Money Clinic: Garbage-In/Garbage-Out

The phrase “Garbage-in/Garbage-Out” (GIGO) is commonly used to describe failures in human decision-making due to faulty, incomplete, or imprecise data. While this expression predates the computer age, the term can still be applied. Some things just never change.

In the world of financial planning and investments, the reality is that we cannot control the future outcomes in the macroeconomic environment. The most we can do is make the best day to day decisions that we can make in the present to influence the probability of positive future outcomes.

The simplest way to do this is to avoid making stupid money mistakes. You must BELIEVE that you can be financially successful too. Also, you need to get a better understanding of how and why money works and which tools to use for specific jobs. You must become more cost and tax efficient with your financial tools and assets. Finally, you must take ACTION and maintain your focus on PROVEN PRINCIPLES that actually work.

One of the biggest mistakes that I have seen people make is to compare their portfolio against a traditional benchmark like the S&P 500. It just doesn’t make sense to try to keep up with an unmanaged, no-cost index that has no relevance to your personal investment objectives. The best thing you can do for your portfolio is to quit benchmarking it against a random market index that has absolutely nothing to do with your goals, risk tolerance or time horizon.

Since we often look at past performance to estimate future returns (something that every investment prospectus warns against), we end up making illogical forecasts that have very little chance of turning in our favor. Most people end up taking on more risk than is necessary or delay their planning which then makes them take more risk in order to reach their goals.

The only benchmark that should matter to you is the annual return that is specifically required to obtain your savings or retirement goal in the future.

I hate when the television charlatans throw-out meaningless advice that only confuses people sincerely trying to do better with their money, especially when the pundits didn’t accumulate their wealth by investing.

For example, Suze Orman (touted as America’s most recognized personal finance expert) spews garbage out of her mouth professing that if a 25-year-old puts $100 into a Roth IRA each month, they could have $1 million by retirement.

First of all, many young people are struggling with finding a good-paying job or severely burdened with college loans to be able to consistently save money for something 40+ years away!

Furthermore, it not that her math is wrong, it just requires the 25-year old to achieve an 11% or so annual rate of return (adjusting for inflation) every single year for the next 40-years! Despite the bullish advance from the 2009 lows, the compounded annual total return for the last 18-years remains below 3%! Also, once the impact of inflation and taxes are included, the outcome becomes substantially worse.

She also fails to mention that WHEN you start your investing, and more importantly WHEN and HOW you make withdrawals, has the greatest impact on your future results. We don’t automatically get to start at some theoretical low point and begin making withdrawals in a peak market that never declines!

Finally, why in the world would anyone ever listen to somebody that didn’t make their fortune by investing? Ms. Orman has been touting her “expert” financial advice for 35 years. Do you really think that Suze made her investment fortune by the time she was 32?

This is a prime example of GIGO. It will derail your best-laid plans if you base your decisions on that garbage. Using faulty assumptions is the linchpin to the inability to meet future obligations. By over-estimating future returns, retirement projections are artificially inflated which makes you erroneously estimate the required saving amounts you need to make today. Is it any wonder that many people are woefully underfunded in retirement?

In the real world, the primary focus of financial planning is to create multiple options that can give you “choices” for the most advantageous use of your money based on the circumstances at the time you need it or ultimately transfer it to your heirs. Where you are in life and where you want to be in the future ultimately dictate the money decisions you should make.

The wealthiest 1% of the population calculate the highest and best use of specific assets and then make a decision to buy or sell based on that calculation.

Therefore, when trying to decide what financial products make sense to use in your financial plan, you just need to copy the characteristics that the wealthiest 1% of the population use in their plans and apply them to your own situation!

The features of the products you purchase should have characteristics that make it easier to reach your goals. You want to have products that you can systematically contribute money into but still have money available when you need it. You need to minimize taxes on those contributions whenever possible as well as minimize taxes on the distributions of your accounts. Your money sources should be protected from loss due to death or disability. You should strive to earn a superior return on your money while minimizing potential losses. Finally, you need to have flexibility to make changes during your lifetime.

