Is Wandering Good?

As part of our investment philosophy, we develop a specific investment plan for each client. When we determine an allocation for each specific investment category, such as "US Small Value" or "Fixed Income" (cash, bonds, or CDs), we want the investment fund that we use, to remain pure to that classification.

With the mutual funds that we use to purchase stocks and the direct buying of fixed income investments, we have been able to accomplish that goal. Most mutual funds hold stocks across multiple asset classes, so they do not adhere to this discipline.

In an interesting article in today's Wall Street Journal, according to an SEC filing, the world's largest bond fund, Pimco Total Return, managed by Bill Gross, will be able to purchase as much as 10% of it's assets in non fixed income investments, such as "preferred stock, convertible securities and other equity-related holdings, during mid-2011.  Gross has an outstanding track record and his successful is undeniable, so I'm not going to question his motives.

However, this move re-inforces the importance of truly understanding what you are purchasing, when you buy a mutual fund or any investment. When we buy a "US" stock fund, we know that all of the companies in that fund are based in the US. With many other mutual funds, you may think you are buying a US fund, but upon further examination, find out that 20% of the companies are internationally based.

This is important if you want to adopt an investment strategy, an asset allocation plan, and then really be able to monitor and stick to it. If the fund that you buy wanders off and buys different things than you originally thought, than your actual asset allocation will not be what you intended. And that could be a problem.

In this case, we believe in purity.

New Tax Law: What You Need to Know

Updated, Friday 12/17/10:  The House passed the bill that was agreed upon by President Obama and Senate. It appears that no changes were made to the bill that the Senate passed. President Obama is to sign it on Friday. The following is a summary of the legislation, but is not intended to cover all the provisions of the new law.
Tax rates:  The current rates will remain in effect for the next two years, 2011 and 2012. There will be no tax increase, even for taxpayers in the top tax bracket of 35% (for ordinary income) for the next 2 years. Note that these tax rates are not permanent, as the law only covers 2011 and 2012.

Capital gains and dividend tax rates:  Current capital gains and dividends rates of 15% remain for high income taxpayers. For those below the 25% tax bracket, the capital gains rate which is currently at 0% rate will remain.

Estate tax rates:  Major Change:  This has been the major point of contention in negotiations this week. The new law will have a $5 million per person exemption and $10 million per couple.  This is a higher level than most would have expected months ago. The exemption amounts are indexed, beginning in 2012.  The top estate tax rate will be 35% for 2011 and 2012.

The law also allows planning opportunities to shift/allocate assets between a couple, upon the first to die, to maximize the use of the full exemption for each individual.

Payroll Tax Reduction:  For 2011 only, the 6.2% social security tax will be reduced to 4.2%, for the first $106,800 of wages, which are subject to this tax. This will provide up to $2,136 reduction in social security taxes for employees whose wages are $106,800 or higher. A couple who each earns at or above $106,800 will save approximately $4,300.  Note that employers will still need to pay in the employer portion of social security taxes based on the 6.2% amount.

Alternative Minimum Tax:  Technical changes were made, so that the AMT will remain at same level as in 2010. This still has a great impact on many middle-high income taxpayers.

Addition to the Deficit:  The bill did not provide for any federal spending cuts. The bill is projected to cost the Treasury $860 Billion over the next 10 years. This does not include the cost of the 13 month extension of unemployment benefits.

Business:  As for individuals, a number of extensions of items for a year or two, through 2012, such as increased depreciation expense and research and development expense credits.

Not included:  There was no change to how private equity and hedge fund executives will be taxed. Most will continue to earn at capital gains rates, not as ordinary income rates, as once thought might be passed. Congress failed to pass any changes related to issuance requirements of Form 1099s, which will be greatly increased from provisions of the health care bill passed earlier in 2010 (don't ask how those are tied together!) Hopefully, some of the Form 1099 rules will be modified in 2011.

Sources:  Wall Street Journal and New York Times, December 13-17

When is 3 Really 1 ?

A new client asked us to review three funds that he had been holding for a very long time in a retirement account.  Each of these funds were managed by the same mutual fund company, but had distinctly different names.

Upon my review, the results were not surprising to me, but startling to the client. Each of these funds were basically holding the same stocks. So while the client thought they were broadly diversified, based on the names of the different funds, the tops holdings read like three interchangeable and almost identical lists. We actually held the three top holdings lists side by side, and they looked almost the same.  Each had many of the same companies like Apple, Exxon Mobil, IBM, GE. You get the idea.

There was no effective diversification at all, if you think about effective diversification as we do. There were no small companies, there were no real estate companies, there were no small value companies. There was minimal international holdings, which is a serious problem, in our view. There were no emerging market stocks.

So while the client had 3 funds, they really just had 1 fund, with 3 different names. They had not achieved the diversification they thought they had, and knew that was in their best interest.

Separate from this client example, the current year's worldwide stock market performance, as viewed by asset class, provides great evidence of why "effective diversification" across many asset classes is so important. A sample of some asset classes, as evidenced by DFA mutual funds for YTD through 11/30/10, makes the point:

US Large, which is similar to the S & P 500:                     +  7.8%
US Micro Cap (very small companies)                                +21.3%
US Real Estate                                                                 +22.9%
International Small Company                                             +11.8%
Emerging Markets Value                                                   +12.7%

Please note that the above is presented only for illustrative purposes, for an 11 month period of time, and before any advisor fees.

However, the point remains, many people have a portfolio which may hold many mutual funds or individual stocks, but if reviewed carefully, basically acts or is very similar to the S & P 500.

That is not in your best interest, over the long run, for a successful investment experience.

Purely Personal

This has been a very meaningful and eventful Thanksgiving and subsequent week, for our firm, in our personal lives.


Keith’s wife Ann had their 5th child on Thursday morning, December 2nd.  They had a very healthy beautiful girl, Olivia Brooklyn, to join her older four brothers. We congratulate Keith and Ann on the new addition to their family! They are all doing very well.

My daughter celebrated her Bat Mitzvah on Saturday of Thanksgiving weekend. This was a very meaningful and wonderful event, which I was fortunate to share with my entire extended family and friends. My daughter was incredible, and she made her entire family very proud of her accomplishments. She is an inspiration to all of us.

It is events like these that give us reasons to reflect on what is truly important in life and be thankful… for our family, our personal  and business relationships and for good health.

While we work with our clients regarding their money, we truly hope that our ability to be successful enables them to reach, enjoy and celebrate many wonderful family milestones.

As I said on Sunday, we are all very fortunate!

Long Term Care Insurance or A Thing of the Past?

Long term care insurance is a complicated, but important topic that most individuals should consider, with the assistance of a number of professional advisors.

We think the purchasing decision regarding LT care insurance falls into 3 categories:

• those who need it, but cannot afford it,
• those who need it, and can afford it,
• those fortunate enough, after a proper analysis, feel they do not need this coverage.

A major development in the LT care insurance field was announced by MetLife, a major seller of LT care insurance, that they would stop offering this insurance to individuals, effective December 30, 2010. This was covered in an excellent NY Times article (see cite below). This continues a trend of dramatically increasing LT care insurance premiums, in the range of 18-44%, as well as other insurance companies not entering or stopping to sell long term care insurance.

While we feel that LT care insurance is appropriate for the group above, in the middle (people that need the insurance and may be able to afford it), the purchasing decision becomes much more difficult now. As the NY Times article clearly states, the insurance companies have underpriced this insurance in the past, due to numerous factors. Thus, if you purchase this type of insurance and pay the premiums for many years, you could then be faced with the prospect of huge insurance premium increases down the road, or having to drop the coverage because of the high cost of the increased premiums. Neither of these are good alternatives.

We would advise individuals to review whether LT care insurance is appropriate for them. It is extremely important to work together with your financial advisor, as well as an insurance professional that is well versed in LT care insurance, in analyzing this decision. Please note that LT care insurance is highly specialized, so we recommend only working with an insurance professional who is very experienced in this specific area.

As many individuals will face the possibility of huge long term care costs, potentially in the hundred of thousands of dollars, due to longer life expectancies, this is another reason for the importance of good financial planning, which addresses these type of issues.

"When a Safety Net is Yanked Away," NY Times, November 13, 2010, by Ron Lieber
http://www.nytimes.com/2010/11/13/your-money/13money.html?ref=ron_lieber

If the Pros Can't Win, How Will You?

We provide many services to our clients. One of them is investment management. Our philosophy for implementing our investment strategy is a clear differentiator from most other financial advisors or investment professionals.


There are two main investment implementation strategies: active management or passive management. In active management, you believe that you can identify, in advance, an investment manager, who can consistently outperform his benchmark for an extended period of time. Academic research shows that this is extremely difficult to do, over a long period of time, for all asset classes, both domestically and internationally.


We believe in a passive approach, which means that we will retain an investment advisor who will purchase stocks based on their respective asset class. Academic research shows that over various time periods, this strategy outperforms “active” management, particularly when costs such as trading and taxes are included in the analysis.


Further real world evidence of this is presented in Morningstar’s “Fund Times” weekly column. In this column, Morningstar reports fund management changes. In recent issues, they have described how Vanguard and SEI (a company that selects money managers, for the various funds they manage, under the SEI name) have made significant changes to some of their largest funds.


