Friday, December 21, 2012

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

Wednesday, November 28, 2012

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

Thursday, November 1, 2012

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.

Monday, October 15, 2012

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.

Tuesday, September 4, 2012

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.

Monday, August 6, 2012

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. ( 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.

Thursday, July 12, 2012

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.

Friday, June 15, 2012

Tax Planning 2012: Last Chance!

By Bert Whitehead M.B.A, J.D. © 2012

Taxes are the biggest debate this election year. Will there be a change passed for next year? Looks doubtful, eh? And if there's no change, we go back to the tax rates of 2002. That means the top rate goes to 39.5% from today's 35%, and other changes reappear which will increase income taxes across the board. Even if a tax bill passes, it will likely include a tax increase.

For those who want to position themselves financially for a higher-tax world in the future, there are two items to consider:

1) The tax deduction for charitable contributions is likely to be reduced or restricted after 2012. This could affect the advantages of using a Donor Advised Fund (DAF) for philanthropy. The Wall Street Journal article, “Invasion of the Charity Snatchers!” covered this on Sat. June 6 and referenced me therein (

2) 2012 will be the best year to convert IRA's to Roth IRA's for many taxpayers who are likely to be in a lower tax bracket now than future years.

The tax planning strategy consists of contributing highly appreciated stock to a DAF before December 31st of 2012. Under current rules, this will avoid the tax on all the appreciation and provide the taxpayer with a charitable deduction for the full market value of the stock. For example, suppose that a taxpayer purchased stock years ago for a low price of $2 per share and it is worth $42 per share today. There is an unrealized capital gain of $40/share. If you hold 1,000 shares, the capital gains tax on the $40, 000 based on current legislation (15% federal) will be $6,000. This tax is avoided by making the donation.

In addition to this savings, the taxpayer will also receive a charitable deduction for the full $42,000 market value of the stock. This will save a taxpayer in the top bracket (35%) $14,700 in 2012 income tax.

The taxpayer can simply save these tax dollars, or they can be applied against the cost of a Roth IRA conversion. If the taxpayer chooses to convert $42,000 of an IRA to a Roth IRA they can do so for no additional tax cost because the additional taxable income of $42,000 for the Roth conversion will be offset by the $42,000 charitable contribution deduction.

To review the full discussion on the current rules on converting IRA's to Roth IRA's, please see Bert's Blog on Roths from 3/2/10(

Our analysis shows that the taxes saved by having your retirement money grow tax-free in a Roth would fully offset the taxes paid now to convert the funds in seven years. So by paying taxes on the IRA money now, you could increase your after-tax retirement income by 13% to 28% for the rest of you and your spouse's lifetimes!
There are still six months left to implement this strategy, and it is somewhat complex. If you are interested, call your Cambridge advisor to discuss it. All members of the Alliance of Cambridge Advisors (ACA) know how this can be set up and can assist you in the implementation.

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

Thursday, April 26, 2012

Faith and Fiat Money

By Bert Whitehead M.B.A, J.D. © 2012

"Fiat Money" is commonly defined as money that has no intrinsic value and cannot be redeemed for specie or any commodity, but is made legal tender through government decree.

I have heard "Faith" defined as the belief in the experience of others.

This sums up our long-term economic dilemma. Since Nixon ended the convertibility of dollars to gold to combat inflation, the U.S. has given up any pretense of backing the dollar with gold or any commodity. So the currency we carry in our wallets and purses is essentially only slips of paper with pictures of dead white guys.

U.S. dollars are nonetheless respected and used globally as the world reserve currency. This only persists because everyone believes the dollar has value and can be used by people to buy things. Thus, we have faith that we can spend dollars to buy what we want. So far, so good.

But what happens if people around the world stop believing this? How could this scenario unfold? What can you do to protect yourself? This is the scare tactic that gold advertisements trumpet to entice people to protect themselves by buying gold as an investment.

There are over a hundred instances throughout the centuries during which governments issued paper money and backed it by a commodity, usually gold. "Fiat" paper money has never, however, lasted more than a few generations. Gradually these rulers or their successors could not resist printing more money to increase their spending to finance wars, or cover desirable social objectives. By decree they declared an increase to the legal currency even though they did not add enough gold to their reserves. This became known as Fiat Money.