In other words, the purpose of the money dictates where you should put it. Any financial decision you make must be considered thoroughly because of the impact that it has on your whole financial picture and how it may affect other assets you own. When building wealth, you must put every dollar towards its greatest use and optimize the performance of each financial asset that you own.

Recycle critical inputs

The characteristics of the ideal financial plan can continuously be recycled during any phase of your life. If something happens in your life and you get off-track, you can simply recycle the successful concepts and characteristics to get back on course.

You can study other financially successful people and learn what they have done to become wealthy. Remember, there is no specific dollar amount that makes a person wealthy. It is a mindset and a lifestyle choice.

While the media “experts” often make everything seem complicated, it doesn’t need to be that way. It is imperative to understand the rules of the game before you get in the game because the system isn’t set up specifically for your benefit. The system is set up by corporations whose number one priority is to maximize profits for the shareholders, not for you.

When you are looking for answers, consider the source. You should be looking for resources that talk about solutions to crucial investment issues like: how to increase savings rates when markets don’t give generous returns, why to factor-in future inflation rates when planning for retirement, where to find tax-favored investments that also generate tax-free withdrawals, how to create multiple sources of retirement income so you are not held hostage by portfolio drawdowns, and how to realistically forecast future returns based on variable rates and not compound rates of return.

Are these tough questions to ask? Yes, indeed. But the answers to these questions and any other inquiries that you have about making decisions that affect YOUR goals and objectives are the most important—not the random bits and morsels handed out by the media.

Sometimes, you can learn from your mistakes and get better. However, it is easier to learn from other people’s mistakes. There is enough information available to you regardless of your present means. You can easily develop a set of rules or guidelines that other successful people have used and apply them to your own situation.

It all starts with the realization that the purpose of money management is to manage the environment that you CAN control and give yourself options to make money in any economic environment as well as to have money available whenever you need it.

If you continue to get smarter about money, you will process less garbage in your head and you will increase your odds of becoming financially successful.

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Money Clinic: Luck of the Draw

When it comes to planning for a comfortable retirement, there is no question that a certain amount of luck is involved in the process. You could build a solid nest egg but still face terrible draw-down issues if you decide to retire right before or during a long bear market. On the other hand, if you are fortunate enough to retire at the beginning of a strong bull market, your savings could easily last for decades.

Unfortunately, nobody can predict the future or what the markets will look like on the day you decide to retire. Yet, while it may seem like an impossible task, you can put the odds in your favor by following a few simple techniques.

The first way to set yourself up for success is to build your retirement portfolio by saving money early and often. The longer you wait to save for retirement, the more you need to plow away. For example, if your work for a company that offers matching retirement funds, you must contribute at least the same percentage they contribute to maximize your savings. If you are older, then you should contribute more but don’t totally sacrifice your current lifestyle either!

Yes, it takes money to make money, but it isn’t only about saving money. You have to build multiple sources of retirement income because you have no idea what the environment will look like on the day you retire. You will also need to build a healthy savings account as you approach retirement so don’t wait until the year before you want to exit the work force to construct it.

Therefore, the next way to help ensure your future financial success is to properly diversify your assets by using multiple financial products to build your retirement portfolio and try to avoid major losses along the way. There is no one perfect financial product. Don’t let the financial charlatans ever sell you that myth.

Many people whose sole source of retirement funds was stashed in 401k’s had to postpone retirement after watching their retirement accounts get destroyed during big market corrections. By using strict investment rules to curb losses and asset allocation strategies to diversify away some of the risk, you can increase your chances for success in a big way.

The little things matter too. Investing more money during market corrections, avoiding panic-based selling decisions and rebalancing your accounts can make a big difference in the amount of money you have available for retirement. Nobody is perfect, so knowing when to cut your losses is very important too. Also, avoiding certain stocks in periods when the market decides it isn’t going to pay a high premium for expensive holdings is a way to prevent big blowouts in your portfolio.

Did you know that a big part of a move in a stock price is based on the sector that it’s in? Due to the plethora of exchange-traded funds and mutual funds prevalent in the market and the pressure for portfolio managers to perform, they are committed to cyclical trends/sector-based thinking to help capture returns and they are big buyers and sellers that help set prices. Therefore, you need to factor this into your selection and timing process. You want to be out in front of them – not behind!