Why is this important? This shows that companies such as Vanguard and SEI, with all of their extensive resources and research, selected money managers for their funds a number of years ago, and have now determined that those decisions were poor. The fund managers they selected vastly underperformed their respective benchmarks. After enough years of underperformance, they needed to change managers. But how can they know that the new managers will outperform their benchmarks in the future? They can’t!

Every week, Morningstar reports the numerous changes of mutual fund managers. Sometimes good managers move to other funds. In that case, future investors in that fund may purchase these funds thinking current management built a good record. But that would not be the case. In other situations, changes are made because the managers underperformed. It is a continuous revolving door, without an ability to reliably predict future sucess.


In our strategy, this is not an issue. We purchase an asset class, a set of stocks within a given criteria, such as US small stocks. Academic research shows that this type of fund will outperform most active managers, over most years. Generally, the longer the time period, the more likely it is that a passive fund will outperform most active fund managers, in each asset class.

While these concepts may be new to non-clients of our firm, we welcome the opportunity to discuss this with you further.


We focus on the big picture, your goals and how to achieve them. We want to provide our clients with clarity and a good investment experience. This important implementation aspect is critical to the long term success of our investment philosophy.

Tax & Estate Planning Update

As a result of Congressional inaction since late 2009, the country faces continued uncertainty regarding future individual income and estate tax rates. The purpose of this post is to briefly explain what is known and unknown, and provide an analysis of how these issues may be resolved.

Income tax rates:

At the end of 2010, the “Bush tax cuts" expire (enacted earlier in the decade), and individual income tax rates would increase at each level. For top taxpayers, the rate would raise from 35% to 39.6%. For lower brackets, without any congressional action, rates would increase a few percent, respectively. The rates for dividends would increase significantly, from 15% to ordinary income tax rates (so as high as 39.6%, for taxpayers in the top bracket). For long term capital gains, the rate would increase from the current 15% to 20%.

Congress will not be addressing this issue until after the November election, and based on most estimates, probably not pass any legislation on this matter until just before Christmas. At a conference that we attended last week, the thought from a top Washington political strategist was that Congress would most likely extend the “Bush tax rates" across the board, for all taxpayers. Thus, income tax rates in 2011 would remain at current levels. This analysis is based on anticipated results in the November election and pressure not to increase tax rates, as it would be a negative factor for the economy.

What we recommend to do now:

In most years, the tax strategy is to delay income and accelerate deductions. For 2010, we recommend the opposite, to accelerate income into 2010 and delay deductions into 2011. We advise this now, as there is no way to know when the tax rate issue will be resolved. It is pretty clear that rates will not be lower than they are now in 2011, particularly at the higher levels. If rates are to increase for 2011, it would likely be for only the top tax brackets.


Estate Tax:

The estate tax expired as of 12/31/09, so there is no estate tax in effect for 2010. For 2011, per current law, the estate tax rate would be 55% for a large estate, with only a $1,000,000 per person exemption.

There are no reasonable projections of when Congress will enact new legislation for the estate tax or at what tax rates. It is possible that this legislation will be enacted as part of the income tax legislation that is discussed above, and occur sometime between the November election and Christmas.

As a purely speculative guess, it would be reasonable for the estate tax to be re-enacted for 2011 at a top rate of 35-45%, with a personal exemption in the range of $3-5 million. However, there is no clear indication of this, or when Congress will address this matter.

If you have questions about any of these matters, or how they impact your personal situation, please contact us. If you have a significant issue, it would be important to consult with us, along with your estate planning attorney.

What we recommend that you do now:

As has been advocated throughout 2010, your estate plan should be reviewed if you are married, as the formulas that are the basis for marital allocations may be distorted, due to the lack of 2010 estate tax. If someone in your family is very sick, we recommend that you consult with a well-qualified estate planning attorney, as there are important steps that may be advantageous, even though there is no estate tax in 2010. While this may be emotionally difficult to do, it is important for your family.

Our Role as an Advisor: Getting Started

A number of months ago, we met with another professional at his office, to discuss our business and his. During the course of the meeting, he asked what differentiated our practice from other advisors. We discussed a number of items, but we knew the best way would be for him to really experience our services himself.

So, after a number of discussions, he and his wife met with us, at our office. We talked about their past investment experiences, their lack of a financial plan ("I just pick stocks and have mostly not done too well"), how they now really want to get serious about their investments and feel they need professional advice. We asked them questions. Like many clients, their desire was in line with our fundamental goal, to have a greater sense of financial comfort and security, as well as clarity.

During our discussion, they asked us questions, which we answered in plain English. I drew some pictures and sketches on a legal pad, to explain our investment philosophy. Their conclusion: our philosophy is logical and makes sense. They liked that we are globally diversified, and realized that their current portfolio had almost no exposure to international stocks at all. We feel that international investments should have a significant place for almost all investors.

We recommended that we evaluate their current investments, which we call a "portfolio review." The emphasis of this analysis is not on performance, it is on how one's investments are allocated. We base our investment decisions on academic research, which teaches us that investment returns are based mostly on investment asset allocation, not individual stock picking. We will present this information in a clear, easily understood manner.

As part of the discussion, we all came to the conclusion that this couple had "made it" financially. They had accumulated adequate assets. However, they were risking this comfort by allocating so much of their assets to stocks (say 60- 70%). This was an uncessary risk for them. In our role as advisor, we recommended that a much more conservative asset allocation made more sense, given their age and financial assets. The primary goal should now be to preserve the majority of their assets, to provide them the comfort and security they desire.

We then talked about the allocation to fixed income, the assets I refer to as "the foundation." We talked about why it made more sense for their fixed income investments to be in individual bonds or CDs, to be generally held to maturity, and not in bond funds (as I've blogged about a number of times). For this, and most others we meet with, this advice is new (and quite welcome). They did not realize that they could be at great financial risk, if interest rates eventually rise, with their bond funds.

Finally, we talked about another potential investment they are considering, an annuity product another person had recommended to them. We are analyzing this product, with very surprising results. What the couple understood to be the great advantage of the annuity product (the terrific guaranteed return), did not turn out to be what they thought. The guaranteed return only represented a small part of the total investment, and only if certain conditions were met. The annuity had very high fees, withdraw restrictions and surrender charges. Investments that we recommend have none of these. We are fee-only advisors, and our fees are clearly explained.

This is a typical example of how we begin to work with a new client. We meet with them a number of times. We want our clients to understand how we work, how we invest, what our philosophy is. We want them to be very comfortable with us. We want them to understand that we clearly understand their needs. To realize that we will utilize our extensive financial experience as CPAs to assist them with their investments and financial planning, as well as their tax and estate planning, along with their other advisors.

Many Quick Thoughts

With the great assistance of my son, and others, I've tried to adopt and learn about new technologies, including what is referred to as "social media" (which is what this blog is). This can be a great way for us to communicate our thoughts to clients and others in the community.

In addition to blogging, I've begun to post thoughts on Twitter, over the past month or so. Many people post multiple times a day and include all kinds of personal information. That is not my intent. I've tried to write selectively, as a way to quickly inform others of financial information or present our investment philosophy in quick bits.

For those of you unfamiliar to Twitter, each post can only be 140 characters. As I enjoy writing, it is actually a unique challenge to say something meaningful in that short space.

What follows is a sample of some of my Twitter thoughts. If you want to follow me, my "Twitter" name is "wassermanwealth."


Recession ended in June 2009. Announced today, 15 months later, by Natl Bureau of Econ Research. Very timely. And stock market soars. Logic? (9/20/10)

Recession ended 6/09. More evidence of why you cannot predict the future, or rely on those predictions for your investment strategy. (9/20/10)

One day interest rates will rise. Then, bond prices will fall. Bond funds will get hit hard. We have a different strategy. Are you prepared? (9/16/10)

Financial risk and return are related. The greater potential return, greater the risk. How much risk do you need to take? Do you know? (9/16/10)

With uncertainty & media pessimism, stock markets up in 3rd Qtr. That's importance of remaining disciplined & sticking to investment plan (9/15/10)

Are you focused on positive or negative? Looking LT or ST? Warren Buffett, Monday:"This country works. The best is yet to come." Retail sales+ (9/14/10)

US National Debt almost $14 Trillion. That is $155,000+ per US family. Congr Bud Office says 2020 largest budget item will be interest pmts (9/13/10)

WSJ survey of top schools 25 for recruiting: 6 are in Big Ten. Univ of Michigan # 5 with #1 Business School, # 6 Engineering. ((9/13/10)

Warren Buffet turns 80 today. For his investing success and then charitable giving to Gates Fdn, he will impact the world for generations. (8/30/10)

Before today, all US asset classes were negative for 2010. Could you have predicted which one was positive? with a double digit increase? (8/27/10)

Only US asset class with positive 2010 returns is real estate. Evidence that you cannot predict markets. Re-emphasizes our philosophy. (8/27/10)

If Congress does not act by 12/31, LT cap gains rates increase 15 to 20% and dividends become ordinary, meaning from 15% to as high as 39.6% (8/26/10)

Morningstar study confirms that lower a mutual fund's cost, greater likelihood of it's success. This has been one of our core beliefs. (8/26/10)

Stocks down in June. Up in July. Down in Aug. Does it affect your LT goals? In 5, 10 years will you remember? Do you have solid foundation? (8/25/10)

Volatility of past months is reminder that no one can predict market moves. So plan and focus on long term. Key to success is discipline. (8/25/10)

How Bonds can be Painful

We have written on numerous occasions about the "risk" that many investors may be subject to, when they think they are investing safely. The Wall Street Journal published an article today, titled "Treasurys Can be Painful, as History Shows," which clearly states the same point.