Once merchants realized that they couldn't convert their money and receive the amount of gold they expected, they raised their prices. Inflation results when too much money chases fewer goods and services. In the 1970's this global issue was addressed by allowing currency values of each country to 'float' against other countries.

Government overspending is a hotly debated topic. Some economists (Keynesians) insist that there are times when it is appropriate for governments to run a deficit. They argue that, unless the government 'primes the pump' by increasing national debt, the country's economy could spiral into depression. The other side provides evidence that a government can't be trusted to ever pay off its debt. Running annual deficits will gradually debase the money and the economy will inevitably be ravaged by inflation.

Both sides of the debate can point to situations as proof that their theory is correct. Take the Great Depression, for instance. Did FDR's social economic stimulus bring our economy back to life in the 1930's, or was it really our entry into World War II that rescued the economy? Was the inflation in the 70's a result of the oil cartel raising prices, or did it arise from Nixon printing more money?

In reality, economics is not, strictly speaking, a 'science.' We can never apply the scientific method to economics since we can’t suspend a complicated global economy in time and study the effect of controlling selected variables.

Modern economists insist that the soundness of a country's 'hard' currency is not determined by how it is “backed”, but rather by whether it is easily converted into other assets. Historically, gold facilitated this convertibility, but that has been replaced by a nation's productive capacity, or gross domestic product (GDP). This seems reasonable, though it can be argued that this is a purely academic paradigm. Alas, austerity is the only known antidote to runaway inflation: we never know when our money ceases to be convertible (or 'spendable') until we can't spend it any more!

Today, for example, people would surely be hesitant to accept Greek drachmas at whatever rates their government decrees. As Argentina nationalizes private property to support their government spending programs, they should expect that the rest of the world will increasingly distrust the value of their peso. All countries that ignore economic realities are eventually exposed as their 'soft' currency starts trading on an internal 'black market.' The 'black market' sets the true value of their currency, irrespective of what the government decrees.

The take-away of this blog is simple: Currencies today do fluctuate in value. Trying to guess which one will go up next is not investing: it is gambling. Gold can be comforting if you can't sleep, but don't bet your retirement on it.

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

Monday, April 9, 2012

Goldman Sachs Fiasco: What it Means to You

By Bert Whitehead M.B.A, J.D. © 2012

It is about time we called it like it is....The ethical standards of financiers across the board are notorious for being somewhere between lax and non-existent. This is so ingrained that most firms dealing don't even think that their behavior is errant.

Goldman Sachs is now the pimple getting squeezed by the feds. Their firm is notable in the acne scarred financial landscape only because their greed duped even their peers beyond prior boundaries. Their financial practices are held up as the cause of the current economic meltdown, but in fact Goldman's executives are not feigning surprise.

Looking back at who caused the current bubble is a charade of shady practices instilled in virtually all the players in the money game. The bubble was kicked off by the politicians in 1999 with the repeal of the Glass-Steagall act. This was pushed by Clinton and endorsed by the then-Republican congress to free banks to participate in the full smorgasbord of financial offerings. Instead of just providing savings accounts and direct lending, now they could offer brokerage services, securitize debts on the secondary market, act like venture capitalists, etc., just like the big wirehouses. It was expected that this would create more competition.

So our current tragedy was birthed by the best of political intentions which seemed like a good idea at the time. Instead, as often happens when the government tries to effectuate public policy, they accomplished the exact opposite of what was intended.

There was a strong social policy, backed by both parties (as well as Acorn), to make housing affordable to all Americans. The percentage of homeownership during the 90’s expanded to almost 70%, up from 62% in the 1980’s. Congress pressured Fannie May and Freddie Mac to loosen lending standards to accommodate the increased demand for families to own their own homes. These private mortgage companies had nothing to lose by taking more risk because they were essentially indemnified by the federal government.

Key to this was the bundling of mortgages to be sold on the secondary market. One problem, however, was there was no experience rating to judge the future performance of such an influx of sub-prime borrowers. Rating agencies over-rated these offerings using the inadequate information available, because they are paid by the folks selling these securities rather than the investors ultimately taking the risk.