Finally, you must know how to withdraw money from your retirement accounts. It is always best to have at least one-years’ worth of expenses in a savings account besides the amount you have reserved for emergencies, short-term expenditures and other big-ticket items.

You should also set up multiple buckets of money that can provide income no matter what happens in the markets. It certainly doesn’t hurt to begin this process years before you plan to retire. Some people use real estate investments to throw-off income, others use annuities with riders that pay lifetime income. Cash value life insurance has been a proven stalwart choice. It’s also never wrong to own strong dividend-paying stocks to provide stable income and potential growth.

Depending on your income tax bracket, it could make sense to have a solid portfolio of municipal bonds to provide tax-free income. In a retirement portfolio, a solid stable of bonds also serves as second-tier emergency fund in case you encounter several years of consecutive market declines.

Of course, it still pays to own stocks over the long-term because you need to keep pace with inflation (including potentially higher health care costs) over a potential thirty-year retirement, so having exposure in 50% of that asset class is not unreasonable. However, you still need to adhere to strict rules for protecting any downside risk. You might think this is common sense, but I’ve seen seventy-year-olds maintaining an 80/20 equity/bond ratio that swear they have a competent financial advisor! It is important to construct an allocation that you can stick with, so if you are asked to complete a risk profile questionnaire, make sure to assume the worst case scenario because when the market corrects, you are likely to bail at the wrong time.

Moreover, the investment process doesn’t end on the day you retire. It is a lifelong process that pits the will of the markets against your will or the will of your financial advisor. You will undoubtedly have to adjust your asset allocations to reflect changes in the market environment. For example, you may have to liquidate some bonds to fill up your savings in a prolonged bear market or you might take some profits from investment gains to have money available for the next correction.

Sometimes, you may need some help along the way. There are times when you can increase your chances of success by working with a top-notch consultant who can help you build, maintain, and protect your different buckets of money.

However, be careful who work with. It is a grueling game and you don’t need somebody who is just a product-pusher coagulating a hodgepodge of financial products that don’t help you play the game any better. The truth is that the financial services industry has many caring people of the highest integrity who truly want to do what’s in the best interest of their clients. Unfortunately, many are operating in a “closed circuit” environment in which the tools at their disposal are “pre-engineered” to be in the best interests of the “house.” The system is designed to reward these salespeople (often disguised with impressive designations after their names) for selling, not providing “conflict-free” advice. Always avoid purchasing any financial product from anyone who makes recommendations without considering your complete financial picture.

It is imperative that you demand the best from yourself and anybody you work with. You can improve your game by holding yourself and anybody that helps you accountable for your results. You also need to exhibit strict discipline in order to stay in the game and sometimes that is what a great advisor can best help with.

Furthermore, always follow the rule: the purpose of the money dictates where you should put it. This is how you can often weed out the financial hacks that try to sell you products that don’t meet your objectives.

When it comes to the luck of the draw, you CAN put the odds in your favor…if you at least know how to play the game.

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Money Clinic: Four Major Risks in Retirement

Now more than ever, creating and sustaining a successful retirement plan involves the necessity for a solid strategy that considers volatile markets, inflation, longevity and the possibility of sustained low interest rates.

Anyone who has money in the stock market over the last few decades has experienced wild gyrations in their investment accounts. While the S&P 500 has increased by about 300 percent since March 2009, most investors have only captured part of that increase. While no one can predict the direction of the markets in the short-term, it pays to have a solid set of rules to follow when investing for the long run. The point of using any method of portfolio risk management is to have a strategy, process and discipline to avoid excessive levels of capital destruction over time. Buying on dips, rebalancing and avoiding severe losses can help capture more of the markets gains while keeping you in the game. Avoiding drawdowns when you are making withdrawals from your retirement account should also be a priority.

I apply three simple rules when monitoring and adjusting portfolios:

1. Trim back winning positions to original portfolio weights by rebalancing as frequently as each quarter or as positions increase by a certain percentage.
2. Sell positions that simply are not working (if something isn’t working in a rising market, it likely won’t in a declining market.)
3. Hold the cash raised from these activities until the next buying opportunity occurs.