For investors that are purchasing or holding bond funds, and particularly bond funds that hold securities with maturities that are longer term, of greater than 5 years, they may face significant investment losses in the future, when interest rates rise.

As the WSJ article stated, as the stock markets have risen in September, 10 year Treasuries have lost 2.2% and 30 year bonds are down by 6.9%. Note that if interest rates rise, the price of bonds fall. If you own a bond to maturity, this should not be a major concern. If you own bond funds, this is a major problem, that should be discussed with us and corrected.

As we base our investment decisions on our understanding of how financial markets work, and not on predictions, we try to learn from the past to prevent current or future problems. In 2003, the 10 year Treasury bond yield increased by one percent in a two month period. This resulted in an 8.2% loss in that two months. During a 13 month period beginning in October 1993, 10 year Treasuries rose 2.4%, which resulted in a 10.6% loss for investors of these bonds.

On Friday, the 10 year Treasury yielded 2.746%. When the economy improves, and if yields rise to 4%, bond fund investors would lose approximately 7%, for that maturity. Holders of bond funds with maturities of 20-30 years could face losses of at least 10%. We feel the losses could be much more severe, as it is likely that investors will flee bond funds all at once, which would further exacerbate the losses, as funds are forced to sell securities en masse to meet redemptions.

The fixed income component of an investor's asset allocation is critical to their investment success. To truly provide a client with comfort and security for the long term, given that interest rates are at all time lows and in the mid-long term will likely increase, we feel that investors would greatly benefit from holding individual fixed income investments, usually to maturity. This would prevent the losses described above.

See also post dated August 18, 2010, on the same topic.


Source: Wall Street Journal, 9/20/10, Treasurys Can Be Painful, as History Shows

What I've Been Reading

The following are some of the books that I've been reading over the past month. Some are investment or business oriented, others are related to personal productivity or improving one's life.

If you would like to discuss any of them, just contact me. I'd love to talk about any of them.

The Investment Answer, by Daniel Goldie and Gordon Murray; this is a concise, well written investment book, which is very consistent with our investment philosophy. Highly recommend it. You can read it in an hour or two.

The End of Wall Street, by Roger Lowenstein. Another book on the financial crisis of the past few years, written by a top financial journalist/author. I have previously written about The Big Short, by Michael Lewis, which is primarily focused on the mortgage backed securities crisis. This book is much more broad in its coverage of the entire financial crisis and how the government and large financial institutions dealt with the crisis. I'm only part way through this book, but recommend it if you want a further understanding of what took place. Very objectively told.

Good to Great, for the Social Sector, by Jim Collins; This is a short supplement to the classic business book, Good to Great. If you run a business, Good to Great should be required reading. At least skim it to get the main points. This supplement is written for non-profit organizations. Very well written and thought provoking. I read this as preparation for a non-profit board retreat that I participated in.


The Compound Effect, by Darren Hardy; The Promise Doctrine, by Jason Womack; and Thrive, by Alan Weiss; highly recommend each of these books, which focus on different aspects of personal productivity and managing your life. They are each excellent in their own respect!


The 100 Best Business Books of All Time, by Jack Covert; this is terrific compilation, organized by topic. The author of this book provides a summary of each of the 100 books, with a few page description of the main ideas of each book. An excellent resource. I am proud of the fact that I have read a significant number of the books featured in this book.

Tale of Two Days. How Can it be so Different?

If this is not evidence of the inability of being able to accurately predict the short term direction of the stock market, then nothing is.

I left my office Tuesday afternoon, 8/31/10, to attend a non-profit committee meeting. It was 3:45 pm, shortly before the US stock markets closed for the day (and month). I turned on my Sirius radio to CNBC. I heard gloom and doom. The few Wall Street analysts said things like: no strategy is working in this market. It is not a stock picker's market. You can't identify a sector or sectors to successfully invest in.

Then a commercial break. The market closed at 4 pm. The day was flat, but August was a down month. They repeated all the stats. More gloom and doom. The worst August in many years for the US stock market. How should we react? Where to turn to next? Nothing is working. On and on....for my 25 minute drive.

The next day, the world changed, at least in China, and then for the US stock market and markets around the world. How could "everything" change from gloom to giddiness overnight?

The next day, Wednesday, I was moving my son up to the University of Michigan, to begin college. Mid-day, I left his new dorm to shop for some things. Turn on the radio. The Dow is up approx. 250 points! The markets end up being up 2-4% for the DAY, depending the asset class. A good portion of the losses for the month of August are erased in one day.

Is this rational? No. Why? What happened? The markets react to new news. Overnight, China reported good economic news. Then reports of better housing starts were reported.

What can be learned from these two days? For us and our clients, this is further re-enforcement of many of our philosophies, all in 2 days!

You cannot predict the stock markets or the future. No one can accurately, consistently and over a long period of time. Not even Warren Buffet.

Develop a plan for your individual situation and stick with it. Be disciplined....until your personal situation warrants a change in strategy. Your personal plan cannot be based on what you think will happen in China, Japan or anywhere else, as you cannot control those things.

This is why we recommend trying to focus on the long-term, as the markets' short term volatility cannot be predicted or anticipated. Reacting to short term swings will not lead to a successful investment experience.

If you want security and comfort, in the long term, you have to focus on the long term and not react to the "noise" of these daily or monthly swings in the markets.

Obviously, we all want more "good" days than "bad" days. Academic research shows that the markets will provide more good than bad days (more positive returns than negative returns), but you need to have a good strategy to be able to experience these positive opportunities.

One Small Act and A Great DVD (and more)

Sometimes small acts can have a huge impact. We never know what tomorrow will bring… or will lead to.

I have read Jason Womack’s blog for many years. He is an executive coach based in California and works with people and organizations to improve their productivity. (See his blog at http://www.jasonwomackblog.com/). After I sent him an email, thanking him for one of his blog post's which really hit home, he sent me a complimentary copy of his DVD, Making Things Possible, 15 Tips for Time Management.

A colleague once told me, if you attend a seminar and get one good idea, then it was worth attending. With Jason, he packs way more than one good idea into this DVD. Almost every idea is applicable to your work and personal life, or leads you to think how you could take his concepts and apply them in another manner. His recommendations on handling emails and Outlook are particularly helpful.

I highly recommend the DVD, though it was produced a few years ago, and thus is not completely current (for example, it is pre-iPhone and apps). Jason’s enthusiasm for life and lessons on goal setting and personal productivity are worth pursuing and learning from. You can read his website and blog, get the DVD or other materials and programs that he has developed, as well as follow him on Twitter.

Jason has motivated and inspired me (and we have never even talked or met). Just because I took a few minutes and sent him an email thank you note, and he responded by thanking me with a DVD, a number of positive things have occurred. I should also mention that he sent me a thank you note, via traditional mail, as a thanks just for my initial email to him. That alone had an impact!

There is more than one lesson, and a worthwhile DVD, here.

One small act, on each of our parts, has led to much greater things. Something to consider….



For more information about Jason Womack, see womackcompany.com. As noted above, as full disclosure, I received the DVD on a complimentary basis.

More Evidence of Why Diversification Matters

One of the differentiators of our firm, is how we truly diversify our clients' portfolios. Many investors feel they are diversified, but upon a detailed review, we show them that they are not truly diversified, as we define this concept.

Further evidence of the benefits of such diversification were provided over the past 10 years. As stated in a WSJ article, "stock returns calculated off the broad-based indexes have been horrendous over the last decade." They are referring to a portfolio that was made up of mostly large US companies, such as would be found in the S & P 500.

"Those who bought value stocks during the tech bubble... have done much better. From December 1999 through July 2010, the Russell 3000 Value Index returned 35% cumulatively, while the Russell 3000 index of all stocks still showed a loss."

When we structure a portfolio, we emphasize value stocks and broad global diversification. In the long run, this should provide our clients with a more successful investing experience.

Are you truly diversified? Do you know?

Source: "The Great American Bond Bubble," The Wall Street Journal, August 18, 2010

The Great American Bond Bubble

This is the headline of a Wall Street Journal opinion article published on August 18, 2010, which echoes a theme that I have written about on numerous occasions.

The opinion column compares the current bond market to the technology stock market bubble that was experienced 10 years ago. The authors state: "a similar bubble is expanding today that may have far more serious consequences for investors."

As interest rates have dropped to historic lows, investors in bond funds, or those who do not hold their bonds until maturity, will face significant losses, if and when interest rates rise. " Those who are now crowding into bonds and bond funds are courting disaster... the possibility of substantial capital losses on bonds loom large... if interest rates rise to 4% (on a 10-year bond, which is currently at 2.8%), the capital loss will be more than three times the current yield." That would mean that an investor would lose over 8.5% of their capital, for what was intended to be a safe investment.