This egregious conflict-of-interest has been an accepted practice for decades. Even when underwriters issuing stocks for companies were exposed, no meaningful changes were made. Instead, the brokerage companies (including not only Goldman Sachs, but Merrill Lynch, Smith Barney, etc.) simply started a new department within their firms for their ratings business. This was justified because these new departments would be insulated by a ‘Chinese Wall’ so that investors could rely on their ratings. This was not only proposed with straight faces, I’m convinced the financial executives really believed that it was ‘business as usual’ and it would still enable them to sell new offerings.

With their mortgage bundles now over-rated, it was a good time to become a mortgage broker serving sub-prime borrowers. To put it gently, most sub-prime customers are not very financially savvy. A predatory mortgage broker would befriend the customer and offer to turn their dreams into reality. The commissions earned on these mortgages typically ranged from 6% to 12% of the full amount of the mortgage. They were constructed so that they were affordable at first, and buyers were assured that they would be able to re-finance in a few years, and the home values would continue to skyrocket.

These over-valued securities started getting wobbly when investors realized that more than the expected 4-5% of sub-prime borrowers were defaulting; the actual default rate even at the beginning was 10-15%. Like a game of ‘hot potato’ financial firms rushed to offload their failing mortgage bundles, and sold them to one another, and any one else. It’s not that they actively mislead other firms, but they didn’t provide full disclosure as to the risks which were becoming evident.

But why should they have to disclose risks, or conflicts of interest? When you listen to a Goldman Sachs executive explain their innocence, it’s like listening to a life insurance or annuity salesperson explain their commissions:

“How much in commissions do you earn on this sale?”
“Why do you need to know that? It has no relevance as to whether this is a great investment for you. Letting me put your money to work will more than cover my commission!”

The real problem here is that the financial industry does not believe they owe a fiduciary duty to their clients. A fiduciary duty means they have to make full disclosure of their fees and compensation, any conflicts of interest involved, as well as all the risks involved.

Yes, I am very biased on this issue because I think financial professionals should be held to the same fiduciary standards as doctors and even lawyers. This has been proposed in recent financial reforms, but the lobbies of the institution as is see no need to change because ‘this is the way business is done!”

Good grief.

N.B. This blog was originally written two years ago. My colleagues cautioned that it was too vicious to send out, so I put it away. With Goldman Sachs back in the news in this context, I brushed it off and had some of my family, friends and clients review it again. They suggested I tone it down, but urged that it be published. So I am going ahead now.

Friday, March 9, 2012

Financial Advisors' Hidden Conflicts of Interest

By Bert Whitehead M.B.A, J.D. © 2012

Fee-only financial advisers have long held themselves out as being more ethical than commissioned stockbrokers. Fee-only advisers claim to adhere to a fiduciary standard which requires them to act in the best interest of their clients, meaning they must set aside their personal interest and fully disclose all of their fees and any conflicts of interest.

Stockbrokers, by comparison, must meet a much lower suitability standard, meaning they must make sure that investments sold are suitable for a client. Certainly, charging a client a fee based on the percentage of assets under management reduces the conflicts of interest that a commission-based stockbroker faces when his livelihood depends on whether clients buy or sell securities. What’s more, it often appears that stockbrokers are prone to recommend investments that carry higher commissions, which need not be disclosed.

Charging clients on an AUM basis, however, often presents more serious conflicts of interests than those faced by brokers because the conflicts may involve much more money than the value of a trade. Here are some typical situations where asset-based fee compensation poses conflicts for advisers:

•When advising a client to roll over a 401(k) for the adviser to manage, even when the client has equivalent and less costly options if they leave their funds with the employer’s fund manager.
•When advising a client not to pay off a mortgage (thus diminishing assets), even when the mortgage carries a high interest rate.
•When advising against making a large charitable contribution to get a tax deduction (but decrease assets under management).
•When advising not to give large gifts to children to avoid estate taxes.
•When advising not to buy a larger home.
•When advising not to buy an annuity or set up a charitable annuity.
•When advising a client not to invest in real estate.

The most egregious conflict of interest inherent in the AUM compensation model is the common practice of charging a higher fee — often 1.5% — for managing equities than for managing bonds and cash, which typically are managed for 0.5%. Advisers routinely justify the difference by claiming that equities are more complex investments to manage, which I find self-serving: why not just charge 1.0% for a balanced portfolio? As a result of this compensation difference, clients are almost always over-allocated to stocks.

