Merriman on High-Frequency Trading

If you’ve been tuned into financial news lately, you’ve no doubt heard about High-Frequency Trading (HFT). HFT is not new. In fact, it’s been around for over 20 years. Investopedia defines HFT as:

A program trading platform that uses powerful computers to transact a large number of orders at very fast speeds. High-frequency trading uses complex algorithms to analyze multiple markets and execute orders based on market conditions.

So why is it news now? Last week, a 60 Minutes interview with Michael Lewis suggested that the stock market was “rigged” by high frequency traders. I want to provide my thoughts, as Merriman’s Chief Investment Officer and as a hedge fund manager, on how HFT is affecting Merriman client portfolios. While we will monitor developments over time, the bottom line is that we believe HFT has minimal impact on our client portfolios.

Here’s why:

HFT firms are the new market markers in the stock market. Market makers, who’ve been active in markets ever since stock exchanges have existed, act to provide liquidity to stock trading by offering to buy stock at the bid price, and sell stock at a slightly higher ask price. While providing liquidity to the market, market makers have always strived to maximize their profits at the expense of institutional investors and the average person buying and selling stock in their brokerage account.

The transaction cost to investors can be viewed as an expense (paid to market makers) for providing liquidity, and has never and will never impact the fundamental value of the stock market. The cost only comes to bare when buying or selling a stock.

Two forces help protect us from market makers making excessive profits.  The first force is the competition among market makers.  As with any business, large profits attract competitors. iStock_000024621112SmallCompetition among market makers drives transaction costs lower as they fight amongst each other to provide this service. The battle among market makers is very similar to an ever increasing arms race, where whoever has the best technology wins. Over the last 10 years, computers have replaced the Wall Street traders and NYSE specialists – who in the old days were just as keen to profit from investors.

The second force limiting market maker profits are the countermeasures institutions use to trade large blocks for their clients. Attentive investors should be monitoring their trading and adjusting their investing/trading approach to minimize transaction costs. HFT is just the next story in the everlasting interaction between market makers and institutional investors. While the SEC and other government agencies will eventually catch on to illegal trading activities, the smartest investors generally take a buyer-beware approach to their trading.

In our MarketWise portfolios we take into account the sensitivity to trading costs when selecting investment managers. Dimensional Fund Advisors is obsessive in monitoring their trading costs and minimizing turnover. Their approach is to trade like a market maker by buying and selling stocks with limit orders and they are agnostic about what stocks they buy or sell (as long as a stock fits that fund’s investment approach). This trading approach is much less sensitive to HFT. Stock-picking active managers, and index funds, are typically demanders of liquidity when they trade stocks, which is much more susceptible to exploitation from market markers whether using HFT or via the old specialist system on the NYSE.

In our TrendWise portfolios, we also carefully track our ETF transaction costs to ensure that our approach is as cost -efficient as possible. And finally, individual investors, trading small quantities of stock in their own accounts, have benefited greatly from HFT as bid-ask spreads have narrowed significantly over the last decade or so.

If you have any additional questions about HFT or its impact on your portfolio, please don’t hesitate to speak directly with your advisor.

Passwords, pin codes, and security

I recently went to visit a friend in a secure building. He didn’t answer his phone when I called from the front door to let me in, but the building had a keypad entrance system.  After a few repeated attempts, I was able to find the correct key code and let myself into the building. When I got to his front door, he was a bit upset that I was able to “hack” into his building. I said it’s pretty easy to figure out PIN codes and passwords because people pick easy to remember numbers, words and patterns. Most of the time you just try the most obvious options first, and you can guess the security code.

In research done by DataGenetics.com in 2012, of the 3.4 million accounts they looked at 11% of people had the PIN code 1234. Over 6% had 1111 and almost 2% had 0000.  Hacking for passwordGiven that knowledge trying only 3 PIN codes gives me about a 20% chance of guessing someone’s personal PIN code.

Passwords for computers, emails, and online accounts are not much different.  Every year hackers post online usernames and passwords they have harvested. SplashData, a password management company, compiles a list of the most common passwords of the year. In 2013 the top three passwords were 123456, password and 12345678. Other common passwords included phrases like amazon, adobe, password1 and one of my favorites: trustno1.

Since most sites require usernames and passwords for access, and our brains are designed to hold 50 different complex unreadable passwords; many of us opted to make them easy to remember.  Unfortunately, an easy password to remember is an easy password to hack. Below are a couple of things to consider when you create pin codes and passwords to help make them more secure.

PIN codes

  1. Select PIN codes that are random and have no association to you. For example a PIN code of 3976 is much better than a birth year of say 1960. If I know the year you were born, I would make that a PIN code to try.
  2. Select a PIN code that is not an easy visual pattern on a keypad. DataGenetics found 2580 was the 22nd most popular PIN code because it is the numbers down the center of the keypad on your phone.  The code 1397 is an easy guess as well because it is the corners for the phone keypad going clockwise.

 Passwords

  1. Avoid using any part of your login or the site name in your password. If your login to amazon.com is joe.example@fakeemail.com don’t make your password joe123 or Amazon1.
  2. Have a different password for every site. I know this can be a big pain, but if a hacker steals your password at one site, they won’t be able to use it at a different site. Imagine if your password was compromised at some site you used three years ago once, and you only use one password. How many sites do you have to update? How much of your data would be at risk (banking, shopping, investment, email)? With a unique password at each site you can reduce your risk.
  3. Try to use a random password. A password like Fj%9cX44 is much better than F00tballs. While F00tballs has the normal 8 character limit with numbers and upper/lower case letters, hackers are getting smarter and computers are getting faster so simple character substitutions are still risky.
  4. Use an uncommon phrase. For a while, people suggested using a simple phrase such as “ILikeSchool.” However, as the hacking has improved, many security experts now recommend that you use non-sensical sentences as passwords. A phrase such as “eat_baseball_Yards” or “doughnuts around circles” is more difficult to breach.
  5. Try using unique logins for various accounts. If possible, I like to have a login that is unique at each site. Also, if it requires an email address, I like to have a few email accounts I can use for different sites. You can easily sign up for multiple Gmail, Hotmail or Yahoo email accounts.
  6. Use a password management program. If it is really hard to remember all those passwords, there are several programs out there that will securely store your passwords. These programs will store you username and passwords and log you into the website automatically. A quick search for Password Manager in Google or Bing will get you on your way.

As I said above, I don’t think we were meant to remember so many sites, logins and passwords stored in our brains. Writing it down on a piece of paper is just asking for trouble. And storing them in an Excel spreadsheet isn’t any better. There is hope on the horizon. As we work with biometric systems for voice and visual recognition we soon might be able to have our image and voice as our PIN code. We might be able to use a fingerprint and say our name to get in our email. No longer will we need to store all these random phrases, we will only need to remember our name. Oh, and the code to my friend’s building was 2468.

Seahawks Secrets to Success

12Flag-1024x728Seattle is still reeling with excitement from the Seahawks winning the Super Bowl! Over 700,000 Seattleites celebrated downtown to welcome the champs coming home. No matter where your team allegiance lies, it’s easy to spot the strengths of the Seahawks both on and off the field. These lessons can be applied to multiple areas of life, including your finances.

Here are 12 things everyone can learn from the Seahawks:

1) It’s never too late: Russell Wilson was a third round draft pick but that didn’t determine his performance. No matter when you start saving and investing, there is always opportunity ahead of you.

2) Diversification is key: Every player on a team has a specific job to do, just as every investment in your portfolio has a unique purpose. It’s hard to win with a team full of quarterbacks! Design your portfolio with broad diversification to cover all types of positions.

3) Defense wins championships: There is a saying that “offense wins games and defense wins championships.” Many times it’s the team’s offense that gets all the praise and glory, but without a strong defense to hold back the competition, all of the points scored are for nothing. It’s easy to get caught up in short term performance chasing of stocks, but make sure to manage downside risk with bonds so that your returns won’t disappear in a down market.

4) Find a coach: Every team needs a coach to lead them to victory. Having a financial advisor will keep you on track toward achieving your goals.

5) Don’t compare your strategy to others: Every team has a different approach on how to win games. Your friends and family have their own ideas about investment that may be different from yours, and that’s okay. Stick with the plan you make with your financial advisor – it is unique to you.

6) Break expectations: Seahawks fullback Derrek Coleman is deaf. No one expected him to be able to play in the NFL but he didn’t let other people’s beliefs hold him back. Commit to success and don’t let others get in the way of what you want to accomplish.

7) Take a look back: Teams spend countless hours watching game footage to learn from their mistakes. Look back at historical investments to learn all you can about performance volatility throughout various market conditions.

8) Go all in: The Seahawks have an “All In” sign that they hit on their way to a workout. Often we don’t want to commit to a plan unless we know for sure it will work out…but a plan can’t work unless you commit. Go all in.

9) Never give up: Even when it looks like a team has lost, there is always a chance for a comeback late in the game. Sometimes when a portfolio is down, we are tempted to switch strategies or abandon hope. If you give up too early, you might miss the winning finish.

10)  Have fun: Football is tough work but it is also a lot of fun. Always make time for the activities you enjoy with the people you love. As we say here at Merriman – Invest Wisely, Live Fully.

11)  Give back: In the midst of practice, games, media interviews, and sponsor appearances, Russell Wilson still makes time to visit the patients at Seattle Children’s Hospital. Appreciate the gifts you have in your life and share them with others.

12)  Identify your 12s: Seattle’s fans are known as the 12th man. Even though the fans aren’t on the field, they play an important role in the game. Find fans who will support you through all your wins and losses, and recognize their contribution to your success.

Seahawks, Merriman and Bowling

We recently had the opportunity to be the title sponsor for Merriman Live Bowl United Presented by Team Avril, a bowling tournament for all ages and skill levels hosted by Seattle Seahawk Cliff Avril. He was joined by several of his teammates: Red Bryant, Brandon Mebane, Michael Bennett and Clinton Mc Donald.

DMerrimanSeahawksuring this fun evening, a few Merriman clients and employees got to hang out with some Seahawks and show off their bowling skills at West Seattle Bowl. I think I threw more gutter balls than strikes, but that did not matter because the evening was about having fun and supporting a great nonprofit organization.

Net proceeds benefited United Way of King County and Strikes for Kids, a nonprofit organization that partners with professional athletes in bringing local business, fans, children and sports together for great causes. There is no better feeling seeing the excitement that the children have to meet their favorite Seahawk while having fun with their family. Strikes For Kids coordinates these bowling and golf tournaments across the United States. We were thrilled and honored to sponsor this first event in the Seattle area.

Below are some links to check out video coverage and photos from this event. Go Hawks!

Seahawks video

Komo News coverage

Live Bowl United

 

 

How the Merriman research team evaluates potential investment opportunities

‘Tis the season for RMDs

Another year flew by and the holidays are already here. Snowflakes are falling, houses are decorated, and families are reunited! In the midst of all the joy, it’s easy to put your finances aside. However, if you will be over 70.5 years old by the end of the year, we want to remind you that it’s time to take a Required Minimum Distribution (RMD) from your IRA or retirement account. An RMD is designed to ensure that you withdraw at least a portion of the funds in your account over your lifetime – and that you pay taxes on those funds. Taking your RMD is important because the stakes are high! Failure to withdraw the required minimum will result in a hefty penalty: The amount that was not withdrawn is taxed at 50%. In other words, if the RMD on your traditional IRA is $8,000 in 2013, but you only withdraw $3,000 during 2013, you will be subject to an excise tax of $2,500 (50% of the amount by which the RMD exceeds your actual distribution). It’s quick and easy to arrange your RMD by calling your financial advisor. We recommend you do so by December 15th to ensure plenty of time for the distribution to occur before the end of the year. The sooner you get it done, the more time (and money!) you will have to spend with the ones you love.

Fall and football

Fall’s arrival is always a sweet end to a perfect summer of sun and warmth – it wakes us up with a blast of cool weather as the leaves change color and fall around us. Most importantly, it brings us football season.

You may now begin your fantasy football addiction, adorn your college or NFL jersey, tailgate, or just notice football games taking over every TV in your life. Football is embedded in our culture. We root for a team to overcome individual idiosyncrasies and be the best and greatest.

Vince Lombardi likes to remind us “Football is like life.” If football is like life, what does your Life Team look like? Is your defense ready to go? Who would be your quarterback? What receivers would make your touchdowns? And what offense is preventing life events from taking you by surprise?

In the game of life, every family needs a good proactive defense behind them:

  • Your goals in life represent the ball – being carried through life against your ever-changing environment and market.
  • An advisor is the quarterback – implementing strategies for success as the on-the-field leader.
  • The research team is the center – the first line of defense to support the advisor in a volatile market, ensuring investment assets are diversified and invested to obtain the best return for the acceptable risk.
  • The technology team and client services are the guards and tackles – creating openings for efficient account activity, evaluating security of trading systems and your data, and blocking negative third-party experiences.
  • The advisor’s professional network represents the receivers – experienced in positioning you for success by looking for opportunities to protect you from potential blocks.

You also need an excellent offense: a proper asset allocation, efficient tax planning, detailed insurance planning and maximized wealth preservation and wealth transfer.

In the team approach, each player comes together to share information and ideas, review strategies for reaching your goals on a holistic level, and ensure an adequate offense to counter life’s hiccups.

Otherwise, the success of one player, you, running the ball all the way to the goal line alone is small. Individuals can at times think too much about changing their strategies, and sometimes don’t take appropriate or timely action when obstacles present themselves. They are not able to move freely through life and enjoy the present.

Consider your current Life Team and what changes you would make.

Over the past 30 years, Merriman Wealth Management evolved into a Life Team to help accomplish your personal and financial goals. We believe by aligning our clients, internal employees and external professionals toward the client’s goals and values, we can make a significant impact in covering the field to implement long-term strategies for success and helping you get what you want in life. Whether you’re ready to take the step to be part of a team, or you’re still thinking about making changes to your life strategies, we will be here when you need us.

Don’t let your emotions invest for you

Monday, October 19, 1987—aka Black Monday—was a fearful day for investors across the globe. The damage exceeded 20% in stock market declines by the time the exchanges closed. In the wake of such steep declines, investors too often are driven to act by their emotions. In this case, fear. Fear that the decline will continue. Fear that their hard earned savings will be sucked dry by the markets. A more recent example of this fear was invoked by the financial crisis. In both cases the markets recovered in short order. But, the market never recovers for those who sell out of it. Clearly, fear selling is a bad idea.

Fear is not the only emotion that muddles our investment decisions. Greed is just as dangerous.

The 1990s seemed too good to be true. Investors could not lose money in technology stocks. Valuations seemed to have changed and the exponential rising prices were within the new norm. People got greedy. Some went so far as to use their home equity to purchase stocks. And then, just like that, the party was over. The end of the decade saw technology stocks come crashing down. Those who got greedy and concentrated all of their holdings in technology stocks paid the price.

Anytime the sky is falling or the markets seem too good to be true, remember the mantra—be greedy when others are fearful and fearful when others are greedy.

While fear and greed top the list of emotions that can wreak havoc on your investments, there are others: angst and excessive pride, for instance.

The issue with angst is if you wait for events to happen (government shutdown, fiscal cliff, quantitative easing, etc.) or for the markets to “normalize,” you often miss the boat.

Excessive pride can sometimes drive people to buy individual stocks. It’s the classic cocktail party conversation where someone tells you they bought Microsoft stock in the 1990s or Apple stock at the turn of the century. They do not tell you about the other 10 stocks they bought that went south. By focusing on the one home run, people subconsciously convince themselves that investing in individual stocks is a wise venture. It’s not. In fact, it’s speculation, not investing. Do not let pride get in the way of making smart investment decisions.

Clearly we cannot let our emotions guide our investment decisions. Emotional investing is not successful investing.

Follow these steps to help avoid the pitfalls:

1)     Build a plan. Write it down and stick to it. If the markets turn over, do not deviate from your plan. If anything, rebalance your accounts back to their initial targets.

2)     Turn off the news and tune out the financial pundits. In the age of information, the evening news is not going to give you a leg up on investing. That is, everyone knows everything and it is all factored into the price of securities.

3)     Do not assume things are correlated when they are not. GDP is not nearly as highly correlated to stock market returns as people think. Nor, for that matter, are political events.

4)     Diversify your portfolio. Put another way, do not put all of your eggs in one basket. Remember what happened to technology stocks in the 1990s.

5)     Focus on what you can control. You can control how much you save and whether or not you succumb to your emotions. You cannot control the markets and politicians.

Here’s the exciting part: if you can keep your emotions at bay, invest wisely and let the markets work, you can reduce your stress and increase the likelihood of a successful retirement period.

Getting debt under control

I recently had the good fortune of being featured in this article which appeared on the front page of the Seattle Times Business section, and I want to share it with you.

A.J. and Amy are a young couple burdened by debt who did not have the resources to pay for a financial planner. The Seattle Times reached out to me through my affiliation with the Puget Sound Financial Planning Association and asked if I would build them a plan. After several meetings we were able to identify and build a plan around their short and long term goals. I am thrilled to report that they feel like they are finally in control of their debt and retirement savings. Most importantly, they have developed peace of mind around their finances.

Please keep in mind no two investors are alike, this article referenced above is a specific recommendation based on A.J. and Amy’s personal finances. If you would like to give the gift of financial peace of mind, I am always more than happy to help your friends and family develop their own personal plan.

Business Continuity Plan

Emergencies and disasters can happen anytime, anywhere, and often without warning. Last year, Hurricane Sandy caused significant and wide-ranging damage, which led to the closure of the equities and options markets on October 29 to 30, 2012. As a fiduciary, Merriman has a responsibility to protect our clients’ interests from risks resulting from the inability to provide advisory services due to a disruption in business, such as a natural disaster. A Business Continuity Plan (BCP) provides guidance regarding the steps and actions that should be taken in the event of an unanticipated interruption of normal business operations.

Here are the top five ways a BCP helps to minimize the effects of emergencies and disasters:

  1. Reduce downtime. Every hour business is down is time we miss helping our clients. Having a BCP helps us get back up and running more quickly. In the meantime, since Merriman is not a custodian, our clients are also able to call Schwab and Fidelity directly if we are ever temporarily unavailable.
  2. Ensure important business operations continue. Some of our day-to-day work is flexible and can be done at any time, but other tasks are time sensitive and cannot be delayed. A BCP helps identify mission-critical staff and processes.
  3. Allow for remote operation. If we are unable to get to our building (for example, due to a large snow storm), employees can work from a remote location via remote desktop connection. We also have a virtual phone system so that if the phone lines in the building are down, all incoming calls can be routed to employee cell phones and/or home phones. In addition, this year we switched our email to Office 365, which is cloud-based – meaning our email is accessible from any location as long as there is an Internet connection.
  4. Protect important information. Merriman keeps electronic copies of important documents so that information is not lost in the event of a fire. We also back up our data so we have redundancies in place in case a server goes down.
  5. Take care of everyone in the office. We have an emergency food and water supply that is restocked annually in case we are forced to stay in the building for a period of time.

It’s not enough just to have a plan; we also need to make sure it works! Every year Merriman conducts BCP testing using simulated disasters to ensure we are prepared for a variety of crisis situations. We take what we learn from our testing and update the plan as needed.

If you are interested in reading more, the SEC, CFTC and FINRA jointly released this advisory alert that addresses the importance of implementing and testing a Business Continuity Plan.

Umbrella insurance

When you hear the term “umbrella insurance,” your first thought might be, “What do umbrellas have to do with insurance? Is this just another product the insurance industry is trying to sell me?” Actually, umbrella insurance has nothing to do with conventional umbrellas.

Umbrella insurance is “extra insurance,” like an umbrella is extra protection against the rain, even though you have a raincoat on. Think of your regular car and homeowners insurance as the raincoat, and the umbrella insurance as the “umbrella” you carry for torrential downpours.

Many people tell me they have liability coverage with their auto and home policies, so why would they want to buy more? A typical individual does in fact have liability coverage on their auto policy and their homeowners policy, usually between $100,000 and $300,000 in coverage. This is indeed a lot of money.

But imagine you are driving your car when it’s wet out and you don’t see a cyclist when you make a turn. You hit the cyclist, who sustains serious injuries. In this situation, you may owe for lost wages, medical bills, and pain and suffering. If this person is the CEO of a large corporation and can’t work for, say, five years, the wages alone might exceed $1,000,000. Medical bills, including physical and occupational therapy, could easily be over $1,000,000. You will have far exceeded the limits of your auto policy.

In situations where losses aren’t covered by your other policies, umbrella insurance can provide the following:

  • Additional lawsuit coverage.
  • Added coverage for defense costs.
  • Liability coverage for some lawsuits not covered by your underlying auto or home insurance (for example, an accident involving a boat you rented on vacation, or a slander lawsuit).

You can also add an “uninsured or underinsured motorist” component to some policies, which can cover damages if you are injured by someone who has no insurance or not enough insurance. For example, you are out jogging and get hit by a car. The motorist’s insurance does not completely cover your medical costs. Your umbrella policy can step in at this point, with the uninsured motorist component, provided that the other motorist was at fault.

The good news is that this is one of the best buys in the insurance business. It typically costs only $150 to $200 per year for the first $1,000,000 in coverage, and then about $100 each for each additional million.

Umbrella insurance can give you peace of mind and help protect against financial ruin. I recommend you pull out those policies, look over the amount of liability coverage you have and schedule an appointment with your financial advisor or insurance agent to see if your coverage has kept pace with your assets and needs.

Longevity risk

My grandmother was born in 1927. At that time, the life expectancy for women was about 60 years, but here we are in 2013 and she is doing amazingly well. During the last 80 years, technological and medical advances have tacked another 26+ years onto her life. Already she has lived 50% longer than the initial expectation.

My son was born in the fall of 2012. He is expected to live about 80 years. Following my grandmother’s case, he would live to 120 years of age. Put another way, he can expect his pre-retirement and retirement periods to be about the same. Clearly, retirement nest eggs and pensions are going to be stretched a lot further than they ever have been.

This is the trend that we need to plan for. The following are key areas of consideration for our increasing life spans.

  • Inflation. At 3% inflation, a $100,000 annual income need today becomes $242,726 30 years down the road. This substantial difference requires careful consideration. Do your pensions have an annual cost of living adjustment built in? Have you built inflation protection into your retirement accounts?
  • Health care costs. Along the same lines, the estimated rate of inflation for health care in 2014 is 6.5%. Should you insure to protect against this risk?
  • Portfolio withdrawal rate. What is a sustainable rate that can last throughout your retirement period? Is your portfolio structure congruent with this rate? That is, do you have the appropriate mix of stocks and bonds with sufficient diversification?
  • Your end of life wishes. Statistically speaking, the majority of medical costs occur in the last five years of life. And, there is little doubt that advances in medicine and technology will afford increasingly difficult decisions. Having a clear medical directive can save significant emotional and financial resources.
  • Savings rate. Pensions are becoming a thing of the past. This has shifted a huge responsibility to the saver. If you are still in your accumulation years, figuring out the savings rate that corresponds to your retirement goals is more important than ever.

As life expectancies increase, so do the complexities of retirement planning. Inflation protection and an appreciable return that keeps up with your distribution needs are just the beginning. If you have not already done so, take the time to meet with your advisor to build a goal-centric plan that is specific to your unique retirement needs.

Protecting yourself against electronic wire fraud

It seems like every year thieves become more creative in finding new ways to steal. A disturbing new trend is directly targeting financial advisors and their clients. Financial institutions are seeing a noticeable increase in attempts at fraudulent wire transfers by email “spoofing,” where an email request appears to be sent from the client, but is actually from a fake-but-similar email account (or sometimes it’s the client’s actual account).

Think, for a minute, about the emails you have sent to your advisor. If your email account was hacked, the hacker would have access to all of those emails in your sent folder. They could easily send an email (from “you”!) to your advisor requesting a fund transfer to a third-party bank account, along with convincingly forged letters of authorization. If you’ve ever emailed a scanned copy of something you’ve signed, they have access to your signature too. Often, by the time someone realizes the request is fraudulent, it is often too late. The money is already gone, the transfer cannot be unwound, and the wire fraud theft is complete.

It is our policy to never accept instructions like this via e-mail, but in response to this increased risk, we have trained our employees to identify warning signs of electronic wire fraud attempts. We have also reviewed and improved our procedures to verify a wire transfer request is legitimate before acting on it, particularly in scenarios where the transfer is going to a third party.

However, it’s important to take steps to make sure your information is secure and avoid the possibility of this type of fraud altogether. We use www.box.com to securely share files with our clients and keep that sensitive information out of your inbox.

Just to be safe, here are some tips on how you can help protect your email accounts from being hacked:

  1. Make sure to use secure complex passwords. We recommend choosing a password with a minimum of 8 characters, including upper & lower case letters, numbers and symbols.
  2. Don’t use the same passwords on multiple accounts. If you get hacked in one, they have access to everything.
  3. Use double authentication if possible. This requires you to enter an extra code when logging in from an unrecognized IP address. Click here to learn more about Google’s 2-step verification.
  4. If you get email on your smart phone, make sure the phone is password protected.
  5. Beware of storing documents in your email that contain your signature, social security number, or other non-public personal identifying information. If your account gets hacked, the thief will have everything they need to steal your identity.
  6. Don’t ignore signs that your email account has been hacked, like finding emails you didn’t send in your ‘sent’ folder, or hearing from your friends that they’ve received spam from your email address.
  7. If you do get hacked, be sure to change your passwords immediately! Also call your financial institutions to make sure your accounts have not been compromised.

Merriman advisors Mark, Cheryl, and Tyler discuss conversations they are having with their clients

An alternative to the financial news treadmill

Every day, financial news sites and channels provide a steady stream of conflicting opinions and predictions that often leave investors feeling confused, frustrated, and paralyzed. Don’t believe me? Please allow me to elaborate.

In addition to reading a wide range of investing and personal finance pieces each day, in the evening I often browse a site called RealClearMarkets.com to make sure I take a look at some of the interesting and/or important articles I might have missed during the day. RealClearMarkets.com is basically a consolidator of articles from a number of other sources. You might want to take a look at it just so you can see what I mean.

When I review the list of approximately 50 headlines, I always find it interesting to see how many compelling yet contradictory articles and videos are in one spot, one right after another. It’s common to see one claiming one view, with another of the exact opposite view right below it. China is imploding/China is still a sleeping giant, Gold is headed much lower/Gold will touch new highs by the end of the year, The stock market is about to re-visit the lows of 2008/The stock market is pausing before reaching new highs by year end, Stick with large cap U.S. stocks/America’s best days are behind us and one should look abroad for better investing opportunities, A bond catastrophe is upon us/Don’t believe the bond bust hype, Inflation is about to run rampant/Deflation is the new worry, Emerging market stocks and bonds are to be avoided at all costs/The long term secular growth story of the emerging markets is still very much intact. Good grief! What’s an investor to do?

We’ll continue to see these contradictions, but one does not need to feel paralyzed by them or compelled to decide which one is the better path to follow. The truth is that they all have elements of truth and quite often are written by some very bright people. This month marks my 27th year in this business, and I have seen investors get caught up wrestling with these contradictions in each and every one of those years. Please let me offer an alternative.

Rather than struggling to decide if this is the right or wrong time to hold stocks or bonds in your portfolio, or which types of each to hold, how about always holding a portion in stocks and a portion in bonds, along with an adequate cash reserve for emergencies or opportunities that may arise? Of the portion devoted to stocks, hold U.S. and foreign (including emerging markets), small  and large cap, growth and value, and also some REITs (both foreign and domestic). Of the portion destined for bonds, hold those of the highest credit quality (which tend to hold up relatively well when the stock market severely declines), and those with short- to intermediate-term maturities (which have lower interest rate risk in a rising rate environment).

With regard to cash reserves, the rule of thumb in the financial planning community is to maintain enough to cover 6 to 12 months of living expenses, depending on your situation, but often these targets tend to be on the low side. My experience has been that during periods of severe market or personal financial stress, nothing provides peace of mind like cash. Nobody ever complains about having too much cash on hand during these times. And when opportunity knocks, it’s nice to have plenty of cash on hand to take full advantage. Even when yields are as low as they are now, cash is king. The purpose of your investment portfolio is to deliver returns in excess of inflation over time. Cash is for liquidity, flexibility, and peace of mind.

The appropriate mix of these various asset classes, of course, depends on your individual circumstances and objectives. A big part of my job as an investment advisor is to help clients establish and maintain this mix in the face of unrelenting alarmist news headlines.

If all this advice sounds like nothing more than common sense and things we’ve all heard before, you’re right. But interestingly enough, many people tend to get caught up in all the predictions and hype out there, and they tend to ignore or forget these time-tested principles. As Paul Merriman once said, “There is a Grand Canyon of difference between what people know they should do and what they do.”

If you are tired of feeling confused, paralyzed, and frustrated and would like to jump off the financial news treadmill, I invite you to contact us. If you are not quite there yet, I wish you luck and a quiet mind as you continue down your path. We’ll be here when you need us.

Have you written your letter of instruction?

image036Maybe you’ve heard of this before. A letter of instruction is a document you write to your executor and family that contains your personalized wishes and instructions for settling your estate. Although it does not carry any legal authority, a letter of instruction can be used to provide tremendous added detail about your financial affairs that doesn’t fit within a will or trust.