We have recommended numerous times in this blog, that a fixed income portfolio is an important foundation of a client's overall portfolio. We feel that a fixed income portfolio should generally be holding short-term individual securities, of a very high credit rating or FDIC insured.

The Investment Company Institute reports that from January, 2008 through June, 2010, outflows from stock funds totaled $232 billion, while bond funds have seen tremendous inflows, of $559 billion. Investors have reacted in this manner, as a flight to safety. However, we feel that these same investors will, at some point in the next number of years, be incurring huge losses that they currently do not foresee and do not understand.

In our role as an adviser, our goal is to provide clarity and insights, so that our clients will have a greater sense of security. While we cannot predict exactly when interest rates will rise, we do know that how we are structuring our clients fixed income portfolios are properly anticipating an eventual increase in interest rates. Our clients should not incur the tremendous losses that the authors of this article are forecasting.


If you are not currently a client of our firm, we would be pleased to review your fixed income portfolio, to see if this very serious issue applies to your situation. Please contact us to discuss this further.


Source: "The Great American Bond Bubble," Wall Street Journal, August 18, 2010

What do the Bank Overdraft Notices and Requests You are Receiving From Your Bank Really Mean

Consumers are being flooded with notifications from their banks, due to new banking regulations that take effect on August 15, 2010.

Simple explanation: Ignore all of it! Don't do anything and do not sign up for the overdraft coverage that your bank may be offering.

Now the details:

The new rules apply to the use of ATM and debit cards, when being used for purchases. If you don't use a debit card or ATM card for purchases, none of these changes will affect you and you can ignore the emails and notices that you have been receiving.

If you do use an ATM or debit card for purchases, we'll explain the new rules. The key is to maintain adequate balances in your bank account and not to incur an overdraft, as the fees are ridiculously high (ranging from $25-$35 per transaction). As of August 15, banks will no longer be able to approve a debit card "overdraft," without your consent (that is what they are contacting you for, your consent for their new overdraft program).

What this means is that if you don't accept the offer they are requesting you to "opt-in" for, your debit card will be rejected when you attempt to make your store purchase, if your bank account does not have adequate funds.

What the banks are sending to their customers now is to request that you opt-in for the new overdraft rules. If you opt-in, they have the discretion (not guaranteed) to approve your store purchase, even though you may not have adequate funds in your bank account. By opting in, they may approve the transaction and then charge a fee, which could be $25-$35, per transaction, per day. There are ways these fees quickly escalate every day, unless additional funds are quickly added to the bank account.

We strongly recommend that you DO NOT opt in for the new ATM/debit card overdraft coverage (by doing nothing, you are effectively doing exactly this). If you do not have adequate funds in your bank account when you are attempting to make a store purchase with your debit card, you are far better off to have the transaction rejected, and then pay by some other form, then have the transaction approved and incur the bank fee. The initial fee (and subsequent fees that can accumulate) are likely to be much larger than the amount of the intended purchase.

We recommend that readers review this with their children and grandchildren, who may be frequent debit/ATM card users, for purchases. They may be more likely to use these cards, and more likely to opt-in, based on their bank's marketing materials.



Source: FDIC website and Consumer Federation of America press release, dated 6/29/10

Why is a Diamond Getting Roughed Up?

On Friday, August 6th, Congress failed to approve 3 appointments by President Obama to the Federal Reserve. This is important, and noteworthy, as the Federal Reserve is to have 7 members. They currently only have 5 members and another member's term is to expire on September 1.

This blog is not intended to be political in nature. Its purpose is to help to clarify and inform its readers of important financial and newsworthy events, which we feel this is. Thus, the purpose of this post is to explain why we feel the action, particularly by Senator Shelby of Alabama, was incorrect.

Due to Alabama Senator Richard Shelby, Peter Diamond’s nomination was rejected and President Obama will need to be re-submit his nomination, if President Obama chooses to do so. Shelby stated that while Diamond is a “skilled economist,” he is not yet ready to be appointed or not qualified to make monetary policy decisions. This is the same Senator Shelby that was against any financial assistance for the automobile industry.

Senator’s Shelby’s comments are very disturbing. A quick review of Diamond’s background indicates that he is an exemplary economist and has headed many major economic organizations/associations. But more importantly, the 70 year old MIT economist’s areas of expertise are the study of the Social Security system and the long term effects of structural unemployment. Both of these topics are critically important to our country today. Additionally, as a Federal Reserve member, he would have the ability to guide the national discussion and awareness of issues, through speeches and writings. Diamond’s expertise and knowledge should be even more important than ever.

The leaders of the Federal Reserve should be a broad and diverse group of financial and economic experts, who would work together and share thoughts, for the betterment of our country and society. The country faces major challenges in dealing with both the Social Security system, as well as structural unemployment. Just as I posted a while ago that we are fortunate that Fed Chairman Bernanke’s expertise was in dealing with the causes of the Great Depression, Mr. Diamond’s skills would be a valuable addition to the Federal Reserve.

As importantly, it is vital that Congress act so that the Federal Reserve positions are filled as fast as possible with very competent individuals. Now is not the time for the Federal Reserve to be “understaffed.” We need the wisest minds working together to help guide our economy.

Harvard's Hard Lesson

It was reported in the Wall Street Journal today that Harvard University's endowment fund may be selling it's stake in 6 US focused real-estate funds for $500 million. According to the article, Harvard is under pressure to take this action, as the endowment fund does not have adequate cash to meet its obligations. The real estate portfolio lost 50% of it's value in the year that ended June 30, 2009.

To me, this is shocking. Harvard and certain other major universities have been acclaimed in the past decade for their aggressive positions in non-traditional investments and illiquid assets. Thus, they took great risk, with the goal of getting higher returns. However, they did not consider the downside risk of purchasing illiquid assets, which might be hard to sell. One would think that an institution such as Harvard, which has a huge endowment staff, would not make such a basic mistake. They did not anticipate the downside of their strategy and did not provide for adequate cash reserves.

For our clients, this is another reason why we have avoided hedge funds and other investments, which do not provide transparency and liquidity. We want to understand what we are investing in. We invest in mutual funds which can be sold and provide liquidity within days. Unlike Harvard, we have not invested in funds which require monies to be tied up for years, which could then result in liquidity problems.

To provide a sense of security, we plan upfront with our clients, to provide for adequate fixed income investments (we refer to this as the "foundation"), so that we are not forced to sell stock investments to generate cash, at fire sale prices.

McDonald's Great Deal: Good for You Also

On July 29, 2010 McDonald's Corp did what many Americans are doing, and even more wish they could do, which is to borrow funds at record low interest rates.

The Wall Street Journal reported that McDonald's borrowed $750 million in the bond market, selling 10 year bonds paying 3.5% and 30 year bonds which pay 4.875%. These are the lowest rates that a US company has been able to pay on a bond since at least 1995, according to the WSJ article. The article cited many other companies which are doing the same, at record low interest rates.

While these are historically low borrowing rates, and thus, for the purchasers of the bonds, they are receiving low returns on the bonds, there is a long term positive to this. For shareholders of McDonald's, and many other companies that are issuing debt at this time, these low rates are providing these firms cash with very low cost of capital. They will be able to use the funds to grow and expand their businesses, or to pay off other higher interest debt. Either way, their intention is to increase their companies' cash flow and earnings.

In the short run, the stock market can be quite volatile. In the long run, a company's stock price should be correlated to it's ability to generate cash flow and earnings. Thus, by borrowing at these low rates, their future stock prices should be positively affected, which is good for stockholders in general. Another reason to be optimistic about the future prospects of equity markets.



Source: McDonald's Deal Sets Low for Bond Interest Rates, WSJ.com, 7/29/10

The Big Short: What I Learned

I finished reading Michael Lewis' book The Big Short a few weeks ago and it has really stuck with me. I have previously written about the book in a post dated June 19, 2010.

If you want to understand, in depth, about the sub-prime mortgage crisis and those few individuals and institutions that really predicted the implosion and made huge sums of money, this is a great read. The book is well-written and you'll learn a lot at the same time.

What has had the most impact to me, after considering the book for a while, is the Big Picture of how these few players were successful. To me, this is the benefit of reading the book, and thus, for our clients.

These investors (some were individuals, some started as individual investors and then formed hedge funds, some were institutions; I'll use the word investors to encompass them all) who were featured in the book were independent thinkers. They did not follow Wall Street. They followed their own thoughts. They were very disciplined and incredibly patient. They placed huge bets, in the hundreds of millions of dollars, which did not pay off for a number of years. This took a great deal of conviction, when many others, including their own fund investors, questioned their "wisdom."

One hedge fund manager who was profiled had phenomenal returns for many years, so institutions were very willing to invest with him. As he invested more and more against the sub-prime markets, these investors grew very impatient with him. They demanded their funds back, but he would not allow them to (hedge fund rules). In the end, he made them all millions. But had they gotten their money back as they wanted, they would not have profited. If it was not for the manager's forceful patience and insistence that he would be proven correct in the long run, these investors in his fund would have missed out on his tremendous thinking.