In all the cases mentioned above there may be good and impartial reasons for an adviser’s recommendation, but in all these cases and many others the temptation to protect or enhance the adviser’s own compensation is too great.

These conflicts are magnified when an adviser claims to be a comprehensive financial planner rather than merely an investment adviser. Comprehensive financial planning includes more than overseeing asset allocation and making individual investments; it encompasses all financial aspects of a client’s situation: estate planning, tax planning, insurance coverage, debt management (including mortgages) and more.
Many comprehensive financial planners who charge a fee based on assets under management often give a short shrift to other aspects of a client’s situation. After persuading a client to sign on, they may speak or meet with the client relatively rarely. This is what would be expected as people generally do what they are paid to do. If they are paid for gathering assets, that’s what they focus on.

The National Association of Financial Advisors (NAPFA) has long championed the importance of commission-free financial and investment advice. The media has recognized their contribution in exposing unethical practices fostered by commission-based compensation. Now, however, most stockbrokers and fee-only advisers (including NAPFA members) charge fees based on AUM. In terms of compensation the two types of advisers have become indistinguishable. As a pioneer and current member of NAPFA, I believe that advisers who charge AUM fees fall short what should be expected of true fiduciaries.

The current NAPFA fiduciary standard limits adviser activity to the ‘purchase or sale of a financial product’ rather than ‘any transaction.’ A clear standard should require that an adviser’s compensation not depend on any transaction where a client is relying on the adviser’s counsel. The examples of conflict of interest listed above all involve transactions that are not ‘purchases or sales’ of investments.

To avoid most conflicts of interest it is simple enough for advisers to charge a flat annual retainer fee that is not affected by a client’s decisions regarding any specific transaction. The structure of a flat fee — which may be more or less than an AUM fee — insulates the adviser from any taint of conflict attributable to compensation. This pricing model is now well established as the minority trend in the profession with hundreds of successful practices having adopted this approach.

Ironically, as common as AUM is for compensation, it is a terrible business model. By tying themselves so closely to forces over which they have little control, excellent advisers can see their annual revenue plunge by 50% in down markets even though their workload is much greater. If advisers are, in fact, providing comprehensive advice and are not being compensated directly for their services, they are providing them for free.

Nevertheless, AUM is an attractive pricing model, but for the wrong reasons. First, it is deceptive. “I charge 1.5% of assets I manage, so I only make more money if you do” is an enticing but misleading sales pitch. Most people can’t or don’t do the math, and don’t realize that 1.5% of $1 million amounts to $15,000 a year — a fee they likely would resist paying if it were transparently stated as a dollar amount rather than as a percentage. Moreover, AUM fees are deducted directly from a client’s account, and so the fee is seldom overtly seen.

A strict ethical approach would require that these potential conflicts be disclosed at the time of engagement, and again whenever an advisor’s specific recommendation may be construed as a conflict of interest. When a situation involves an egregious conflict of interest, such as advising an investment in the adviser’s own investment schemes, an adviser should be required to recuse himself and recommend that the client get a second opinion — a practice common in other professions.

If fee-only advisers want to hold themselves out as being the most ethical practitioners of their profession, they should commit themselves to adhering to the highest possible — and least conflicted — standard.

Bert Whitehead, the President of Cambridge Connection Inc. and Founder of the Alliance of Cambridge Advisors, is the author of “Why Smart People Do Stupid Things with Money” (Sterling, 2009). This was an editorial I wrote for Investment News Weekly which prompted a heated discussion in the on-line Wall Street Journal. I thought clients would find it interesting.

Tuesday, February 14, 2012

Kiss and Tell About Your Status

Bert's Guest Blog: By Erin Baehr,* CFP, CDFA, E.A. © 2012

It is estimated that 10 percent of all proposals happen on Valentine's Day — that's what the Internet says anyway, and if it's on the Internet it must be true, right?

All kidding aside, if it is even close to being true, that is a huge number of people getting engaged in the coming week. The pressure's on, guys. The world (aka the flower and jewelry industries, et al) expects an over-the-top proposal and two months' salary for her ring.