One of the most important purposes of a letter of instruction is to lead the person in charge of settling your estate through the process step by step. A good letter of instruction should contain the following:

  • Detailed list of your assets and belongings.
  • Copy of your monthly budget.
  • Login ID and password list.
  • Contact information for financial professionals and beneficiaries.
  • Location of important documents such as the will, trust, deeds, birth certificate, tax returns, bank statements, bills, life insurance, etc.
  • Creditor statements for any mortgages, credit cards or other loans.
  • Location of keys for house, auto or safe deposit box.

A key function of the letter of instruction is to specifically indicate which household belongings go to which heirs. Your will and/or trust will generally only address big ticket items. Through the letter you can decide who receives the family albums, the silverware, stamp collection, artworks or family knickknacks. Providing clear guidance can keep your family from devolving into arguments and resentment when emotions and grief run high.

Burial Arrangements

You can also use a letter of instruction to tell your family how and where you would like to be buried or cremated. You can be as elaborate as you desire. If you want, you can choose funeral readings, pick your flowers, charitable donations, etc. You can even prewrite your own obituary here, so be creative. Whatever your desires, putting your wishes in writing will help reduce guesswork and potential arguments among those who will handle these arrangements when the time comes.

Other Advantages

If desired, you may use the letter of instruction to voice personal requests and your expectations for how your heirs use their inherited assets. After all, these were your possessions! Some people also include their personal values, in a section known as the “ethical will,” which allows you to pass your core values and beliefs down to your family and beneficiaries.

Another benefit of this letter is that you can augment your living will with regard to end of life care, providing more detail about the circumstances under which you want to be kept alive or taken off of life support. This can be very helpful in reducing stress or uncertainty for your family if the health care directive or living will lacks this detail.

Conclusion

Remember, a letter of instruction does not replace a will, durable power of attorney or living will. If you don’t already have these documents in place, you should have them drawn up by a qualified estate planning attorney. A letter of instruction can be a fantastic tool to articulate your final wishes and decisions for your executor and heirs. Be sure to update it periodically and file it along with your other estate planning documents. At its heart, the letter of instruction is a last gift of your voice that you leave to your family, so make it count.

Go fishing, not phishing!

If you use email, you are under constant attack. Every ploy imaginable is being used against you in attempts to get you to open an email that has the goal of connecting you with a website to enter your account number and password information.Phishing concept This “phish” email will look very official, be urgent in nature, and connect you to an official-looking website. Don’t take the bait!

One scheme sends you an email stating that your credit card or bank account at Bank XYZ is going to be closed immediately unless you reset your password by clicking on the attached link. The link will take you to a very official looking Bank XYZ website where you are instructed to type in your current account number and password. They now have your login information and can access your real account directly. Keep this in mind: Banks and other financial organizations will not ask you to provide account and password information via an email. Common scams include more than just trying to get your banking information; be on the lookout for wire transfer requests from friends stuck overseas, lottery winnings, investment schemes, fake checks and pretty much anything related to money.

For a long time we thought it was safe to click links and attachments from people we know, but hackers have gotten much more sophisticated and now use your friends’ email names and addresses that have been harvested from social media or malware. By using the email addresses and names of people you know, they increase the chance that you will open those emails. The links and attachments can often lead to software that will attempt to infect your computer with malware or take you to a bad site. So always use extra caution when you get an email asking you to provide any type of personal information.

How do you protect yourself? First, don’t give out personal information that is requested in an email. Also make sure that the address in the browser matches where you think you should be. If you expect to be at www.paypal.com and the browser says you are at www.stealingyourmoney.com you should leave that site immediately. Of course, it’s not always quite so obvious. But if you look closely, you’ll often be able to detect a discrepancy in the web address.

You should always make sure your computer and devices are patched and up-to-date with the latest security updates. Most major software companies update their software on a regular schedule to help keep security issues down, so don’t avoid those update notifications. Use a firewall and anti-virus software, which will do a good job of keeping a lot malicious items at bay. Most Internet browsers have pop-up blockers that can help reduce your risk as well. Finally, if you are unsure if the email is real, call the person who sent it to you and ask them about it.

In the end, you are the last line of defense. Always be skeptical of things that don’t seem quite right. While in the real world it may be admirable to trust the good intentions of others, things are not always what they seem in the online world, and it is best to have your best defenses forward.

Maximizing the impact of charitable contributions

With the recent tornado in Oklahoma we are reminded of the importance of charitable giving.  In fact, since the tornado, over $15 million has been donated to the American Red Cross. According to the Giving USA Foundation, individuals gave over $217 billion dollars to charitable causes in 2011, a 3.9% increase over 2010. As charitable giving increases, I want to make sure you know not only how to maximize your charitable contributions from a tax standpoint (see my post about using the donor advised fund), but also that you are informed about the effectiveness of the charities you choose.

There are a couple resources available now to help understand how effective a charity is with the money you donate. Charity Navigator has been around since 2001 and now assesses over 6,000 charities. Its goal is to provide one overall rating based on two areas of effectiveness: 1) their financial health and 2) their transparency and accountability. For example, the American Red Cross, a popular one at this moment, shows a total score at 59.64 out of 70 as of fiscal year end in June of 2011.

Another website, CharityWatch.org, also rates different charities’ effectiveness. While they rate only 600 or so of the largest charities, they tend to dig much deeper into the inner workings of the organization than Charity Navigator. They study the individual finances of every charity to give a clear picture on what the money is actually being used for. Instead of taking the information at given at face value, they try to determine if the donors’ objectives are actually being met. Because their analysis is more in-depth, Charity Watch charges $50/year for access to their Charity Rating Guide, which provides financial data and a rating from “A+” to “F” for each charity.

We all want to make sure the money we give generously is used effectively. Whether you’re giving funds to aid with large natural disasters or donating to your local food bank, donations are needed and greatly appreciated. Now, in addition to maximizing the tax effectiveness of your charitable donations through donor advised funds, these tools can help you choose organizations that will help your dollar have maximum impact.

Managing through difficult markets

Bear markets can get ugly. Unfortunately they will, just as they have in the past, continue to plague the markets. You can prepare for their arrival and understand how your investment plan dictates navigating through them. The hard cold facts of bear market history provide direction.

For those unfamiliar with the term, a bear market is not a simple market correction, which is more benign and happens with greater frequency. It’s a peak to trough loss of more than 20% in the broad equity markets. In total there have been 13 bear markets since the end of the Second World War. That is one every five years or so.

Here is the promising part: In May of 1946 the S&P 500 was at 19.3, and at the end of March, 2013 it was at 1570. In total, over 81 times higher than where it started 67 years ago. And, this number excludes dividends, which historically make up around 40% of the total return.

So the question is not of avoidance, but one of preparation and acceptance. Accept that in the next 30 years we can expect to experience several bear markets. Embrace the fact that they will be temporary setbacks to a long-term trend of rising prices. Finally, prepare a plan that fits your unique set of circumstances.

For investors in the accumulation phase, take advantage of bear markets. Fight the inclination to sell investments in fear and do what you would do at any other sale – buy more stocks at their newly discounted prices.

For those in retirement, formulate a flexible income plan. Include a cash cushion in this plan that allows your portfolio to stay dormant during the tough times and to thrive as the stock markets resume their long-term ascent. Most importantly, do not let a temporary setback ruin your long term plan. And remember that over time, equities are the best hedge for inflation, which is so important for the long-term viability of your portfolio. Life expectancies are increasing and fixed-income investments (aka bonds) are just that, fixed.

There is always going to be some perma-bear forecasting the death of equities and a market optimist predicting a new era of exponential returns. Neither of them knows the specifics of your retirement plan and they rarely understand that “this time” is never different. Do not get enamored of prognostications based upon remote possibilities. Rather, work with your advisor to build a plan around the historical probabilities of the markets and your unique retirement needs.

I’m finally making some money…now what?

I recently had the pleasure of sitting down with a client’s daughter. She’s in her twenties, just finished up her nursing degree six months ago and is working the night shift at a local hospital. She is living with a couple of roommates and is finally in a position to save some money after being a very broke college student. She now faces the question posed by many young people who are starting their first “real” jobs.

Now what?

Michelle (as we will call her) wanted to know what to do with the money she’s now able to save. She had no idea where to start getting her finances in order. To get her started on the right track, I suggested she focus on a few key areas.

Live within your means

She’s already years ahead of many twenty-somethings in that she is living on less money than she earns. She wasn’t sure how much money she would be able to save on a monthly basis so I suggested she set up a rough budget. I didn’t encourage her to be terribly rigid with the budget but to use it to get a sense of where she is spending her money so she’s aware of her spending habits. This will help her decide what she wants to spend money on and what is less important to her.

Create an emergency fund

While she enjoys her job and has no plans to quit anytime soon, you never know what life will throw your way. So I recommended she save three to six months of income and have it very liquid (money market, for example), which will enable her to have a safety net in place.

Understand your insurance policies

Michelle wasn’t sure exactly what her benefits were at work. She knew she had medical but wasn’t sure of the deductible. She also didn’t know if she had dental or vision coverage. As a young woman in her twenties, the likelihood of an expensive surgery or illness is very low, but injuries can still happen.

She also had no idea whether her employer provided disability insurance. I recommended she read through her employee materials again as things are typically a blur when starting a new job. I also encouraged her to ask the HR department about any questions she may still have after reading the policy information.

I checked to make sure she has car and renter’s insurance and that the policies are up to date. When you’re just getting started financially, you don’t want to find out after an accident that your $10,000 car is only covered up to $5,000, or regret not having renter’s insurance after your upstairs neighbors leaves a faucet on, flooding your apartment and ruining your new laptop, couch and clothing.

Pay off your debt

This is typically the ball and chain around many people’s ankles when they first start their careers. I recommended that Michelle pay off the money she owes by attacking the debt with the highest interest rates first. She has about $10,000 in student loans and another $1,500 in credit card debt. The credit card debt has a much higher interest rate than the student loans, so she’ll pay the minimum on the student loans until she pays off the credit cards. Then she’ll pay down the student loans. A good way for her to keep debt in check moving forward is to use primarily cash for all purchases or to use a credit card and pay it off monthly.

I also recommended she compare her local credit union fees and programs to that of her bank. She’ll likely save money on ATM transactions, credit card interest and loans in the future by using a credit union.

Identify short-term and long-term goals

Michelle’s short-term goals include a trip with college friends to Hawaii later in the year. Her longer-term goals include retirement and buying a house. It was important to identify these goals so she can budget for the trip and start down the road to home ownership and retirement. While retirement is probably 40 to 50 years off for Michelle, she will not have to save nearly as much towards her future as friends who start saving in their thirties. She’s fortunate to have a 401k plan and the hospital provides her with some matching as well. The matching is basically free money to her so she would be wise to take advantage of it. By contributing to her 401k plan, she’ll pay less in taxes and benefit from the employer match, which is a win-win. She may not be able to add as much as she’d like to her retirement plan right now, but she can always increase that after building up her emergency fund and paying off debt.

Get organized

Michelle is well on her way to a successful future just by addressing her finances at such a young age. She’ll have a good handle on her spending habits, her debt level and goals.

My final piece of advice, which Michelle has already followed, is to talk to your parents’ financial advisor. The advisor may not be in a position to take you on as a client, but they should be happy to meet with you and get you headed in the right direction.

 

Joint or Single Life Pension? An important question

While corporate pensions are on the decline for many younger workers, many clients nearing retirement still have pensions through their employers. One topic that often comes up with married clients is the question of a survivor option: Should you take a single life option and collect the highest monthly payout, or take a lesser amount and ensure that some percentage would go to your spouse if something were to happen to you?

One solution you might consider is something called pension maximization. The question that we are trying to address then is: Can you buy life insurance to replace the pension for less than the monthly “cost” of taking the survivor option?

We don’t sell insurance, but work with highly qualified professionals that do this full time. We don’t receive any compensation for any insurance our clients buy, but looking at coverage is part of our comprehensive approach to addressing all of our clients’ financial needs.

How does pension maximization work?

Here is a recent example where one client could take a single life pension of $6,041/month or a 100% survivor option for $5,401/month, a “cost” of $640/month ($6,041 – $5,401). When considering the insurance option, we would need to recreate this income stream based on him passing away in year one with the following policies:

  • A 10yr term policy for $225,000 ($44/month)
  • A 15yr term policy for $125,000 ($32/month)
  • A 20yr term policy for $100,000 ($31/month)
  • A 25yr term policy for $105,000 ($54/month)
  • A 30yr term policy for $110,000 ($103/month)
  • A no-lapse guarantee universal life policy for $275,000 ($274/month)

The reason you would layer policies in the above example is because you need less insurance as you get older since the time you need the insurance to last is shorter. When you add up the above policies, you get a monthly expense of $538/month, which is $102/month less than the “cost” of the 100% joint survivor option. After 10yrs, the $44/month policy will drop so you will get a raise of $44/month. By the time the 20yr policy has lapsed, you’d be receiving almost $1,300 more per year than when you started. Also, if the spouse passes away first, then this client could cancel the insurance and keep the premiums or keep some of the insurance to pass on to their heirs.

Who does this work well for?

  • People who are in good health and can qualify for lower insurance premiums.
  • People who have kids or family they want to leave money to. If both spouses passed way together early on, their heirs would receive no additional money under the pension and survivor options. However, by using the pension maximization strategy above, this couple’s heirs could receive $940,000 income tax free.
  • People who are comfortable with a little added complexity. It is much easier to just take the survivor benefit from the company. Dealing with insurance policies and then having to either invest the money or buy immediate annuities (this is what the example above solved for using current annuity rates) with any proceeds takes additional time and effort. The example above had six different policies, but I’ve often seen it work with  only three or four.
  • People who have some time before a decision needs to be made. The underwriting process can take a few months and you don’t want to make this type of decision before life insurance is fully in place.

Final thoughts

I’ve looked into this strategy for many clients, and it doesn’t always work out. Sometimes, the company pension option is the best choice and you don’t have to go through any underwriting like you would in the example above. It is important to work with professionals who have the resources and expertise to help you solve these complex financial issues. Here are Merriman, we work with a number of professionals who are experts in their field to help solve problems like this, and other complex issues, for our clients. Please reach out to your advisor if you would like to discuss this option for yourself.

Risk mitigation

The return-centric environment in which we live too often gives little credence to an equally important measure – risk. Professionals and individual investors alike can often quote the return of a given stock or index, followed by silence when asked to recite its relative measure of risk. The financial crisis shouted to us the importance of understanding and controlling risk. If you did not hear the call – and hopefully you did before the fall – it’s not too late to answer it.

Two quantifiable means of controlling risk are diversification and asset allocation.

Proper diversification stretches well beyond your region and your country of residence. It has little to do with individual stock positions or individual sectors. It consists of all types of stocks – large, small, value, growth, etc., which are located all over the world. Global diversification is the goal.

Diversification is equally important for bond allocations. A bond portfolio consisting of high-yield bonds differs from one invested in U.S. treasury bonds. Obtaining an adequate amount of diversification on both sides of your portfolio is essential in controlling your risk.

Asset allocation speaks to the percentage of stocks and the percentage of bonds in your portfolio. While the specific mix has many variables, age and retirement goals are often large factors. Each investor’s situation is unique and there is no “one size fits all” solution. A good place to start is by answering the following questions:

  • At what age do I begin adding bonds? 40? 45?
  • How often do I add bonds and how much do I add?
  • What is an appropriate allocation once I am retired?

If you are struggling to answer these questions, it may be time to seek professional guidance. The answers are essential to your long-term investment success.

Investor discipline is a less tangible but equally important component of risk mitigation.

As stocks outpace bonds, a portfolio’s risk increases. At some point, there will be a need to sell the stocks to buy bonds and maintain the target allocation. In essence, this follows the golden rule of investing – that is to sell high and buy low. The same logic holds within each asset class of the portfolio, such as when international stocks outpace domestic stocks or small cap stocks outpace large cap stocks.

I can almost guarantee that when the time comes, rebalancing will not feel like the natural thing to do. Why, for example, would you want to buy into an underperforming asset class? Despite our rational brain, loading up on the winners will feel like the right thing to do at that moment. There are two questions you must ask yourself:

  • Do I have the discipline to rebalance my portfolio?
  • What mechanical process will I use to rebalance?

Your long-term investment success hinges on your answers to these questions. If you do not know how to answer them, seek guidance.

Investing is about risk and return. Understanding how much risk you can afford to take and how much risk you’re willing to take is the key. Quantitatively, two ways in which we control risk for clients is through diversification and asset allocation. Keeping clients disciplined in their goals and executing on a well thought out rebalancing process is another, less tangible means of controlling risk.

As Warren Buffet famously said, “It’s only when the tide goes out that you learn who’s been swimming naked.”

Spring cleaning: 10 ways to freshen up your financial situation

After cleaning the garage, packing away your winter clothes and cleaning the windows, turn your spring cleaning efforts to your finances. Here are ten ideas to freshen up your financial situation:

1.      Reduce paper: Most banks, brokerages, credit cards, and utilities offer online delivery and storage of statements and bills. Sit down with your paper statements and see how many you can move to online. You will save the time spent opening mail, remove clutter and help the environment.

2.      Pay your bills online: Sign up for an online bill payment service if you don’t already. Set up automatic payments for recurring bills.

3.      Purge: Get a good shredder and use it aggressively. You really don’t need the water bill from two years ago. Purge! This can also help reduce your risk of identity theft.

4.      Eliminate redundancies: Eliminating clutter is not only about getting rid of paper; Identify what accounts are redundant and can be combined and/or closed.

5.      Organize: Get a label maker and create a small, efficient filing system.

6.      Reduce costs: Review bills you get from cable and phone companies, because when contracts expire they may revert to higher charges. Give them a call and you’ll be surprised how easy it is to have your rates reduced.

7.      Check your coverage: Review your insurance coverage to make sure that it is appropriate for you.

8.      Compare interest rates: Make sure your banks and credit cards are competitive for their fees and interest rates.

9.      Track your goals: Create easy-to-use systems for tracking your big picture goals, including a simple budget, college savings, and retirement.

10.  Think about getting help: Identify what areas you may need professional help, and create a plan to interview candidates.

You’re invited to a Merriman-sponsored Earth Day planting event!

When: April 20th and April 27th, 2013, from 10:00 am – 2:00 pm

Where: McCormick Park in Duvall, WA

I am pleased to announce that Merriman employees and their families will be partnering with Sound Salmon Solutions to plant trees along the Snoqualmie River to help restore salmon habitat!

On April 20th and 27th, we will be working side by side with Sound Salmon Solutions staff and volunteers to restore salmon habitat at McCormick Park along the banks of the Snoqualmie River in downtown Duvall, WA.  Over 1,600 new trees need to be planted! These new trees will provide shade, erosion control, and essential food and habitat for the insects that rearing juvenile salmon need during multiple stages of their lives

If you are interested in making a positive impact on the future of salmon populations and our community, please come join us!  This is a unique site where volunteers will have the opportunity to see exactly how big of a positive impact their efforts will have on salmon recovery in as little as 5 years!

Please join us by emailing Dave@Merriman.com or signing up directly with Sound Salmon Solutions!

The insidious effects of inflation

We have all heard the expression, “back in my day…” followed by the amount a particular item used to cost. While it’s somewhat of a cliché, it does carry a lot of weight. The impact of inflation on your cost of living has real consequences, and factoring it into your retirement plan is of paramount importance.

Consider someone who is planning to retire at 66 years old. Current actuarial figures give them a retirement window of about 25 years. Using 3% for average annual inflation, the future value of a dollar 25 years out is $.48. Put another way, you can afford to buy less than half as many goods 25 years into retirement as you could when you started. Fortunately, that is not the end of the story.

There are several ways to insulate your retirement income from the effects of inflation.

One solution has to do with retirement pensions. Once the pension spigot is turned on, one thing that can increase the flow is a Cost of Living Adjustment, or COLA. A COLA increases annual pension amounts based upon the previous year’s rate of inflation. The important thing to know is whether your pension has a COLA. Without one, you will become increasingly dependent upon other assets as time goes on. Remember, 25 years from now a dollar will be worth less than half of what it is worth today. With a COLA, you will still need to understand how your increasing income stream fits in with your other assets and your specific retirement plan.

Another pension source most people have in retirement is Social Security Income, or SSI. The COLA for SSI is tied to the Consumer Price Index. As such, it varies from year to year.

The final piece to consider is your retirement accounts, such as IRAs, Roth IRAs and taxable brokerage accounts. These accounts do not provide a fixed income stream in the sense that a pension does. Typically, they are invested in an allocation of stocks and bonds controlled by you or your investment advisor. Distributions are on an as-needed basis.

Stocks have historically been the best long-term hedge against inflation. In a sense, they act as a super charged COLA for your retirement accounts. How much stock you allocate to these accounts and how the accounts will supplement your pensions requires careful consideration.

No two retirement plans are alike. Understanding how the unique pieces of your retirement puzzle fit together to meet your retirement goals is what’s important. If you have not already done so, take the time to sit down with a professional who can help you figure out where you are, where you want to go and most importantly, how to get there.

Are you making these mistakes with your car insurance?

Insurance can seem like a nasty word, and I’ve found that most of us would rather not talk about it. However, it’s all about protecting and preserving your assets. Our job is to help our clients grow their wealth so they can achieve all that is important to them. However, we’d be foolish if we neglected to also help them mitigate risks that could eat away at all their hard work.

When it comes to car insurance, I’ve found a few common mistakes.

Too little insurance

Many states require all drivers to maintain a minimum level of coverage in order to drive legally. Some states even require a minimum level of coverage for medical or personal injury. This is just a minimum standard and is often not even enough to cover the average cost of repair from an accident. In every accident, the human body is the weakest link in the chain and the one at greatest risk of injury. Cars are a fixed cost to repair – you know how much a BMW will cost to repair or replace, whereas we don’t know how much it will cost to save or repair a human body.

Rather than getting the minimum, consider carrying coverage based upon the car you drive, and more importantly, the cost of the other cars on the road.

Too much insurance

Every once in a while, I run across a situation where someone has purchased higher limits of coverage. Usually this person is terrified of the risks that exist in the world and will pay absolutely anything to protect themselves. As a result, they often have excess liability or umbrella insurance coverage, which is usually a very wise investment.

This additional insurance is fantastic, and something that I suggest for almost everyone. However, they might be paying more for auto insurance coverage that they just don’t need. If your auto insurance liability coverage is $500,000 and your umbrella coverage begins at $300,000, you are paying for $200,000 of unnecessary coverage. You could reduce your auto coverage to $300,000 and save on your premiums.

This is generally a good idea. However, if your umbrella coverage doesn’t include an additional layer of underinsured (or uninsured) motorist coverage, you might want to keep the higher coverage on your auto policy.

Incorrect deductibles

Generally speaking, the higher the deductible, the lower your premiums will be. The deductible is the amount you are responsible for before the insurance company provides protection.

I see situations where the deductibles are far too low and one could easily save 20-40% on their premiums by simply increasing the deductible. If you are able to stay accident free, you’ll often save enough on the premiums over the next few years to be able to cover this increased deductible. This isn’t always the case, though. I had a client looking to increase their deductible from $1,000 to $2,000 and we were both shocked that the premium savings was less than $100 annually.

If you drive an older car, it doesn’t make sense to have a low deductible for collision or comprehensive coverage on a vehicle that is relatively inexpensive to replace. In fact, if your car is older, consider getting rid of collision and comprehensive coverage altogether. If you do this, it’s still important to carry the proper amount of liability protection.

Not combining policies with one company

If you have your auto policy and homeowners policy with the same carrier, you’ll tend to save on your premiums and have better coordinated coverage with your umbrella policy, if you have one.

Failing to review your coverage

It’s very easy to get your insurance in place and then forget about it for many years. There are a few problems with the set it and forget it approach as your lifestyle and potential risks may change over time. It’s always good to have a history with an insurance company. However, you should periodically review your coverage to make sure that it fits your needs today.

Solely focusing on the cost

Insurance is one area where focusing solely on the cost could get you in a lot of trouble and financial pain. I find that many of us don’t want to be educated on the need for various types of insurance coverage, and often view this education as a sales pitch. You may find the lowest absolute cost for any given coverage, but it might pale in comparison with what a competitor offers for just a few dollars more. The devil is in the details, and I suggest looking at the details of the coverage so that you know exactly what you are getting for your money. Also, rather than focusing solely on the cost, you should work with a professional who will take the time to evaluate your situation and help you understand your insurance needs.

Book review: “Abundance – The Future Is Better Than You Think”

As the S&P 500 reaches new highs, it is interesting to think about the volume of bad news we have faced over the bull market of the past 4 years. We were subjected to what seemed to be an epidemic of economic challenges, from the fear that Troubled Asset Relief Program (TARP) would lead to runaway inflation, to the debt ceiling debate and the “fiscal cliff” we were sure to tumble over at the beginning of the year. There was news of more global concerns over the world, with new challenges faced in feeding and providing fresh water for the ever growing global population, which now exceeds 7 billion people. There have been many headline stories building a case for a grim outlook of the future. It seems to me that the good news is usually more subtle and harder to find.

I recently picked up a copy of  “Abundance – The Future Is Better Than You Think.” The authors, Peter Diamandis and Steven Kotler, make a case for optimism. They present a neurological reason for why we are more sensitive to bad news than we are at recognizing opportunity. Fear has served the human race well in many ways for many years; it activates our limbic system, which manages our “fight or flight” circuitry. Diamandis and Kotler then look at how we have solved problems of scarcity in the past, and examine amazing advances in science and engineering that are being made right now.

This book presents a different perspective than we are bombarded with in the daily news, and I think it’s worth reading. Diamandis and Kotler explore some very exciting new technologies that are making giant strides against some of the world’s biggest challenges, like scarcity in access to energy, clean water and good medical care.

“I’m not saying we don’t have our set of problems; we surely do. But ultimately, we knock them down” -Peter Diamandis.

Before finding the book, take a few minutes out of your day to listen to his inspirational and educational TED talk here.

Six must-know investment terms

Industry specific jargon can be intimidating. Fortunately, you can leave most of it to the experts. The six terms listed below are the exceptions – understanding them is crucial to your long term investment success.

Fiduciary. Someone who is legally obligated to put your interests ahead of theirs. In the investment world, Registered Investment Advisors (RIAs) have a Fiduciary responsibility. Stockbrokers do not. The difference is dramatic. Do yourself a favor and make sure you work with someone who is legally obligated to put your interests first so that you can prosper.

Market index. Indices are measuring sticks for different sections of the market. A good example is the S&P 500, which represents the 500 largest companies in the United States. Understanding the indices allows you to track your relative performance. To do so, it’s important to understand which indices are fair representations of your portfolio. Using the S&P as a barometer against a portfolio of international stocks, for instance, does not make sense. In this case, using the EAFE Index (Europe, Asia and Far East) would be suitable.

Personal risk tolerance. In its simplest sense, how much of your portfolio should be allocated to stocks and how much to bonds? The answer depends upon your unique set of goals and circumstances. Remember – it is a personal risk tolerance. Speak with a Certified Financial Planner™ to guide you to an answer.

Stock risk. Ever heard the saying “don’t put all your eggs in one basket?” While some companies may seem like a sure thing, remember this – the S&P 500 of 1960 looked much different than the S&P 500 of today. Times change, companies grow and others fail to meet changing demands of the world. Eastman Kodak and Enron come to mind. Successful investors use diversification to increase their long-term risk adjusted return.

Loaded mutual funds. A front-end load is recognized when you purchase a mutual fund. A back-end load is recognized when you sell one. Choose their no-load counterpart. You will save the fee and the performance is more often than not just as good. After all, a no-load fund has a head start in the amount of the load, which can be upwards of 4% in some instances.

Pundit. Someone who prognosticates, in this case, about the financial markets. Their pedigree may be impressive and their intellect alluring, but do not follow their advice. No doubt they made a few good calls in their day. Chances are they made more bad ones. Your best bet is to develop a long-term strategy with your financial advisor that you can stick to. One that is tailored to your specific needs and goals.

Volunteering with Friends of the Cedar River Watershed

I consider myself very fortunate to work at Merriman for many reasons, two of them being our dedication to community involvement and our commitment to being a “green” organization. Merriman employees are given 100 hours per year to volunteer at other non-profit organizations during regular business hours. As someone who is passionate about watershed restoration and education, I have chosen to use my volunteer hours assisting Friends of the Cedar River Watershed.

Friends of the Cedar River Watershed has been a private, non-profit organization since 1996. Their mission is to engage people to enhance and sustain watersheds through restoration, education, and stewardship.

The Cedar River and Lake Washington Watershed is the land area in which rainwater drains to Lake Washington and out through the Hiram Chittenden Locks in Ballard. The watershed includes the Cedar River and its tributaries, May Creek, Coal Creek, Mercer Island, Mercer Slough, Kelsey Creek, Fairweather Creek, Yarrow Creek, Juanita Creek, Forbes Creek, Lyon Creek, McAleer Creek, Thornton Creek, Ravenna Creek, and Lake Washington. The river itself is about 45 miles long, originating in the Cascade Range near Abeil Peak, flowing generally west and northwest, emptying into the southern end of Lake Washington. The watershed is home to more than 83 species of fish and wildlife, including 14 species of concern, such as sockeye salmon, and the endangered Chinook salmon – it is considered to be one of the best remaining salmon habitats in King County.