The lesson for us is that we should not follow what we hear on TV, in the papers and what market "experts" tell us. After years of careful research and thought, we have adopted and adhered to a disciplined investment philosophy which is fundamentally sound and rationale. It is academically based and not based on "predictions" and calls on what the market will do in the next week or few months.

It requires discipline and patience, but will be rewarded in the long run. With proper planning, it will provide our clients with a sense of security. It is a clear philosophy, which can be understood.

As we discuss with clients the ups and downs of the market in the future, the lessons of The Big Short will be a way to clarify why patience and discipline are so important. It is our role as your advisor to assist you in maintaining these qualities, which will lead to a more successful investment experience.

New FDIC Rules and Planning Opportunities

As a result of legislation enacted on July 21, 2010, FDIC insurance for bank deposits has been permanently increased to $250,000 per depositor, per insured bank.

This is great news for investors, as this permanent change extends the increase in coverage, which was to expire December 31, 2013. This means that investors who purchase CDs with maturities beyond 2013 will know their funds are insured.

There are very specific, and very beneficial rules that can greatly broaden this coverage far beyond $250,000 per individual. For example, if an investor has an account established using a Revocable Living Trust at an FDIC bank, and has 3 beneficiaries of the trust, the account will be insured up to $1,000,000. This is determined by combining the owner of the account and each beneficiary, so would total 4 times $250,000.

The maximum number of beneficiaries that are eligible for FDIC coverage would be 5, so the maximum coverage for an account established with a Revocable Living Trust is now $1,250,000.

This is of even greater relevance right now, given current interest rate conditions, as we are finding that CDs are good, secure investments, and even for taxpayers in high tax brackets, CDs may be safer and provide nearly the after-tax return of top quality municipal bonds.

If you have questions regarding how to structure your investments to gain the security of additional FDIC insurance, please contact our office.

Firm Updates

On a personal note, we would like to share with you that Keith and his family are expecting their fifth child later this year.

Brad’s oldest son, Daniel, recently graduated from high school and will begin college this fall at the University of Michigan.

We are also pleased to inform you that Brad was asked to join the Board of Directors of Fresh Air Society, the governing body of Tamarack Camps. This is one of many non-profit boards and committees that Brad serves on.

July 2010 Client Quarterly Letter

This is the quarterly letter that we sent to our clients during July, 2010:

Worldwide, stock markets during the second quarter of 2010 saw the return of market volatility, with wide daily swings and negative returns. Then, the first two weeks of July have seen positive returns, which erased these losses. We thought some perspective may help. Let’s look back, long term.

The year was 1960. The S & P 500 was at 60. The country would soon face the difficulties of Vietnam, the Civil Rights movement and the assassination of President Kennedy. It would also experience the Bay of Pigs crisis and land a man on the moon.

The year was 1970. The S & P 500 was at 92. The country was still in the midst of the Vietnam War. It would face the Watergate crisis, the resignation of President Nixon, the Middle East crisis and the ensuing gas shortages. The prime rate rose to over 15% by 1979.

The year was 1980. The S & P 500 was at 108. The country would face unemployment and high interest rates. Chrysler would face bankruptcy, but recover. The prime rate would reach 20% in April, 1980. The later part of the decade saw the Savings and Loan crisis, which resulted in the closing of 296 financial institutions with total assets of $125 billion.

The year was 1990. The S & P 500 was at 353. By 1994, over 1,500 institutions were closed from the 1980s S&L crisis. The country grappled with health care reform, but it was not approved. Health care costs continued to skyrocket. The internet arrived and high technology stocks would go nowhere but up. The mantra was “this time was different.” But it wasn’t.

The year was 2000. The S & P 500 was at 1,469. The tech bubble was about to burst. 9/11 became emboldened in our memory. Wars began in Afghanistan and Iraq, which still continue. The housing market went up, then came crashing down. Major financial institutions and industrial companies went bankrupt, were taken over by the government or were struggling to survive by the end of the decade.

It is now 2010. The S & P 500 was 1,115 at the beginning of the year.

What can we learn from this information?

• Note the increase, over the long term, in the S & P 500.
o 1960: 60
o 1980: 108
o 2010: 1,115


• If you focus on the day to day problems that face our cities, countries, specific companies or parts of the world, you would focus on the near term and probably be quite pessimistic about future prospects.

• If you focus on the longer term, you become more positive. You realize how resilient the economy, companies and countries can be to resolve issues, innovate and these successes translate into positive stock market returns.

• When we develop your investment plan, we focus on both the short term and the long term. We use very prudent fixed income strategies for the foundation of your portfolio, so you will have a solid base. For the long term, we structure a diversified global portfolio, which should provide for positive results over a longer time period.

o It is our role as your advisor to assist you in reaching a balance, so that your portfolio can give you the comfort and security that the fixed income allocation provides, while providing the longer term perspective to achieve the greater potential returns that stocks can provide.

• We are realistic and very cognizant that many states, municipalities and governments face significant issues. But looking back through history, each time period faced different challenges and problems.

o As we assist you in building and monitoring your investment portfolio, and work with you to provide financial comfort and security, we rely on historical facts and academic information and research, not on the media or market forecasters. We do not have a crystal ball. No one else does either.

o We will work with you, so that you will have the patience and discipline that is required to be a successful long-term investor.


If you are concerned about the economy or the markets, call us. Meet with us. That’s what we are here for.

Clarity

Part of the reason for this blog is to share my feelings about current events. Part is that I enjoy writing. Part is that I hope it helps to inform others about our firm and our philosophy.

This morning I feel moved to write, as I am reading a book and various thoughts came together and became very clear.....and provided some real clarity.

I'm reading The Big Short, by Michael Lewis. He is a terrific writer, who has written a number of financial and non-financial books, many magazine articles, as well as wrote the book The Blind Side, which became the movie.

I am only part way through the The Big Short, which describes how a number of individuals placed huge financial bets against the home mortgage markets in the late 2000s, and made fortunes. The book is fast paced and very interesting, and as of now, I highly recommend it.

Yesterday, in a office meeting, as a result of a number of seminars that Keith and I attended in May, the word clarity was brought up. While reading this book this morning, I looked up the word clarity (in an old fashioned real dictionary): the state or quality of being clear; transparency; a difficult idea presented with clarity.

In The Big Short, it describes how Wall Street firms, mostly Goldman Sachs and AIG, combined and restructured residential home loans, most of very poor credit quality, into what later became AAA loans (top rated and considered very safe). Essentially, these investments/products were the complete opposite of "clarity," to everyone except for the few individuals who are featured in the book, who truly understood what a sham these products were, and were willing to bet against them. As Lewis describes it, Goldman and others took lead and turned it into ore, and then turned it into gold, then sold the gold to investors. If a portion of the lead was not immediately turned into gold, they would take the residual lead, and then turn that into gold also (from page 76).

This is meaningful to me, and thus my clients, as I consider the evolution of my firm and our investment philosophy from day one. One the fixed income side of investing, we have completely avoided corporate bonds (debt), due to the academic research that showed that the risk of default, while relatively low, was not worth the risk. When first presented with these concepts and information in 2002 and 2003, I was skeptical. I followed the advice, but did not completely buy into it. But it was totally correct. With new clients, we almost always sell many of their fixed income investments, as we do not think they are safe enough. On behalf of a non-profit that I'm involved with, I had many discussions about these matters with a top leader many years ago, who has since passed away. Fortunately, they agreed with me and we restructured their investments. We have almost always purchased only CDs, and top-rated municipal bonds and governmental agency bonds for our clients. We can understand these. They are clear and transparent.

When it comes to alternative investing, a phrase for hedge funds (which are mutual funds that are private, not like public mutual funds, in which the investors really don't know what the manager is investing in), we have also avoided these, for many reasons. Most importantly, if you can't see what you are investing in, and can't understand it, why would you invest in it?

So back to clarity. The investments we use for our clients, to implement their investment plans, are clear and straightforward. They are not hard to understand. The result of this is the comfort that the clarity provides. By knowing and understanding what you are invested in, and that you have an investment plan, we have provided clarity and comfort.

In Michael Lewis' book, I'm reading about the products and actions that Goldman Sachs and AIG and others are doing (or were doing a number of years ago). While I do understand it, it is beyond comprehension, in terms of rationality. There was not clarity to the American public. There was not even clarity to many of the people and companies that were involved. There certainly was not full disclosure (and Lewis has some strong comments about Goldman Sachs!).

Did You Learn from the Past?

As Warren Buffet has said, the stock market can be a great teacher. While the Gulf Oil spill is certainly a terrible environmental disaster, it also provides another vivid reminder of the risks of concentrating your portfolio in a few stocks or allowing one stock to become a huge portion of your wealth.


This story has been repeated many times in the past. Many well known names, that were considered safe, incur huge declines, sometimes in a day or two or within months, without any prior warning and certainly not predicted or knowable in advance.



Think of:

Merck and the Vioxx legal issues (dropped almost 50% in very short time period)

British Petroleum (down almost 50% since the oil spill occurred)

General Electric lost 88% from its peak in 2008 to early 2009

United Health Group, which lost 40% during 2006 due to corporate options issues

The key is to structure your portfolio so it can withstand an event such as the BP oil spill. By owning a broadly diversified global portfolio, your lifestyle will not be dramatically affected by the events (or failure) of one company or one industry.