By using some type of fundamental or technical measures to reduce portfolio risk by taking profits as prices/valuations rise, the long-term results of avoiding periods of severe capital loss will typically outweigh missed short-term gains. Even small adjustments can have a significant impact over the long run.

It should also be obvious to everyone that things don’t cost what they used to. Inflation drives up the cost of all goods and services, including health care costs. This a very important factor to consider when determining the amount of money you will need to accumulate in order to reach your retirement goals. While in retirement, you also need to continue to earn a higher rate than inflation or you will see your nest egg dwindle quicker than you might imagine.

Individuals are living longer in retirement than at any point in history. Most people would like to maintain their standard of living when they reach retirement and have the confidence that they will not run out of money. Not knowing how long you are going to live makes it difficult to determine how much money you will need to last a lifetime. Most workers relied on pension income that was guaranteed to last for as long as they lived. Those days are gone and the burden of investing for retirement has been shifted to the individual. With the likelihood of a three decade-long retirement, this has become an difficult task.

Back in the 1980’s, retirees could simply put their money in guaranteed savings accounts and Certificates of Deposit and live off the interest. However, in the low interest rate environment that we have witnessed over the last decade, conservative strategies like this have not provided adequate growth for accumulating retirement assets nor have they provided stable income options. Many people have decided to prolong retirement or work part-time jobs to help supplement their retirement income.

In these ever-changing times, creating sustainable retirement income strategies is more important than ever. It is essential to adapt to the changing landscape and consider these risks when planning your retirement roadmap. While each of these hazards may be independent of each other, the combined effects must be considered when creating and executing your retirement plan.

But you have to be careful when seeking advice.

I see advertisements from financial salespeople saying that they do “holistic” planning while formulating a way to get you to pay them upwards of 2% to manage your investment account. It’s just a sales gimmick. They do not use a proven wealth model to structure your complete financial situation so that all your assets work together in harmony. They just say they do “holistic” planning and then proceed to sell you their money management platform.

You see, it doesn’t matter how much money you have – what matters is that you are efficient. Real “Holistic” financial planning allows you to understand how a financial decision you make affects other areas of your life because it includes all aspects of a person’s “Life Assets”. By viewing each financial decision as part of a whole, you can consider its short and long-term effects on your life goals. You can also adapt more easily to life changes and feel more secure that your goals are on track.

The charlatans that are using “Holistic Planning” to sell you something are purely salespeople pushing financial products on you that have nothing to do with improving your complete financial picture. If “holistic” means that the whole is greater than the sum of its parts, why do financial advisors push ONE product so hard? Because financial institutions make money by making steady fee income!

Remember, holistic financial planning is the continual process of pursuing your life goals through the proper management of your resources, not the process of selling you a financial product.

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Money Clinic: Snowfall in Spring

There is an old saying that April showers bring May flowers. Well, if you look outside most areas in the northern U.S., you’re seeing snowflakes! Therefore, it is reasonable to infer that April snowfall creates dead flowers this May!

I guess the weather is fitting for the climate in the investment markets and the economy. After a long bull market run that has acted as a rising tide that has lifted almost all investments, now is the time to be more selective in your asset allocation process.

If your portfolio allocations are heavy on the equity portion due to the run-up of stock prices, you should consider how exposed you want to be to equities if there is a major downdraft or extended period of underperformance.

Markets hate uncertainty. Right now, there is plenty of uncertainty in many parts of the economy. Potential legislative and fiscal policy gaffes, possible trade wars, higher interest rates, high valuations in speculative investments and a relatively mature business cycle all lead to serious questions about how much room is left in the bull market.

Despite the recent correction, the U.S. equity markets still lead all major global markets in terms of valuation. While it would appear to be positive, it is also a sign of extended risk. The outlook for earnings has theoretically improved due to tax reform and other recent fiscal policy measures, but even with that boost, earnings do not support these valuations.

Moreover, if the recent tax cuts fail to “trickle down”, there is a real threat that consumers are not going to have money to purchase higher priced goods and services. This could also put the brakes on housing affordability and other real estate activity – especially if interest rates edge higher.