So why exactly am I interested in helping Friends of the Cedar River Watershed carry out their mission? I was taught how to fly fish about 10 years ago and it quickly became a passion of mine. The best part of fishing, in my opinion, is not landing the biggest fish but simply being on the water. My fondest fishing memory is being on the banks of the Madison River in the Madison Valley of Montana, outside of Yellowstone National Park, and watching the sun set while listening to the fish munch on the latest hatch of insects. It is a day I’ll never forget and something I hope my future children and grandchildren will be able to experience.

Being able to live sustainably in places such as the Madison Valley, at home right here in Seattle, and everywhere in-between is very important for our future generations. The Cedar River/Lake Washington Watershed area is home to 22% of the population in the state of Washington. There are over 30 cities in the watershed and each of these cities is connected to the health of another and the greater whole. Think of it this way, if you live in the Cedar River/Lake Washington Watershed, everything you pour down the drain or onto the ground eventually gets to the river, making its way to one of the tributaries, and ultimately ending up in the Puget Sound. The connection between the people, the river, the lake, the sound, and the land is profound.

How can you help? Friends of the Cedar River Watershed offers a variety of events, programs, and services that you can learn more about on their website. They are always looking for volunteers and are currently looking for board members. I hope to see you there!

Charitable IRA distributions renewed for 2013

We have great news for people making charitable gifts this year! Thanks to the American Taxpayer Relief Act of 2012 (ATRA), IRA owners can once again make a qualified charitable distribution (QCD) from an IRA to a qualified charity of their choice.

For those who are charitably inclined, a QCD can really maximize the effectiveness of charitable gifts.

Here’s how it works:

For this year, IRA owners who are 70 ½ or older and would otherwise have to satisfy a required minimum distribution from an IRA may donate any portion up to $100,000 of the required distribution directly to a qualified charity(ies). Additionally, the IRA owner can exclude the amount of the QCD from his or her gross income on their 2013 tax return. The amount of the QCD excluded from the gross income is not included when determining any deductions made to qualified charitable organizations.

As with many IRS provisions there are a number of fine print items to keep in mind.

  • You are only eligible to make a QCD if you are 70-½ or older.
  • Contributions can only be made to 501(c)(3) charities and 170(b)(1)(A) organizations.
  • Donor advised funds and 30% public foundations are not eligible to receive the QCDs.
  • The QCD must be made directly from your IRA to the desired charity, meaning that the check issued from your IRA must be payable to the charity. If the check is made payable to you, then it counts as taxable income and will be considered a normal IRA distribution.
  • The QCD can be made from any IRA. SEP and SIMPLE IRAs are only eligible if they are not receiving employer contributions in the same year as the QCD is made. You cannot make the QCD from any employer retirement plans, such as a 401(k), 457 or 403(b), etc.
  • The QCD cannot be a split-interest gift, meaning that 100% of the gift must go to a single charity and the gift cannot be shared with the donor or any other designee of the donor. The donor cannot receive any economic benefit as part of the gift.

At this time, the QCD provision is only extended through the end of 2013. We do not know if the provision will be renewed in years beyond. If you are interested in making a donation directly from your IRA to a charity, reach out to your advisor to get started and make 2013 a year of giving!

A stellar 2012 for DFA

The article “All in the Family” by Barron’s ranks mutual fund families across several asset classes and time periods. A stellar 2012 for the DFA Value Portfolio helped it earn first place for the US equity fund category. Its three year performance was also very respectable. DFA took 16th place overall for 2012 and 33rd for five-year performance. This article substantiates our use of DFA in client portfolios. The funds served clients well in the short term, but more importantly for the long term. Investing is, after all, a marathon, not a sprint.

2013 update to the ultimate buy-and-hold strategy

Every year, we update some of our core articles.

The 2013 update of The ultimate buy-and-hold strategy, which includes performance information through 2012, is now available in our Best of Merriman library.

LTCi rate increases coming soon for single women

It’s no surprise that women tend to live longer than men. Therefore, it should be no surprise that women tend to need long-term care more often than men. In fact, Genworth Financial, a leading provider of long-term care insurance (LTCi), estimates that two-thirds of their benefits paid go to women. However, up until recently, insurers were not allowed to charge different rates based on gender. That may all change in April, when Genworth is allowed to restructure new policies to incorporate gender-distinct pricing, which may increase the rate for single women by as much as 40 percent. Genworth was the first carrier to win approval from state insurance commissions to raise rates on new policies for single women, but it is expected that other carriers will soon follow suit. Long-term care insurance will become much more expensive for this segment of the market.

What should you do? If you are a single woman considering LTCi, you should consider making a move soon. If you are unsure whether LTCi makes sense for you, talk to your financial advisor or a licensed insurance agent as soon as you can.

For more information on these upcoming changes to LTCi, see For Women, Reduced Access to Long-Term Care Insurance.

Travel made easy

Client review meetings always give me something to look forward to. Not only do they present an opportunity to ensure we are on track for meeting the client’s financial goals, they also give me a chance to find out what is new in the client’s life.

I especially love hearing about the travel adventures of my clients – everything from the destination and local sights to the food and the culture. For me, it is a great opportunity to learn about new places and always gives me new ideas for my own dream vacation list. I only wish I could share this information with other travel seekers. Fortunately for my clients, I am busy working on their financial plans, and putting together an archive of travel information is not something I have time for. The good news is there are plenty of websites that have already taken care of it.

Frommers is a great place to start. The website has an interactive map of the continents which lets you narrow in on specific destinations. Once you’ve found the place you’re looking for, it offers an array of helpful information, including suggested itineraries, organized tours, and suggestions for restaurants and hotels.

TripAdvisor is another great resource to consult in addition to Frommers. The thing that makes TripAdvisor stand out is its ability to create community around travel. There are thousands of reviews covering everything from activities to restaurants and hotels. There are also forums that allow you to interact with other travelers who can help answer your questions. This site will help you cut through the weeds and create a trip worth remembering.

Once your trip is mapped out,  make sure your itinerary is organized. The last thing you want to do is miss a flight or be late and lose out on a hotel reservation. This is where TripIt comes into play. Simply email your confirmation emails to TripIt it will build your itinerary for you to print or access from your mobile devices.

A few other quick mentions:

1) Travel blogs: Once you have a destination in mind, search for blogs that cover it. You can sort through older posts and be alerted when new content is posted. All in all, it is a great way to get “in the know” on your destination.

2) For privately-owned accommodations: try Airbnb and VRBO

Our job at Merriman is to help you invest wisely, freeing up your time so you can focus on living fully.

Give your valentine the most thoughtful gift ever

Happy Valentine’s Day!

Instead of giving your sweetie another trinket they will forget about within a week, why not give them the most thoughtful and caring gift you can give your spouse: A conversation about your finances. I realize this is not the most romantic gift, your spouse will thank you some day.

If you are like most married couples, you have divided up the household chores. This makes sense; it’s both efficient and keeps the peace. Unfortunately this often means that one member of the relationship takes over the banking, investment and retirement plan duties and the other pays little to no attention to that part of the household duties, as they have plenty on their plate as well. This may work out just fine for you as a couple, but what happens when one of you is not around anymore or incapacitated? As we all know, this can happen overnight with no warning, no matter what your ages.

I have worked with several clients who have lost their spouses to heart attacks, strokes and even accidents in the blink of an eye. The surviving spouse often times has no idea where all the investment and bank accounts are held, what the online passwords are or even how to log on to their home computer accounts.

They are in the midst of grieving and may have no idea how to free up cash for a funeral, where the copies of the wills are and who the current beneficiaries are on their retirement accounts.

Unfortunately this is not just limited to losing a spouse or partner. My brother and I went through this process following my father’s death. We had no idea if he had a will and if so, where it was kept. We found odd-looking keys at his home and wondered if they were for a safety deposit box or some other lock (we never did find out). It was a very challenging process both mentally and physically to grieve and try to sort out an estate with little to no information to go on. (To read more on this, please see my new eBook: The Transparent Legacy)

So this Valentine’s Day (or at least this month), be extra caring and give your loved one the gift of peace of mind and knowledge about your wishes, your finances and your passwords. But just to be sure you aren’t spending the month sleeping in the garage; you might want to also pick up those chocolates and that card.

The ABCs of Medicare

Medical insurance can be a major expense for retirees.

The government segments Medicare plans into four categories: A-D, which I will explain at a high level below. There are also standardized supplemental plans available, known as Medigap policies.

Understanding the Medicare program in its entirety can save you money and ensure you are well taken care of.

A – Hospital Insurance

This portion of Medicare is free if you or your spouse have paid into Social Security through employment for at least 10 years.

What’s included in Part A?

- Inpatient hospital services, along with some skilled nursing and hospice care.

Important info about Part A

- Most people do not have to pay a premium. However, deductibles and co-pays will apply.

B – Medical Insurance

This supplemental plan is an optional program, with a monthly premium that can be deducted from your social security check.

What’s included in Part B?

- Doctor’s services, diagnostic tests and outpatient care.

Important info about Part B

- You may have coverage for Part B through your employer if you are still working.

- If you don’t sign up at age 65, your premium increases and will remain elevated for the rest of your life.

- A premium, deductibles and co-insurance will apply.

C – Medicare Advantage Plans

In its simplest sense Part C aggregates Part A with Part B. They are private plans that may provide more coverage than the first two parts would independently.

What’s included in Part C?

There are two coverage options:

1) Medical only

2) Medical with prescription drug coverage

Important info about Part C

- Most states allow for pre-approval if you sign up within six months after you turn 65.

- Monthly premium and fixed co-pays will apply. Certain plans also have a deductible.

Medigap, Medicare Supplement Plans – Alternative to Part C, Medicare Advantage

Medigap is a group of 10 standardized plans available through the private market that assist with out-of pocket expenses.

What’s included in Medigap?

- Medigap covers the gaps in Medicare Parts A and B.

- Drug coverage requires the addition of a stand-alone prescription drug plan, just like Medicare Part C medical only coverage.

Important info about Medigap

- Unlike Part C, it does not aggregate with Parts A and B. Rather, it serves to fill in the gaps of A and B.

- Monthly premium will apply. Copayments and co-insurance are plan dependent.

D – Prescription Drug Coverage

There are two ways to obtain Part D coverage: 1) through a Medicare approved stand-alone plan or 2) Through a Part C Medicare Advantage Plan with prescription drug coverage.

What’s included in Part D?

-Each plan maintains its own list of covered drugs.

-There is a “donut hole” in the program. The hole begins when your total retail cost of drugs (your cost plus Medicare Part D’s contribution) reaches $2,970. It ends when your actual out-of-pocket costs reach $4,750. Note: these are 2013 figures, which are subject to change.

Important info about Part D

-Monthly premiums and co-pays are plan dependent.

Doing your homework can save you money or enhance your coverage for the same price. A good place to start is with the Medicare Plan Finder, found on Medicare’s website.

 

 

5 ways to simplify your finances

For many Merriman clients, getting investments right is only part of achieving their financial goals. I am often asked what else people can do to help improve their financial outlook, and I always answer that being financially disciplined is just as important as investing wisely.

Here are five things I think everyone should do to simplify their financial situation and become more disciplined with their finances:

  1. Consolidate your accounts. If you have an inactive 401(k) with an old employer, transfer it into an IRA. Often, 401(k)s have limited investment options, and you can take advantage of diversification and management benefits by moving your old 401(k) into an IRA account held elsewhere.  Likewise, if you have several IRAs in your name, consider consolidating them into one. There is no real benefit to maintaining multiple accounts, and it can be a headache to manage them all.
  2. Get a handle on what you are spending. There are dozens of apps and websites that can simplify the process of tracking expenses. Mint.com is a great example – it is free and anyone can use it. If you own an Apple device, go the App Store and search for “budget.” Find the app with the highest ratings and download it. Knowing how much money you spend and what you are spending it on is important, both before and after retirement.  You cannot, for instance, know how much you are going to need in retirement unless you know how much you typically spend.
  3. Put your savings on auto-pilot. If your employer matches contributions to your 401(k), you should contribute at least enough to max out that matching and take advantage of that “free money.” If you can afford more, all the better. Don’t forget that saving is not limited to company-sponsored retirement accounts. Saving toward your emergency fund in a bank account or your child’s education in a 529 college savings plan is just as important.  As with your 401(k), you can set these types of accounts up for automatic contributions. Ideally, you would work with a Certified Financial Planner™ to figure out the exact percentage you need to contribute based upon your specific set of circumstances.
  4. Limit the number of credit cards you own.  The more cards you own, the more complicated it becomes to manage them. If you have several cards with outstanding balances, consider transferring balances to consolidate your credit card debt at a lower interest rate and save yourself a substantial amount in interest payments.
  5. Use an auto-pay service to manage and pay your bills. I have a Schwab checking account that allows me to pay thousands of vendors directly from my account. It also alerts me when I have a bill due. If you do not bank with Schwab, don’t worry – most banks now offer a similar service. Ask your local branch for help in getting this set up.

Some of these steps may sound daunting, but are actually quite easy to complete. I know you’ll be glad you did it. Ultimately, these steps will allow you more time to focus on the things that matter most to you.

Investing and uncertainty

There are many things in short supply, but uncertainty is not one of them. Three economists1 have compiled an index of uncertainty, which is comprised of newspaper coverage of policy-related uncertainty, expiring federal tax code provisions and disagreement among economic forecasters. You can see the trend in Figure 1 below. The index peaked with the debt ceiling imbroglio in late 2011, fell in the early part of 2012 and then rose again.

Throughout the year there has been a great deal of focus on a number of worrisome issues, including the U.S. deficit, debt ceiling and the fiscal cliff, high unemployment, and the European debt situation. Reflecting all this angst, investors through November withdrew a net $88.9 billion from actively-managed U.S. stock mutual funds (net of inflows into U.S. stock exchange-traded funds).2 Yet for 2012, stocks were up nicely.

How could stocks have gone up while uncertainty increased? While many people naturally worry about the past and still feel burned by previous sharp plunges in stock prices, the stock market is forward looking, incorporating the perceptions of millions of investors. While national economies are still relatively sluggish, actions taken by the U.S. and European central banks to combat economic weakness are having a positive impact.

Housing, while not rosy, is seeing some welcome improvements, with 6.9% of U.S. consumers planning to buy a house in the next six months, the most since August 1999.3 Confidence among U.S. homebuilders reached a 6 ½ year high in December.4 U.S. sales of previously occupied homes increased to their highest level in three years in November.5 And home prices rose 4.3% in the twelve months ending October 2012 in the S&P/Case-Shiller 20-City Composite.6

Another positive, with major longer-term implications, is the widespread development of hydraulic fracturing (or fracking, the process of extracting oil and natural gas from shale rock). The International Energy Agency projects the U.S. will become the largest global oil producer by around 2020, and a net oil exporter by around 2030.7 While there are important environmental issues associated with fracking, including potential contamination of local water supplies and massive use of water in the process, electricity produced by natural gas gives off 43% less carbon dioxide versus coal. Due to a combination of increased use of natural gas, the weak economy and more fuel-efficient cars, America’s emission of greenhouse gases has fallen to 1992 levels and is expected to continue to fall.8 So, like any energy source, there are costs and benefits. Cheaper energy will lead to more manufacturing being done in the U.S., which is good for the economy. One analyst estimates the U.S. will add three million new jobs by the end of this decade due to the natural gas industry.9

Waiting for that perfect time to invest when there is no uncertainty could lead to cash unproductively sitting on the sidelines. Investing only after good news also means buying stocks after they have gone up. A good example of this is the S&P 500 going up by 2.54% on January 2, the day after the fiscal cliff legislation passed. Another example is the MSCI EAFE index of developed countries in Europe, Australasia and the Far East, which increased 6.57% in the fourth quarter, reflecting the relative lack of bad news, and some stabilizing events, in Europe.

While uncertainty is an uncomfortable fact of life, it is easier to handle by following a well-formulated diversified investment plan that invests in stocks and bonds, the allocation to which incorporates your risk tolerance and long-term needs.

1. Scott Baker, Nicholas Bloom and Steven J. Davis at www.PolicyUncertainty.com.
2. Wall Street Journal, “Investors Sour on Pro Stock Pickers”, 1/4/13.
3. Ned Davis Research, 12/10/12.
4. http://finance.yahoo.com/news/us-homebuilder-confidence-6-1-150113216.html
5. Wall Street Journal, 12/20/12.
6. http://www.standardandpoors.com/indices/sp-case-shiller-home-price-indices/en/us/?indexId=spusa-cashpidff–p-us—-
7.Wall Street Journal, 11/12/12.
8. U.S. Energy Information Agency, as discussed in http://finance.yahoo.com/blogs/daily-ticker/fracking-good-economy-environment-155325507.html
9. As reported in New York Times, “Welcome to Saudi Albany”, Adam Davidson 12/11/12.

Tax provisions in the American Taxpayer Relief Act

The American Taxpayer Relief Act, passed by Congress on January 1, 2013, contains many far-reaching tax provisions. In addition to extending many tax items that had expired or were due to expire, the act also made permanent many provisions of previous tax acts. The tax features of this act are too numerous to list here, but the most comprehensive description of these changes I have found is this Journal of Accountancy article.

I highly recommend you read this article or consult a qualified tax professional to assess the impact of this act on your personal situation.

Volunteering at Seattle Children’s Hospital

I volunteer once a week for Seattle Children’s Hospital in the Child Life Department. Part of my job as a volunteer is to visit inpatient children in their hospital rooms. The volunteer shift can include anything from holding a baby while the parent is away, playing Legos or coloring with a child, to reading and playing games with teenagers. If the child/teen is feeling well enough, we can bring them to the playroom where there are a variety of activities available for them.

Volunteering with Children’s hospital has really opened my eyes to how brave these children are. They are in a new place with new people coming in and out of their rooms, and sometimes their parents have to go to work so they are alone in their rooms for a good part of the day. Recently I was with a little girl who was very happy to have someone come to her room with coloring books, crafts, and a movie. For two hours we colored, made snowman crafts, and giggled at the silly Sponge Bob movie. Being able to give back and volunteer at Seattle Children’s hospital means so much to me. Every week I get to visit a different patient with a different circumstance and the fact that I have the privilege to bring some happiness into a sick child’s day by bringing them a toy, a game, a book, or just sitting and talking with them is one of the most rewarding feelings.

The motto at Seattle Children’s Hospital is “Hope. Care. Cure.” These words are not just words; they have built a culture for the people that work at the hospital. There is an incredible vibe throughout the hospital that these doctors, nurses, volunteers, and employees are dedicated to bringing hope to the lives of these children and families. As we approach this holiday season, I am thankful for good health in the lives of those around me and send thoughts of hope and happiness to those who may have to spend their holidays in a hospital with their loved ones.

2013 retirement contribution limits

As we near the end of 2012, it’s time to start thinking about your finances for 2013. While some year-end planning might still be needed, it’s not too early to start thinking about next year. Many employers will start having their open enrollment periods over the next few weeks, and this is a great time to review your retirement plan contributions.

The new 2013 retirement contribution limits are as follows:

  • The elective deferral contribution limit for 401(k), 403(b) and most 457 plans increased to $17,500 from $17,000 in 2012.
  • The catch-up contribution limit for employees aged 50 and older into those same plans remains unchanged at $5,500 for 2013.
  • The maximum total contributions into a defined contribution plan rise to $51,000 for 2013 compared to $50,000 for 2012. For those aged 50 and older, the limit is $56,500.
  • If you participate in a Simple IRA plan, the salary reduction contribution limit increases to $12,000 in 2013, up from $11,500 in 2012. The catch-up contribution remains at $2,500.
  • The limit for IRA and Roth contributions increased to $5,500 from $5,000 in 2012. The catch-up contribution remains at $1,000 for 2013.
  • For traditional IRAs, there are a few different scenarios where different income limitations apply. These income limits increased from years prior and need to be looked at in more detail for each specific situation.
  • For Roth IRAs, the AGI phase out range is $178k-$188k for married couples filing jointly. For single and heads of households, the phase-out range is $112,000-$127,000.

If you’d like to learn more, you can read the IRS press release here.

Hedging higher tax rates with Roth conversions

With the Bush-era tax cuts set to expire at the end of 2012, many investors are seeking ways to hedge against a potential increase in tax rates for 2013 and beyond. One option that should not be overlooked is the use of Roth conversions.

A Roth conversion allows you to pay tax on the converted IRA assets now, with those assets then growing tax-free for the rest of your life. It is generally preferable to defer taxes for as long as possible, but in a situation where tax rates may increase in the future, it may be worth locking in the taxes at today’s rates. For example, the top tax rate in 2012 is 35%; In 2013, the top tax rate may be as high as 43.4% (39.6% top marginal rate plus the 3.8% “Medicare surtax”). If tax rates don’t increase, you can always undo the conversion by recharacterizing the Roth back to a traditional IRA. As long as a recharacterization is done by the extended due date of the tax return (October 15th), you’ll just be back to where you started.

It is also important to recognize that a Roth conversion may bump you up into a higher tax bracket in the year of the conversion, depending on the amount converted. In that case, you should consider a partial conversion, where you only convert enough to stay within your current tax bracket. This is where the assistance of a tax professional can be invaluable.

Everyone’s situation is different, and whether a Roth conversion makes sense for you will depend on your particular circumstances and desires. Your financial advisor and CPA can help you weigh the costs and benefits of such a strategy to determine if it is right for you.

Thinking ahead to your next move

From time to time, a piece of economic news will surface that leads people to question whether it is really a good time to be invested. The announcement of round 3 of quantitative easing (QE3) was one such news item that worried some of our clients (interestingly enough it added optimism to others), and it provided us at Merriman with a great opportunity to reiterate why we think making large changes to your investment portfolio based on economic news is a bad idea.

The evidence is overwhelming that markets are not predictable. If you had asked me for a reason to stay in the market in, say, 1999 or 2007 when economies looked extremely healthy, I could have given you a long list of reasons. But what followed each of those years was a sustained drop in stock prices. On the other hand, if you posed the same question in 2002 or at the end of 2008, there was hardly any good economic news to point to. And what followed? An incredible market rally that recouped market losses much faster than anyone expected. Selling and buying based on our read of the news has a high risk of whipsawing us in and out at the worst possible times.

There are always a host of positives and negatives weighing on the markets. It’s important to remember that economic news, and everyone’s expectations of its impact, is already factored into current market prices. We believe the academics’ argument that the sum of everyone’s expectations is far more accurate than the predictions of any one “guru.”

The risks of high levels of debt, uncertainty around upcoming tax changes (known as the “fiscal cliff”), and continued weakness in Europe may drive prices lower. While current trends, including a dramatically improving housing market and declining unemployment, may drive prices higher. We believe the best way to capture growth over time is to stay invested in a portfolio designed to satiate your appetite for growth while staying within your tolerance for risk, and rebalancing when your portfolio’s mix has materially changed.

If you feel like the risks have become overwhelming, there are some additional things you should consider before deciding to throw in the towel. You need to think ahead to your next move. What will you do after going to cash?

There is risk in not being invested in the markets: First and foremost, cash provides no defense against inflation. Your money may need to be defended against inflation for a long time, and cash does not provide a good defense. Beating inflation is one of the main reasons we advise people to stay invested through retirement.

If markets drop, when will you get back in? Each of the last two market rallies began well before any good news was to be found. Waiting for good news meant missing the bulk of the market gains. On the other hand, if there is a continued market rally after you sell – if markets grow faster than you expect – what will you do then? My experience is that it is very difficult for investors to get back in the market at higher prices; there tends to be a very real fear that the next challenge will cause a decline after having just missed an unexpected rise in values. We have found that over time, disciplined rebalancing has been a better way to buy lower and sell higher than “timing” based on your expectations of the future.

Our strategy is based on the academic philosophy that the future is unpredictable and our clients need to be able to stay the course through unexpected events and drops in the market in order to reap the benefits this strategy has to offer.

Simply being invested is not good enough; you have to be invested the right way. We feel that massive diversification with exposure to large and small companies in both U.S. and international markets, with a healthy allocation to bonds, is the best defense against a range of risks affecting your retirement portfolio.

If you’re ever feeling doubts about your investment strategy, I highly recommend speaking to your financial advisor right away. Rather than moving to cash, it may simply be time to re-evaluate your appetite for risk and returns. An adjustment to the percentage of your portfolio allocated to bonds may be enough to ease your mind.

In the meantime, here are some additional online resources you might find encouraging:

Young Americans: The Death of Equities May be Exaggerated

Liz Ann Sounders, Chief Investment Strategist at Charles Schwab published a piece in August that presents both the challenges facing the economy and the positive forces that are at play.

Equities critical for investment returns, despite volatility

This piece from Marlena Lee’s presentation at the Institute of Advanced Financial Planners Annual Symposium in Vancouver presents research showing that even as the market continues to be volatile, history shows that equities are the best way for clients to earn the returns necessary to meet their goals.

What is a Required Minimum Distribution (RMD)?

The RMD is the amount that Traditional, SEP, SIMPLE IRA owners and qualified plan participants must begin distributing from their retirement accounts in the year in which they reach 70.5.  The RMD must then be distributed each subsequent year.

The standard deadline for taking your RMD is December 31st.  However, you can use a one time exemption for your first RMD and delay until April 1st of the following year.  If you choose to utilize this deferral you will have to take both your first and second year distributions that year.

The amount of your RMD is calculated by dividing the year end value of all of your IRAs by your distribution factor.  Your distribution factor can be found using the IRA Uniform Lifetime Tables which are prepared by the IRS.

Advisor Forum on International Exposure and Diversification

A few weeks ago, four Merriman advisors got together for a round table conversation to review themes that came up during meetings with their clients. Aaron Spencer, Mark Metcalf, Paresh Kamdar and Tyler Bartlett all provided insights on the most common questions that investors are asking. Over the 40 minute conversation, you’ll hear their take on the following themes:

  • International exposure
  • Diversification
  • Bond rates being at an all-time low
  • Inflation
  • DFA and the value they add

Enjoy!

Value and blend vs. value and growth – which is better?

You have previously suggested a mix of value and blend funds. However, Burton Malkiel states in his book “A Random Walk Down Wall Street” that value and growth are equal over time. His argument suggests that a mix of value and growth – not blend – with annual re-balancing would be a better strategy. Both you and Malkiel cite historical figures. Can you explain the difference in your point of view?


Great question. I cannot speak to the context of how it was stated but I would argue the premise that value and growth are equal over time.

Consider the following return figures from Dimensional Fund Advisors over the period of 1927-2011:

US Large Cap Value10.03%
US Large Cap Growth9.75%
US Small Cap Value13.50%
US Small Cap Growth8.8

As you can see, value has historically outperformed growth.

The use of value and blend funds enables us to take advantage of the value premium illustrated by the preceding figures. Of course, blend is a combination of the two so the same result could be accomplished with a mixture of roughly 3 parts value to 1 part growth. However you slice it up our recommendation is to tilt to value.

 

Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Compound returns have an assumed rate of return, are hypothetical, and are not representative of any specific type of investment. Standard deviation is one method of measuring risk and performance and is presented as an approximation. Past performance is not a guarantee of future results.

Good Reads: The Wealthy Barber by David Chilton

I am often asked if I know of any good books on investing for those just starting out. Many times this is for the children or grandchildren of my clients. While I do know of many such books, I find a few challenges. Investing books can be somewhat dry and boring, especially if you are not all that interested in the subject matter. While I think investing is definitely important, and investing well can make a huge impact, I also find that learning about investing without the basics of handling your financial affairs to be somewhat like putting the cart before the horse. By not paying attention to some of the basics everything can be destroyed in the blink of an eye. If we do everything correctly with basic financial management and planning, investing well becomes the icing on the cake.

A big turn-off to reading almost any book about money is the snooze factor. Many are about as entertaining as watching paint dry. The Wealthy Barber by David Chilton, however, takes a novel approach, providing some personal finance education in a narrative/story form.

It’s the story of three young adults who realize they don’t know anything about how to create a long-term financial plan for their future. They turn to a parent for help who points them to an unlikely expert: The local barber. This barber has managed to turn a low-wage job into a comfortable lifestyle with millions of dollars in the bank. Their monthly meetings include plenty of humor and enough character development to keep it interesting. The barber imparts such wisdom as the value of saving, wills, life insurance, retirement, housing, investing and taxes. The secrets imparted are simple, easy to follow, and illustrate that you don’t have to have high paying job to live the good life.

In my opinion, this book imparts valuable wisdom that is not only easy to read, it is also easy to comprehend and retain. It’s one of the first books I recommend anyone read on financial planning.

The Ultimate Buy-and-Hold Strategy article is back online

We recently removed our Ultimate Buy-and-Hold strategy to make some updates, and now we’re happy to share that it’s back online.

In the article, we show how a series of simple but powerful concepts can potentially benefit patient, thoughtful investors. This 2012
revision includes hypothetical examples with data through 2011.

Read it here.