It's easy to be swept up in the romanticism of it all, but after the pictures are posted on Facebook and your relationship status is updated, you are left with two people planning not just a wedding together, but a life and all its not-so-romantic details. Financial compatibility is a big deal, and ideally should be assessed before the engagement, but it's still not too late. Here are several financial things you should know about your partner (and what your partner should know about you) before you marry.

Credit score: Your credit score is like your financial GPA, and largely determines your freedom of financial choice. A good score can open the door to the best interest rates, for instance, while a poor one can affect your chance at a new job. If your fiancé's score is less than stellar, find out why. Was it something out of his control, like a prolonged job loss or a medical issue? That's certainly understandable. Or was it from overspending and irresponsibility? If so, think twice about merging finances before those issues have been worked through, or you may be dragged down with him.

What does she own and what does she owe? How will you know your fiancé is really a rich princess in disguise unless you ask? While that's not likely, it is still important to know what she does own, and decide if those assets will be commingled as marital property or held separately. Of vital importance is the type and extent of her debt if she has any. Is she weighed down by credit card debt or large student loans? You'll need to discuss who will be responsible to pay those debts after marriage. And like the credit score, excessive debt can limit your options financially, or worse, be a symptom of financial dysfunction in your fiancé.

Employment history: Has your beloved been in the same position for a decent period of time, or does he flit from job to job, complaining about the unfairness of each position? Hmm, that may be a red flag. Pay attention to his work ethic and desire to work. Is there a large income disparity between the two of you, and if so, will that have an effect on the balance of power in your relationship?

Career goals: Where do you see yourself in five and 10 years in your career? Do your fiancé's career ambitions mirror yours, and if not, will that frustrate you or her? Does she plan to devote countless hours to earn a promotion, or take time off to complete a master's degree? If you have similar ambitions, you may be understanding of each other's drive, but if you look forward to relaxing over an early dinner, her late nights at work or school may leave you lonely.

Money personality: We all have a "money personality," or a style of relating to money. Which one we are depends on where we fall on a continuum of saver versus spender and operating out of fear or greed. Are you a miser type personality, thinking of marrying a shopaholic? I predict friction in your future. It's good to find out what personality you each tend toward, and understand if they balance each other out or are a toxic mess. For more information on money personality, check out "Why Smart People Do Stupid Things with their Money" by Bert Whitehead.

His money biography: What was money like in his family of origin? We tend to act in ways familiar to us, so if money was not ever talked about while growing up, it is likely we will be uncomfortable talking about it as an adult. If his parents tried to buy his love, it is likely that he will see spending as a measure of caring. Or if things were tight, he may now have an extreme fear of losing his wealth. Or, on the other hand, he may be a big spender as an act of rebellion against a restrictive childhood.

Unspoken expectations: These are tough to uncover, because we often don't realize we have them. For instance, in your family of origin, it may have been common for your dad to buy your mom a dozen red roses on Valentine's Day, regardless of the cost. If you marry someone whose expectation is that the two of you would save your money by cooking at home with a Red Box movie because his father thought it outrageous to spend that kind of money on flowers, you may be quite disappointed when he comes home empty handed and angry that he expects you to cook (and he will be blindsided by your anger). Or if he expects to have a wad of cash each week to walk around with and not account for it, while you expect to count every penny spent, that also can lead to anger and resentment. Without bringing these into the open you may be completely confused by your intended's behaviors and reactions.

Money motivation: What drives her uses of money? Is it a means to power, influence or notoriety? Or is it a way to show love to her family? Looking at what motivates each of you to earn, give, save, or spend money can predict some of your financial behaviors. Are your motivations compatible?

Lifestyle expectations: Does your fiancé envision one of you staying home with children should there be any, or does he expect that you will both work outside of the home? And how big of a home will that be? What kinds of vacations does he like to take? Again going back to the hidden expectations, if your family took a European vacation every year while your fiancé's family camped in the backyard, unless you talk about it, you may naturally assume he wants to save for that kind of vacation, too.

*Erin Baehr, CDFA, CFP, EA is the principal of Baehr Family Financial, LLC, and a member of the Alliance of Cambridge Advisors in Stroudsburg, PA ( She was recently named "Greatest Around the Poconos" in the financial advisor category.