The scary thing about the fabulous bull market run since 2009 is that many consumers have had to draw down whatever savings they amassed before the multiple stock market corrections beginning in 2002 and they have run up credit-card debt to keep up with the basic necessities of life. Consumers are once again heavily leveraged with sub-prime auto loans, mortgages, and student debt. Furthermore, surging health care, rent, food, and energy costs will only continue to impede economic rates of growth.

Meanwhile, corporations continue to opt for share buybacks, wage suppression and accounting gimmicks to fuel bottom lines earnings per share.

This isn’t a formula for strong economic growth.

The biggest problem that I have seen developing over the last ten years is that it isn’t a severe correction or crash in the financial markets that has me worried, but the ongoing structural shift in the economy that is depressing the living standards of the average American family.

One thing is for sure, the easy money has already been made. Now it’s going to be a lot harder to make money in the markets and you better make sure your appetite for risk is appropriate for your investment time horizon.

If recent weather patterns tell us anything, it is that we should always be positive but still be prepared for the worst.

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Money Clinic: Skip-Over Technique

So, you’ve worked hard, played the investment game well and have accumulated plenty of money for retirement. You’ve done some basic estate planning to make sure your heirs don’t get clobbered in probate. You’ve made sure that you and your spouse have enough income to last for your lifetime. Everything seems to be working out as planned.

One thing that you may be overlooking is that it could be very possible that you simply cannot spend all the money that you’ve accumulated. Even if you or your spouse live past your life expectancy, there is a risk that a good chunk of your money won’t stay in your family.

There are a few solid strategies that help to make sure the money you’ve worked hard for stays in the family. You’ve heard of the Mellon’s, Rockefellers, Kennedy’s and countless other billionaires that use creative money strategies to hold on to their wealth generation after generation, right?

Well, you don’t have to be a billionaire to use some of the same strategies they use to grow and protect your wealth.

Relatively common examples of wealth transfer planning include making annual gifts to children and/or grandchildren, paying tuition for grandchildren, creating irrevocable life insurance trusts, and using all or part of your gift tax exemption sooner rather than later. Without setting up corporations or family limited partnerships or complicated trust funds, which are often irreversible, you can apply a few simple techniques to keep more money in your family instead of giving it to the government.

One of the simplest strategies is to use a “skip-over” tactic where you put money into a single premium life insurance contract (or a single premium annuity if you are uninsurable) and still retain ownership of the contract while you are alive. The trick is to name your children as the primary beneficiaries instead of your spouse.

While this may seem to be a disheartening gesture toward the love of your life, it is actually an extremely practical money maneuver if it is implemented properly.

First of all, if your spouse has generous savings and more than enough income to live a prosperous lifestyle, the last thing he or she needs is more money than they can possibly spend that ultimately gets wasted in estate and income taxes when he/she dies.

Secondly, if your kids are in a higher tax bracket than you, it becomes very difficult to pass money to them without them incurring more tax than necessary. Its not that the kids are looking for a handout but there is no reason to waste hard-earned capital in taxes instead of keeping that money in the family.

Furthermore, if you can maintain control of the money while you are living, you still have the opportunity to use the source of funds if something devasting happens and you need to use it. In some cases, it could make sense to earmark this money for future medical or nursing home care costs on a tax-favored basis. Of course, the best financial product to use with this strategy is life insurance since it escapes federal income tax and inheritance tax upon death of the insured. Many policies also include provisions for tax-favored withdrawals as well, if used for critical health care or terminal illness.

The only drawback with the “skip-over” technique is that you have to plan this out while both spouses are still living. It just doesn’t work as well if there is nobody to skip over. Kind of dry humor, but true nonetheless.

The simple fact is that it becomes more difficult to use creative gifting techniques when there is only one spouse living. The gift tax exemptions are smaller, and the risks of gifting large sums of money are greater. Wealthy people understand this and often implement wealth protection strategies as early as the beginning phase of their retirement.

I always say that the purpose of the money dictates where you should put it.

Well, the best money maneuvers enable your money to serve multiple purposes. Since a “skip-over” strategy allows for control and tax-favored use of the money while alive, while providing potential tax savings at death, it makes an ideal multipurpose money maneuver and should be utilized whenever it is appropriate.

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