appointments, we have generally calculated 'market rate of return' at 7 -8%. We are now also looking at the impact if rates of return fall to 5-6% (assuming a portfolio of 50% interest earning and 50% stocks). Finally, we urge clients to remember that it is a mistake to take more portfolio risk to offset the decline in market rates of return.

I am not predicting the future will unfold as outlined above. There are likely many countervailing developments, many of which will be positive.

But I do think that there is a new reality that has been set in motion that is not going to be reversed in the next generation or two. Most of it is based on modern longevity and will require a change in financial expectations.

But remember your grandparents and ignore the basics at your peril. While there are some long-term possibilities that we should consider in our decision making today (like less Social Security for the young), we can only fruitfully focus on the three issues above that are in our control. I am comfortable thinking that the actions needed to adapt to the ‘new’ investment reality will have a very familiar sound.