The Freedom Trail

An Awakening

I have been quite reflective over the past month.  You probably noticed since I have not had any blog posts in quite awhile.  My reflections led me to the realization that I've been asking myself the wrong questions for way too long.  In fact, you will notice a name change for my blog.  It is no longer the "Road to Prosperity".  I now lead clients down "The Freedom Trail".

Now, I realize this is quite the cheesy title for a blog considering there is a little path in the Boston area that is known by the same name.  My title is significant to me because I have grown to love the Boston area for one and because I feel that I do lead my clients down their own personal Freedom Trail.  A trail that can free them from the tyranny of simply living life to the joy of having a life that is designed on their own terms. 

Now I know this may sound like some "pollyannaish" vision, but, I can tell you from personal experience that it is one that works!  I've spent too much time helping clients achieve the goals they believe "conventional wisdom" says they should have.  "I want to retire at 65"..." , "I want to ____ at __".  (You fill in the blanks.)  However, I found that my clients were not as personally fulfilled as they thought they would be once they got to this "goal".  Somewhere along they way, they may have had a dream that went unfulfilled.  They may have felt they sacrificed too much time with family.  They may have lost sight of who they were as a person to become the person they thought society wanted them to be.

The "Freedom Trail" I lead my client's on is one that helps them unfold their most profound values....their richest potential as individuals - and merge these into their daily lives.  It creates a certain energy - a willingness to stick with the plan through both good and bad times.  It helps them realize a life that once may have only been an unfocused dream...or a long forgotten yearning.

Have you had an awakening?

Building Wealth: Diversification (Part 2)

In a continuation from our previous post, I wanted to discuss what diversification means to you. 

The most commonly used example is the S&P 500 Index.  According to Ibbotson Associates, the S&P 500 (with dividends reinvested) has lost money 14% of the time over a 5 year period.  If you stretch the time period out to 10 years, it has lost money 4% of the time.  And a 15 year time frame does not show any negative returns.  So, as long as you hold the stocks long enough, your risk goes down.  Correct?

Not necessarily so says Mark Kritzman.  The scenario above showing positive return over the long term indicates an ability to withstand severe market downturns in the interim.  As we talked about in the post "Fat Tails and Black Swans", it is possible to underestimate the impact such events can have on your overall portfolio.  In fact, the longer you stay 100% invested, the higher your risk is that such an event will have an detrimental impact on your portfolio.

The solution?  Diversifcation thereby your hedging risk.  No that does not mean exotic derivative instruments, it means sound Strategic and Tactical allocation models.  Gather investments with very low & negative correlation.  These are assets that will, theoretically, not track each other that closely - if at all.  A sound strategic approach.

However to best limit risk, you should also consider the Tactical side.  This is because correlations change.  The correlations are the best measure of the market over the long term, however, periods of significant market decline can lead to increased correlation between assets.  Not good.

Attention should be given to asset classes that can diversify in a down market.  This does not mean that your entire investment policy should be based unique events, but a certain awareness of these facts can help limit potential losses so you can maintain a certain level of wealth.

Building Wealth: Diversification (Part 1)

I always get the same response when I ask people how well diversified their investment portfolio is.  The response - without fail - is something to the effect of 60% Stocks and 40% Bonds.  My reply is always the same.  That's a great place to start.

But, when I talk diversification, I don't want to see a pie chart that looks like this:

 
I want to see one that looks like this:

This is what a truly diversified portfolio would look like.  The stock portion would be broken down into size, style, sector, etc.  Bonds would be broken down by duration, quality, etc.  You would have some cash and commodities thrown in as well for hedges.  You would look both strategically and tactically.  You would consider your time horizon..so on and so forth.

The point is to diversify until you don't think you can anymore..then diversify some more.

Come back tomorrow as I will continue my discussion on diversification and tell you how to do it more effectively.

5 Steps to Wealth Building

We are going to start the week with 5 simple strategies to wealth building.  No - we are not going to be giving the greatest stock pick of the week.  Nor are we going to make it simple.  These are internal beliefs that you need to have in order to achieve the wealth you desire and deserve. 