Isn't that the goal anyway? To reach a level of financial comfort, by saving and investing, so that you can enjoy your life, regardless of the success or failure of one or a few companies in your portfolio. For our clients, that would be our goal!

Wealthy Thoughts - 2

A collections of thoughts and ideas about various things.....

"The US has discovered nearly $1 trillion in untapped mineral deposits in Afghanistan... enough to fundamentally alter the Afghan economy and perhaps the Afghan war itself...," the New York Times reported on June 13.

These mineral deposits are so big that Afghanistan could eventually be transformed into one of the most important mining centers in the world, according to an internal Pentagon memo. It states that Afghanistan could become "the Saudi Arabia of lithium," a key raw material in the manufacture of batteries for laptops and cell phones. The article states that Afghanistan's current gross domestic product is only $12 billion.

A Federal Reserve research paper released Monday by the Federal Reserve Bank of San Francisco indicates that the Federal Reserve is likely to wait until 2012 before it starts to raise interest rates. This paper does not represent the official position of the Federal Reserve, but it is notable. The author based his research on the relationship between consumer price inflation and unemployment statistics over the past 20 years.

The authors stated that given these historical relationships, the Fed in theory should have lowered short-term interest rates by another 5% in 2009. That was already impossible, as the short-term interest rates that the Federal Reserve controls were already near zero.

We do not view this research as a direct indication of what the Federal Reserve will actually do. Although we do not make investment decisions based on predictions of when or by how much interest rates will change in the future, this certainly gives credence to the concept that interest rates in general may remain very low, on a historical basis, for the next year or two.

Mortgage rates again near all-time lows
For the week ended June 11, Freddie Mac reported that interest rates on 15 and 30 year mortgages fell to their lowest level of 2010 and were just barely above their all-time lows.

The average for a 30 year fixed mortgage was 4.72% and 15 year mortgages averaged 4.17%, the lowest since this began to be reported in 1991. (per LAtimes.com, 6/11/10)



Sources:
The New York Times, US Identifies Vast Mineral Riches in Afghanistan, June 13, 2010
The New York Times, Fed Study Suggests Rates Will Stay at Record Lows until '12, June 14, 2010

The Value of Real Research

Most traditional Wall Street research is based on an analyst making a prediction on a particular stock, usually by providing a rating on the stock and a future price target.

Our firm does not use this type of strategy. We focus on a client's long-term goals, meeting their needs and determining an appropriate asset allocation. To implement their investment strategy, we rely on sound financial principles and academic data. Hopefully the following will clearly contrast this difference.

The Wall Street Journal reported on June 11 that Goldman Sachs was suspending coverage of many high-tech companies, after the departure of their lead analyst. This means "our current investment ratings and earnings estimates for the stocks are no longer in effect and should not be relied upon."

The Journal stated: "clients have had reason to wonder whether they should have relied upon some of Goldman's calls in the IT hardware sector. We previously highlighted the fact that Goldman's stuck with its neutral rating on Apple from December 2008 to the present." Goldman actually downgraded Apple in December 2008 to "neutral." The shares are up more than 150% during this period. In changing its rating on December 15, 2008, Goldman cited weakening consumer demand for Apple's products. This analyst could not have been more wrong in his analysis and future "prediction" (my term) for Apple.

When we implement a client's stock portfolio, we generally utilize a fund manager that focuses on broad, global diversification. Their investment management is based on many years of rigorous academic research, not on predictions about specific stocks. As a result of their continuous research, they recently informed us that they will be excluding a certain segment of stocks from their small stock mutual fund.

This small cap strategy would currently hold about 2500 eligible stocks. Based on the new research, they will exclude approximately 240 stocks, which they have identified as "the worst of the worst." They have identified the stocks to exclude based on specific financial criteria, not on the future predictions of the specific company. Over a 30 year period, from 1979 to 2009, this change would have resulted in an improvement of nearly 1.4% annually. This strategy would have had a return of 13.30% annually, versus the Russell 2000 index of 11.26%.

While we focus on meeting with clients, understanding their needs and determining an investment policy to help them reach their goals, we rely on the strength of this type of academic stock market research to implement the investment plan that we develop. As we don't know of anyone who has an accurate crystal ball of the stock market, this is the most rational way of investing that we know of.

If you would like to know more about this topic, or our investment methodology, please contact us.

Sources: Wall Street Journal, June 11, 2010 "After Missing Apple's Surge, Goldman Cuts Coverage" and April 21, 2010, Goldman on Apple: Yes, We're Stickin' to that "Neutral " Rating

What we are getting asked about

The most common questions that we are being asked about in client meetings are about municipal bonds, interest rates and inflation (fixed income investments in general).


Interest rates: They are currently at all time lows, based on the past 5-10 years or over a much longer time period, such as 30-50 years. However, predicting the short term direction of interest rates (such as will they be higher 3 months from now), is nearly impossible to predict.
Implication: When we structure our client's fixed income portfolio's, we do not make investment decisions based on our "predictions" about future interest rates. We make purchasing decisions on the current rates that are available, with the intention to hold the investments to maturity (not buying them to trade them in 6 months or 2 years, based on our "bet" of the direction of interest rates).

Municipal bonds:
We view fixed income investments as an area to minimize risk. This should be the foundation of your portfolio, with the objective of preserving your investment, while getting a safe interest rate return.

Due to the greater rate of defaults, we do not purchase corporate bonds. The risk of default and not getting your principal back is not worth the additional small amount of annual interest that you would receive. Others may disagree with this philosophy, but it has enabled our clients to sleep well.

We believe in holding individual municipal bonds or certificates of deposits, as long as they are FDIC insured. When selecting municipal bonds, we are extremely particular about what sectors the bond is in. As much of our investment philosophy is based on academic data and research, so to is our fixed income strategy. For municipal bonds, sectors such as housing, healthcare and industrial development have far greater default rates than other areas, such as school districts, highways, and public transportation. You may have never even heard of these statistics or had it brought to your attention by another financial advisor. In our purchasing criteria, we only buy top rated municipal bonds in certain sectors, that have the lowest historical default ratio.

We also advise our clients to diversify nationally, and not hold bonds in just one state. While this may cost some small amount of additional state taxes, the benefit of diversifying your fixed income investments is well-worth the cost. Again, this helps you to sleep well at night.

Inflation, interest rates and bond funds:

As discussed in this and other posts, we cannot predict future inflation rates or interest rates. We do know, however, that interest rates are at a historical low, and it is very likely that inflation will rise at some point in the future. If either of these events occur, the value of bond funds will decrease, and for some bond funds dramatically. If you are holding intermediate or long-term bond funds, of corporate, government or municipal bonds, and interest rates rise, you'll be faced with a permanent loss in the value of your bond fund.

For this reason, we feel it is critical that investors be very selective and hold only individual fixed income investments, not bond funds. We feel there is the potential for huge bond fund losses, at some point in the future, when interest rates rise. These losses could be similar to losses incurred in the tech bubble. This would be almost more tragic, as bond fund holders feel that their investments are intended to be safe. However, interest rate risk will negate the perceived safety of these fixed income investments.

If you have significant bond fund holdings, we would be pleased to review them and provide you with our thoughts and recommendations.

What's Going On?

The stock markets have dropped significantly in recent weeks. What are our thoughts?

Through the end of April, 2010, there had been a significant difference between the performance of US stocks markets (positive) and International stock markets (negative). The difference, depending on the asset class, was between 5-20% (meaning the best performing US asset class may have had a 20% better return than a poor performing international asset class).

Quick thoughts on that? Diversification is always working. It is impossible to know which asset class will outperform another. These are themes that we continuously focus on.

Other events have further caused significant gyrations in the worldwide stock markets and commodities. The economic crisis in Greece and potentially other countries in Europe are certainly the root of much of the markets' declines during 2010. While in late 2009 indications of problems in Greece were beginning to appear, it is events such as these that provide further evidence of how difficult it is to make accurate market predictions and investment decisions based on "having a crystal ball."

Late in 2009, most forecasters were predicting greater inflation in the US, based on governmental spending that was causing even greater budget deficits. So.....the Wall Street Journal blared last week in a huge headline that the most recent inflation statistics were at a 42 year low!

Most economists predicted rising interest rates and higher mortgage rates for 2010, to correspond with the expected rise in inflation along with the Fed's moves to stop purchasing mortgage backed securities in spring, 2010. So....interest rates have declined during 2010 and mortgage rates have decreased, not increased.

Gas prices have dropped, based on expected declines in economic activity, stemming from the problems in Europe. Few would have predicted this decline, as no one could have predicted the oil spill. One would think the oil spill would cause reduced oil supplies, which would increase the price of gas. For now, that has not happened. At the same time, the reduction in gas prices will help to limit or reduce other inflationary factors.

The impact to our clients and our investment strategy?

We are focused on long term investing, not short term market predictions and reactions to short-term market activity. We are not changing our investment strategy based on these market movements. As part of a client's long term investment plan, we may view the market decline as an opportunity to BUY stocks, if a client's allocation to stocks has decreased below their planned allocation to stocks. In other words, as disciplined investors, we would recommend buying low (even though we don't know whether the market will go higher or lower in the short term).