Retirement: A tough transition

The stereotypical vision of retiring includes gold watches, sun filled landscapes in foreign lands, vacation homes, and lots of smiling faces. We hold on to this vision to get us through the long road of a lifetime of work. A comfortable retirement is our motivation, and ultimately a reward for a job well done. For a few the transition to retirement is wonderful as they waltz into their retirement years with ease. In my observations over the past 25 years, I believe these lucky individuals are the exception, not the rule.

For most the transition to retirement is a very difficult time of their life. The distress that many new retirees feel is not widely acknowledged or discussed. For a life transition that is supposed to be joyous, new retirees often feel uneasy, fearful, and overwhelmed. Many feel like a rudderless ship. Issues surrounding self-worth, mortality, and lack of control can make a person feel anxious or even depressed. Spousal dynamics often change with the new schedule and routine and can be another source of stress, adding to the confusing mix of emotions that are part of this difficult transition.

Some things that I have seen help make the retirement transition easier are to acknowledge and understand that this transition is going to be another one of life’s challenges, and to prepare yourself for a full range of emotions. It’s perfectly normal to feel uneasiness for no particular reason.

Celebrate! Employers rarely throw a party for retirees anymore as most of us ultimately quit our jobs, or are downsized. Even if you retired some time ago, throw your own party or event to let you and others appreciate your accomplishment.

Communication is very important as you navigate the many emotions you will feel. Talk to your spouse, family, and friends openly about how you are feeling and you might find comfort in the fact that many feel the same as you do. Professional counseling can be very helpful.

Most importantly, ease into retirement. Many retirees feel out of control and rush to “take control” and end up making poor decisions about finances, housing or personal relationships when they should be taking a year of “vacation” to let the rhythms and patterns of your retirement life form. Give yourself a relaxed existence as you deal with the wide range of emotions that come with this difficult transition.

Volunteering for the Washington Trails Association

On Thursday, June 21st, Washingtonians saw what seemed like the first rays of sunshine peak through the clouds. It was the perfect day to experience the beautiful terrain our wonderful state has to offer. Luck would have it that I had previously scheduled this as a volunteer day with the Washington Trails Association (WTA). “Volunteer day,” you ask? You heard me right. As Merriman employees, we are each granted 100 volunteer hours per year. It is a way for us to give back to the organization(s) that matter the most to us.

For me, the choice is obvious. The WTA gets you outside and gives you the opportunity to meet a diverse group of people. Most importantly it preserves the trails that have exposed millions of people to the Washington wilderness.

For this trip, our group met at a local Park and Ride and carpooled 40 minutes east to the Franklin Falls trailhead located in the central Cascades. Our projects for the day included first cutting up an old tree that fell on the trail last winter, and then rebuilding the trail entrance. The first project was tougher than I anticipated. The tree was four feet in diameter and we had to use an old fashion crosscut saw (think circa 1900 logging photo) to cut it up. Luckily we were 8 people strong and with a few rotations our crew managed to clear the trail.

The driving force behind our second project was a grant given to the WTA to make trails wheelchair accessible. This translated into using rock from a scree field to widen the entrance. We then put a layer of fine gravel on top to smooth it out.

By the end of the day we had accomplished what we set out to do. It was time to head back home and plan our next volunteer outing.

Whether it is a one day work party or a week long “volunteer vacation” it’s not all about work. The experience of meeting new people, relaxing in a beautiful location and connecting with the environment makes volunteer work with the WTA a truly unique experience.

Postponing retirement

Many people are not optimistic about the chances of being able to retire at the traditional age of 65. In one survey, 39% of those surveyed said that they would work past age 70 or never retire.

A more recent study published by the Center for Retirement Research at Boston College paints a more optimistic picture. It concludes that almost half of households can retire at 65 and maintain their standard of living in retirement. For those households whose members can’t afford to retire at 65, 23% would have to work another 1-3 years, and 17% of households would have to work an additional 4-6 years. The study concludes that 88% of households should be able to retire by age 70 and maintain their pre-retirement lifestyle.

Postponing retirement is a powerful way to improve your chances of not outliving your money. Each additional year you work means more savings, more chance for your investments to grow, fewer years to draw down your savings in retirement, and greater Social Security (which increases as you delay claiming it until the age of 70).

While you might not be enthusiastic about the prospect of having to work longer, the reality may not be as bad as you think.

Meet Hannah!

Bringing in a new year always presents new opportunities and possibilities. As we began 2012 we brought in some new talent to the Merriman team – Hannah Mitchell. You may have already met or spoken with Hannah, as she is one of the great people who greet our clients and answer our busy phones. Hannah works in our Support Services team and has already embraced her new role, leaving a wake of greatness as she grows in her position.

Hannah comes to us with experience in planning events, as she owned her own wedding planning business for the past four years. She also brings a new level of creativity to her position given her lifetime of dance, both as a student and recently as a teacher for the past five years. Hannah taught all types of dance at a local studio and developed a dance program at the YMCA for kids and adults.

Born in Montana, Hannah moved to Washington State as an infant and grew up in the Snohomish/Monroe area. Hannah spent much of her school years performing and acting. Hannah married her husband, Todd, last August and they spent their honeymoon in Hawaii – which quickly became Hannah’s favorite vacation spot. Along with appreciating the beauty of Hawaii, she experienced the thrill of zip lining and also took a helicopter tour!

Here are a few more fun, random facts about Hannah:

  • Hannah is a fan of working out (who says that, really?) and is currently training for her first half marathon, the Seattle Rock ‘n Roll at the end of June.
  • She is the middle child, with one older and one younger sister.
  • Hannah loves to travel and has set a goal to get to Greece, Italy and Switzerland within the next couple of years.
  • Hannah’s two favorite parts she played while acting in high school were those of Margot Frank in The Diary of Anne Frank and Hellen Keller in The Miracle Worker.
  • Hannah recently tried surfing for the first time and really loved it!

We are very excited to have Hannah joining our fantastic support services team at Merriman!

The 529 Plan Series – Part III: The best 529 plan I know

Part I of this three-part series reviews 529 plan basics. Part II examines Washington State’s 529 prepaid tuition plan, the GET. This final section focuses on the best 529 savings plan I know, the West Virginia Smart529 Select.

Five years ago, my younger sister gave birth to her first child, a beautiful baby girl named Sydney. I was there at the hospital right after Sydney was born, and I instantly fell in love with her. When her 1st birthday came around, I decided the best gift I could give to her was the gift of education (or at least help with it). I set up a 529 account and began making monthly contributions for her benefit. My examination of 529 plans four years ago led me to the West Virginia Smart529 Select, and I believe it’s still one of the best 529 plans available today.

Why the West Virginia Smart529 Select?

I like the WV Smart529 Select plan for three main reasons:

  1. It offers access to a world-class family of funds, Dimensional Fund Advisors (DFA).
  2. The costs are low and very reasonable.
  3. Set-up, maintenance and contributions are simple and easy.

Dimensional Fund Advisors (DFA)

The WV Smart529 Select is the only 529 plan in the country where 100% of the investment options are DFA funds. Clients who work with Merriman may recognize these as the same funds we use in our investment portfolios. DFA funds are rooted in the science of investing, and we believe they offer superior exposure, diversification and returns when compared to most other mutual funds and Exchange-Traded Funds. Ordinarily, you can’t get access to DFA funds unless you are an institutional client or you work with a DFA-registered advisor. However, through the WV Smart529 Select, all investors have access to this great fund family for college savings purposes!

Costs

The WV Smart529 Select has no sales charges, application fees or set-up charges. There is a $25 annual maintenance fee, but that is waived if you enroll in their Automatic Investment Program and contribute $25 or more each month, if the account value is $25,000 or more, or if you’re a resident of West Virginia. The annual program expense ranges from 0.65% to 0.88% of the account balance each year, depending on the investment options chosen—very reasonable for this type of plan.

Set-up, maintenance and contributions

Setting up a WV Smart529 Select account was a breeze. I was able to establish and fund the account directly online, and also enrolled in the Automatic Investment Program which transfers money from my bank account into the 529 account each month. The minimum initial investment to open an account is very low, only $250.

The plan also makes investing simple by offering Age-Based Portfolios, which are managed by DFA and automatically shift in allocation every 3 years as the beneficiary grows older. For example, when the child is between 0-3 years of age, the portfolio will be invested in 100% stocks. When the child turns 19 or older, the portfolio will be 20% stocks, 80% bonds and cash. This provides for greater growth potential while the child is younger, but increases capital preservation potential as the child approaches college. The plan also offers Static Portfolios that don’t change with age, but for my money the Age-Based Portfolios are a simple and elegant solution.

Satisfaction

Four years into it, I’m still making monthly contributions into my niece’s WV Smart529 Select account. I intend to continue this until she finishes college, wherever she may go. She probably won’t realize all of the thought that went into selecting this plan for her; she may simply know that her uncle loves her and has planned ahead for her future. I, however, will know that I have used the best tool for the job, and that gives me tremendous satisfaction.

For inquiring minds: A white paper about umbrella insurance

We’ve written two posts on our blog in the last year about the importance of having umbrella insurance for those who have wealth:

Why lose what you’ve worked hard for?

Umbrella insurance – why it might be a good idea for you

If you want to understand this type of insurance and the risks it covers in much greater detail, please click here to read an excellent white paper on this subject, published by ACE Private Risk Services.

All that glitters is not gold

Merriman does not include a specific allocation to gold in our standard portfolios. This article, by Bryan Harris of Dimensional Fund Advisors, discusses why gold has not been an ideal long-term investment. It includes the following key concepts:

  • Gold has done well since the year 2000 and in the 1970s, and can potentially be a safe haven during times of political and economic stress. However, for the entire period of 1971 – 2011 gold performed worse than the S&P 500, U.S. small-cap stocks and non-U.S. stocks on an inflation-adjusted basis.
  • From 1980 – 1999, gold experienced a negative return after inflation of -6.5%, vs. strong positive returns for stocks.
  • While gold has held its value against long-term inflation, there have been extensive periods when gold did worse than inflation. Gold is also much more volatile than inflation, and can add substantial volatility to a portfolio.
  • Unlike stocks, which are productive assets which generate growing levels of income and dividends over time, gold has no cash flow and costs money to own.

For more detail and some illuminating graphs, please see the article.

Setting your spouse up for success

In our household we refer to my wife as the “Chief Domestic Officer,” which means she is the keeper of passwords, pays the bills, monitors and tracks our insurance and, as you can imagine, anything in between. Although I am a financial advisor, I do not pay our household bills. Seems a contradiction of terms, given my profession, but in our house this is how it worked out.

Like most households we have our basic monthly bills – electricity, water, cable…you name it. We also have our scheduled and unscheduled bills. Take for example, our medical expenses: We know when our prescriptions need to be refilled and have a good idea of the cost; those are scheduled. And we have the unscheduled medical bills for those late-night trips to the ER with an illness or injury.

We run our home with a color-coded budget that fits on to a single page. We created it together with the goal that either one of us can use it with ease. The colors represent how the bills are paid, whether by check, internet or automatic debit. On a quarterly basis we sit down together and talk about our finances. We discuss upcoming events, vacations, bills, our goals and house projects. We try to plan for the next 3 to 6 months and during this time we also update the budget.

The second important element to running our household smoothly is the password spreadsheet. In this time of computers and smart phones, each person has to have a username and password for just about everything. On this spreadsheet we keep track of our username, password, website it belongs to, who it belongs to and the security questions that are asked. I have no idea what my wife’s high school mascot was. But I don’t have to because the answer is on our spreadsheet. The only password I have to remember is the one that gives me access to the spreadsheet. Then I can check the balance in our bank account or order flowers for my grandmother.

In the event that my wife is unavailable or if something should happen to her, I have the tools I need to keep our household running smoothly with minimal effort. Life is full of unknowns and I firmly believe that chance favors those who are prepared. Granted, bill paying is not the most exciting thing you probably have ever done, nor is it necessarily that complicated. Why make things any harder than they need to be? With just a little effort and time we have set each other up for success. The question is: Have you set your spouse up for success?

Dangerous words: “It’s different this time.”

During periods of significant volatility in the capital markets, investors can lose patience and/or perspective and draw the conclusion that long term risk/return dynamics no longer apply because somehow “it’s different this time.”

I’ve been in this business for over 25 years, and time and again I have seen investors come to this conclusion, making big portfolio shifts because of it, only to regret these decisions later.

I vividly recall conversations with folks in the 1980s who insisted that Asian stock funds should constitute the bulk of one’s portfolio since America was in decline and Asia was rising. In the1990s, it often was very difficult to have meaningful conversations about asset allocation and thorough diversification when so many genuinely felt that all they needed was a few technology stocks or technology stock funds. In 2008 and early 2009, few had the stomach to trim their nicely performing government bond funds and add to their stock funds during the worst stock market environment since 1932.

In each of these examples, the phrase ‘it’s different this time’ crept into many conversations. Obviously, none of the above decisions worked out well.

At Merriman, we’ve always maintained the portion of clients’ accounts invested in stocks at 50% US and 50% foreign. This has served our clients well for many years. We invest this way because the US represents less than 50% of the world stock market capitalization, and because maintaining this kind of allocation can serve to increase returns while lowering overall portfolio risk.

Lately, foreign stocks have been significantly underperforming US stocks, and this has been causing some people to ask if maintaining our desired 50/50 US/foreign split still makes sense. And once again, we are starting to hear the ‘it’s different this time’ comment again. It is human nature to think this way, but history would suggest that one should not make a big shift in allocation because of it, other than some routine portfolio rebalancing.

Keep this in mind: While it’s always a different set of circumstances driving the capital markets, rarely is it wise to conclude that a paradigm shift is at hand and make major portfolio shifts in response. As legendary investor Sir John Templeton used to say, “The four most dangerous words in investing are ‘it’s different this time.’”

European exposure and global diversification

Some of our clients occasionally express concern about the situation in Europe. Here’s what our Director of Research, Larry Katz, has to say about Merriman portfolio exposure to those markets:

Europe’s ongoing debt problems have prompted many investors to consider their European exposure, especially to the euro zone’s weaker countries. While there certainly could be global impacts emanating from any area of the world, a major benefit of true global diversification is the controlled direct exposure to the problems of any given geography.

For example, one of our major portfolios is MarketWise Tax-Deferred, a globally diversified, buy-and-hold portfolio with a value and small-cap tilt.  Half of the stock exposure of this portfolio is in the United States. The other half is distributed throughout the world.

Of the 50% overseas exposure, as of the end of March 2012 just over 22% was in Europe. Notably, most of that exposure was to the stronger European countries. The top six European countries by exposure (United Kingdom, France, Germany, Switzerland, Sweden and the Netherlands) comprised almost 18% of the total invested in Europe. The weaker countries of Greece, Ireland, Portugal, Spain and Italy totaled only 1.73%.

So a 60/40 stock/bond portfolio had just over 1% exposure to these five troubled countries.

Every portfolio has to incur various risks to generate returns. The key is to intelligently diversify so that, under a variety of market conditions, those risks remain under control.

And the envelope please……

One of life’s happiest moments for any financial advisor who seeks the CERTIFIED FINANCIAL PLANNER™ designation is the day a letter arrives in your mailbox, congratulating you on passing the very challenging ten-hour comprehensive CFP® exam.

After using all your free time for one to several years to study for this difficult exam, it’s a huge relief to know you’ve accomplished what you set out to do. Soon, you’ll be able to use and display the CFP® credential proudly and forever.

This week, two of our financial advisors at Merriman, Mark Metcalf and Eric Jonson, received their “pass or fail” letters from the CFP® Board of Standards. Opening the envelopes to discover they had passed the exam was a very proud moment for the two of them, their families and for our entire company.

As the good news spread around the office, there were a whole lot of high fives, hugs, laughter, slaps on the back, sighs of relief and very big smiles. When I learned the news, I threw in my own loud “WOO HOO!!”

An advisory firm is only as good as its people. That’s why we are very proud that all ten of our advisors have successfully gone through the very challenging process of acquiring this credential. Throughout our advisory offices, you will see our CFP® diplomas displayed proudly.

Why do we care about this designation and why should you care? Click here to for more information about the CFP® designation.

Not only has the sun been shining all this week in Seattle, it came out just in time to shine a spotlight on two of our talented advisors! Congratulations, Mark and Eric, on a job well done!

The 529 Plan Series – Part II: Assessing Washington’s GET Plan

While all 50 states offer some type of 529 plan, only 18 states offer the prepaid tuition variety.  Some of these prepaid tuition plans are now closed to new enrollment, but Washington’s Guaranteed Education Tuition (GET) plan is still available to Washington residents (and WA residents only).  It is only one of five prepaid tuition plans in the country that is guaranteed by the full faith and credit of the state.  The GET was created in 1998 and is Washington’s only 529 plan.

How GET works

In a nutshell, account owners can purchase up to a maximum of 500 GET “units” at a specified price and redeem those units for college expenses in the future.  100 units represent the cost of one year of resident, undergraduate tuition and state-mandated fees at Washington’s most expensive public university (either the University of Washington or Washington State University).  Individual units are worth 1/100th of that cost.  For the 2011-2012 academic year, GET units paid out at a rate of $102.23 per unit.  Account owners can use up to 125 units per year, plus any rollover units from a prior year, to pay the cost of qualified education expenses.

Buying units and the GET premium

It is critical to note that the current purchase price of GET units is not the same as the payout value.  While GET units pay out at $102.23 for the 2011-2012 academic year, new units cost $163.00 to purchase (through June 30th, after which date the purchase price may be annually adjusted).

According to the GET website, the reason for this premium (the excess of the unit purchase price over the current payout value) is because the state guarantees the GET account will keep pace with tuition in the future, even if it doubles or triples in price, and this premium over current tuition ensures stability for the program.  In examining the history of this premium, it is interesting to observe that it has been generally increasing each year, which suggests that finding the right balance has, and may continue to be, a difficult challenge for the price-setting committee.

Breakeven

It’s evident from the previous chart that the GET premium has ballooned in past few years.  It begs the question, “Is GET still a good deal?”

The answer depends on how much time your child has before they start college and your expectation of tuition increases during that time.

According to the GET website, annual tuition increases in Washington state have averaged 12.03% over the past decade, with double-digit increases occurring over the past three years.  At that rate, one would break even from paying the current GET premium in about 5 years.  But how realistic is it to assume double-digit increases in tuition over the foreseeable future?  Can families continue to afford college at that pace?  If actual tuition increases turn out to be less than this average, the breakeven point will move out further.  For example, if annual tuition increases average 6% in the future, it will take approximately 10 years to recover the premium.

In actuality, the breakeven point should be further out than the examples above because your money would earn some return if it was invested in something other than the GET plan.  In other words, we should expect to have more than the original $163 purchase price in 5 or 10 years, and that would extend the breakeven period.

Other note-worthy observations

  • There is a one-time setup fee of $50 per GET account, capped at $100 per family.
  • The maximum number of units that can be purchased per student is 500 units.  At the current purchase price of $163, this amounts to $81,500 of assets that can used to fund this 529 account.  Many other 529 savings plans have contribution limits in excess of $300,000 per beneficiary, so using both types of plans can allow you to save more.
  • Students attending a non-Washington college can also use GET units to pay for education expenses at the payout rate in effect at that time, subject to the same annual limitation of 125 units plus unused rollover units from prior years.  Given the typically higher cost of out-of-state tuition, additional funds may be required to cover the full cost.
  • The GET payout value is tied to the increase in tuition and state-mandated fees.  If college costs rise but are not categorized specifically as tuition or state-mandated fees, we may see the GET payout value lag behind.
  • Refunds of GET units not used for education are subject to additional program penalties as well as federal tax on the earnings.  However, unused units can be transferred to other student beneficiaries.

Final thoughts

With the cost of college continually rising, it’s reasonable for families to seek ways to hedge against this ever-increasing expense.  The GET plan has offered decent protection, with units purchased as recently as 2010 having already broken even.  There is no doubt that the early adopters of the GET plan have been rewarded handsomely, particularly when compared with an alternative investment in stocks and bonds over the past 10 years.  However, I find it hard to believe that tuition will continue to increase at double-digits levels unchecked, and I don’t believe the below-average returns of the market over the past decade will persist indefinitely.  I believe the GET can still add value for families with very young children, but the current large premium makes other 529 plans far more appealing.

 

If you missed Part I of this series, read it here.

Why you should consider a Solo or Individual 401(k) if you’re self-employed

If you are self-employed or have any self-employment income, you’ve probably wondered about the different types of retirement accounts available to you. Three of the most common types of accounts are SEP IRAs, Simple IRAs, and the Solo or Individual 401(k) plan. This recent post I wrote gives more information on these three account types. Here, I’ll focus on the Individual 401(k) and why it might be right for you.

The Individual 401(k) plan is, in many cases, the better choice for self-employed people because of several key benefits that aren’t available with the SEP or Simple options.

First, for most individuals, the Individual 401(k) allows for a larger contribution to the retirement plan than a SEP or Simple IRA. For example, if you are a sole proprietor and make $100,000 per year, the employer contribution would be the same as a SEP IRA. However, because you can also make an employee contribution to an Individual 401(k), it would allow you to put in a much higher amount each year. The exact amount you would be able to contribute can be difficult to determine because it depends on how your business is structured, so it’s important to work with a knowledgeable CPA.

The Individual 401(k) can also work well for a couple where one person earns significantly more than the other. If one earns $20,000 and the other earns $200,000, and they want to save more money pre-tax, the Individual 401(k) will allow the lower-earning spouse to save almost all of his or her income. The SEP or Simple would allow for less savings in this situation.

Additionally, the Individual 401(k) could allow someone to either isolate after-tax IRA basis or to do a backdoor Roth IRA. This is a very powerful benefit that is often overlooked. For example, suppose you had $500,000 in an IRA account, and $50,000 of it was after-tax money (basis). While it would be nice to be able to convert just the $50,000 to a Roth, the IRS requires you to use a pro-rata rule which makes this less than ideal. Because the pro-rata rule also applies to the SEP and Simple IRAs, these retirement plans won’t give you the same flexibility. Luckily, there is an alternative.

Assuming you had self-employment income, you could instead open an Individual 401(k), which accepts only pre-tax dollars, and transfer the $450,000 into the individual 401(k), leaving only the $50,000 of basis left. Then, you could convert the $50,000 to a Roth without any tax consequences because it was only after-tax money. In addition, in each year going forward, you could make a non-deductible IRA contribution and then immediately convert it to a Roth, which is discussed here.

The planning can be difficult, and it requires a lot of moving parts to make sure it happens properly. There also are some very important reporting requirements that need to be followed closely. However, with the right CPA and advisor, I’ve found this to be a great solution for many of my self-employed clients.

For further information about SEP, Simple, and qualified plans, refer to this IRS publication.

Convertible bonds as an asset class?


Please share your view of convertible bonds as an asset class for folks entering retirement.


Convertible bonds are a unique asset class in that they have features of both stocks and bonds. They are often referred to as “hybrid” securities. This, along with their typically sub-par credit rating, is why they do not fit into our bond portfolio.

We prefer to keep the stock and bond components of our portfolios separate. Our bond portfolio is designed to buoy the allocation in times of stock market stress. The potential for convertible bonds to act like stocks does not jive with this logic. If convertibles – due to their hybrid nature – were showing stock-like tendencies when stocks were declining, your portfolio would have much less downside protection. As we have seen in the recent past, it is extremely important that investors maintain some level of protection in their portfolio. We do not believe convertible bonds are the solution.

Also worth your consideration is the credit quality of convertible bonds. Our MarketWise tax-deferred bond allocation uses exclusively US government and treasury debt (we also use municipal bonds in our MarketWise tax-managed bond allocation). This supports your portfolio when the stock markets fall. How it works is pretty straightforward. During a recession or market correction, there is typically a flight to quality. One of the most sought after destinations for this flight is US government and treasury debt. If people are flooding into these securities, guess what happens to their price? That’s right, it goes up. When stocks are falling this is exactly what your portfolio needs. Convertible bonds do not offer this same level of protection. In fact, they are typically offered by companies with poor credit ratings. This translates to increased risk for your portfolio. At the end of the day, we don’t think convertible bonds are a substitute for high quality bonds.

We look to our bond portfolio for security and capital preservation. In this context, convertible bonds are simply not a good fit.

The 529 Plan Series – Part I: Plan basics

At Merriman, we often help our clients plan for more than just retirement. One topic that commonly comes up is saving for college. My colleague, Lowell Lombardini Parker, wrote about the various college savings options in an earlier post, and this three-part series will focus specifically on the 529 plans highlighted in his article. Part I will review 529 plan basics; Part II will evaluate Washington’s 529 prepaid tuition plan, known as the GET; and Part III will take a look at the best 529 savings plan we know – the West Virginia Smart529 Select.

The cost of education

According to The College Board, the average tuition for an in-state student at a public four-year college is $8,244. The tuition cost for an out-of-state student is often more than twice this cost, and a private college may cost over three times the amount. After adding in additional costs for housing, food, books and supplies, it’s not difficult to imagine why the annual cost of education can easily range from $20,000 – $50,000 in today’s dollars. Financial aid and scholarships can help, but most parents will need to be intentional about saving for college if they want their children to graduate without a mountain of debt on their backs.

How 529 plans can help

529 plans come in two flavors: savings plans and prepaid plans. All 50 states have one form or the other, and some states offer both. The benefits and drawbacks of 529 plans typically apply to both.

The primary benefit of a 529 plan is tax-free growth, as long as the funds are used for qualified educational expenses. As an example, $10,000 invested today and growing at a 7% annual average for 18 years will become $33,799 by the end of that period. This growth of $23,799 can be withdrawn and spent entirely tax-free if used for qualified educational purposes—and the definition is fairly broad, including tuition and fees, books, supplies, room and board, meal plans, and even computer equipment and internet access. It can be a huge benefit in coping with the high cost of education.

Although the growth in a 529 account is tax-free, contributions to the accounts are not tax-deductible for federal purposes. However, some states offer a state income tax deduction if you contribute to that state’s 529 plan. Each state manages their plan differently, so it’s important to understand the rules and costs of the plan because the state income tax savings alone may not be worth giving up access to a more flexible or cost-effective plan elsewhere.

Another important benefit of 529 accounts is that the donor remains in control of the assets, even though the value of the account is removed from the donor’s estate. This is especially useful for donors who want to reduce their taxable estate (federal or state, as many states have a lower estate exemption than the current federal estate exemption of $5,120,000) but who also want to ensure the funds are used as intended. Gifts to 529 accounts qualify for the annual gift tax exclusion of $13,000 per donor per donee, and a special provision even allows 529 accounts to be “front loaded” by providing donors the ability to contribute up to five times the annual gift tax exclusion and electing to spread that gift over five years. This ensures maximum growth inside the 529 accounts while eliminating the need to pay gift tax (although a gift tax return is still required to be filed in the year of the front loading).

In addition to maintaining control, assets in 529 accounts are considered assets of the owner for financial aid purposes, which is far more beneficial than having the assets belong to the beneficiary/student. For example, assets in a parent-owned 529 account for the benefit of a child will be assessed at the parent rate of 5.64% when calculating the expected family contribution for financial aid purposes, as opposed to the 20% rate applied to assets belonging to the student. Even better still is to have a grandparent own the 529 account; those assets are not factored into the calculation of expected family contribution at all! This may allow the student to qualify for a higher financial aid award than they might otherwise receive.

The primary drawback to 529 plans – and it’s a big one – is that any earnings withdrawn for non-qualified purposes are taxed at ordinary income rates and assessed a 10% penalty. One concern my clients often voice is, “what if my child doesn’t go to college?” It’s a valid concern, and there isn’t an easy answer. 529 plans do contain provisions that allow for changes in beneficiaries, so if one child doesn’t attend college, you could reassign the funds to a different child or family member (including stepchildren, nephews or nieces, spouses of family members, or even yourself) – but if no one goes to college, you may wind up having to pay the income tax and penalty to withdraw the assets.

It’s a calculated risk, and I advise clients to consider splitting their intended contribution between a 529 account and a regular taxable account as a way to hedge against this risk. They may not be maximizing the potential tax-free growth, but they’re also not stuck with a potentially large account that would be taxed at ordinary income rates, in addition to a hefty penalty, if the child doesn’t go to college.

I encourage you to speak to your financial advisor or accountant if you believe a 529 plan is appropriate for your situation. With the increasingly high cost of education, families need all the help they can get to maximize the value of their money. A 529 plan is a great start.

Why I golf in the rain

At work on a Monday someone will ask “what did you do this weekend?”  My answer is usually “I golfed,” and their response is usually “in the rain?”

Putting aside my addiction to improving my golf handicap, the desire to surround myself with the beauty of nature provides me a calming perspective.  Often when I am in the fairway, I stop to look at the beauty that surrounds me.  Not in a passive sort of way, but to really take it all in. On some courses there are breathtaking views of The Puget Sound, gorgeous colors of foliage and wildlife.  Just last weekend, we encountered two deer walking across the fairway.  Visual reminders like the deer stick with me when I am making environmental choices.

In going about our daily lives – working, eating, commuting, and taking care of our home – we have an impact on our surroundings.  If you take a moment to pause and appreciate the beauty around you, you may be motivated to make small changes in your own life to decrease your carbon footprint and keep the beauty that is in nature.

