Advice or Accomplice
There is a very important question you need to ask yourself when you visit with a financial consultant — are you seeking advice? Of course, you may say. But many times you are not really looking for advice but an accomplice. Sounds complex? Let us try to understand this. When I visit a financial consultant, is it because I have a few ideas, have I made some decisions that I want him to endorse, or is it because I go with an open mind and ask him for his competent financial advice under the given circumstances? More often than not, it happens to be the first situation, maybe subconsciously.
Let me explain with an example. An engineer meets with a consultant with his wife looking for advice. He is ready with his tax returns and shows how he has smartly invested $100,000 in CDs earning him 5% interest at that time. His mortgage interest was less than 4% and he was saving tax on mortgage interest too. So he was under the impression that he was making thousands of dollars every year. Great, indeed!
The financial consultant explained to him that firstly, the interest he earned on CDs was actually causing taxes on his Social Security. If this component were taken away then the taxes on Social Security would go away too. These additional taxes paid on Social Security were more than the money he was making on his mortgage interest. Secondly, he thought he was getting a lot of tax deduction on his mortgage interest but in reality he was getting only about $1000 because the standard deduction was covering most of his deductions. So, he did not even get the deduction he assumed he was getting. The sound financial advice given to him was to pay off his mortgage.
Did he listen to this advice? No. He was not really looking for advice. He wanted to show his wife how smart he was in front of a financial advisor, but he ended up doing the opposite. He just wanted an accomplice.
So, when you go out seeking advice, consciously seek advice. Do not go with biases, closed minds, or any agendas in place. They will put blinkers on your mind and filter out any sound advice given to you. Do not go out looking for accomplices for your ideas. Only good financial advice can lead to sound financial prudence.
Seek advice not an accomplice!
The Diversity Trinity
Today we are talking about a very important aspect of financial investing – diversification. Diversification means using your financial resources in different areas. The Diversity Trinity explains how diversification can be achieved in financial investing.
The Diversity Trinity is a simple yet powerful concept. The Diversity Trinity is essentially a triangle. At its three vertices we have, The Financial Diversity — In, Within and Without.
You have your financial resources and the first thing you do is decide to invest in stocks, so you are “in” stocks according to The Diversity Trinity. Now, is it enough to just be invested in stocks? No, you need to be “within” stocks; you need to be diversified within stocks. Own stocks of different companies for example: large, mid, and small cap companies; in different sectors for example: retail, manufacturing, pharmaceuticals, etc.; and in different countries. It is important that all your stocks are not affected by the same economic factors. So now you are truly diversified within stocks. Is that enough? No, you need to invest “out” of stocks as well. This means investing in bonds, annuities, and alternative investments. Now your financial basket is truly diversified according to the Diversity Trinity and you have tried to insulate yourself from economic changes affecting a specific sector, industry, or country. What you have achieved for yourself is diversification and minimized of risk.
Another example would be if you want to invest in real estate stocks. You can buy a single real estate stock to be “in” real estate as per the Diversity Trinity. But buying a single real estate property is not as smart as buying a real estate investment trust which invests in hundreds of income producing properties, this is being “within” real estate. This is not adequate though; you need to be in other sectors “out” of real estate to ensure that all your investments are not hit when the real estate market is affected. Therefore, the Diversity Trinity and diversification are simple yet complex principles.
Most people know that they must achieve diversification in their investments. And some are under the illusion that they are well diversified. In reality, most analysis done reveals that most people put 75% of their money in large capital stocks. So study your investments carefully, use the Diversity Trinity, and do your own analysis. Measure your diversification and use the Diversity Trinity as your guide to Diversification.
The Best Tax Deduction Ever
It says right on my business card, “Integrated Tax and Retirement Planning”. So you’d be right if you guess we spend a lot of time helping our clients save money on taxes. There are great ways out there to reduce your tax burden and keep more money in your profile. Many of them only apply to investors with certain circumstances, but there’s a tax deduction out there that everyone can take advantage of, and it has benefits that may surprise you.
What is it? First, let’s think about what creates a tax deduction. Most tax deductions come as compensation for having some cash flow out of your life. The classic example is buying a bigger house. A lot of financial advisors tell clients who want bigger tax deductions to buy a bigger house. Why? That way you can deduct a larger amount of mortgage interest, and thereby pay less in taxes. But think about it – when you buy a bigger house, is your interest payment the only thing that changes? Nope. Heating bills are higher, electric bills are higher, maintenance costs go up – it’s expensive to save that much tax money! Plus, a bigger house is more work! I’ve got a deduction that’s even better, and you don’t need to increase your monthly overhead to get it. Are you ready? Wait for it…
It’s charity. Giving your money to a charitable cause has the same tax impact of giving a larger mortgage payment to your bank, doesn’t it? And you don’t end up stuck in a bigger house than you need – one which will consume more of your life to maintain. Give that extra money away instead – you’ll get the same tax benefits, and you don’t complicate your lifestyle. You avoid giving up time you could spend with your family in order to care for a new big house, and you’ll be putting money in a place where it actually makes people’s lives better!