The key are the discussions that we have with our clients, both when we develop their investment plan and possibly now, when they may be concerned about the recent market declines. As we did during the declines of 2008 and 2009, we talk and discuss the markets. We listen. We counsel our clients to focus on their goals. As part of the plan we developed, the money that is allocated to stocks is not expected to be needed for many years. If this is so, then the movements of today become less of an issue.

Although we clearly are concerned about many of the economic problems throughout the world and in the US, we remain optimistic and positive for the long term. Our economy and the world are resilient and that solutions and innovations continue.

Client Letter: A Great Story

This is the letter that we sent to our clients in mid-April:

As spring has arrived with thoughts of warmth and renewal, we thought this would be a great opportunity to share a wonderful story, which is interwoven with many lessons and insights, which we can all learn from.

A 100 year old woman died in a northwest Chicago suburb in January, leaving her entire fortune of $7 million to her college alma mater, Lake Forest College. Orphaned at age 12, Grace Groner got her college degree and went to work as a secretary for Abbott Laboratories, where she worked for 43 years. When she began working at Abbott, she purchased 3 shares for $60 each in 1935.

So what happened to that $180 investment over the last 75 years?

• With dividend reinvestments, and no sales, her 3 shares grew to over 100,000 shares, worth approximately $7,000,000. This was an annual return of 15.13%.
• Compare this return to other asset classes and what the result would have been:
o US Treasury bills - $3,046 (3.84% annualized)
o S&P 500 - $210,000 (10.87% annualized)
o US small value stocks - $6,900,000 (15.75% annualized)
 Note the phenomenal difference in compounded effect of just a few % points of increased return, over a very long time horizon!

• Our investment strategy generally emphasizes small and value stocks, both US and globally, over a more traditional US growth stock bias, which would be represented by the S&P 500. Note the tremendous performance difference in these two asset classes since 1935.
o Further, as we did not believe the amount of the difference ($210,000 vs. $6.9 million), we re-calculated the figures to prove it ourselves!

• Groner’s strategy, which we would never recommend (hers was the absolute opposite of the broad global diversification we advocate), did require many of the fundamental behavioral concepts that are necessary for successful investing: patience, discipline and the ability to weather the periods of bad performance of the stock market (or her one stock).
o She did not sell, even though Abbott lost 1/3 of its value in 1937.
o Though she paid $60 a share, the price did not again exceed the mid-50s from March 1937 through March 1944. Would you have been as patient with a single stock or your entire portfolio?
o She endured plunging stock prices in 1962, 1970, 1974, 1982, 1987, 1990, 2002 and 2008. Yet, she did not sell.


• Can you predict a great growth stock in advance and have the patience to hold on, over long periods of underperformance?
o During the 1950s, most stocks did quite well, as measured by the Dow Jones Industrial Average, which more than tripled. Abbott only increased 22.7%.
 Would you maintain your holding in such a “losing” stock when “everything else” is doing much better?
 Would you continue holding an asset class, when others are doing much better?


• Groner was truly lucky, based simply on where she was born and chose to work.
o For the 50 year period ending in 2009, only seven stocks had higher returns than Abbott in the entire US stock universe.
o Unless she had worked at or invested in Altria Group (formerly Phillip Morris), Kansas Southern, Loews, Walgreen, Radio Shack, Dover or Johnson & Johnson, she would not have done as well.
o If she had worked at many other companies which were in the DJIA at the time in the 1930s, such as DuPont, National Steel, Chrysler, General Motors, US Steel, Woolworth or Sears, her investment would not have grown to be nearly what it eventually became. It certainly would have been very different outcome.

So while this woman is truly to be admired, and her alma mater will benefit wonderfully, we do not advocate her investment philosophy.

We do advocate and admire her long term approach, her discipline to stick to her plan (even if we disagree with it) and her ability to be resilient and maintain her stock position, during long periods of stock market declines and uncertainty. Those values and behaviors resulted in her tremendous financial success. We hope you are able to follow those traits, as it will do you, your family, and your beneficiaries well over the long term.

Sources: Chicago Sun Times, LA Times, Dimensional Fund Advisors, Center for Research in Security Prices (based at the University of Chicago).

Would you buy this fund?

Let's go back to the early part of this decade, to the year 2000. Let's consider the experience of a well-known value oriented mutual fund. Providing this example, gives us further evidence of our investment philosophy and the frustrations that investors who try to identify "the best mutual funds" continually face.

In the year 2000, the dot.com bubble was bursting and funds such as this were clearly out of favor. The hot funds were growth funds. Everyone wanted tech funds. Many investors were withdrawing money from this fund. So while the fund was experiencing massive investor withdrawals in 2000 and 2001, the fund returned approximately 26% in each of those two years, far outperforming the S&P 500 by 35% and 38% respectively.

So, in early 2002, if you'd gone to an adviser, he may have looked at the recent track record and advised you to invest in this fund, based on its past few years performance. The fund was considered a mid cap value fund, and was one of the tops in its category.

Great decision, right? In 2002, the fund was in the 48th percentile and exceeded its category benchmark by 2%. Things get worse. For the next five years, the fund underperformed its benchmark during every year between 2003 until 2007. Its category percentile rankings, starting in 2003, were 70%, 83%, 60% and 62% (1% being the best). And finally in 2007, the fund's performance was in the 99th percentile of its category. So much for that great strategy in early 2002 to jump right in.

So by the end of 2007, when the S&P made approximately 5%, and this fund lost 14%, I'm sure that you and your advisor, along with many other investors, were heading for the hills and withdrawing your money to look for the next great fund. How much underperformance can you take? Isn't five years enough to show that this fund doesn't have what it takes?

But then in 2008, the fund loses approximately the same as the S&P 500, around 36%. However, that puts it in the 28th percentile of its new "large blend" category. Then in 2009 it earns over 52%, while the S&P 500 only earned approximately 26%. The fund was in the top 2 percentile of its category for the year. So if you jumped ship and pulled money out after its poor performance in 2007, now must be the time to get back in, right? How can you possibly know?

Through this volatile decade, even with five straight years of significant "underperformance," the fund is ranked in the top 2 percentile for large blend funds, for the past 10 years, as of the end of 2009. Incredible?

Reviewing this shows the challenges of trying to identify the best actively managed funds out of the thousands of funds that are available. How can an investor know in advance, which fund will outperform others? Answer: you can't! And that is why we don't even try to play this game.

We would rather utilize a strategy that relies on investing in specific asset classes, rather than relying on the judgment of a mutual fund manager, which may go in and out of favor.

The fund in this illustration is actually the Oakmark Select fund, which I had personally invested in during the 1990s, prior to entering this business. I highly respect its manager, Bill Nygren, and their firm's value investment philosophy. I still learn a great amount from reading his quarterly investment commentaries. They diligently adhere to their strategy, but it has resulted in a roller coaster, in terms of annual performance, when tracked against comparable funds.

For our clients, we feel that purchasing mutual funds that do not make huge bets on specific companies or industries, will in the long run, provide them with a better investment experience. We would rather build a globally diversified portfolio that is not reliant on the judgment of a few individuals, as we cannot predict how successful they will be. And I don't think that you can predict that either.

Source: Morningstar.com

Firm News: New Credentials

We are pleased to announce that both Brad Wasserman and Keith Rybak received designations as Personal Financial Specialists (PFS), during March 2010.

This designation, which can only be acquired by CPAs, requires a minimum of 3,000 hours of financial planning experience, in addition to extensive continuing education requirements and passing a rigorous examination. As CPAs, this credential represents the highest professional standard of any financial planning credential and sets the PFS holder apart from other financial planners.

The PFS credential was established for CPAs who specialize in personal financial planning, and is awarded exclusively to AICPA members who demonstrate considerable experience and expertise in this area. Currently, the AICPA has granted only 3,800 PFS designations throughout the country.

We are proud to have earned this new designation, as it reflects our extensive experience, which has benefited and will continue to benefit our clients in the future.


Source: AICPA.org

Goldman Sachs Lawsuit: Understanding and Implications

On Friday, Goldman Sachs was accused of wrongdoing in a SEC civil lawsuit of fraud. Let me explain, by way of an analogy, what is alleged in the SEC suit. Please note, this is not intended to be a full analysis of lawsuit, only a general explanation intended to help readers of this blog understand some of the issues of this case. These are allegations only and no parties have been proven guilty at this time.

Let's say the general manager of a baseball team wanted to place a bet in Las Vegas on a baseball game (not legal, but assume it is and follow along). The GM, John Peters, wanted to place a bet against his own team, the Phoenix Mortgages. He went to his manager, A. Choosy, who was preparing the line up. Peters worked with Choosy to put forth the least desirable team of his 25 ball players. Choosy benched the starters for that day and turned in his line up card. Choosy, with Peters' assistance, started the worst pitcher on the Mortgages for this game.

Peters then went to Las Vegas. He bet $1 Billion that his team, the Phoenix Mortgages would lose the game. When placing the bet, Peters did not disclosure to the casino (professionals at what they do, which is accept bets and wagers) that Peters had helped to select the players involved in the game. However, the casino are professionals and are supposed to be experts at these type of transactions.