Why do I golf in the rain?  Well, we live in Seattle. All this beautiful nature often happens in rain. In the elusive sun, clouds, or in the rain, the Pacific Northwest landscape is visually magnificent.

This Sunday is Earth Day, and I challenge you to celebrate this magnificence with a hike, walk, gardening, or a round of golf – any activity that will take you outside to enjoy the beauty of nature, even if it’s raining.

Are you prepared? I am!

Recently, my daughter’s preschool put on an emergency preparedness seminar. Preparing for a disaster of some kind has been in the back of my mind for a while, but I hadn’t really given it my full attention until I was listening to the Red Cross representative walk us through possible scenarios and realized how entirely unprepared my family is.

Just last week, local news stations shared a warning from the U.S. Geological Survey: There is an 84% chance of a 6.5 magnitude earthquake in Seattle in the next 50 years. Our office is certainly prepared for an event like this — we have trained floor wardens, supply kits in the office and plans for running operations in the event of a disaster — but at home, I’m not nearly so prepared.

Between the USGS warning and the seminar I just attended, I became highly motivated to make sure my family will be taken care of in the event of a major emergency or natural disaster. Now, I’m sharing some of the steps I’ve taken, in the hopes that you too will be inspired to get prepared.

1. Make a plan.

  • Assign an out-of-area contact. After an emergency, it can be easier to get through to an out-of-area number than to make a local call. Appoint someone out of state and make sure everyone in your family has their contact information. Print a copy of their information and keep it in your wallet, in your car, by your home phone.
  • Designate a meeting place. Consider the places you go most frequently. If you’re at work, can you walk home? What if a bridge is down and can’t make it? Have a back-up location as well.
  • Don’t forget about pets, if you have them.
  • Make sure everyone in your family knows your plan.

2. Make a kit for your home. The Red Cross recommends three days’ worth of supplies, and a major catastrophe might require at least seven to 10 days’ worth. You can decide how much you think is prudent, but even three days’ worth is better than none! Here are some lists to get you started:

3. Make a kit for your car. What if you’re on the road when disaster strikes? There’s a checklist for that too – build a car kit.

4. Most cities have a plan too – find out yours.

  • Some have emergency update hotlines that provide recorded updates. Keep that number in your phone and with your kits.
  • Know where the closest shelter will be, and how to get there.

These are just a few of many things you can do to help prepare yourself and your family for a major emergency. Check out these resources for more valuable information:

American Red Cross

What to do to Make it Through

It’s not what you know, it’s what you do

Behavioral finance is a fascinating field to me. It’s the study of how our emotions and judgment can affect decision making with regard to investments. In the time I have spent advising people on their investments, I have witnessed the power fear and greed can have over logic and reason. The good news is that the more we understand where our intuitions and biases come from the better chance we have at making good investment decisions.

Studies continue to find that investors earn lower returns than the funds in which they invested. Dalbar, a market research firm, issued their 2011 report showing investors achieved a mere 41.9% of the S&P 500‘s performance over the twenty years ending December 31, 2010. In other words, investors managed to leave a staggering 58.1% on the table. What could possibly explain missing out on these returns? It is largely due to investor behavior.

The goal of investing is to buy low and sell high – that’s a given – but our emotions, intuitions, and bias frequently work against us. Most investors did not begin buying technology related stocks in the early 90’s when prices were still reasonable; the vast majority bought in the late 90’s at astronomical prices, just before the “tech bubble” burst. Similarly, it was incredibly difficult to keep many investors positive about the prospects of the future during the first quarter of 2009 – the market bottomed on March 20, 2009 from the “housing bubble”- just before the markets began a climb to double in less than 2 years.

I recently read a wonderful new book written by Larry Swedroe & RC Balban, called “Investment Mistakes Even Smart Investors Make, And How To Avoid Them,” and I think it’s worth adding to your reading list.

I won’t re-write their book for you here, but Swedroe and Balban have done a great job of compiling a list of the most common mistakes and what you can do to avoid making them. This book will help you better understand why our investment strategies work, even though they can sometimes seem counterintuitive.

If you are not a client of ours and are considering hiring an advisor, this book may help you understand the mistakes a disciplined investment strategy can help you avoid.

By studying history and behavior, we can learn to avoid the same mistakes in the future. We can also understand why the disciplined investment decisions are sometimes the most uncomfortable. If we do our job well, you’ll be encouraged to stand by them anyway, knowing that discipline will pay off in the long-run.

Meet Aries!

As we closed out 2011, we added a couple of really great new hires to the Merriman team. Aries Lazaro came on board this past December as our new Assistant Controller as we bid adieu to Sandy Chudler, his predecessor who retired in February 2012. We wish Sandy many great ventures in her new life of leisure and we are truly excited to welcome Aries aboard!

Aries has five years of great experience as an Audit Supervisor for Clothier and Head. Although he enjoyed and valued his experience there, Aries was looking for a new opportunity to utilize his skills in a more expansive business capacity.

Born in Seattle, Aries grew up in the area and his parents still live in the house where he was raised. He graduated from Issaquah High School, then ventured north to Bellingham to attend Western Washington University where he earned his Bachelor’s degree in Accounting. Most of Aries family is in the Philippines, and he and his wife Mary have made several trips to visit. Aries and Mary are also new parents to their four month old daughter, Caroline. Here are a few fun, random facts about Aries that he was willing (well, some he was a little reluctant!) to share:

  • Aries is a big sports fan and an active hiker, loves camping and anything he can do in the great outdoors.
  • He once pitched a no-hitter while in sixth grade little league baseball!
  • Aries and Mary love to travel. Besides the Philippines, they have visited Italy, Spain and France. With the addition of little Caroline, he is wondering when they will travel again…
  • For the first week of his life, his name was Troy, but his dad decided the name just did not fit, so they changed it to his astronomical sign, Aries.
  • Aries frequently got himself in trouble as a child by cutting his own hair. His mom would give him a haircut, and he wouldn’t like it, so he’d sneak out to the back yard with a pair of scissors and have at it. Needless to say, his mom wasn’t too thrilled. He has since realized that a professional salon is a much better choice. J

We are very excited to have Aries joining our fantastic finance team at Merriman!

Five easy strategies to save on college costs

High school seniors are now in the process of getting acceptance letters to colleges.

When the thick envelope comes, there will be well-deserved joy, possibly followed by the dismaying thought on how to actually pay for those four expensive years.

Hopefully, parents will have done some advanced planning and saving for this major event. There are various strategies which can substantially ease the financial burden of higher education, some of which should be started many years before high school.

Background

Before we discuss strategies, let’s review some key terms, as they say in school.

There are two major financial aid forms which could be completed. The first is FAFSA, the Free Application for Federal Student Aid. This has to be submitted to be considered for any federal financial aid. It can be completed as early as January of the child’s senior year in high school. FAFSA assumes that 5.64% of parental assets can be used to fund annual college expenses, while the assessed rate on the children’s assets is a much higher 20%.

A second form, called the CSS Profile, is required by an increasing number of private colleges and some public schools as well. Both FAFSA and CSS use family income and assets to determine how much the family can spend on college, and how much aid they might receive. CSS counts some family resources which are excluded by FAFSA, and assesses some assets at a higher rate, leading to a higher expected family contribution and less aid.

The Expected Family Contribution, or EFC, is the total amount the family is expected to contribute for college education in any given year.

Federal aid includes grants and loans. Grants do not have to be repaid.  Loans either start accruing interest after college or during college, and do have to be repaid. Institutional aid includes the separate funds the college may give, including grants, scholarships, and work/study programs.

Each school may have its own Net Price Calculator, which will give an estimate of federal and institutional aid, and the total EFC, depending on your circumstances.

There are various options to save for college, including 529 Plans, Coverdell Education Savings Accounts and custodial accounts. These are described in College Savings Options by Lowell Lombardini Parker.

Strategies

Based on how various items are classified on the financial aid forms, families can do some advance planning to maximize the potential aid. The following five strategies, in order of how early you can start them, could really help.

Consider having twins!

Having more than one kid in college at the same time can increase financial aid. The expected family contribution is the total for the family, regardless of the number of children in college at the same time. This means that, if you have two kids in school at the same time, the EFC per child will be cut in half. For example, if you were expected to pay $30,000 if you had one kid in college, you would be expected to pay $15,000 per kid, or $30,000 total, if two of your children were in college at the same time. The lower EFC per kid could lead to more financial aid.

Max out parental retirement savings

Neither FAFSA nor CSS includes parental retirement assets when calculating financial aid. This means that one very important way to increase financial aid is to put as much as possible into the parents’ retirement accounts as early and consistently as possible.

Pay down your primary mortgage

FAFSA excludes primary home equity from its calculations. A perfectly acceptable technique to decrease the amount FAFSA expects you to contribute to college is to use some of your liquid assets to pay down the mortgage on your primary residence. CSS does include home equity – the more home equity the more they expect you to spend. Various schools which use the CSS form may place limits on the amount of home equity they include in their own calculations.

Have money in parent’s name

Because FAFSA assesses parental assets at a much lower rate than the child’s assets, it makes sense to keep assets in the parents’ name. Custodial accounts are considered the child’s assets, and will be assessed at 20% each year for the EFC. It could be more beneficial to fund 529 Plans, which are considered parental assets, and are assessed at a much lower rate.

Avoid capital gains when kids are in college

Capital gains increase your adjusted gross income, which will mean a higher expected family contribution. If you have appreciated securities which you will use to fund college, consider selling them by December of the child’s junior year in high school.

These five strategies can each have a beneficial impact on the amount of aid your child may get. When combined, these strategies can really help finance your child’s bachelor’s degree.

Self-Employed: What are your retirement saving options?

Being self-employed has many advantages compared to being an employee of a firm. However, retirement planning isn’t quite as easy as signing up for the company 401(k) plan like many of your friends do. That said, with some guidance from a qualified professional, you too have many excellent options. Below are a few choices to consider when planning for your retirement. I’ve focused on the options for those who are self-employed and do not have any employees, but the SEP and Simple options below are also available to those with employees.

Simple IRA

A Simple IRA is one option for self-employed individuals. The Simple IRA contribution limit is made up of two parts: employee salary reduction contributions and employer contributions. The employee contribution is limited to $11,500 for 2012. If you are over age 50, you can also make a catch-up contribution of $2,500 for 2012. And, since you are also the employer, you can then make an elective employer match of 3% of net self-employment earnings. You can deduct contributions up until the due date of your tax return, but you need to have the plan set up by October 1st of that tax year unless you are a new business.

There are a few other considerations. You can roll over into other types of IRAs; however, you can only do so after a 2 year participation period. Early distributions are subject to a 10% penalty like IRA accounts, but it increases to 25% if done within the first 2 years of participation.

Simplified Employee Pension (SEP) IRA

A SEP IRA is a retirement plan that potentially allows you to contribute more than the Simple IRA, but without the requirements of a more complex retirement plan. The IRS allows self-employed persons to set up and contribute to a SEP up until the due date (including extensions) of your income tax return for that year. For example, if you’ve filed for an extension on your 2011 tax return, you have until October 15th of this year to establish your SEP.

The SEP contribution formula can change depending on your business structure, so it is very important to work with a qualified tax professional to determine the proper amount. The limit is 25% of an employee’s compensation or 20% of your net earnings from self-employment, up to $50,000 for 2012.

Individual 401(k) or Solo 401(k)

A solo or individual 401 (k) is a qualified plan designed for self-employed individuals. Like a standard 401(k) plan through an employer plan, it allows for an employee contribution in addition to an employer contribution. For 2012, the maximum that an employee can put into a 401(k) is $17,000, plus a catch-up contribution of $5,500 if the participant is over age 50. With the employer contribution, the maximum is $50,000 for 2012 or $55,500 with a catch-up contribution.

While you have until the tax filing deadline (including extensions) to make a contribution to the plan, you would need to set up the solo 401(k) plan by the end of the tax year for which you intend to make a contribution. Also, if the plan has assets above $250,000, you would need to file a form 5500-EZ every year. In the final year of the plan, everyone should file a form 5500-EZ even if you had less than $250,000 of plan assets.

Which option is the best?

Many business owners find that the individual 401(k) allows them to contribute the most. However, this plan also comes with more difficulty depending on how the business is structured. Also, if you’re under 50 and make roughly $250k or more, the SEP might allow you to contribute the same as the individual 401(k), but without the filing requirements.

Here, I’ve only touched on the highlights of each plan. Each retirement plan has many other benefits and drawbacks, so it is important to work with a qualified professional who can guide you and help determine which is best suited for your business structure and retirement goals.

For more information, please check out the resources below:
http://www.irs.gov/publications/p560/index.html
http://www.retirementplans.irs.gov/

Five reasons to track expenses before retiring

For individuals nearing retirement, one of the first things to consider is: How much money will I be able to withdraw from my portfolio on an annual basis? This is a very important issue and ideally should be determined before entering into retirement.

Whether you use spreadsheets, receipts in shoe boxes or a computer program to track your expenses, it is important to know how much you spend to support your lifestyle. Before considering how much equity you will need in your portfolio during retirement, you should track your expenses for a few years to give you a firm idea of your outflows.

There are a number of software solutions available to help, including Quicken, Microsoft Money and Mint.com. While I don’t recommend any particular software, I do think you should find and use one that suits your needs. Here’s why:

  1. You can easily view expenses broken down by category. Until you actually measure the monthly expenses in an accurate and systematic way, you may only have a vague idea of how much is being spent in each category.
  2. With financial software, it is much easier to prepare your tax return. This is especially true if you itemize. All of the good personal finance software options have preloaded categories that are set up to capture deductible items. Once entered, you can produce individual category reports.
  3. With the aid of software, you always have access to a current balance on your credit card and personal checking accounts. This data can also be downloaded into the software, making catching errors or fraud very easy.
  4. The personal financial software can make it easier to pay bills on time and keep track of your automatic payments. Since it is possible to automate some of your monthly bills to be charged to a credit card or auto-debit from your checking account, the software helps you track all the different payment transactions in one central location.
  5. It allows for a smoother transition in the event you become incapacitated. Your spouse, partner or other family member will have a much easier time assuming bill paying responsibilities if you are using expense software.

Personal expense tracking software will help give you accurate, reliable information about how much money you are likely to need in retirement. This will help you determine if your monthly expenses can be supported by your current portfolio and if any changes need to be made – either to your expenses or your portfolio. Remember, if you can track it, you can manage it.

The best way to begin retirement planning is to start early. The sooner you know if your annual requirements are out of sync with what a balanced portfolio can produce, the more options you will have to correct the situation.

 

SmartMoney: Fix Your 401(k)

Merriman Financial Advisor Lowell Parker is quoted in this Smart Money article on how employees can patch the holes in their 401(k) plans.

Adding bonds in preparation for retirement


At 61 years old, what is the best way to transition from an all stock portfolio to a 60% stock 40% bond portfolio?

 

This is a difficult question to answer without knowing your specific set of circumstances. To narrow the scope I will assume the following: 1) you will retire at 65, 2) you will take a 4% annual distribution from the portfolio upon retirement, and 3) you are using a globally-diversified portfolio like the one we outline in The Ultimate Buy-and-Hold Strategy.

Regarding the third assumption, it is extremely important to understand that different portfolios have different risk characteristics. A 60% stock 40% bond (60/40) portfolio allocated to the S&P 500 and high-yield junk bonds is entirely different and much riskier than the one discussed in the aforementioned article.

That said, I would make the switch immediately. With four years until retirement you cannot afford to subject the entirety of your portfolio to the risks associated with stocks.

For perspective, consider that the financial crisis cut the average stock portfolio value in half. Taking distributions from an all-stock portfolio during such a time period has disastrous consequences on the longevity of your assets. This is why, as investors near retirement (the distribution phase of a portfolio), they should – as you’ve indicated – consider adding a preservation component (bonds) to their portfolio.

If the goal is to achieve a 60/40 allocation by retirement, many people will initiate the transition process around the time they reach age 50. This longer time frame for transition allows the use of ordinary cash flows and rebalancing opportunities to make it a cost-effective and natural process. Your situation calls for a less subtle shift. Nonetheless, it is a shift in the right direction and, as mentioned above, I would proceed.

Why lose what you’ve worked hard for?

Recently there was a nine car and truck pile-up in Florida caused by fog and smoke that suddenly came across the highway in the middle of a dark night. Unaware of the danger ahead, drivers blindly slammed into each other at high speeds. The light of day revealed a gruesome scene of twisted metal strewn for over a mile. Ten lives were lost.

About six months ago, someone I know was standing on a wooden deck at a friend’s home when suddenly the deck gave way and crashed to the ground. He fell from a height of around seven feet, leaving him with bruised ribs, cuts, and a very sore knee. Fortunately for the homeowner, no one was killed or seriously injured and no lawsuit ensued.

For those who have worked hard and saved a sizeable amount of wealth, these stories highlight that, without the right kind and amount of liability insurance, the risk is very real that you could lose all or part of your nest egg to some sudden and unpreventable event. Many people correctly buy an umbrella policy to cover these kinds of risk, but they fail to increase the amount as their net worth increases over time.

If I haven’t scared you enough already, the median award nationwide as a result of a wrongful death due to an auto accident is $1.5 million, not including loss of service, grief, sorrow, or punitive damages or payments to additional injured passengers riding in a car owned by you.

Another scary thought….the next time you’re driving along the interstate, look around at the drivers surrounding you. One out of six has no auto insurance whatsoever. And that number is rising. This does not even include the people who are underinsured.

With the cost of umbrella insurance averaging only $100 to $200 per $1 million in coverage per year, why keep this on your worry list any longer? Although this is beyond the scope of the advice provided by Merriman to our clients, your property and casualty insurance agent stands ready to do a personal insurance review for you.

So if you want to sleep better tonight, pick up the phone and make that call today!

Are you saving enough in your 401(k) to retire comfortably?

I am asked this question often, which is good because if someone is not saving enough we can make adjustments and get them on the right track. The people I worry about are the ones who don’t ask this question, either of me or of themselves. Maybe they are afraid of what the answer might be or they figure their employer or the custodian of the plan is looking out for them. Well, typically they aren’t.

In 2006, the Pension Protection Act went in to place. This was a nice step towards increased retirement savings, even for the most complacent of employees. This Act allows employers to automatically enroll their employees in the company 401(k) plan. Everyone has the ability to opt out, but they have to request it. Due to human nature, we tend to follow the path of least resistance, so the results were a huge increase in 401(k) plan participation. According to a recent study done by Aon Hewitt Associates, the participation rate in company 401(k) plans is now at 85% compared with 67% for companies who do not have an automatic enrollment program.

So if you are automatically enrolled in to your company’s 401(k) plan, will you have enough money to retire? The answer is: Not likely. You will need to dig a bit deeper in to your personal situation.

The Pension Protection Act I mentioned also allows companies to set an initial default contribution amount. So a company could automatically enroll an employee in their 401(k) plan, designating for example, 3% of that person’s salary for deposit in to the 401(k) plan. This has turned out to be good and bad. The good news is that the complacent employee is participating in the 401(k) plan and automatically contributing 3% of their salary, unless they make the effort to opt out. The bad news is that 3% savings per year of your salary is not likely going to get you through retirement, unless you are expecting to really reduce your standard of living.

Let’s assume our complacent employee is named Larry. Larry makes $50,000 a year and is 35 years old. He plans to retire at age 65. If Larry adds 3% per year to his 401(k) plan (because he just can’t be bothered to opt out or add more), he will have added $45,000 over 30 years (this is before any investment gain).

If Larry made no investment selections for his 401(k) plan (which we know he probably wouldn’t, as he is Lazy Larry), then he would have automatically been invested in the money market. This would amount to about $45,000 in today’s dollars of spending money when he turns 65. Even with some Social Security, that isn’t going to last Larry long.

The good news for Larry is that his 401(k) plan also has an automatic escalation. This would allow his plan to automatically increase his savings by a set amount (perhaps by 1% per year up to a certain set point), which would ensure that Larry saves a bit more every year.

Some more good news for Larry is that his company plan also has default investment allocations related to his age. What this means is that the plan would have some investment options with more stock exposure for younger investors, slowly adding more bonds as the person ages and thus gets closer to retirement. These funds are not necessarily the best investment option for everyone, but for Lazy Larry, they make a big difference.

If his company plan enrolls him automatically, starts him with a 3% contribution rate, increases that 1% per year up to 10%, and he is invested in an age-based mutual fund (we’ll assume 8% return over the 30 years), his 401(k) could be worth approximately $398,000 at retirement. If his company does some sort of matching contribution each year, this would grow even more.

$398,000 is a lot of money, but at a 5% withdrawal rate per year ($19,900), Larry will need to supplement that with some Social Security as well as some other savings.

We know from this exercise with Lazy Larry that the less he has to do, the better it is for him in the long run. The increased company influence in the employee options can have a major impact.

What if your employer plan offers you no guidance?

For those who may not have any guidance coming from their company plan, there are several things you can do to help yourself:

  • Check with your HR department to see if you can set up an automatic increase in your retirement savings per year.
  • If your company offers a match, invest at least enough to maximize it (if not more). According to a study done by Financial Engines, 39% of 401(k) participants do not save enough to receive their full match; for employees under 40, the number is 47%. Those people are essentially passing up free money.
  • If you change jobs, move your 401(k) plan to an IRA. Most people who have a 401(k) plan of less than $5,000 take a distribution when changing jobs. This results in a penalty of 10% (if they are under 59 ½) and income taxes will be applied as well. That typically means that their $5,000 is reduced to $3,500, and most people I talk to who have “cashed out” their former 401(k) plans have no idea what the money was spent on.
  • If you don’t understand what to invest in, don’t wing it. Ask a professional advisor, not your neighbor or the guy in front of you in line at Starbucks or your brother-in-law. An advisor can help you select the best portfolio from within the investments offered in your specific plan. This is a service we offer for free to our existing clients.

The difference between a good solid investment allocation and a haphazard one could be substantial. Let’s say one portfolio gets a 3% return over 30 years and the other grows at a rate of 9%. If you started with $10,000 in your 401(k) plan and added $5,000 per year, at 3% growth you would have $366,376 at age 65 and with a 9% return, $1,406,260. Those balances make for two very different retirements. A balanced portfolio that you understand will also make you more likely to stay on track and not panic.

When dealing with your own 401(k) plan, take some time to put a plan in place and make sure you are your own best advocate. Even if you are afraid to find out what you should be saving, I promise that having a plan will give you much more peace of mind than the unknown.

Contribution limits for the 2012 tax year

Each year, the IRS releases inflation-adjusted figures for key retirement contribution limits.  Some limits remain the same, while others may experience a slight increase.  Below are the contribution limits for 2012.  The “catch-up” limits apply to those 50 years or older.

2012 Contribution Limits

Traditional IRA$5,000
Traditional IRA with catch-up contribution$6,000
Roth IRA$5,000
Roth IRA with catch-up contribution$6,000
401(k)$17,000*
401(k) with catch-up contribution$22,500*
403(b)$17,000*
403(b) with catch-up contribution$22,500*
SIMPLE IRA employee contribution$11,500
SIMPLE IRA employee contribution with catch-up$14,000
SEP IRA$50,000* or 25% of employee salary (whichever is smaller)

*indicates a change from 2011 tax year limits.

How can I get hurt holding bonds?

I am considering buying bond funds and would welcome your recommendations. I recently read in Time magazine that you could get hurt if you’re invested in a bond fund. How can I get hurt holding bonds?


Many people think bonds are risk free, but that is not actually true. There are multiple risks associated with bonds, but they can be an extremely important component of a portfolio despite those risks. And, if properly allocated, they can provide a level of security above and beyond the equity markets. Of course there is no free lunch, and the added stability of bonds requires a tradeoff. Namely, you are foregoing the equity premium associated with stocks.

We recommend using a mix of high quality short- and intermediate-term government and Treasury issues. For tax-deferred accounts we include Treasury Inflation Protected Securities (TIPS). This allocation is purposefully designed to be very conservative. Nonetheless, it is still subject to certain risks. Interest rate and inflation risk make the top of the list. You can alleviate the risk of inflation through the use of TIPS. Interest rate risk is somewhat of a different story.

There is an inverse relationship between bond prices and interest rates. As rates rise, bond prices fall and as rates fall, bond prices rise. Longer-term bonds are hit hardest in a rising rate environment; short-term issues are hurt the least. Of course shorter-term issues generally pay less interest. If you want an appreciable return – especially in today’s low rate environment – you need to extend beyond extremely short-term debt. Our solution is to limit risk exposure and also gain some additional yield by using high quality short- and intermediate-term US government and Treasury debt.

Wall Street Journal: A Low-Cost Choice for Muni Income

Merriman Director of Research Larry Katz is quoted in this Wall Street Journal article on municipal bonds and how to use them in your portfolio.

Best of Merriman updates for 2012

Every year, we update some of the core articles in our Best of Merriman library.

The 2012 update of The ultimate buy-and-hold strategy, which includes performance information through 2011, is now available in our Best of Merriman library.

The ultimate buy-and-hold strategy

In this update to one of the most important items in our article library, Merriman shows how a series of simple but powerful concepts can benefit patient, thoughtful investors. This 2013 revision updates our hypothetical examples with data through 2012.

1099 changes for the 2011 tax year

The new cost basis legislation means some changes to the 1099 Composites you will receive from your custodians in late January. The most notable change is the revised 1099-B, which now displays cost basis information, including: the date of acquisition, the adjusted cost basis, disallowed wash sale losses, covered and uncovered securities status, as well as the specific holding period indicating your total short and long term gains and losses.

Also included in the Form 1099 Composite this year is a newly revised Year-End Summary Report (for Charles Schwab accounts) or a Supplemental Information Report (for Fidelity accounts). These additional summary reports provide a consolidated view of the realized gains and losses, the cost basis summary and the wash sale data for the tax year 2011. A summary of fees and expenses has also been added to help you identify the total management fees debited from your account(s).

This new format now consolidates all of your tax information into one easy and convenient report, making the headache of tax preparation much easier for yourself and your tax preparer. For tax year 2011, the cost basis information is being provided to you for informational purposes only and will not be reported to the IRS. However, cost basis information on mutual funds and ETFs purchased on or after January 1, 2012 will be reported directly to the IRS on an annual basis beginning with the tax year 2012.

If you have questions, please consult with your tax preparer or refer to these guides from Charles Schwab and Fidelity. Additionally, some custodians provide tax information electronically, so you don’t have to wait for the hard copy to arrive in the mail. If you have not already selected that option for your account(s), you may do so by accessing your account online or, if you’re a Merriman client, by calling your Merriman Client Service team at 1-800-423-4893.

Top 10 blog posts of 2011

As we enter a new year, we thought it would be fun to look back at the ten most-read blog posts of 2011:

#10 – Fixed index annuities: Perfect product or a ripoff? By Jeremy Burger

#9 – Performance: Time Weighted Return vs. Internal Rate of Return by Dave Spratt

#8 – Social Security as fixed income by Paul Merriman

#7 -  Tracking error: What is it, and why does it matter? by Jeremy Burger

#6 – We’ll say it again: The choice of assets can make a big difference by Larry Katz

#5 – Is rampant inflation an upcoming problem for the US? by Mark Metcalf

#4 – Strategies for recovering from market downturns in retirement by Mark Metcalf

#3 – Evaluating new investment products by Dennis Tilley

#2 – How to invest so your money lasts in retirement by Larry Katz

#1 – Are dividend-paying stocks good bond substitutes? by Larry Katz

Year-end tax planning

Our friends at Thomson Reuters have provided another wonderful checklist of year-end tax planning opportunities. As we enter the final week of the year, it’s worth considering if any of these options can save you money.

Year-End Moves for Individuals

  • Make HSA contributions. Under Code Sec. 223(b)(8)(A), a calendar year taxpayer who became an eligible individual under the health savings account (HSA) rules on December 1, 2011, is treated as having been an eligible individual for the entire year. Thus, he may make a full year’s deductible-above-the-line contribution for 2011. That means a deduction of $3,050 for individual coverage, and $6,150 for family coverage (those age 55 or older get an additional $1,000 catch-up amount).

  • Nail down losses on stock while substantially preserving your investment position. A taxpayer may have experienced paper losses on stock in a particular company or industry in which he wants to keep an investment. He may be able to realize his losses on the shares for tax purposes and still retain the same, or approximately the same, investment position. This can be accomplished by selling the shares and buying other shares in the same company or another company in the same industry to replace them. There are several ways this can be done. For example, an individual can sell the original holding, then buy back the same securities at least 31 days later.

  • Convert a regular IRA to a Roth IRA. Individuals who believe a Roth IRA is a better strategy than a traditional IRA, and want to remain in the market for the long term, should convert traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA if eligible to do so. Note, however, that such a conversion shouldn’t be done without considering the individual’s overall tax situation. Even at depressed market levels, a 2011 rollover or conversion still will increase a taxpayer’s AGI, possibly propelling him or her into a higher tax bracket, and diluting (or eliminating) those tax breaks that have AGI-based phaseouts or “floors.”