As the week goes on, we will expand the writing to include specific strategies.  But first things first...

1)  Create a specific amount of money that represents financial abundance to you.  Make it a must that you will achieve this goal.

2)  Have an effective strategy to help you build wealth.  If you don't have one already, get one!  Call someone, talk to someone.  Find out what the steps you need to take to make your goal a reality.

3)  Follow through and follow through consistently.  I don't know how many clients I talk with that have taken the initial steps towards their goals, but they end up getting side tracked along the way.  Don't get sidetracked!  Follow through.

4)  Know what you know...but even more importantly, know what you don't know.  What you don't know, go out and learn.  If you have neither the time nor the inclination to learn, find someone that can help you.

5)  Understand the why behind the reasons you are committed to achieving this goal.  Write these reasons down in a journal and keep it with you.  Refer back to it when you feel yourself becoming complacent or unmotivated.  Keeping the why fresh on your mind will help with Step 3 above.

Work through these steps and begin to realize the financial future it is that you desire.

Transitions

Job loss?  New job?  Death in the family?  Inheritance?  Getting married?  Having a baby?  A huge downturn in the market?  A recession?

All of these situations signify both a beginning and an ending.  Some are positive, some negative.  Some are planned, some unexpected.  However, they all represent a chance to change and to grow.  To become more than you once were.

These events will cause us to let go of the familiar and face a future that is unknown and one that can leave us feeling vulnerable.  We may feel afraid.  We may feel anxious.  We may feel as if our lives are spinning out of control.

The key is how we handle this situation.  Many of these events can be planned for with the appropriate strategies since you know they are going to happen.  This will decrease the uncertainty and allow the individual to move through the transitions stage much faster.  However, when the unexpected does happen, it is often vitally important to seek assistance - or be "helpable".  You may only see your options as either X or Y.  A third party may provide additional insight and, together, the two of you may come up with option Z.

As a life & financial planner, I have seen clients come in that have the right strategies in place to help them through these situations.  Then I have seen others come in without any strategies in place.  Yet, we were able to devise the appropriate strategies together.  All because they recognized they did not have all the correct answers and allowed themselves to be "helpable".

How will you handle the transitions that life brings?

Q&A Tuesday

I have decided to dedicate every Tuesday's blog to Q&A.  I will try and post the most common types of questions I receive.  Please e-mail us if you have a question you would like to ask.

Q:  Whose name should I put my child's college savings under?  Mine or theirs?

A:  There are advantages and disadvantages to both.  Generally speaking, the disadvantages of having the money in your child's name outweigh the advantages though. 

One, there will be a kiddie tax levied on earnings in excess of $1,700 if the funds are not in a tax advantaged vehicle.  The first $850 is exempt from taxes, the second $850 will be taxed at the child's rate with the remaining earnings taxed at the parents highest tax rate.

Two, there are control issues involved.  If a custodial account is set up for the child via UGMA or UTMA the child will often times gain complete control of it once they reach the age of majority (usually 18 - 21).  The money will be theirs, whether they choose to use it on education or not.

Third, and perhaps most important, is the impact the type of saving will have on the expected family contribution for financial aid purposes.  Assets in the child's name are assessed at 20% while the parent's assets are assessed at a rate of 5.6%.  Consequently, this can result in a significant difference in the amount of financial aid the child qualifies for.

_{The above is not intended as financial, legal or tax advice.  You should see a competent professional if you have questions about your specific situation.}

Buying High....Selling Low

In all my years as a financial planner, I have never met anyone that consciously set it to do that.  Yet, I don't know how many times I've heard someone say, "I'm just going to get out of the market for awhile, then I'll get back in again when it looks better."  We would ALL love to be able to do this, however, it will take us to make - not one - but TWO correct guesses if we are going to try this strategy.  You have to know when to get out AND when to get back in.

Now, lets assume for a second that you make the correct decision on when to get out of the market.  When do you get back in?  When the market has increased 10%?  15%?  20%?  I'm not sure - are you?  I do know, however, that if you are the slightest bit late in timing your entrance you will receive a substantial penalty on your overall returns.  The following is a chart you have probably seen before, but the message is the same:

It is not difficult to see that if you don't time your entrance perfectly, you will have severe erosion of your overall return.