You know the outcome. The Phoenix Mortgages lost the game, as the worst players were selected to participate in the game. The casino lost their $1 Billion. Peters however, made out very well, winning $1 Billion.

How does this relate to the Goldman Sachs SEC lawsuit? A hedge fund investor, John Paulson (ie John Peters) thought that the subprime mortgage market was going to do poorly. He went to Goldman in 2007 and requested their assistance in preparing a pool of mortgages, so he could "bet" against them. The suit alleges that Paulson helped to select the mortgages, and tried to find the worst quality ones he could find. Thus, he helped to prepare the lineup card he was going to bet against.

Goldman, per the SEC lawsuit, then went to other experienced, professional institutional investors (not individuals) and sold them the $1 Billion + pool of mortgages, without disclosing that Paulson helped to structure and select the mortgages. They also did not disclose to the investors of the mortgage securities that Paulson was placing a bet against them (or in my example, Peters did not tell the casino that he had been involved in selecting the players for the game). The institutional investors who purchased the pool of mortgages were provided with details of the mortgages, and one of the major investors was also involved in the selection of the mortgages (as a casino would be involved and study a baseball team, before it sets the "spread" of a given game).

In my analogy, the baseball game was over quickly and the bet was won in no time. In the real world, Paulson's bet was won pretty quickly as well. This deal closed on April 26, 2007. Paulson's hedge fund paid Goldman $15 million to structure "Abacus" (the name of the pool of mortgage securities). By October 24, 2007, 83% of the mortgages had been downgraded and by January 28, 2008, 99% of the portfolio were downgraded. Investors in Abacus had lost $1 Billion and Paulson's hedge fund was ahead by $1 Billion.

As investors, this is again a reminder of many concepts. As your financial advisors, we have a fiduciary responsibility to act only in your interest (our interests are aligned with yours). We feel it is important to understand what you are investing in. We do not invest in hedge funds or exotic investment products. We understand the philosophy of the mutual funds that we utilize and they are very transparent about their holdings and actions.

Sources: Wall Street Journal, April 16, 2010; SEC Complaint filed April 16, 2010

Note: this post was updated on 4/19/10, based on Goldman Sachs' third statement regarding this matter, particularly noting that the investors in this transaction were "two professional institutional investors." Source: Goldman Sachs statement dated April 19, 2010

Putting Volatility into Perspective: It's better than you think

The US stock market has seen two very dramatically different years in 2008 and 2009, as 2008 was the worst second worst calendar year in 84 years and then 2009 was one of the best years.

As we base our investment decisions on academic data, principles and discipline, and not predictions of the future, the data below is very helpful to gain a long-term view of market performance and put recent market volatility in perspective.

The following is a review of the total US stock market (defined as all stocks on US stock market exchanges, but not international markets) from 1926 to 2009. The data below shows the number of years that each investment return occurred, for the overall US stock market:

Loss 50% to 40%:........ 1
Loss 40% to 30%......... 2 (including 2008)
Loss 30% to 20%......... 3
Loss 20% to 10%......... 8
Loss 10% to 0%........... 8

Gain 0% to 10%.......... 15
Gain 10% to 20%........ 13
Gain 20% to 30%........ 19 (including 2009)
Gain 30% to 40%........ 11
Gain 40% to 50%.......... 3
Gain 50% to 60%.......... 1 (1933, just in case you were wondering!)

Observations:

Positive v. negative years: There were 62 positive years and 22 negative years. Thus, 74% of the calendar years were positive.

Not just positive, but better: Not only were there many more positive years, but the positive years were concentrated with performance in the higher ranges of returns.

Randomness: I have not presented the year by year data in this blog, but the returns have no sequential pattern. Thus, the ability to predict future performance by an investor or mutual fund manager would not be assisted by this data.

Staying the course: Over time, investors have been rewarded by remaining invested in the US stock market. They will have to endure down years or periods of years, but should be rewarded for remaining committed and disciplined through those down years.

We work with our clients to educate them, so they can remain disciplined in bad and good markets. Establishing an asset allocation of stocks that is in line with your risk tolerance will lead to the ability to stay the course, remain invested as appropriate for you and your family, and which will hopefully provide you with positive stock market returns that occur over the long term.

Note: The above information is based on US stock market performance. We generally recommend that a significant portion of our clients' stock investments be allocated to foreign markets, which is not included in the above information. We think the conclusions as stated above would be the same, if they were to include foreign stock market data. Further, adding foreign investments generally results in improved diversification, which lessons the volatility of an overall investment portfolio, which would lead to increased returns over time.


Source: Center for Research in Security Prices (CRSP), University of Chicago

Wealthy Thoughts - 1

Collection of thoughts and ideas about various things....


Apple stock "started at Outperform" This was the headline in the Wall Street Journal online edition on 3/31/10, citing a stock recommendation by a French brokerage firm, Exane BNP Paribas. Everyday, brokerage firms make recommendations like this. It caught my eye, as Apple stock has risen incredibly over the past year, from the $80s to $235 per share. So after this terrific rise in the share price, why are they predicting it to outperform now?

Apple certainly has great prospects and is a great company, but wouldn't this have been a lot more helpful at $80 or $150 per share? This is why we find little value in brokerage firm recommendations. It is hard to accurately predict the future, and very few, if anyone can do it accurately over a long period of time. That is why we follow a different investment philosophy, which is not founded in brokerage firm "predictions" about the future.

Record Retention: There was an excellent article in the New York Times, dated 3/31/10, which accurately provided guidelines for record retention rules for tax and other documents. If you have any questions on this topic, please contact us. The article is: "Retain your Records No Longer Than You Must," by Jennifer Saranow Schultz (see nytimes.com)


Vanity Fair Magazine: This magazine has become a must read for me, as during the past years they have added a number of terrific financial writers, particularly Michael Lewis, who have provided excellent analysis of world economic events, major individual players in Washington and New York, as well as prominent book excerpts on these topics. If you want more in depth information about these topics, I highly recommend you review this magazine. I'll leave it up to you if you want to pay attention to the numerous fashion ads.

"Bonds Cap Epic Comeback" This was the leading headline that blared on the top of the 3/31/10 Wall Street Journal. But the much more important question, which I've written about extensively, is what will the future hold for bond fund investments?

The article states that investors "poured a record $375.4 billion into bond mutual funds during 2009, while pulling out $8.7 billion from stock funds, according to data compiled by the Investment Company Institute." (a mutual fund trade organization)

We think this is a huge error by investors, as when interest rates rise (which they will do eventually), these investors will face dramatic losses in these bond fund investments.

Our advice to you is as follows: If you have significant bond fund holdings, please contact us immediately and we would be pleased to review these investments, to discuss why this is a bad strategy and what we would advise as a solid alternative.

If you know someone else who has large bond fund investments, do them a favor for which they will be very grateful and have them contact us, and we will review their holdings and advise them appropriately.

This is the next big mistake in the financial world. This is not an if, but a when.

Truly Free Credit Reports and Gift Card Law Change

Free Credit Reports and Why You Should Do This (at least annually)

The only truly free website to obtain a free credit report is: http://www.annualcreditreport.com/. This site is governed by the Federal Trade Commission (FTC). You may also call 877-322-8228.
Beginning April 1, 2010, other websites offering credit reports must clearly indicate in a box the above information. This site will provide you with a link to get your credit report and you will need to answer a number of personal questions, for identification purposes.

The Fair Credit Reporting Act guarantees consumers access to their credit report information from each of the three credit reporting companies, once per year, for free. The best and only way to ensure that you are getting this information for free is to use the above website, http://www.annualcreditreport.com/.

The 3 major credit reporting agencies are Experian, Equifax and TransUnion. Using the above website, you are entitled to one report from each company every 12 months. You can obtain a free report from all three at one time, or order them one at a time, at various times during a 12 month period.

There are many companies that offer credit reporting services and most will charge various fees, along with the "free credit report." You should be careful of such services. While they may provide you with valuable services, you should not have to pay for the above credit report. Note that this free credit report is not your "credit score," which is the basis for most lending, such as mortgages and credit cards.

We recommend that you request your free credit report information from each of the 3 companies at different times during the year, not all 3 at once. This is recommended to monitor if the information maintained is accurate and to spot identify theft. You have the right to inform the agencies if you note any errors.

If you want to purchase an additional credit report, for up to $10.50, you can contact each agency as follows:
Equifax: equifax.com, 800-685-1111
Experian: experian.com, 888-397-3742
TransUnion: transunion.com, 800-916-8800

Source: Federal Trade Commission, www.ftc.gov/freereports


New Gift Card Rules: The purpose of the new rules is to prevent service fees on gift cards unless the consumer has not used the card (or gift certificate) for more than one year. The consumer cannot be charged with more than one fee per month and the fees must be clearly disclosed.The Federal Reserve released the rules on March 25, 2010, which go into effect on August 22, 2010.

Expiration dates for gift cards must be at least 5 years after issuance, or five years after funds were last loaded. These rules are for retail gift cards or network branded cards, like Visa gift cards.

The new federal laws will override any state laws that are not as beneficial to the consumer.

Source: Journal of Accountancy, March 25, 2010, "Fed Issues Final Rules on Gift Card Fees, Expiration Dates"