How many problems in our country would improve if charities were better funded? Think how much less our country would need to depend on the government to help people, if charities could accomplish more of what was needed. It’s worth pointing out the obvious here; charities are way more efficient at allocating money to places where it’s needed than governments are or ever will be. This will never change, because charities can give money directly to the people that matter. Of course, use discernment when picking a charity; some charities are more efficient than others, and some spend a surprising amount of money on their own administration costs. But I assure you – the best tax deduction ever is the one you get when you freely give your money away to a good cause.
You Can’t Have the Horizon
One benefit of my job is that I get to meet a lot of very financially successful people. Some have accumulated as much as several million dollars. But do you want to hear something surprising? A lot of them are never really happy. Part of this comes from being driven. You don’t amass millions in net worth without being able to drive toward a goal. These people have spent years, and typically decades, pursuing goals relentlessly – always keeping their focus on what’s ahead so they can steer toward it. As a result, many of them have a hard time settling in and appreciating their success. As a small business owner, I’m vulnerable to that myself.
Learning How to Avoid the Gap is a book by Dan Sullivan. Dan’s organization, Strategic Coach, helps entrepreneurs grow their businesses, while at the same time enriching their personal lives. His book emphasizes a key point I want you to hear: you can’t have the horizon. Entrepreneurs instinctively put their focus on the horizon – the farthest point they can see in the future, and they pour all their effort into heading there. And that’s a good thing – we want to be improving; we want to move toward excellence; we want to anticipate problems and steer around them. That’s true in our personal lives, as well as in business. The only problem is that we’ll never get there. The horizon isn’t not a destination, any more than the end of the rainbow is a destination. It’s an illusion. If you keep waiting to get to the horizon to enjoy what you’ve accomplished, it’ll never happen. You can’t get there. In short, you can’t have the horizon.
So what’s the solution? In Learning How to Avoid the Gap, Dan points out that even though we still need to look to the horizon compared to where we are now, we must not stop there. We also need to look the other way, and see where we were when we started. If you can own the fact that you’ve made progress, that’s something you can celebrate now – in the moment. You still need to be reaching toward the horizon, but don’t miss the enjoyment that comes from enjoying how far you’ve come.
The 401(k) Jockey
In another article, I analogized fees on mutual funds to jockeys on racing horses. My point was that there are some great, well managed mutual funds out there, but that some of those funds that have such staggering fees that they become like a prize-winning race horse saddled with a chubby jockey.
I had some new clients come into my office today. They had been retired for over 10 years, and still had a large portion of their retirement money in a 401(k). I looked over their portfolio, and found that not only were there fat jockeys riding the mutual funds in the 401(k), but the 401(k) had its own fat fees on top as well! These poor folks were betting their retirement on a horse with two fat jockeys on it!
A lot of investors with money in a 401(k) should make preparations to move that to an IRA right away. Why do I say that? I have a Labor Department report on 401(k) fees and expenses here on my desk that was published in 1998. This report identified the median of all 401(k) annual fees (the fee with as many fees above as below that number). The median was 1.32% in fees on the 401(k). The mean (average) was 1.28%. The bottom line is you are losing one and a quarter percent more money to fees that you could have avoided if that money was in an IRA instead of a 401(k).
Now don’t forget, there are always exceptions. If you’re under 59 ½ and still working for the company where you have the 401(k), there are good reasons to leave it there. But if you’ve stopped working, or left your company, or even if you’re still with the company but you’re over 59 ½, pull that money out now! You’re betting your retirement on a horse with twin jockeys on his back!
The Call of the Entrepreneur
“…Greed – for lack of a better word – is good. Greed is right. Greed works.” says Gordon Gekko, in the popular film Wall Street. I believe this kind of thinking is our enemy. Greed isn’t right. It doesn’t work for anybody. It’s not good for business, and it’s not good for ordinary people; most people know that. Greed is not how you get ahead in business, and finally there’s a movie I can recommend to you that showcases business with what I think of as the correct point of view.
The film is called The Call of the Entrepreneur, and it’s fantastic. The film is produced by Acton Media, and was created by Rev. Robert A. Sirico. I’m having my family watch it, and I’m recommending it to anybody who thinks of the business world as something you stumble into when you can’t make it in a nobler field. The film holds up the call to be an entrepreneur as a calling as important as that to be a Mom, to be a pastor, to hold any position of honor in our society.