  • Recharacterizing a Roth IRA back to a traditional IRA conversion. If an individual converted assets in a traditional IRA to a Roth IRA earlier in the year, the assets in the Roth IRA account may have declined in value. If things are left things as-is, the individual will wind up paying a higher tax than is necessary. However, there’s a way to back out of the transaction, namely by recharacterizing the rollover or conversion. This involves transferring the converted amount (plus earnings, or minus losses) from the Roth IRA back to a traditional IRA via a trustee-to-trustee transfer. The individual can later reconvert to a Roth IRA.

  • Accelerate deductible contributions. Individuals should keep in mind that charitable contributions and medical expenses are deductible when charged to their credit card accounts (e.g., in 2011) rather than when they pay the card company (e.g., in 2012).

  • Solve an underpayment problem. An individual who expects to be underwithheld for 2011 should consider asking his employer—if it’s not too late to do so—to increase income tax withholding before year-end. Generally, income tax withheld by an employer from an employee’s wages or salary is treated as paid in equal amounts on each of the four installment due dates. Thus, if an employee asks his employer to withhold additional amounts for the rest of the year, the penalty can be retroactively eliminated. This is because the heavy year-end withholding will be treated as paid equally over the four installment due dates.
  • Outside-the-box solution. An individual can take an eligible rollover distribution from a qualified retirement plan before the end of 2011 if he is facing a penalty for underpayment of estimated tax and the increased withholding option is unavailable or won’t sufficiently address the problem. Income tax will be withheld from the distribution at a 20% rate and will be applied toward the taxes owed for 2011. He can then timely roll over the gross amount of the distribution, as increased by the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2011, but the withheld tax will be applied pro rata over the full 2011 tax year to reduce previous underpayments of estimated tax.

  • Accelerate big ticket purchases into 2011 to get sales tax deduction. Unless Congress acts this year or next to extend it, the option for itemizers to deduct state and local sales taxes in lieu of state and local income taxes will expire at the end of 2011. As a result, individuals who will elect on their 2011 return to claim a state and local general sales tax deduction instead of a state and local income tax deduction, and are considering the purchase of a big-ticket item (e.g., a car or boat), should consider accelerating the purchase into this year to achieve a higher itemized deduction for sales taxes.

  • Pre-pay qualified higher education expenses for first quarter of 2012. Unless Congress extends it, the up-to-$4,000 above-the-line deduction for qualified higher education expenses will not be available after 2011. Thus, individuals should consider prepaying eligible expenses if doing so will increase their deduction for qualified higher education expenses. Generally, the deduction is allowed for qualified education expenses paid in 2011 in connection with enrollment at an institution of higher education during 2011 or for an academic period beginning in 2011 or in the first 3 months of 2012.

  • Be sure to take required minimum distributions (RMDs). Taxpayers who have reached age 70- 1/2 should be sure to take their 2011 RMD from their IRAs or 401(k) plans (or other employer-sponsored retired plans). Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. Those who turned age 70- 1/2 in 2011, can delay the first required distribution to 2012. However, taxpayers who take the deferral route will have to take a double distribution in 2012—the amount required for 2011 plus the amount required for 2012.

  • Make year-end gifts. A person can give any other person up to $13,000 for 2011 without incurring any gift tax. The annual exclusion amount increases to $26,000 per donee if the donor’s spouse consents to gift-splitting. Annual exclusion gifts take the amount of the gift and future appreciation in the value of the gift out of the donor’s estate, and shift the income tax obligation on the property’s earnings to the donee who may be in a lower tax bracket (if not subject to the kiddie tax).
    • A gift by check to a noncharitable donee is considered to be a completed gift for gift and estate tax purposes on the earlier of:
    • the date on which the donor has so parted with dominion and control under local law as to leave in the donor no power to change its disposition, or
    • the date on which the donee deposits the check (or cashes it against available funds of the donee) or presents the check for payment, if it is established that:
    • … the check was paid by the drawee bank when first presented to the drawee bank for payment;
    • … the donor was alive when the check was paid by the drawee bank;
    • … the donor intended to make a gift;
    • … delivery of the check by the donor was unconditional; and
    • … the check was deposited, cashed, or presented in the calendar year for which completed gift treatment is sought and within a reasonable time of issuance.

Thus, for example, a $13,000 gift check given to and deposited by a grandson on Dec. 31, 2011, is treated as a completed gift for 2011 even though the check doesn’t clear until 2012 (assuming the donor is still alive when the check is paid by the drawee bank).

 

Where is the best place to put money gifted to children?

 

I have 5 nieces ranging in age from 2 to 14. We want to give them money instead of toys for birthdays and Christmas. We are talking about $25 each for birthdays and Christmas for now. That’s only $50 per year until we can increase it. Where is the best place to put that money?

The ability to delay gratification goes hand in hand with long term success.  Not only will your gift help provide financial security but it will set an important example.  Sure, every kid would love to have the latest and greatest toy.  But – at least to us boring adults – the prospect of an extra several thousand dollars for college, retirement, or a down payment on a home is much more appealing.  Granted this is not as tangible and doesn’t present as well to a 7 yr. old as a box of Legos, for example.

The option you choose depends upon the circumstances of each child.  If the goal is to fund college my first recommendation would be to use the West Virginia Smart 529 Select plan.  This plan has a low minimum initial investment and offers age-based portfolios that allocate amongst stocks and bonds based upon the beneficiary’s age.  As the child approaches the distribution phase (college) the portfolio automatically adjusts to a more conservative allocation.

However, the West Virginia does assess a $25 annual maintenance fee for smaller accounts.  The details of which can be found in the aforementioned link.  In your case it may be best to explore the 529 plan associated with your state of residence.  When the account meets one of the exceptions for the $25 West Virginia plan fee you can roll the assets into it.

Another option would be contributing to a custodial account such as a UTMA or UGMA.  The downside to a custodial account is that there are no real tax advantages.  However, if the child is not going to go to college it may be a sensible option.  Unlike 529 plans the only restriction for a custodial account is that the money must be used for the presumed benefit of the minor.  As mentioned above this would be an appropriate vehicle to save for something such as a down payment on a home.

Finally, once the kids begin to earn income you have the option of helping them set up an IRA.  What I love about this option is the time horizon and the shared responsibility.  Not only could you contribute $50/year, but you could encourage them to do the same.  Again, this is setting an example that will help shape their perspective and increases their chances, in this case for retirement success.

At the end of the day the foregone toy will be a distant memory.  More importantly, you will have made a lasting contribution to the financial security and education of your nieces.

Tracking Error: What is it, and why does it matter?

During several recent discussions with clients, I’ve heard a common question, “Why isn’t my portfolio doing as well as the market?”  This inquiry, of course, leads to another question: “What is the market?” To most investors, the market is either the S&P 500 or the Dow Jones Industrial Index. While these two indices are often cited by news outlets, they only cover portions of the larger global market.

At Merriman, we have long advocated that the allocation of the equity portion of your portfolio include large company stocks, small company stocks, international stocks, emerging market stocks and real estate investment trusts. Each of these asset classes perform differently over time, sometimes dramatically so. Tracking error, the way we refer to it here, is the amount by which the performance of a portfolio differs from that of the major market indices. In some years, this difference will be positive, meaning your portfolio outperformed a major index like the S&P 500. However, there will be years like 2011 when these additional asset classes will lead your portfolio to underperform the S&P 500.

To show how tracking error can affect year by year returns, let’s look at two separate time periods.

First, 1995-1999. This was a period in which US stocks, especially growth stocks, did extremely well. The 100% equity portfolio underperformed the S&P 500 in 4 out of 5 years, often by a significant margin. This was because small cap and international stocks didn’t do nearly as well as US large cap growth stocks did.

For the first few years, if you were following Merriman’s strategy you probably would have stayed the course. If you were a Merriman client, your advisor would have been selling U.S. large cap stocks and investing in international or small cap stocks. However, in 1998, $150 billion flowed into domestic stocks, while only $8 billion went into international/global stocks. In 1999 it was $176 billion to $11 billion(1). Put yourself in this position and try to determine if you would have been able to stay the course. Every cocktail party you went to, your friends would mention how rich they were getting on technology stocks. Meanwhile, you owned some tech stocks, but you were also heavily invested in international markets, which weren’t the buzz among those gathered around the cheese and crackers. Why was your money invested there? Money continued to flow into the U.S. markets; in fact in the first quarter of 2000 capital appreciation funds averaged $48 billion per month of net new money versus $9.8 billion per month during the same period in 1999(1). If you were consistently comparing your account to the S&P 500, this would have likely shaken your confidence in Merriman’s diversified strategy.

Now let’s review 2000-2004. In this 5 year time period, the tracking error versus the S&P 500 was positive by a significant margin in each of the 5 years. This was a time in which it was easy to be in an allocation that looked so different than the popular S&P 500 benchmark. This portfolio continued to out-perform through 2006. However, just as before, investors wanted to start allocating more to small cap stocks and emerging markets. Using the same disciplined approach to re-balancing, Merriman was selling the hot sectors while moving money back into US large cap stocks during these years.

Overall, we recommend an equity allocation with wide diversification within the U.S., international and emerging markets. This portfolio will perform differently than the S&P 500 over time, with the long-term returns expected to be higher. With a diversity of asset classes, there will surely be years in which the performance of your portfolio is lower than that of a popular benchmark. Just as each investor needs to understand the level of risk in his or her portfolio, he or she also needs to understand the possible tracking error in the portfolio and how to respond to it. Working with an advisor here at Merriman can surely help you stay the course. Your advisor helps ensure that you avoid excessive risk and relates portfolio decisions back to your long term financial goals, allowing you to focus on more enjoyable things in life. By utilizing an advisor and increasing your awareness of your own natural response to tracking error, you will better weather the emotional hurdles that can accompany the ups and downs of market movements.

 

1 http://www.ici.org/pdf/per07-02.pdf

Is Your 401(k) Healthy?

If you are like most of us, you likely visit your doctor’s office at least a couple of times a year. But when was the last time you had a check-up for your 401(k)?

It would not surprise me if you said, “not in quite a while”. But getting a financial check-up for your 401(k) account is extremely important, especially given the heightened economic issues and market turbulence over these last few years.

One of the many benefits of being a Merriman client is that we have the tools to help you align your 401(k) investments once a year. All you have to do is provide us with the mutual fund choices within your 401(k).

We will evaluate these choices and will then recommend an allocation that will mirror our research as well as match your long term goals and feelings about risk. This will ensure that every investment dollar you have is working as effectively as possible.

But what if we discover that your choices are very high cost or they just don’t allow us to mirror the tried and true Merriman investment philosophy? If you have changed jobs or have retired, you are now free to roll your 401(k) dollars over to an individual retirement account (IRA). Many of our clients then have us manage their new IRA along with their other accounts.

If you are still working and with the same employer who holds your 401(k) account, we can check the plan to see if it has a self-directed option. Fidelity’s self-directed option is called BrokerageLink and Schwab’s is called Personal Choice Retirement Account (PCRA). If your plan has either of these options, we may be able to manage your 401(k) dollars for you while you are still working!

So add these to your list of New Years’ resolutions: (1) call your doctor to get a physical if you haven’t had one in a while and (2) call us sometime during the coming year to get a 401(k) check-up, along with a review of all your accounts and your situation.

Here’s to your physical and financial health in the New Year!

Will European markets underperform in the next 10-20 years?

Is it a smart bet to reduce European exposure? It seems certain that these markets will continue to underperform for the next one to two decades.


Based on recent political and economic events we understand the skepticism surrounding the long-term growth prospects of European markets. However, we do not feel it is a foregone conclusion that European markets will produce sub-par returns over the coming decades. In its simplest form I see three potential outcomes:

1) European markets underperform

2) They keep pace with other financial markets

3) They outperform.

Under scenario one you are correct and moving out of European markets would have been a good move. “Would have” being the operative phrase. There is certainty in the past not in the future. On the flip side there is the chance that European markets outperform in the coming decades. Under this scenario we should have increased the European exposure. Again, should have – past tense.

We are not making tactical bets based on current political and economic circumstances. Rather, we are using historical data in conjunction with decades of academic research to build well-diversified portfolio designed for the long-term.

The Modern Budget

As the old adage goes, it is best to focus on what you can control. The weather, for instance, is not worth fussing over. In the world of investing, two of the most important things we can control are our budget and how much we contribute to our retirement accounts. Fortunately, both of these items are very closely related. The more you save in your budget, the more you can afford to contribute to your retirement accounts.

We’ve all heard the old song and dance about how skipping your $4 dollar daily latte can have profound impact on your budget. Well, guess what? It’s true. That’s $120/month that could have been better spent. With 7% interest over a 30 year period that adds up to $147,000 dollars!

I don’t want to pester you over your daily decisions; rather I want to point you in the direction of a budgeting tool that will help you identify the “latte” expenditures in your budget.

One such tool is called Mint.com. The cool thing about Mint is that it allows you to consolidate your bank accounts, credit cards, home loans, and investment accounts under one user interface. Rather than spending 30mins checking each individual account Mint.com brings them together and gives you the 300ft view. It even gives you tips and suggestions for ways to improve your budget and allows you to set goals for things such as retirement and large future expenses. I should also mention that it is free.

Mint is also extremely interactive. It alerts you via email, for instance, if you have exceeded your monthly budget for a particular category or if a bill is due. To avoid inundating you with these notifications it has the added benefit of letting you control the content of the alerts.

You may be wondering about the security of Mint. Having all of your financial account in one location is daunting. Two points sold me on it:

  1. Bank level security that alerts users to any suspicious transactions.
  2. It is a read only service. Money cannot be moved between or out of your accounts. That said is important to understand that all of your passwords will be in their system. To further protect your information I recommend you utilize the security features of your individual accounts.

The typical budgeting process of balancing your checkbook and creating excel spreadsheets can be a hassle. With the advent of web based tools such as Mint.com the process has been streamlined. Even better, it will help highlight the “latte” type expenses that, when avoided, can have a substantial impact on your retirement goals.

Mint.com comes in web format as well as an application for the iPhone, iPad, and android devices.

Expiring Tax Provisions

It seems like every year there’s a slew of tax breaks in danger of expiring.  Sometimes Congress extends the tax break, other times they actually expire and fall by the wayside. 2011 is no different, with 3 potentially useful tax breaks on the cutting room table.  Those who may be able to benefit from these tax breaks should consider taking advantage of them soon, before it’s too late.

  • Sales Tax Deduction – Individuals who itemize their deductions can elect to deduct their sales tax or their state and local income taxes, whichever is greater.  There are seven states without a state income tax, so those residents would surely elect the sales tax deduction.  Residents of other states may find that they paid very little in state income taxes and may decide to elect the sales tax deduction instead.  For those who are taking the sales tax deduction and considering a large purchase, such as a new car, it may be worthwhile to complete the purchase this year in order to maximize this tax benefit while it’s still available.
  • Energy Efficiency Credit – Individuals can take a credit of up to $500 for making energy efficient improvements to their homes, including upgrades for roofs, doors, insulation, windows, furnaces, air conditioners, and many others.  There are limitations on the amount of eligible credit for the various improvements, and you can find a list of those here. It’s also important to note that unlike many other credits, this one is a lifetime credit–so if you’ve utilized all of the $500 credit in the past, you cannot take any more regardless of your qualified expenditures now.  However, if you haven’t benefited from this tax break yet, and are considering making energy efficient improvements to your home, you may want to do so before year end.
  • Qualified Charitable Distributions from IRAs – Individuals older than 70 ½ can make tax-free distributions from their IRA to qualified charities.  The distribution is not includable in the donor’s income, but it is not deductible as a charitable donation either.  This provision primarily benefits individuals who are charitably inclined but don’t have enough deductions to itemize.  The qualified charitable distributions will count towards an individual’s required minimum distribution (RMD) for the year, allowing those who don’t need the money from their IRA to donate it without being taxed on it.  With year-end fast approaching, individuals who have yet to take their RMD may want to consider this option.

Each of the tax breaks above had been due to expire at some point in the past but was subsequently extended at the last minute.  It is possible that Congress will extend these breaks again, but nothing is certain given the deficit and debt problems currently facing our country.

If you think you may benefit from any of these tax breaks, please be sure to consult with your accountant to see how these tax savings may apply to your specific situation.

The house that Merriman is building (UPDATE)

If you are a regular reader of our blog, you may remember that a group of Merriman employees have been using our volunteer hours with Habitat for Humanity at the Rainer Vista location. The house was scheduled for completion in December, but we finished greatly ahead of schedule and the ribbon cutting ceremony was held on Sunday, October 2nd!

Having now completed our first Habitat house as a team, there is much to reflect on.  Was the work strenuous and tiring?  Yes.  Did the notoriously fickle Washington weather make things uncomfortable?  Frequently.  Were we always sore at the end of the day?  Definitely.  But did our team leave the worksite every single day with smiles on our faces?  Absolutely.  Would we ever choose to use our volunteer hours with Habitat in the future?  In a heartbeat.  This relationship that we have built with Habitat as well as the new inhabitants of the four-plex we  and other volunteers worked side by side with for the whole year has been unfathomably rewarding as well as productive.

We experienced several pleasant surprises during our time at Rainer Vista, including unintentionally volunteering with a Merriman client!    He is a long time Habitat volunteer, and now that he is retired donates a significant portion of his time to various Habitat locations.  He was very proud to be a client of a company that gives back to the community like Merriman does, and we are quite delighted to have such wonderful and well balanced clients to work with!

Another nice surprise came at the very end of the last day before the ribbon cutting ceremony.  While moving a washer and dryer set upstairs in one of the houses, we noticed that all of the appliances happened to match each other.  A little known fact is that Whirlpool donates a brand new Refrigerator, Range, Washer, and Dryer to every Habitat home worldwide.  Those 130,000 appliances represent a $72 million dollar commitment, and we at Merriman applaud their advocacy and desire to make a difference.

Despite all these successes, our long term mission is far from over.  Habitat has broken ground on another four-plex near Rainier Vista, with access to the same urban farm and light rail mass transportation system, and we hope to continue our efforts there.  An ordinary house key may not seem like much to most, but to those that have never owned a home before, that simple house key is precious metal.  Everyone deserves a decent and affordable home, and Merriman will do what it can to make that happen, one family at a time.

How to invest so your money lasts in retirement

Editor’s Note: Below is an article published first on MarketWatch.com that was written by Larry Katz, CFA – Director of Research at Merriman.

A major concern of many people is whether their savings will last for their entire retirement. If the savings do last, it’s a success, but if the savings don’t last it could be considered a failure.

Key factors which influence whether savings will last for your entire retirement include the size of your portfolio at retirement (bigger is better), the amount of periodic withdrawals (the lower the withdrawals the greater the chance of not running out of money) and longevity (the longer you live, the more you need at the start of retirement).

Another consideration is the diversification among various asset classes within the portfolio. The greater the diversification and exposure to beneficial asset classes, the lower the portfolio risk, and the greater the chance of financial success in retirement.To illustrate this, let’s look at two hypothetical equity portfolios. The first is a diversified portfolio of U.S. large cap, large value, small cap and small value indices (from Dimensional Fund Advisors), each with a 25% allocation. Value stocks and small-cap stocks have tended to outperform the S&P 500 over time. The second equity portfolio is the S&P 500 index.

Each equity portfolio will be combined with five-year Treasuries, in 10% increments, from 0% to 100%.

We’ll use returns from 1928 through 2010. In all cases we will assume that the retiree starts with a portfolio of $1 million. At the start of retirement, we’ll withdraw either 4%, 4.5%, or 5% of the initial portfolio, which will then grow annually at the previous year’s inflation rate. Each simulation will be run for 30 years. If the portfolio lasts for 30 years, it is a success, while if the value goes below zero at any time it is a failure. We’ll compare the number of failures for the different portfolios.

In order to generate the greatest number of 30-year periods, we’ll use a continuous loop of returns, by having the returns of 1928 follow the returns of 2010. So, for example, one simulation will start with 1928, and run through 1957. Another simulation will start with 2000, run through 2010, and then be followed by the returns of 1928 through 1946. This method allows 83 different return scenarios.

Results

The following graphs show the number of failures for the three different distribution rates (4%, 4.5%, 5%) using the two different equity portfolios. For example, on the first graph, for each of the 83 simulated thirty-year periods, there were five simulations when the portfolio comprised of 20% diversified equities and 80% five-year Treasuries failed to last throughout retirement, using an initial 4% distribution rate.

In all cases, if there was a difference, the diversified equity/Treasury portfolio had fewer failures than the portfolio comprised of the S&P 500 and Treasuries.

Now let’s look at how distribution rates impact success or failure of the portfolio over time. The next two graphs show all three distributions on the same graph, for each of the two different equity portfolios.

In each case, as the distribution increases, the number of failures increases.

Also in each case, stock allocations of between 40% – 70% seem to provide the lowest number of failures, or the highest success rate. Equity allocations below 40% don’t provide enough inflation protection, while equity allocations above 70% lead to more volatility, which increases the chances that negative returns combined with necessary withdrawals will wipe out a portfolio.

What does this mean for you?

  1. Diversify among beneficial asset classes. Diversifying among beneficial asset classes leads to more robust portfolios. Adding appropriate asset classes can both add to return and lower risk, making it less likely that you’ll run through all your money in retirement.
  2. Take moderate distributions from your portfolio. The more you take out of your portfolio each year, the less likely the portfolio will last your lifetime. Before retiring, determine your spending needs, and the sources of those funds, including Social Security, pensions, and your portfolio. Instead of assuming that your portfolio will last a long time with a high withdrawal rate, think about decreasing your spending assumptions or working slightly longer, to bring the distribution rate down to a more manageable level.
  3. Choose a reasonable stock/bond allocation. A very low equity allocation may be too conservative, and may not be able to compensate for inflation over time. A high equity allocation may lead to too much volatility. Stick with a moderate equity allocation which is within your risk tolerance.

Making these good choices could increase your chances of financial success in retirement.

 

Important disclosure information:

This article contains hypothetical results, including annual return sequences which did not take place. Hypothetical performance is potentially misleading. Hypothetical data does not represent actual performance and should not be interpreted as an indication of actual performance. This data is based on transactions that were not made. Instead, the trades were simulated, based on knowledge that was available only after the fact and thus with the benefit of hindsight. Past returns are not indicative of future results.

Reported or simulated results (1) assume reinvestment of interest and dividends; (2) do not reflect any effect of management fees, transaction costs, or taxes.

All returns data from Dimensional Fund Advisors Returns 2.2.

Diversified U.S. Equity portfolio is an annual average of the returns of four indices:

  • Dimensional US Large Cap Index
  • Dimensional US Large Cap Value Index
  • Dimensional US Small Cap Index
  • Dimensional US Small Cap Value Index

S&P 500 is the S&P 500 Index.

Stretch IRA?

Have you ever heard the term “stretch IRA”? According to the IRS, there is no such thing. What has become known as a stretch IRA is really a withdrawal strategy geared to spread the tax-deferred status of your IRA assets across multiple generations. Basically this is a provision you can add to any traditional IRA, ROTH, SEP-IRA, or SIMPLE IRA by using a beneficiary designation form.

Typically, a spouse is named as the primary beneficiary of an IRA, with children as the contingent beneficiaries. In this approach, after your death your surviving spouse rolls the balance of your IRA into his or her own IRA. This will allow your spouse to use the money from your IRA to cover his or her living expenses.

Alternatively, if your spouse will not need the assets in your IRA for living expenses in retirement, then you may consider naming your children and/or grandchildren as the primary beneficiaries. This will create the “stretch IRA.” After your death, your beneficiaries would each acquire what’s known as an inherited IRA from which he or she would have to withdraw a required minimum distribution each year thereafter. Here is an example to illustrate:

John (original IRA owner) passes away in December of 2011. His IRA has a balance of $600,000 on 12/31/2011. Below are the hypothetical required minimum distributions depending upon who inherits John’s IRA:

  1. Spouse: Susan (age 75 in 2012); her RMD will be $26,200.87 in 2012.
  2. Son:  Mike (age 50 in 2012); his RMD will be $17,543.86 in 2012.
  3. Grandson:  Evan (age 25 in 2012); his RMD will be $10,309.28 in 2012.

For John’s son and grandson the RMDs would be significantly smaller, based on a separate IRS table for non-spouse beneficiaries. If they withdrew only the required minimum amounts, the assets in their inherited IRAs could continue to grow on a tax-deferred basis and could potentially last the rest of their lifetimes. This is effectually like creating a personal pension for your child or grandchild.

How should I invest my IRA if I don’t need the money?

One approach you may consider is to invest the IRA using the risk tolerance of your children if the money will ultimately pass to them. Your advisor can help you explore the implications of this choice.

Can I establish an inherited IRA now?

Unfortunately, no.  An inherited IRA is created only after the original IRA owner has died. If you are interested in the stretch IRA strategy, you may consider including your named beneficiaries (children and/or grandchildren) in your planning discussions and educate them on this plan and your wishes.

How are inherited IRA distributions taxed?

Generally, RMD distributions are taxable to the recipient as ordinary income with the exception of an inherited ROTH. The more they take out each year, the greater the taxes they will likely owe. Owners of inherited IRAs are not subject to 10% early-withdrawal penalties on RMD distributions.

Are there any drawbacks with an inherited IRA?

Tax laws can change at any time, and what is true today might not be true next year.

The stretch IRA is only an opportunity to extend the life of an asset, but it’s no guarantee of how the new owner will use that. Your heirs may take out more than their RMDs, subject of course to taxes, or may liquidate the entire account. You may consider this an education opportunity for your children and your advisor can help with this.

Still, if it is used properly, the stretch IRA approach is a relatively straightforward way to provide an added income stream for your children or grandchildren throughout their lives. If you are interested, please consult with your financial or tax advisor.

MarketWatch.com: How to invest so your money lasts in retirement

Merriman Director of Research Larry Katz wrote an article for MarketWatch.com in the Personal Finance section of their website: How to invest so your money lasts in retirement.

The Folly of Predictions

The authors of “Freakonomics: A Rogue Economist Explores the Hidden Side of Everything” maintain a blog.   University of Chicago economist Steven Levitt and New York Times journalist Stephen J. Dubner use statistics to test many social ideas.   I found their recent podcast titled “The Folly of Prediction” to be quite interesting, especially as it relates to investing.

The gist of the podcast is something like this:

  • Human beings love to predict the future.
  • Human beings are not very good at predicting the future.
  • Because the incentives to predict are quite imperfect – bad predictions are rarely punished – this situation is unlikely to change.

Here is an excerpt that sums up Levit’s view:

“So, most predictions we remember are ones which were fabulously, wildly unexpected and then came true. Now, the person who makes that prediction has a strong incentive to remind everyone that they made that crazy prediction which came true. If you look at all the people, the economists, who talked about the financial crisis ahead of time, those guys harp on it constantly. “I was right, I was right, I was right.” But if you’re wrong, there’s no person on the other side of the transaction who draws any real benefit from embarrassing you by bring up the bad prediction over and over. So there’s nobody who has a strong incentive, usually, to go back and say, Here’s the list of the 118 predictions that were false. … And without any sort of market mechanism or incentive for keeping the prediction makers honest, there’s lots of incentive to go out and to make these wild predictions”

They propose a rather ingenious solution.  They propose that financial pundits should have their “batting average” published with each article.   This is a way readers would have a better idea of the past success of the author’s predictions.   I’m not holding my breath in anticipation of this proposal actually happening.   I will continue to read predictions of the future with healthy skepticism.

Find the podcast here.

Financial Fitness After 50 with Paul Merriman PBS Schedule

Merriman founder Paul Merriman is back on TV this fall! PBS stations around the country will be airing his presentation, Financial Fitness After 50! This presentation is in conjunction with his new book Financial Fitness Forever: 5 Steps to More Money, Less Risk, and More Peace of Mind.  Here is how PBS is describing the show:

High unemployment, investment scams, declining home equity and other bad economic news may have baby boomers in a gloomy mood these days. But help is on the way. Noted educator, best-selling author and money manager Paul Merriman has designed a straightforward, easy-to-follow program to help boomers grow and manage their money in retirement. Through his five life-changing choices, viewers can learn to use smart diversification, cut their expenses, invest wisely and avoid making the wrong choice at the wrong time.

Click here for a complete listing of all PBS shows

DateTimeMarketChannel
12/712:00 PMSeattleKCTSDT
12/712:00 PMYakimaKYVEDT
12/711:00 PMSeattleKCTSDT
12/711:00 PMYakimaKYVEDT
12/78:00 PMMiamiWPBTDT
12/711:00 PMDenverKRMZDT/KRMADT
12/88:00 PMTampaWEDUDT
12/910:00 PMSan FranciscoKTEHDT/KQEDDT2
12/108:00 AMNew YorkWLIWDT
12/101:30 PMLos AngelesKOCEDT
12/1112:30 PMMinneapolisKAWBDT/KAWEDT

Is volunteering worth your time and energy?

A majority of my clients are in retirement or they will be retired within the next 5 years or so.   These relationships give me some great insight in to what retirement can be, for better or for worse.  I have found over the years that my healthiest and even more importantly, happiest clients in retirement are those who are quite busy.  I am often told that they do not know how they had the time to work as they feel even busier now and they are loving it!

Most of these busy individuals are doing some sort of volunteer work.  You have probably heard people say that as a volunteer they get more out of it than they feel the person or organization they are helping is gaining from the relationship. And if you have given some of your time and energy to someone besides yourself, you know this to be true.