Ultimately, someone may, one day, successfully time the market.  But history is not on their side if they do.  People have been trying for 100+ years, and I can't name one person yet who has discovered a way to do so consistently.  Remember there are no free lunches in the market.  Just ask the people who invested with Madoff and Stanford.  If "the answer" had been found, they would not be wasting their time trying to sell it to you.  They would systematically execute it until they owned the free world.

Work the plan that is right for your situation and you will create the life you want.

Fat Tails and Black Swans

Everyone that could, wanted to invest with Long Term Capital Management back in the mid 1990's.  After all, there were some really smart people running the fund and the fund's returns were in excess of 40% - and that is after fees!  The college professors and noble prize winning principals of the firm had created a system that could not fail - mathematically speaking that is. 

The checks and balances were in place to safeguard the fund from any event that could ever be imagined.  There was a statistical impossibility that the fund could ever lose enough at any one time period to become insolvent - or almost topple the financial system.  Oops.  It did become insolvent and it did almost topple the financial system.

The firm used vast quantities of historical data to arrive at their trading strategies.  Most of the assumptions they made were 100% valid.  However, they did not take into account the possibility of the fat tail and black swan.  These are events that are not mathematically possible.  But math alone can not factor in the "human element" of real-world events. 

In the case of LTCM, trouble began with the East Asian financial crisis of 1997 and culminated in the default of the Russian ruble in 1998.  This cataclysmic turn of events was not something that LTCM could ever had envisioned.  Yet they happened.

What does this mean to the average person?  That overall portfolio return MUST be integrated with sound risk management techniques to try and guard against these types of events.  Sound Strategic and Tactical asset allocation models should be used because a 100% blind faith that the historical relationships between asset allocation will hold can be hazardous to your health.  It is true that, over time, everything will return to the mean.  Yet, can you hold on long enough for the fat tails and black swans to run their course.  LTCM could not.

Doctors/Lawyers/Financial Planners...

Bear with me, this is a lengthy discussion.  But one that is essential reading!

A Financial Planner held to a Fiduciary Standard occupies a position of special trust and confidence when working with a client. As a fiduciary, the Financial Planner is required to act with undivided loyalty to the client. This includes disclosure of how the Financial Planner is to be compensated and any corresponding conflicts of interest (source www.FocusOnFiduciary.com).

If you haven’t heard of a Fiduciary Standard of Care, you haven’t done your homework on selecting your financial planner. The single most important thing your doctor, your lawyer, and your accountant (your accountant has an implied Fiduciary Standard) have that 99% of all financial advisors DO NOT have is the Fiduciary responsibility to you, their client.  Every financial planner should be held to a Fiduciary Standard, but 99% of them will not put it in writing, legally binding them to that extra level of care and responsibility.

So just what is a Fiduciary Standard? A Fiduciary Standard is the absolute and undeniable obligation to provide you (the client) the most appropriate financial advice and guidance REGARDLESS of personal gain (compensation/commission/fees/perks, etc.). A Fiduciary Standard entails acting with complete disregard as to how the recommendations and planning advice will affect the planner, but rather how those recommendations and the planning advice will benefit the client financially and accomplish the clients financial goals. A Fiduciary Standard requires a complete and consistent focus on the client from the beginning stages of the financial planning and investment process, through the execution, implementation, and monitoring of the clients financial plan.

What would you think, how would you feel if you went to your doctor with a life threatening condition and they weren’t held to a Fiduciary Standard of Care? What if they received compensation or perks for recommending one drug over another? What if their income was dependent on which drugs or course of treatments they recommended? What if they needed to sell “X” amount of “ABC” drug and the generic counterpart never entered their mind?

You’d feel betrayed, you’d feel distrust, you’d think your doctor didn’t have your best interests at heart, you’d be hesitant and concerned as to where to find real honest medical advice. You’d have every right to feel that way.