The Call of the Entrepreneur highlights the fact that business is not a zero-sum game. In Gordon Gekko’s world, the way you get money for yourself is taking it unfairly from somebody else. That’s not the business world I know; I have to create something in order to be wealthy. The business world is more like planting crops. I buy a stock of corn seeds, and invest time, effort, and resources in those seeds, and I get wealth from that. I get food to feed my family; I get revenue from selling the corn to other people who need it; I get a supply of seeds to use for the next year.
A dairy farmer, a retail banker, and a refugee from a communist regime are the characters in this fantastic video, and they make it perfectly clear that the business world isn’t a necessary evil, but a high calling. Some people hear the call to become a pastor and care for hurting people by sharing the hope of their faith. Others hear the call to be a Mom, and shepherd the next generation of humanity. The Call of the Entrepreneur shows how important the calling to be a business owner is, a call that our society lately disparages and takes for granted. See this film. I’m encouraging churches to see this film together and discuss it. You can get your copy at the website for the film, http://www.calloftheentrepreneur.com/. Who knows, maybe you too will hear the call to become an entrepreneur, and change the lives of others for the better.
Change in Vocabulary
Financial advisors have been debating for a while the various merits of “active investing” versus “passive investing”. In the vocabulary of the financial industry, active investors are frequently trading in and out of different kinds of holdings, using market timing techniques to beat the market, buying assets when their price is low, and selling when their prices is at its height. The passive investors, in this way of thinking, build a portfolio of assets and hold it for the long term, hoping that the savings in trading costs will allow that approach to outrun the active traders over time.
Here’s my problem, I don’t like this whole vocabulary of this debate. I think it creates a straw man argument about passive investors. You see, I’m not a passive guy; I don’t sit around and wait for things to happen. But I build lots of portfolios for clients that use that ‘passive’ sort of approach. And my portfolios aren’t passive at all. Sure, they are structured a certain way, and we hope to minimize trading needs, but like a ship changing course to compensate for changing currents, I do adjust these ‘passive’ profiles to stay on target during changes in the market. The ‘passive’ terminology also wrongly leads people to think you can never change what’s in such a portfolio. Wrong! If you aren’t rebalancing your profile every now and again, your financial ship is adrift in the current, and you may be heading for the rocks.
So I’m changing the vocabulary of this debate right now. From now on, I’m referring what I do as “structured”, or “disciplined” investing. And I’m relabeling the other kind of investing as “speculating”. It’s been called “active” investing, just because so-called active investors are always trading into or out of something. But those investors don’t know the future any more than I do, so they’re always chasing the market from behind. They’re starting ten steps behind what the market is doing, and hoping to get to being only one step behind. They’ll never get ahead of the market – nobody can.
So from now on, we’re using a new vocabulary. The choice is not between passive or active investing; it’s between structured or speculative investing. I choose the former. How about you?
Pick Your Jockey First
Horse racing provides all sorts of great analogies for financial planners. After all, what are we doing when picking assets for clients but betting on horses that we hope pull ahead of the others? Now, what we do is very different from gambling, but there are lessons we can draw from the comparison.
Imagine you’ve found the perfect racing horse to bet on. He’s won the last 50 races he’s in. The rest of the competitors in his race are shills. They’ve been planted there to make your horse look good. There’s no way your horse can lose, right? That depends. Who gets to pick the jockey? If I pick a five hundred pound man, and put him on top of your prize-winning horse, guess what? You’re doomed. There’s no way you can win.
Mutual funds are very popular investment vehicles – I don’t necessarily recommend them, but I have to admit they’re popular. Some do well, and some others – not so well. Some of them are superstars – they’re winners, and have been winners for a long period of time. The rest of the pack looks like they’re standing still. But you know what? Some of them have big fat jockeys on their backs. The jockeys of the mutual fund world are fees. If you buy a fund with 5% fees, you can’t succeed. You’re going to waste so much money in fees that it’s going to eat an unacceptably big chunk out of any gains you might see.
I know what you’re thinking. “Not so fast, John; I use the low-price leaders like Vanguard, Fidelity, and American Funds, because they have low fees.” Be careful! A lot of the so-called low-fee mutual funds have a plethora of hidden fees waiting to shave some performance off the fund. Find out what the fees actually are – there are web sites where you can check this out for a low cost. Everyone knows to check out the management fees, but do you know what your fund’s distribution fees are? How about the tax burden absorbed internally within the fund? Have you found out what the fund’s trading costs are? A lot of these fees aren’t disclosed in advance, because the fund managers may not know in advance what the total of those costs will be. So they aren’t in the prospectus; they are in the annual report. Have you read the annual report for your fund? You should – there’s information in there you need to know.
When picking a horse to bet on – look first and see if it’s being ridden by a sumo wrestler. If it is, it doesn’t matter how fast he is – he’s going to lose. Filter your mutual fund choices by their fees first, and only then turn your attention to the fund’s management style.