You may not realize it but so many of our local and national organizations would either not exist or be much less effective without the help of their volunteers;  Nonprofits, churches, schools, and hospitals, just to name a few.  If you are looking to volunteer, a great place to start is with your local organizations that you may already support financially.

If you like kids and you’re a retired engineer; perhaps you could help to tutor a student who is struggling with their Math.  Maybe you’d rather do something quieter and not so interactive; many groups need help with office duties or computer work.  Do you like to be outside and physical? Your local parks department or national forest would love your help.  Are you handy around the house? I’m sure there are many fellow seniors who need some help fixing things.  These are just a few options. If you want to branch out, then take a look at www.volunteermatch.org.  There are many organizations that could use your skills.

I recently read a study done by the National Survey for Giving, Volunteering and Participating (NSGVP) that 79% of volunteers say their interpersonal skills, such as understanding people better, motivating others and dealing with difficult situations have improved through their work.  78% say they have learned new skills.  So it isn’t just the “feel good” factor of helping out a group that is in need, you are also using your brain and learning new things as well.

I am passionate about this subject because I have unfortunately witnessed several clients who have experienced depression and many health issues within a year or so of retirement.  This is by no means a scientific study, but I have seen this mental and physical downward spiral occur mostly in clients who are not getting out of the house frequently and who seem to be watching an awful lot of daytime TV.  Let’s face it; we all know that the daytime TV programming can be quite depressing for anyone!  The talking heads don’t seem to have anything nice to say about anyone or anything.

My advice, give yourself some purpose by giving back in any way you feel comfortable and I bet  you’ll feel a whole lot better.  Those of you who are already busier than ever, keep up the good work!  You inspire me!

Want to be a Certified Financial Planner™?

As I read many articles about how to select a financial advisor I frequently see mentioned the importance of working with a Certified Financial Planner™ (CFP®). But what does the designation mean, and how does a person become one?  Since I am in the middle of working on my designation, I thought I would provide some insight.

If you decide to become a CFP®, here’s the process you would face.  First, you must have a Bachelors degree from an accredited university and a minimum of three years of applicable work experience. I’ve got these requirements covered and am working on the next step, which is the educational work.  The courses are offered by numerous sources and follow the same general topics. I chose the College of Financial Planning for my coursework.

Each course listed below is similar to a college quarter of studies with approximately 1000 pages of reading and 500 pages of questions and casework.  Each course takes about 160 – 220 hours of study and has a final exam.  My program includes the below five courses, and starting in 2012 the college will add a sixth “capstone” course that will be casework on the entire program.

  • Financial planning process and insurance
  • Investment planning
  • Income tax planning
  • Retirement planning
  • Estate planning

When you finish your coursework, you can then sit for the comprehensive exam given by the CFP® board three times a year.  It’s a two day test of your knowledge, comprehension, and your ability to apply what you know to cases.  The approximate pass rate is 50% and it’s recommended to have an additional 250 hours of study for the exam.  The course, materials, testing fees and test prep can easily cost you $5000 – $7000.  After passing the exam there are ethics requirements and continuing education.  To see a complete listing of requirements and topics, visit www.cfp.net.

To become a CFP® is a rigorous and costly endeavor.  The process has helped me to do a better job advising my clients and I can see the value in the recommendation that people work with a CFP®.

MarketWatch.com: 5 questions to ask before taking on more debt

Merriman Client Experience Director Elaine Scoggins wrote an article for MarketWatch.com in the Personal Finance section of their website: 5 questions to ask before taking on more debt.

Meet Dawn!

In continuing with our great hiring success in 2011, I have the pleasure of introducing our newest member to the Merriman team, Dawn McGeorge. Dawn joined us on April 27th and is the newest member of our support services team.  By now you have likely had the chance to speak with Dawn, as she is one of the fantastic people you initially interact with when calling our office. She is a truly great addition to our already wonderful support services team!

Dawn has several years of great experience serving clients and trying to help make their experience memorable and pleasant. Dawn just moved to the Seattle area from North Carolina where she was the manager of a well-known barbecue restaurant called The Pit. She takes great pride in making sure our clients know how much we love working with them. She looks forward to her daily interactions and loves to help each of our clients in any way possible.

Originally from the upper/lower peninsula of Michigan (Boyne City), Dawn earned her Bachelor’s degree from Lake Superior State University. Most of her family still resides in Michigan and she was able to visit them just a few weeks ago. Dawn comes to us with a great deal of enthusiasm and truly wants to make a difference for our clients. You can read more about Dawn on our website. Here are a few fun facts that you won’t find in her bio:

  • Dawn is a huge Baltimore Ravens fan, despite the fact she did not grow up there or attend school anywhere near the area.
  • She spent one summer living in Yellowstone National Park.
  • Dawn has a new kitten she named Benjamin, but now he is just lovingly called Smooches.
  • She was a cheerleader in high school
  • Dawn has a goal to visit all the National Parks. So far her favorites include Yellowstone and the Grand Tetons.

We are excited for you to get to know Dawn and we are thrilled to have her on our team!

The Millionaire Next Door Revisited

Like millions of people, I read Thomas Stanley, Ph.D.’s fascinating book The Millionaire Next Door when it first came out in 1996.  So when I noticed recently that he’d written a new book called Stop Acting Rich…And Start Living Like A Real Millionaire, I wondered if it contained anything new.  As it turns out, it does contain some new insights.

My biggest take-away:  The greatest impediment to becoming wealthy is all the spending people do in order to make themselves appear wealthier than they really are.  Marketing professionals understand this and exploit it to the max.

Stanley gives some great data on why having a high income doesn’t necessarily translate into having a high net worth.  He refers to people with fat incomes and thin balance sheets as the “big hat, no cattle” group.

A few interesting tidbits about wealthy Americans:

  • Boats:  Fewer than 7% own one.
  • Vacation homes:  Less than half own one.
  • Luxury watches:  Half of wealthy Americans who wear a Rolex received it as a gift and would not have purchased one otherwise.  The preferred watch brand of millionaires?  Seiko!
  • Reading:  What do they spend the most time reading?  If you said magazines about wine, luxury products, or travel, you guessed wrong.  Answer:  Trade journals that will deepen their knowledge of their chosen profession.
  • Leisure time:  Favorite way they spend their free time?  If you said shopping or traveling, sorry…you’re wrong again!  Answer:  Low cost social interactions with family and friends.
  • Wine:  Average price paid for a bottle of wine?  $12.95.  Further, most don’t have homes with wine cellars, own expensive wine collections, or spend much or any time learning about wine.

A few things marketing professionals don’t want you to know but they’re helpful to know if you’re trying to build wealth:

  • In many blind taste tests, people cannot distinguish the difference between expensive and inexpensive brands of liquor and wine.
  • The “aspiring to be rich” crowd, as opposed to the “already wealthy” crowd, by far, consumes the greatest amount of high priced brands of everything including liquor, wine, automobiles, and luxury merchandise.

The book also contains some interesting occupational data.  For example, a surprisingly small percentage of highly paid physicians are wealthy.  Why?  For them, there can be a tremendous amount of pressure to spend in order to keep up with their colleagues and neighbors.

Because of that pressure, Stanley says the nicer the neighborhood you live in, the harder it is to attain wealth.  Reason:  People follow the consumption cues of their neighbors including country club memberships, luxury cars, etc.

For me, the book is a great reminder that spending to feel better about ourselves or to increase the level of satisfaction with our lives is a losing proposition.  If you want better self-esteem, building wealth is a better path than buying expensive stuff.

Happy fall reading!

Public transportation for Merriman and you!

The honor of being recognized as one of the 50 greenest companies in Washington by Seattle Business Magazine means a lot to us.  We are always looking for ways to encourage green living and commuting.

In 2010, Americans took 10.2 billion trips on public transportation.   From 1995 through 2010, public transportation ridership increased by 31%.  The American Public Transit Association claims that public transit saves an estimated 1.4 billion gallons of gas annually, which translates into about 14 million tons of carbon dioxide.

In an effort to offset our carbon emissions, reduce the cost of parking in downtown Seattle and shorten the length of commute times, we know that providing our employees passes for public transportation is the most cost effective and efficient way for them to get to work.  We are pleased that 90 percent of our employees use public transportation to commute to our office.

We want our clients to have options when they come to our office as well.  The next time you travel to our Seattle office for your review we would be happy to give you a bus ticket for your ride home.

Updates from the Merriman Research Team

Little known by most, behind the scenes at Merriman we manage a small hedge fund for many of our accredited clients. This fund, the Leveraged Global Opportunity Fund L.P., is now in its 17th year. During this time we’ve received various honors, and last week our fund made the finalist list for the 2011 HFMWeek U.S. Performance Awards for the Macro Under $1 Billion category. Winners will be announced at an event in New York on October 13th. More information is available on their website HFMWeek.com.

In other news, on September 18th the Dimensional Fund Advisors Inflation-Protected Securities Fund, Symbol DIPSX, reached its fifth anniversary. Why is this so interesting? Merriman played a role in developing the specifications and seeding this fund. Five years later, the DFA TIPS fund has $1.8 billion in assets, an extremely low expense ratio of 0.13%, and was ranked 2nd out of 127 over its first five years (in the inflation-protected category according to Morningstar). The successful collaborative process between Merriman and DFA illustrates how we are always striving to implement the best investment solutions for our clients – even if we have to create something from scratch.

We point out these bits of news to highlight a very talented and passionate research team dedicated to providing investment portfolios at the forefront of academic research and practical implementation.

 

 

Solution for a lack of choices in company sponsored retirement plans

I use your investment strategy for my Roth IRA and Rollover IRA.  My current employer uses Prudential for my company’s 457 plan.  Looking at the options, I cannot seem to use your allocation strategy due to a lack of choices.  Do you have any suggestions?

A recurring theme in most plans is a limited number of investment options.  This restricts your ability to properly allocate and diversify your account.

If you find yourself in this situation the allocation tactic described below is a simple and practical way to get your portfolio on track.

First, use the table below to identify any asset classes that are missing in your plan.  Put a check next to each asset class that is available in your plan.  (To determine the asset class of a particular fund go to Morningstar.com and enter the fund’s name in the search box.  The asset class will then be indicated in the category field.)

ASSET CLASSAGGRESSIVEMODERATECONSERVATIVE
Large Cap Blend10%6%4%
Large Cap Value10%6%4%
Small Cap Blend10%6%4%
Small Cap Value10%6%4%
REITs (Real Estate Investment Trust)*10%6%4%
International Large Cap Blend10%6%4%
International Large Cap Value20%12%8%
International Small Cap10%6%4%
Emerging Markets10%6%4%
Short-Term Bonds0%12%18%
Intermediate-Term Bonds0%20%30%
TIPS (Treasury Inflation Protected Securities)*0%8%12%

*REITs and TIPS should only be used in tax-deferred accounts.

The asset classes without check marks represent the areas you need to invest outside of your employer’s plan.  Note: if you are utilizing an aggressive allocation strategy, don’t worry about the bottom three asset classes.

To keep things simple I will give you an example assuming the following:

  1. You have $100,000 split between your company sponsored plan and an IRA.
  2. You are utilizing an aggressive allocation (no fixed-income funds).
  3. You went through the above checklist and determined your company plan offers funds in the following asset classes:
  • Large Cap Blend
  • Large Cap Value
  • Small Cap Blend
  • Small Cap Value
  • REITs.

Based on the third assumption you need to invest in the following asset classes in your IRA:

  • International Large Cap Blend
  • International Large Cap Value
  • International Small Cap
  • Emerging Markets.

Ideally you would be able to utilize all of the above asset classes in each of your accounts.  Since you are unable to do so I think it is important for you to understand the pitfalls of splitting the asset classes amongst several accounts.

The first thing to be aware of is that – using the above scenario – your company plan and you IRA will behave differently.  Certain asset classes, such as emerging markets and international small cap value, are more volatile than, for instance, large cap blend.  Concentrating the more volatile asset classes into one account – in the above example the IRA – increases the relative volatility of that account.  This makes looking at both accounts as one portfolio imperative.  Otherwise you may be tempted to reduce your equity holdings in the more volatile account in times of market stress and do the same thing in the less volatile account when markets are performing well.

To the extent that you can evaluate the totality of your accounts and regard your overall portfolio as having one return, you should be able to improve your long-term returns and control your risk by building a well-diversified portfolio across multiple retirement accounts.

Merriman named one of Washington’s 50 Greenest Companies!

We are proud to be named in the October 2011 issue of Seattle Business Magazine as one of the 50 greenest companies in the state of Washington.  Making this list demonstrates pronounced leadership in areas of sustainability, green practices, commitment to our environment and the future of our natural resources.  Part of the entry was an essay submission written by Merriman employee Megan Stariha.

Merriman is passionate about conducting business as an environmentally responsible organization.  Dedication to these values extends beyond company objectives and is instilled in each one of Merriman’s employees.  Major pillars of Merriman’s business operation are driven by our effort to be green and encourage those we do business with and our community to adopt that same priority.  The efforts of our business are echoed in policies meant to foster and encourage green living in the office and at home.  The evolution of Merriman’s existence as a Green organization began with the construction of our office, continued with mastering the foundations of reducing, reusing and recycling, and is renewed and updated through various communications and programs in the organization.

As we mastered the foundations of operating as a Green firm through implementing company policy and resource guidelines regarding recycling, composting, preserving electricity and much more, we wanted to extend our enthusiasm for environmental responsibility beyond the basics.  The result was the presence of the Green section on the company’s intranet.  This gateway is open to all employees and is the mode of communication for many important pillars of our business.  Because of its importance to business operations, it is the ideal platform for the Green programs to reside.  These programs give the individuals that make up the Merriman team the tools and know-how to implement more Green living solutions into their lives and also recognition when they go the extra mile.

In addition to the provision of the Weekly Green Tip, Caught You Green Handed is also a prominent fixture in the Merriman culture.  Caught You Green Handed is modeled after an existing program intended to recognize individuals for going above and beyond the confines of their jobs.  Similarly, Caught You Green Handed is intended to credit employees for stellar Green actions and efforts.  Caught You Green Handed encourages individuals to be creative in their Green solutions and dedicated to supporting Green Initiatives.  Caught You Green Handed is an integral part of Merriman’s monthly Recognition Hour.  Employees with the most outstanding display of consideration for our environment are awarded each month with a Green Prize.  Green Prizes are selected and distributed as resources that aid individuals in their environmentally conscious efforts.  Prizes have ranged from plantable greeting cards to reusable lunch supplies.  The awards are meant not only to reward Green behavior but to encourage consistent future Green awareness and actions.

At Merriman, environmental responsibility is a commitment to not only utilize Green business practices, but also to educate and inspire those around us to adopt eco-friendly lifestyles.  Our green programs are innovative and effective mechanisms to motivate the Merriman team to constantly be thinking of the environment and our impact on it.  We will continually strive to be one of the 50 Greenest companies.

5 questions to ask before taking on more debt

Editor’s Note: Below is an article published first at MarketWatch that was written by Elaine Scoggins, CERTIFIED FINANCIAL PLANNER(TM) and director at Merriman

Early in my career, I knew a wealthy man who took his own life. He left a suicide note saying he was pushed to the breaking point trying to pay back some sizeable business and personal debt.

From the outside, he appeared to have it all: a successful business, a beautiful new luxury home, expensive vacations and a wonderful, loving family. But, like with so many people we’re impressed by, no one knew about the dangerous levels of debt he’d taken on in order to have all those things.

I use this story knowing it is an extreme case. Debt, in the right amounts and at the right times in our lives, can be very beneficial in helping us get ahead. But if you get into a situation where you can’t pay it back, it can turn out to be one of the ugliest nightmares you’ll ever face.

You might think that if the lender says you’re fine to borrow the money, it must be OK to proceed. But there’s one gigantic problem with those income and debt ratios that are commonly used to screen us all before we borrow: They assume nothing in your life is going to change.

Taking the time to honestly answer these five questions could save you from years of misery.

Do I have to depend on positive economic trends continuing?

Here’s what went wrong with the man I referred to at the beginning of this article: The economy was booming when he took out all his debt. He assumed this would continue. When the country went into a recession two years later, his small business revenues plummeted leaving him unable to make his loan payments.

Borrow as if the economy is going to be lousy, not as if it’s going to soar. Many of us have jobs or small businesses that are highly sensitive to the health of the economy. If this is the case for you, figure out your plan B for repaying the loan if the economy doesn’t do what you hope it will. Again, hope is not a good repayment plan.

And if you decide to take out a floating rate loan, ask yourself if you could comfortably handle the larger payments if rates rise. No one ever dreamed in 1981 and 1982 that mortgage rates would hit 16%. I lived through that time and it wiped out many people who had adjustable rate loans.

Do I need two incomes to pay this loan back?

The biggest problem with the “two-income” plan is that it gives you and your partner little freedom to change your lives. What happens if, after you take the loan out, one of you loses your job, wants to go back to graduate school or to stay home with young children?

If you cannot make the loan payments without that second income, what will you do? Hoping for the best is not a good answer.

How close am I to retirement?

If you are within five to seven years of achieving financial freedom, be very wary of taking on new debt, especially sizeable long term debt like a residential or commercial mortgage. Are you really willing to trade your financial freedom and the peace of mind that comes with that for the thing you are about to buy?

I’ll call out one other dangerous kind of borrowing for all of us, but especially for those who are close to retiring: investing in a high risk venture or investment. If it doesn’t do well, not only can you lose your money, you’ll be stuck with the debt. Learn to say “no thanks” to keep your nest egg safe.

What is at the core of my need to borrow?

Who among us has ever borrowed to buy something, thinking our friends, neighbors, or colleagues would like us better if we owned it? Of course the answer to that is: all of us. The reality is that years from now when we’re still laboring to repay the debt, we won’t even know these people or remember what we borrowed the money for.

Is it any wonder that borrowing to create an illusion of success almost always leaves us feeling unfulfilled, shallow and stressed out? Bottom line: our true friends will always value us for who we are, not for what we own.

Can I keep saving for retirement while paying this loan back?

If your answer is no, I think you’ve already guessed what I’m going to say … don’t do it.

Now, if you answered my five key questions above with accurate and reasonable answers, congratulations. But before picking up the phone to make an appointment with a lender, there’s one last step I want you to take.

Ask yourself this: “Is there another way to accomplish what I really want to accomplish without borrowing money?” This will require you to stop and think before you act. By taking this extra time to think about it, you may find another option that leaves you happier in the long run.

For example, instead of rushing to borrow $40,000 for a new car, a friend of mine instead stopped and thought about it for a while. As a result, he ended up borrowing $4,000 to refurbish the car he already owned. He’s happy because his car now looks brand new. He’s also breathing a sigh of relief because his new monthly loan payment will be so much easier to make than if he’d rushed out and borrowed to buy a new expensive car.

The more you think about it, the more likely you are to come up with an alternative plan that’s even better than the one you had in mind because it gets you what you need while taking on less or no debt. If so, you could be saving yourself from the worst financial mistake of your life.

Older Americans Have Increasing Amounts of Debt

An article in the Wall Street Journal (Debt Hobbles Older Americans, 9/7/11) paints a sobering picture of the impact that rising debt levels have on people’s retirement plans.

Thirty-nine percent of households headed by people aged 60 through 64 had primary mortgages in 2010, up from 22% in 1994. The median value of mortgage and home loan debt, adjusted for inflation, for homeowners aged 60 to 62 also increased, from about $40,000 in 1994 to $80,000 in 2008.

Housing price declines have made it more difficult to pay off these mortgages, forcing people to work longer before retiring.

Another issue hurting retirement plans is that people just are not saving enough. An earlier Wall Street Journal article (Retiring Boomers Find 401(k) Plans Fall Short, 2/19/11) showed that the median household headed by a person aged 60 to 62 with a 401(k) account had less than one-quarter of what was needed in that account to maintain its standard of living in retirement, defined as 85% of their working income. This is after taking Social Security into consideration.

To decrease the possibility of having to postpone retirement, start saving as soon as you can. Consider saving more of your income (12% to 15%, including any employer contribution, or higher if you can). If you are over the age of 50, and are able to, take advantage of the additional $5,500 you can contribute to a 401k plan above and beyond the $16,500 pre-tax contribution limit.

A variety of methods can be used to help pay down your mortgage prior to retiring. Use a portion of any bonus or raise towards the mortgage. With interest rates so low, consider refinancing from a 30-year to a 15-year mortgage. Think twice before drawing upon a home equity line.

Having more savings and less debt will give you much greater flexibility and control in deciding when to retire.

Can you benefit from a “Backdoor” Roth?

Since their introduction in 1998, Roth IRAs have become an important part of the financial planning landscape. They offer the unique ability for investors to grow their money tax-free, not simply tax-deferred like traditional IRAs. They also avoid required minimum distributions so they can grow undiminished for many years. In fact, Roth IRAs are wonderful assets to pass along to the next generation, where they can continue to grow tax-free even longer.

Until recently, this unique retirement vehicle was available only to individuals with incomes below certain thresholds. “High-income” individuals could not contribute to Roth IRAs or convert traditional IRAs into Roth IRAs. Some of this changed in 2010, when the Roth conversion income limitations were permanently repealed. Now, anyone (regardless of income) can make a Roth conversion.  However, the Roth contribution limitation was not repealed. This means that if your income exceeds the levels in the table below, you cannot contribute directly to a Roth IRA—but you can achieve the same result by first contributing to a non-deductible traditional IRA and then converting it to a Roth IRA.

This presents an interesting opportunity for high income individuals, who perhaps yearn to save beyond their 401(k) or 403(b) retirement plans or who simply desire the account diversification that comes with adding a Roth vehicle to their retirement mix.

These individuals have the potential to now fund what’s known as a “backdoor” Roth IRA by funding a non-deductible traditional IRA and then immediately converting it to a Roth. This may seem a round-about way, but there’s a reason it has to be done this way.

The reason lies in the income limitations for contributing to the different IRAs. For illustrative purposes, the table below shows the income limits for contributing to and converting to Roth IRAs.  (If your income is below these amounts, this strategy should not be necessary for you.)

Pre-201020102011
Roth IRA contribution - income limitation
> Single$120k$120k$122k
>Married, filing jointly$176k$177k$179k
Non-deductible Traditional IRA contribution - income limitationnonenonenone
Roth IRA conversion - income limitation$100knonenone

As the chart shows, a married couple earning, say $200,000, cannot contribute to a Roth IRA, even under current rules. Before 2010, they could have contributed to a non-deductible traditional IRA, but they couldn’t convert that to a Roth because of their income.

This year and in the future, that couple can fund a non-deductible traditional IRA and then immediately convert it to a Roth, since the Roth conversion limitation has been removed. This effectively circumvents the Roth IRA contribution limitation. With proper timing, there should be very little, if any, tax consequence on the conversion since the non-deductible traditional IRA contains, by definition, post-tax dollars which would not be taxed again.

This strategy works best for taxpayers who have no other pre-tax IRAs, such as a rollover or contributory IRA. If you have other pre-tax IRAs, you may be subject to pro-rata rules on the Roth conversion that would severely diminish the appeal of this strategy. If this applies to you, we recommend that you consult with a tax professional before attempting this strategy.

Even if you do have other pre-tax IRAs, there are potential moves that might let you benefit from the “backdoor” Roth. You might be able to roll your pre-tax traditional IRA into your employer retirement plan (such as a 401(k) or 403(b)) first, and then perform the Roth conversion. This strategy is particularly compelling for self-employed individuals who may be able to establish their own Solo-401(k) into which they can roll over pre-tax IRA accounts. Again, we recommend that you consult with a tax professional before attempting this.

It is clear from the income thresholds that the “backdoor” Roth will only apply to a limited number of individuals, those with high incomes and no other pre-tax traditional IRAs. But for those who qualify, the “backdoor” Roth IRA can open up access to a highly tax-efficient retirement vehicle that was previously out of reach.

How can I invest for my grandchildren on a few hundred dollars a year?

A couple recently asked my advice about how to put aside money for their new grandson, money he could use in his retirement. They didn’t have much money, but they wanted to get an early start.

I suggested a variation of an old formula that calls for setting aside $1 a day starting when you’re born. Babies can’t do this for themselves, but grandparents can. I told them that if they put aside $1 a day until their grandson’s 18th birthday, in theory, that money could grow to $1.5 million by the time he reached 65.

They could save $365 during their grandson’s first year, then add the same amount on every birthday until he reached 18.  Their total investment: $6,935.

It’s not easy to invest $365 efficiently, but exchange-traded funds (ETFs) don’t have minimums. If they could earn 10 percent, they could turn this money into more than $16,000 by their grandson’s 18th birthday.

Even during the relatively unfavorable first decade of the 21st century, ETFs that invested in small-cap stocks, real estate investment trusts and emerging markets all produced annualized returns higher than 10 percent.

The best tool available today for producing tax-free long-term returns is the Roth IRA. Any child with earned income can contribute to an IRA at any age, and I told this couple that by the time their grandson is 18 he will presumably be able to earn at least a few thousand dollars a year. The sooner this starts, the more opportunity the money has to grow without taxation.

I suggested that they offer to match whatever he earns, up to $5,000 a year, and put that amount into his Roth IRA until their $16,000 savings was all invested. (Of course there’s no law against further savings, too.)

It’s obviously impossible to predict investment returns far into the future, but I don’t think it’s out of the question that this couple’s out-of-pocket savings, just under $7,000, could grow to $1.5 million or more by the time their grandson is 65.

If he began taking out 5 percent of that money every year, he would have $75,000 – tax free – to presumably last the rest of his life. Even with its diminished purchasing power because of inflation, that’s a very impressive gift from his grandparents.

The biggest potential threat to the long-term success of this plan is the fact that the grandson can cash out the account at any time. Unless they create a trust or some other structure for ownership of the money, his grandparents can’t prevent that.

Somehow the grandparents have to motivate their grandson to keep the dream alive. One way is to have a series of conversations with the grandson, perhaps starting when he’s 20 or so. Whatever happens with the IRA, this is an excellent opportunity for building a relationship.

A conversation could go something like this:

“Your grandmother and I were young once and dreamed that one day we would be able to travel and play golf whenever we wanted, to live well and give money to our family and our favorite charities.

“But that dream didn’t quite come true for us because we didn’t figure out investing until we were older. We want you to benefit from what we’ve learned, and we want you to get an early start at creating your own dream for when you’re older.

“What would make us the happiest is to know that this money will be there for you when you’re 65 so you can do what you want. And every time you take a trip or do something special, we hope you’ll remember the dream and the love we have for you.”

Doing something very special for a grandchild doesn’t require a lot of money. But it takes planning, patience, and follow-through – three things that are necessary for success in any long-term investment. I hope they are successful with this.

4 great places to retire…Seattle???

In a recent article, Fortune magazine named our wonderful city as one of 4 great places to retire.  They identified four archetypes of next-generation retirees and found a place for each of them a college town for the academically minded, a city for the urban-inclined, a mountain town for lovers of the outdoors, and an overseas destination for explorers.

Personally I was quite surprised to see Seattle top anyone’s list.  We all love living here and enjoy the great beauties that surround us, however all you hear from everyone is that it rains a lot and the skies are always grey.  Journalists will often highlight the abnormally high occurrence of those diagnosed with Seasonal Affective Disorder (SAD), which refers to episodes of depression that occur every year during the fall or winter months.  However, in this article Seattle was highlighted for the urbanite based on the city being a mecca for the arts with a small-town feel despite the size, and top-rated health care facilities.

I was surprised to see that they didn’t mention the bounty of outdoor activities available.  Within a few hours drive you can be in the mountains, on one of the many lakes or rivers, drying out in the desert, or hiding out in the rainforest.  For the urbanite they also suggested Portland, Oregon and New York, New York.

For the college town they suggested Athens, Georgia and also mentioned San Luis Obispo, California and Madison, Wisconsin.

For the nature lover St. George, Utah was the highlight, and they also suggested Whitefish, Montana and Maggie Valley, North Carolina.

For the intrepid traveler they brought up the overseas locations of San Rafael, Argentina, Boquet, Panama, and Ambergris Caye, Belize.

Dollar Cost Averaging

Dollar Cost Averaging (DCA) is a method for reducing your costs as you make regular investments over a long period. By investing the same number of dollars regardless of market prices, you automatically reduce your average price per share.

Consider this simple example: You decide to invest $100 on the same day every month in a fund that tracks the Standard & Poor’s 500 Index. When the index price is relatively low, your $100 will buy a few more shares; when the index price is relatively high, your $100 will buy fewer shares.

Over time, DCA forces you to automatically buy more shares when prices are low and fewer shares when prices are high. You’ll never have to decide whether you’re at a high point in the market or a low point. The math will do that for you. And your average cost per share will be lower than the average of all the prices at which you bought.

If you have money regularly taken from your pay to fund a 401(k) or similar plan, you’re already using DCA. This technique does not guarantee that you’ll ever make a profit on your investments. But it will give you a price break, so to speak.

Just as important, DCA gives you a plan. Having a plan leads to a greater success rate in any endeavor. And in this case, the plan is simple and easy: Determine how much you’ll invest, how often you’ll invest it, and what you’ll buy with your investments. Then set it up and let it work for you.