Wednesday, January 25, 2012

Is It Time to Panic Yet?

By Bert Whitehead M.B.A, J.D. © 2012

Some days it seems like our economy is improving, then you turn the page and major world problems (Mideast, Europe, Korea, etc.) are just getting worse.

So what if you are a baby-boomer (or older) and are starting to think that your retirement isn’t going to be as joyful as you expected? Or maybe you are younger than that but wonder about your ability to take care of your parents, put your kids through college, and ever have enough money to retire yourself?

To evaluate yourself financially you need to answer four basic questions:

1)Are you living within your means?
2)Are you saving at least 10% of your gross income?
3)Are you covered for possible catastrophes in your life?
4)What is your ‘Plan B?’

You will note that these four questions have nothing to do with the worldwide currency crisis, the future of the stock market, or the political outcome of the next election. Instead, they refer to issues that you can directly control.

1)Are you living within your means? I have a short cut to figure this out. Do you pay off your credit cards in full every month? If you do, you are generally living within your means. If not, or if you have to take out loans (home equity, more credit cards, etc.) to pay off your credit cards, you are living beyond your means.

If the latter applies, you are probably spending more than your take-home pay and the shortfall shows up on your credit card. If you have tried to restrain your spending and have not been successful, it is usually because you have ratcheted up your standard of living beyond what you can afford. Being ‘house poor’ often causes this. That means that you have too much house, and to cut your spending you will have to downsize. Downsizing is much easier if you are relocating into another housing market.

2)Are you saving at least 10%? When we talk about ‘saving’ in this context, we are talking about long-term permanent savings, i.e. your investment portfolio. People sometimes emphatically assure me that they have been saving money regularly for years, but they have not accumulated an investment portfolio. They confuse ‘saving up to spend later’ with ‘saving for long-term investments.’

The financial objective of long term permanent savings is to invest enough during your working years so that later in life you can live off the money your money makes, rather than from the sweat of your brow. This is required if you are to be truly ‘free.’ Those without an investment portfolio are destined to have to work their whole lives, depend on the benevolence of others, or live in poverty.

3)Have you protected yourself against catastrophes? The best-laid plans can be derailed by unexpected calamities. Sudden medical conditions or disability, loss of car or home, unexpected death, lawsuits, etc. are all dangers than you seldom have to deal with, but they do happen and they can be devastating.

Basic insurance coverage and simple estate planning can shield you from these hardships. Although you might set these protections up, it is easy to forget about reviewing them. Then when you need them, they may be stale or inadequate. Make sure they are updated at least every five years, or whenever your life situation shifts (marriage, children, family deaths, etc.).

4)Do you have a ‘Plan B’? Even when people have done everything ‘right’ (i.e. #’s 1, 2, and 3 above), life can present unexpected challenges that they can never prepare for. Even with a college education, you will never be certain to have a job. You may take risks that flop, like starting a business. Shadowy medical conditions, like depression, might go unrecognized and can be debilitating.

For some younger people, Plan B is moving back with their folks. For some older people, Plan B is moving in with their adult children. Plan B might simply entail a willingness to drastically reduce your living standards so you can maintain your independence.

Sadly, my experience has shown me that many people live lives of quietly repressed panic, with an intangible sense of deprivation anxiety. They may not recognize it themselves, but a sense of financial foreboding shadows their lives every day. This can lead to behaviors like intense miserliness or as denial expressed by mindless spending. Others distract themselves by focusing on the possibility of widespread debacles due to economic and social issues. They spend their time playing “Ain’t it awful…” with their comrades in fear. They may overreact by radically altering their financial positions (“gold and canned goods.”)

I find that our present times have not changed much from past times. I recently saw the movie “The Iron Lady” which reminded me that we were dealing with the same issues 30 years ago as we are now. Somehow we, as a people, are able to rise up and defeat fear.

The real danger is not outside of us in the economy or the country. Our biggest danger lies within ourselves. We cannot control our individual destiny by anxiously reading the papers and watching TV. After all, magnifying the negative is much more profitable for journalists than reporting slow, steady progress.

Review your own situation and make the changes you need to make so that you can answer ‘Yes!’ to each of the four questions above. Then I can assure you, it is not time to panic!

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