Attorney’s have a similar Fiduciary responsibility to their clients. An attorney must act with good faith and in their clients best interests always. The client is trusting the attorney to represent them in the most prudent manner possible, and the attorney must not breach this confidence placed in them by their client.

Yet everyday the average consumer with financial and investment needs signs over their financial security and future to an individual not held to a Fiduciary Standard of Care. Every day the average consumer continues to re-hire that same NON-Fiduciary financial advisor - because not firing a non-Fiduciary advisor is the exact same as re-hiring that person everyday that passes. Every day millions of investors naively but trustingly believe they’ve received the most prudent and unbiased advice possible, when this isn’t necessarily the case.

Your doctor is held to a Fiduciary Standard of care, your attorney is held to a Fiduciary Standard of Care, and your accountant by implication is generally held to a Fiduciary Standard of Care.

Why would anyone accept anything less than a complete acceptance of the Fiduciary Standard on the part of their financial advisor?  Simple - 99% of financial advisor “professionals” choose not to (or cannot) adhere legally (or philosophically) to a true Fiduciary Standard. They’re enriched by large commissions, perks and other hidden fees to sell products rather than solve problems. Their incentive is lining their own pockets, not helping you achieve your financial and retirement goals. These financial advisors are paid from the Wall Street firms or insurance companies they work for, not their clients.

Most consumers assume the Fiduciary level of responsibility and duty is already present in the financial services industry, and they’d be right to a limited extent. The Investment Advisors Act of 1940 mandates that to offer financial advice one must be a Fiduciary. To avoid this higher standard of care and responsibility the securities industry created what was coined the “Merrill Lynch Rule”, exempting certain types of fee-based accounts from coverage under the Investment Advisors Act of 1940 (labeling them brokerage accounts rather than advisory accounts).

The Merrill Lynch Rule was overturned in May of 2007 thanks in part to the Financial Planning Association’s legal efforts. Wall Street does NOT want the imposition of a Fiduciary Standard because it clearly opens them up to more regulation and lawsuits from many standpoints, including a breach of fiduciary responsibility and suitability. But the simple fact remains that a Fiduciary Standard protects you, the consumer of financial and investment services.

Although the Merrill Lynch rule was overturned, there still today does not exist any reasonable or consistent set of Fiduciary Standards in the financial planning and investment management industry. The primary reason this issue is so challenging for the industry to manage is compensation. If a financial advisor is paid directly from the client (or the financial advisor’s only source of income is through fees from the client in some form), they can in theory embrace a Fiduciary Standard. However, if a financial advisor is paid by some Wall Street investment banking firm or insurance company - their responsibility is to their employer who signs their paycheck first!

If you believe that extra level of care and responsibility should be present in your financial advisor, demand clearly and in writing from them that they agree to be held to a Fiduciary Standard as described under the Investment Advisors Act of 1940. Demand they put your best interests first. Demand they provide you exceptional and unbiased financial and investment advice.

A Fiduciary Standard is the highest standard of care, duty and responsibility in a relationship. Anything less than a Fiduciary Standard of care from your financial planner is unacceptable. This is your financial future, your nest egg, your retirement, your family, and your security we’re talking about…right? Isn’t it time you expected more from your financial planner?

Today's Opportunity

July's unemployment was 9.7%.  There is not much job security anymore.  The Dow is still down roughly 35% from its all time highs.  The world markets have followed suit.  The pace of the recovery is still very uncertain.  The financial market nearly had a complete meltdown.  I could go on, but you get the point.

The times are tough, however, I feel it is what leads us to today's opportunity.  There is no better time to look at yourself in the mirror and reflect on what is is that you are truly passionate about.  To reiterate from the previous blog entry, find out what it is that you truly want - what it is that you want to be in life.  And commit to yourself that you will have that kind of life.  No matter what.  Come hell or high water.

And where does it begin?  You are correct if you answered with the right plan.  Not just any plan, but one that is:

• Clear
• Concise
• Compelling AND
• Consistent

A plan that has these properties will allow you to be committed to following through with it.  It will get you excited about getting up in the morning.  It will be something you will accomplish because you have internalized it.

That is the opportunity you have today.