Maintain a long-term perspective

The last several weeks have been trying times for investors.

Since July 22nd, the S&P 500 has fallen sharply including large drops on August 8th and 10th. The main catalysts for this sharp decline include a U.S. debt deal that did not address the underlying fundamental issues in a satisfactory way, some weak U.S. economic numbers which may presage a double‐dip recession, the realization that there is little flexibility with regard to either fiscal or monetary stimulus, the S&P downgrade of U.S. debt, and the continuing debt problems in Europe.

There is a long list of troubles, and things may get worse before they get better. There are also many positives, including the following:

  • A 28% decline in the price of oil from its recent high, which has reduced inflationary pressure and helped consumers.
  • The four‐week average of initial unemployment claims declined to the lowest level since April.
  • Continuing low interest rates, on both the short and long end.
  • Greatly improved corporate profitability and cash flow, with increasing capital spending.
  • Healthy corporate balance sheets and improving consumer balance sheets.
  • A depreciating dollar which could enhance exports.

We think that the best course for long‐term investors is not to sell now. While it may be emotionally difficult, we believe it is best to stick with the asset allocation that you (and possibly your financial advisor) calmly chose which was appropriate for your circumstances and risk tolerance.

Stock prices incorporate all available public information, are forward looking and exhibit both risk and return. Selling after a sharp and sudden market decline means suffering through the market’s risk without being able to benefit from any subsequent return.

For example, there was a double‐dip recession in 1980 – 1982, with unemployment reaching a high of 10.8% while mortgage rates went above 18%. Six months after the end of the second dip, the stock market was up almost 20%.

We can’t call the market bottom with any certainty. What we do know with certainty is that institutions, investors and markets react to events. Congress may finally become serious after the S&P downgrade and work together to credibly tackle the long‐term deficit issue. Investors may look at cash‐rich companies with good earnings and lower‐than‐average valuations and eventually decide to buy. The European Central Bank has started large purchases of Italian and Spanish bonds, helping to lower rates and trying to calm the debt markets.

We certainly empathize with any distress you may have experienced due to the recent market drop. It is human nature to panic and consider selling after a steep market decline. If you are considering that, think about those portfolios which were sold at the bottom of the market in March 2009 and did not get the benefit of the subsequent recovery. Stocks have an expected positive return over time, which just became more positive with the steep price drop.

For your own benefit, avoid short‐term panic and maintain a long‐term perspective.

What’s the best way to transition from stocks to index funds and ETFs?

I have read Paul Merriman’s book, Live It Up Without Outliving Your Money and watched some of Paul’s videos and listened to his podcasts. I have a question that hasn’t been addressed: What’s the best way to transition a portfolio from individual stocks to index funds and ETFs?

I would like to make the change quickly, but I’m worried that my timing might turn out to be all wrong. Should I do it all at once, or gradually over a period of time?


We believe that the move you are describing is a good way to reduce your risk and potentially improve your return, because index funds and ETFs will give you much greater diversification. I recommend you follow the recommendations that you’ll find in Paul Merriman’s article “The Ultimate Buy and Hold Strategy.”

Once you have made this decision, I cannot see any good reason to spread it out. If you do it all at once, you will get it over with quickly so you can focus on other things. I recommend you sell all the stocks in a single day. Stock trades typically take three business days to settle, so there will be a short delay before you can reinvest the proceeds.

During that brief period while your money is in cash, the market may go up or it may go down – or it could remain largely unchanged. You can’t control that, so you will have to accept it as an unknown price you’ll have to pay (if you must reinvest at higher prices) or an unknown bonus you receive (if you reinvest at lower prices). Either way, make the change and get it over with.

If you try to control this, you’ll have to predict or guess future stock prices, and that’s likely to lead to second-guessing your plan and not getting it accomplished.

There’s an exception to that advice. If the stocks you own are in a taxable account, it’s important that you consult your tax advisor before you move forward. Tax consequences in some cases should dictate the timing of your sales.

Charitable giving: Donor-Advised Funds

If you are like me, then you receive lots of invitations to donate to your favorite charities. There are natural disaster funds, religious contributions, education, health, and many other non-profit groups that look to individuals for funding. According to the Giving USA Foundation, individuals gave an estimated $211.77 billion in 2010, a 2.7% increase from 2009. Since this is an important topic to many people, it is good to be informed on the most effective ways to give to your favorite charities.

One common way to contribute to charities is to give cash. This is simple, and charities can easily handle the different contribution levels. The downside is that you may have to sell an asset (stock, bond, mutual fund) in order to free up the cash you intend to donate. Usually, when you sell something, there are tax consequences to doing so. For example, if you had a stock worth $10,000 and the basis was $5,000, you would create a tax consequence by selling and would likely have less than the full $10,000 to give to the charity.

One easy way around that is to give the stock directly to the charity. You could potentially avoid paying capital gains tax and presumably could deduct the full $10,000.

However, because your chosen charity might not be set up to accept stock directly, another great solution is to use a Donor-Advised Fund as a convenient, low cost, tax-efficient way to support charities with a flexible grant making process.

After you open a Donor-Advised Fund account with a tax deductible contribution of cash and/or stock, you can instruct the fund to make a donation immediately or you may choose to let the money grow tax-free in different investment options available through the fund. You can specify one or more charities to receive the money later. You can also name one or more people to continue to make decisions about your account if you are deceased or otherwise unable to do so.

Two popular Donor-Advised Funds are the Schwab Charitable Fund and the Vanguard Charitable Endowment Program. The Schwab fund has an account minimum of $5,000, an additional contribution minimum of $500, and a minimum grant size of $100. The Vanguard program has a higher initial contribution minimum of $25,000 and a minimum grant size of $500.

Overall, a Donor-Advised Fund may be a great way to contribute to your favorite charities in a tax-efficient manner. Please make sure to consult with a qualified tax professional to determine if this method is appropriate for your specific situation.

Here are some additional resources to help you learn more about this topic:

Schwab Charitable Fund

Vanguard Charitable Endowment Program

IRS Publication 526, Charitable Contributions

A little perspective

In managing investments, making decisions based on feelings of excessive optimism or excessive pessimism rarely ends well. Maintaining a balanced perspective in an ever-changing and often chaotic world is a difficult yet critically important part of achieving long-term investing success.

To be sure, the news lately has been enough to scare many people into believing that things are shaping up for another 2008 debacle. Seemingly at every turn we hear of the debt crisis in the Eurozone, the possibility that the United States might not meet its deadline to raise the debt ceiling and the ramifications that may have, China potentially slowing down, and the U.S. housing and unemployment figures remaining at disappointing levels. And this is just to name a few!

While the United States and the rest of the world are facing many significant obstacles, and while nobody knows for sure how future events will unfold, I offer the following examples of recent positive, noteworthy items that went largely ignored:

  • Japanese auto manufacturers and parts suppliers resumed shipments after being forced to essentially shut down because of last winter’s earthquake, tsunami, and nuclear incident.
  • Foreign and domestic auto manufacturers established new plants and/or increased hiring in the United States, and sales increased meaningfully.
  • Companies such as Boeing and Caterpillar expanding and increased production.
  • PACCAR (a major manufacturer of large trucks) recently added to its workforce and announced a 50% increase in its dividend. This was especially notable because PACCAR is known for running a tight ship and does not adjust its dividend without careful consideration of its prospects.
  • Retail sales continued to grind higher.
  • In the aggregate, U.S. companies continued to become increasingly well-capitalized.
  • A recent Business Roundtable survey indicated the majority of CEOs of leading U.S. companies were rather optimistic with regard to their near-term sales, capital expenditures, and hiring plans.

Again, I offer these recent positive developments only as a way to help provide some much-needed perspective in the face of all the troubling issues that seem to be dominating the headlines of late.

So before you decide to put the pedal to the metal and invest everything you have in the global equity markets, please note the important caution lights out there. And before you decide to run for cover and go to cash, please note that these same caution lights could soon turn from amber to green.

A much better approach would be to maintain a well-balanced and thoroughly diversified portfolio, keep a comfortable level of cash on hand for emergencies and opportunities, and then let the future unfold.

There will always be plenty of plausible and even compelling reasons to be pessimistic, and plenty of equally plausible and compelling reasons to be optimistic. All those reasons involve predicting the future, which is notoriously hard to do. Think about this: the biggest events that have shaped our economy over the past 10 years were items that nobody predicted.

The hidden costs of your 401(k)

Are you a participant in a 401(k) or similar retirement plan? If so, do you know what that plan is costing you? Ron Lieber of the New York Times thinks you don’t, and I think he is right. In a recent article, he says there’s really no way you could know what your plan is costing you – but the total might add up to thousands of dollars in hidden fees over the years while you work and (if you leave your money in the plan) after you retire.

To understand the issue, it helps to know that employee retirement plans typically have four players. The first is you, the employee. The second is your employer, who offers to withhold money from your pay and (sometimes) to match part or all of what you contribute. The third is a corporate administrator hired by your employer to operate the plan and choose investment options. The fourth player consists of the mutual funds, brokerages and insurance companies that provide those options.

Starting next year, the U.S. Labor Department will require that mutual fund fees be spelled out in retirement plan account statements. Lieber says that will let plan participants know whether or not the funds in the plan are paying part of those fees, which are collected from workers’ contributions, back to the plan administrators.

Lieber’s article shines a badly needed spotlight on the mostly hidden arrangements, politely known as “revenue sharing,” between plan administrators and mutual fund companies. In my own view, these relationships have become so private and so cozy that they cannot operate in the best interests of workers.

The new requirements will make fees more transparent. But transparency doesn’t do you much good if you have no choice.

For better or worse, 401(k) and similar plans provide the main savings vehicle for the majority of workers. While these plans provide a convenient, automatic way to save money, they lack a key part of our economic system: competition.

As a participant, whether you are still working or already retired, you are stuck with whatever arrangements your plan administrator makes regarding your investment options and the fees you pay. Once the plan administrator gets the contract, the competition seems to be over.

Here’s my idea for a better way to do things: Employees should have a choice among plans, with fees and other costs spelled out. Of course I don’t know just how this would work, but it’s interesting to think about something similar that’s already working: the 529 college savings plan.

Raising kids in the age of instant

Do you remember having to wait patiently for someone to return your call, instead of texting them your question?  I remember the excitement of call waiting, when it became an option to answer an incoming call when you were already on the phone. At my house now we don’t even have a landline any more. My children will probably rarely encounter a busy signal; they can practically call anyone from almost anywhere. Do you remember having to make an appointment and then wait for the date to talk to the doctor? I recently emailed the doctor my question, and then wondered why it took so long for him to answer.

With cell phones, email and internet at your hip, how do we teach our children we can’t get everything by pushing a button? How do we raise patient children when things are so available and instant to our children? My wife and I have struggled with these questions.

At my house we have started a reward system using quarters. Have you ever tried buying anything for a quarter these days? Even arcade games and those toy machines at the grocery store charge at least 50 cents.  Toys and games start at a dollar and go up, so why did we pick quarters?

We wanted to give our children choices and incentives. They can earn quarters for helping out on extra house chores or if they behave well in public when we have to run errands. When we are out and about we are careful to explain what we are doing and to set reasonable expectations for their behavior. With their earnings their choice is simple: spend their quarters now or save them for later.

After the first couple of trips they spent their quarters on those little rides in the mall. Then we created what we call the “mom store,” which is a basket at home filled with some candies, small Lego® men and other small toys they can buy from us with their quarters. All of the items are priced in quarters. They started setting goals and saving their quarters. Sometimes the rides at the mall are still too tempting, but with a little reminder of how close they are to their goals their patience has begun to shine through.

Does this always work? …well, no. Sometimes just maintaining this system is a lot of work. The one person we did not factor into this lesson was Grandma. The children have started asking Grandma for quarter chores. They quickly realized that Grandma tends to pay more quarters for comparable tasks and then takes them to ice cream too. When they return from Grandma’s they go right to the “mom store.” I would not change the Grandma factor though. They are learning that different people expect different things.

As a result of implementing this reward system, we have better-behaved children and much less whining for things when we are shopping. We simply ask “how many quarters do you have?” or remind them it “looks like you better save some more quarters.” It has helped us cut down on the amount of clutter we have, especially those low quality toys that get played with once or twice and then break. We hope to teach them that it is better to acquire the things in life they want by earning them.

It’s 10 PM. Do you know how much you’ll need in retirement?

Americans’ Financial Capability” by Professor Annamaria Lusardi is a new working paper published by the National Bureau of Economic Research. Professor Lusardi’s paper reports the results of a survey of nearly 1,500 Americans regarding their financial status and investment knowledge. As reported by Mary Pilon in an article from The Wall Street Journal, Most Americans Haven’t Planned for Retirement and Other Areas of Concern, there are many areas of concern.

Among other questions, the survey asked whether people have tried to estimate how much to save for retirement. Only 42% of all respondents had tried to calculate how much they would need in retirement. The results were not much better for those closer to retirement. Among respondents who were 45 to 59 years old, only 49% had tried to estimate how much they needed to save for retirement.

Planning for retirement is a crucial step towards successfully saving for retirement. Whether you estimate it on your own, use a free web-based tool, or consult with a reputable financial advisor, take the time to plan for retirement. It is well worth the effort.

College savings options

In today’s competitive job market, saving for your child’s higher education is as important as ever. Although there are not an overwhelming number of savings choices, the subtleties between them are paramount. Below you will find what we at Merriman feel are the most important distinguishing characteristics between 529 plans, Coverdell ESA’s and UGMA/UTMA accounts.To find out why we favor using a 529 plan read the article “Saving for college just got better,” by Rich Buck.

529 PlanCoverdell Education Savings Account (ESA)Uniform Gift/Transfer to Minor Account (UGMA/UTMA)
Investment options availableThere are two types of 529 plans: 1) 529 savings plans, where the mutual fund investment choices are dictated by state run allocation programs, 2) 529 prepaid plans, which allow you to purchase tuition credits at prevailing rates.Investment options include individual stocks, CD's, or mutual funds. Precious metals, collectibles, partnerships in private business and direct ownership in real estae are not permitted.These accounts allow for stock, bond, and mutual fund investments. However, stock options and buying on margin are not allowed.
Contribution limitsYou can currently contribute $13,000 per year. As an alternative, you can contribute $65,000 (five times the annual gift tax exclusion) without incurring gift taxes, but then cannot contribute for the next four years.You can contribute a maximum of $2,000 annually.For 2011, contributions above $13,000 per year ($26,000 for married couples) are subject to gift tax.
Donor income restrictionsThere are no donor income restrictions.Donor income restrictions apply.There are no donor income restrictions.
Tax implicationsAssets grow tax-free and withdrawals are tax-free if used for qualified education expenses.

Certain states offer tax incentives for investing in 529 plans.
Contributions are not tax-deductible, but the account grows tax-free and withdrawals are tax-free if used for qualified education expenses.

Both the Hope and Lifetime Learning tax credits are allowed in the same year as an ESA withdrawal is made.
Contributions are not tax-deductible and they do not receive the tax benefits associated with 529 plans and ESA's.
Restrictions on use of fundsWithdrawals are only tax-free when used for qualified education expenses.

There is no age limit for investment disbursements.
The assets can be used for eligible expenses from kindergarten through graduate school.There is no requirement to use the funds for qualified education expenses.

When the beneficiary reaches the age of majority (usually 21, but could be 18 depending on the state), there are no restrictions on the use of withdrawals.
Who owns the funds?The account owner retains complete control of the assets and may change the beneficiary to an eligible family member of the original beneficiary.The account owner retains complete control of the assets and may change the beneficiary to an eligible family member of the original beneficiaryAssets are treated as belonging to the beneficiary, and will impact their ability to receive financial aid.

Meet Mallory!

2011 has been a great year for hiring fantastic new team members at Merriman. Mallory Braun, our newest client services team member, joined us on March 31st.  There is something quite soothing in her extremely pleasant phone voice. If you get the chance to speak with Mallory, you will quickly hear what I mean. She is a fabulous addition to our already wonderful client services team!

Mallory BraunMallory has three years of great client service experience under her belt, having worked for Key Bank prior to joining Merriman. She won numerous awards for achieving her goals and treating her clients with great care. Mallory gives every client an extraordinary experience and she is very excited about the interactions she has in talking with different Merriman clients each day.

Mallory grew up in Spokane, WA and went on to earn her Bachelor of Arts degree at the University of Washington in Seattle. She comes to us with a great deal of enthusiasm and truly wants to make a difference for our clients. You can read more about Mallory on our website, and here are a few fun facts that you won’t find in her bio:

  • Mallory was named after the TV character on the sit-com “Family Ties”
  • The first car she owned was built the same year she was born
  • She contemplated fashion or art school before deciding to attend the UW
  • She played tennis for her high school, Shadle Park
  • Mallory’s favorite vacation spot thus far is the Atlantis resort in the Bahamas

We are excited for you to get to know Mallory and we are thrilled to have her on our team!

401(k)s have mostly missed the boat on index funds

For over 28 years I have been chastising 401(k) plans for not offering some of the best funds in the industry. The investment offerings  that have been most obviously missing  from plans are index funds. What’s not to like about low costs, broad diversification and low turnover? Sometimes trustees will throw employees a bone by offering an S&P 500 index fund, but the long list of index funds we have been recommending for 15 years are rarely included.

Ron Lieber writes the Your Money column each Saturday in the New York Times.  He recently wrote a terrific article entitled, “Why 401(k)’s Should Offer Index Funds.” If you have a trustee who is dragging his or her feet in adding index funds, I suggest you put a copy of this article on their desk with a little note, “Wouldn’t you like to quit paying the extra fees and keep those profits in your account? The rest of us would. Signed, A Prudent Investor”

The gap between fund returns and investor returns

We advocate that investors choose a diversified portfolio of stocks and bonds, with the percentage in each depending, to a large degree, on their overall risk tolerance (the higher the risk tolerance, the higher the allocation to stocks). When the markets move and the actual weights deviate from the target weights, investors should then periodically rebalance by trimming those asset classes which have done best and buying those assets classes which have not done as well. This simple rebalancing technique removes much of the emotion from investing.

Emotions can have a negative impact on investment returns. Many investors respond to short-term market moves by buying assets after they have gone up and selling assets after they have declined in price. This is just the opposite of what we do when rebalancing our client accounts.

Russel Kinnel at Morningstar wrote an interesting article on this topic (“Mind the Gap 2011,” 4/18/11). He compares a mutual fund’s total returns with the fund’s investor returns, which take investor cash flows into account. If investors pour money into a fund after the fund has gone up, and sell after the fund has gone down in price, the investor returns will be less than the total returns of the fund.

Kinnel writes “In 2010, the average domestic fund earned a return of 18.7% compared with 16.7% for the average fund investor, making for a gap of 200 basis points. For the trailing three years, that gap was 128 basis points. For the past five years, it was 98 basis points, and for the past 10, it was 47 basis points.”

This shows the average domestic stock fund investor consistently demonstrates a poor sense of market timing.

Sticking with a long-term investment plan and not letting fear or greed unduly influence your portfolio decisions can increase your portfolio returns over time.

Bankrate.com: Gas drives consumers to shift spending

Tyler Bartlett, a Merriman financial advisor, comments on the effects of rising gas prices in this Bankrate.com article.

Bankrate.com: “What the nation said” about saving gracefully

Merriman financial advisor, Tyler Bartlett, was recently quoted by Bankrate.com in a Q & A on how people feel about the amount of money they have in savings now versus a year ago.

How risky is your portfolio?

One of the most important things you can do as an investor is keep your risks under control, and this is one of the most powerful lessons we teach at Merriman.

Our work has lots of fans. Allan Roth, a financial planner and author who teaches behavioral finance at the University of Denver, recently drew on some of our work to make the case that many investors are taking more risk than they realize. You can read his blog post on the topic at CBSMoneyWatch.com.

The house that Merriman is building

Our company tagline “Invest Wisely. Live Fully.” is centered on a healthy balance between work and life. This includes working passionately to better our clients’ investments as well as our community as a whole. For 2011, our company gave each employee 100 paid hours to do volunteer work during company time. When I heard that, I immediately realized the seriousness of this commitment. This was no token gesture; this was a real pledge to improve the community outside the walls of Merriman.HabitatTeam

Spearheaded by our Client Experience Director, Elaine Scoggins, an ever growing group of Merriman employees has been volunteering one Friday of every month with Habitat for Humanity at the Rainier Vista location in South Seattle, a generally lower income area. Habitat works in partnership with people everywhere, from all walks of life, to develop communities with people in need by building and renovating houses using volunteer labor, donated land, and donated materials. After making a down payment and contributing 500 hours of “sweat equity” on the construction of their home, families are given the keys to their new house with a no-interest mortgage, funded by Habitat. Families are selected based on level of need, willingness to become partners with Habitat, and ability to repay their loan.

HabitatAtWorkOur current work to build a group of four houses encompasses many different tasks, from shoveling gravel to moving lumber to hammering nails and everything in between. This being Washington after all also means that we have experienced a variety of conditions, including heavy rain, bitter cold, and even a few sunny days that you can see in our pictures. Naturally, this is quite a departure from our daily work in a climate controlled high rise office. Starting literally from the ground up, Merriman staff has done whatever we could and whatever was needed to turn dreams into reality for these families.

What is the end game of all of this labor? Four low income families who have never owned a home will get a chance to experience the safety, the security, the sense of place and belonging that many of us take for granted.

This has been a rewarding and positive experience for all of us, and we look forward to going there once a month until Rainier Vista’s scheduled ribbon cutting ceremony in December!

The effect your emotions around money can have on finances

I’ve always been fascinated by people’s emotions around money. I believe emotions are often the root cause of some of the most devastating financial mistakes that people make. Here at Merriman, we not only help our clients invest wisely, we also help them avoid these kinds of mistakes.

Now a study has been done by a professor at Kansas State University on this very topic, and an article about the study appeared in The New York Times this past weekend. As you read it, much can be learned from figuring out which group you fit into. It’s also interesting to think about which group your parents fit into and how their emotions around money may have affected you.

Meet Mischa!

If you have had the opportunity to speak with one of our great additions to the client services team, it’s likely you felt well taken care of when you hung up the phone. Mischa Bellarin is one of the newest members of our client service team. Mischa BellarinHe has been rigorously working away at learning how we take great care of our clients at Merriman. Mischa has a great deal of genuineness, warmth, and he definitely wants to make sure our clients’ needs are met. He also aims to exceed expectations, as do all of our fabulous client service team members.

Mischa grew up in Tacoma, WA and went on to earn his Bachelor of Arts degree in Economics at Eastern Washington University. He comes to us with endless amounts of enthusiasm and truly wants to make a difference for our clients. To get you started, here are a few fun facts you won’t find in his bio on our website:

Mischa…

  • just got married in September of 2010.
  • has a cat who won a beauty contest last year.
  • loves to find hidden burger dives when on a road trip and collects t-shirts from each one.
  • recently started playing the board game “Agricola” with a few other Merriman team members.

We can’t wait for you to get to know Mischa and we are thrilled to have him on our team!

Wall Street Journal: How to hit the target

Merriman Client Experience Director Elaine Scoggins is quoted in this Wall Street Journal article on target-date funds in a retirement portfolio.

CBS MoneyWatch: How risky is your portfolio?

Allan Roth, blogger for The Irrational Investor on CBS MoneyWatch.com quotes Merriman data in this post on portfolio risk.

Merriman in the press

You may have noticed that our talented staff members are more frequently being published outside our own Merriman blog and website. We’re proud to tell you this occurred twice in the past few days:

Director of Research Larry Katz’s article, “Three keys to a richer retirement,” was published on MarketWatch.com

Senior Editor Rich Buck was a featured blogger on Crosscut.com with a post on “The best graduation gift ever.”

Publishing in the national press allows us to share the expertise and writing talents of our team with a national audience. Since a big legacy of our company is providing free online financial education to the public, we feel like this activity is a perfect fit with who we are.

We hope you enjoy these two articles and future ones to come.

A blog post by Rich Buck on Crosscut.com

Merriman Senior Editor, Rich Buck, was featured on Crosscut.com with a blog post about the best graduation gift one can give.

Read the full post here.

Retirement article by Larry Katz on MarketWatch.com

An article by our very own Larry Katz has been featured on MarketWatch.com. Click here to read Larry’s thoughts on how to mitigate the impact of market declines after you’ve already retired.

Evaluating new investment products

“People calculate too much and think too little.”

This is a quote from Charlie Munger, Warren Buffett’s right hand man, and a world-class investor in his own right.

It is one of my favorite quotes and has rung true throughout my investment career. In my experience, many financial professionals accept numbers too easily without fully understanding assumptions, sensitivity to inputs, and general rules of economics and competition.

We are always looking for ways to better design client investment portfolios. Every year, we are bombarded with new investment approaches, new products and new trading strategies to beat the market. Most new products can be tossed aside immediately, but a few require more detailed investigation.

We necessarily perform calculations to back-test the new idea. That’s 20% of the work, and our first checkpoint to determine if an idea has merit. The remaining 80% of the work is thinking. Here are just a few of the questions we ask:

1. Can the source of enhanced returns be arbitraged away when many investors adopt such a strategy?

Generally, the more assets devoted to, and the more firms employing a strategy, the lower future returns. Some strategies have an enormously large capacity to manage assets before returns begin to suffer, while others, especially those with high turnover, are extremely sensitive to asset levels.

2. What is the risk story? Since expected returns increase with risk level, can we identify a non-diversifiable risk factor that an investment approach is exploiting?

Risk factors provide the basis for a well-designed portfolio because they are much less impacted by the number of investors and amount of money invested to exploit them. Common risk factors include the value and small-cap premiums for stocks, and the term premium for bonds.

3. Do back-tested results rely on constraints that no longer apply?

It’s hard for us to accept back-tested results for a strategy when transaction costs were much higher in the past or when no trading vehicle was available to exploit the strategy. Enhanced performance in the past is most likely a function of these constraints, which of course no longer apply.

4. How is the strategy expected to perform in a bear market or financial crisis when the correlation of all risky securities goes to one?

There are at least a dozen more questions, all of which help us to follow the spirit of Charlie Munger’s advice in designing an investment portfolio for long-term success.

Teaching young children about money

When I read this article from The New York Times, I was very happy to see that we as a nation are starting to expose young children to money matters. Using Sesame Street and the beloved Elmo is a perfect way to interest kids in the concepts of spending, saving and sharing, without talking over their heads or losing their interest.

The Sesame Street gang also spends time talking about want versus need. My brother started to teach this concept to my nephew when he was between 3 and 4 years old, and now at 5 he truly “gets it.” It doesn’t mean that he doesn’t feel he really NEEDS that new Star Wars Lego set at times, but when asked if he really does need it, he will admit he actually just wants it.

I’m as guilty as the next person of spoiling my nieces and nephew by being more than happy to buy them anything their hearts desire. But I have learned to hold back as I have seen the consequences of this behavior in many teenagers and young adults coming out of college in to their first jobs.

I hope you find The New York Times article informative and that you begin to expose kids as young as 3 to the concepts of want versus need as well as spend, share and save. You will be setting them up for success in the long run.

Rising college debt levels

This article in The New York Times (Lewin, Tamar, “Burden of College Loans on Graduates Grows”, April 12, 2011) speaks about the growing total level of college debt, which is a function of increasing college costs, increasing numbers of students going to college and the increasing numbers of those students who need to borrow to attend school.

The article goes on to state that two-thirds of those who received bachelor degrees graduated with debt in 2008, compared with less than half in 1993. In 2010, the average loan amount for those graduates finishing college with debt was $24,000.

Attending college is great for its own sake, and also leads to substantially higher lifetime earnings and lower unemployment. However, both parents and students should consider the incremental costs and benefits of attending, for example, an expensive out-of-state private university instead of an in-state public university. Both might give the student a fine education, with good prospects for future potential graduate schools and/or jobs.

The private school might have more prestige.  The question is whether this is a sufficient inducement to incur large amounts of debt which could negatively impact the retirement plans of the parents or the future lifestyle of the student. There is no right answer to this, but it is certainly something our clients can discuss with their financial advisors.

Stay connected with Merriman

We like to share whatever is currently on our minds, and there are a number of ways we do it. In addition to blog posts you read here, we frequently post on a number of other information sharing networks, so you can get information from Merriman wherever is most convenient for you.

Follow us on Twitter: @MerrimanLLC

Like us on Facebook: Merriman, LLC

Subscribe to our RSS feed

And, if you haven’t already, you may want to sign up for our semi-monthly email newsletter. It contains links to some of our most valuable educational materials, in addition to some features not seen elsewhere. Take a look at the most recent edition here.

Umbrella insurance – why it might be a good idea for you

Say it out loud: “Today I will schedule a time to talk with my insurance person about an umbrella insurance policy.”

Why?  Soaring healthcare costs and the lawsuit-crazy world we live in certainly can put you at risk of exceeding your liability limits on your home and auto policies.  An example: you are driving and slide on some ice and strike another vehicle and the driver of that vehicle suffers a broken arm.  You would think your auto policy liability coverage should be enough, but in this case the driver is a surgeon who can’t work for 18 months.  You could end up with liability above what your policy pays.  This is where the umbrella policy will step in and cover much higher limits. Typically, people will get coverage of $1-2 million, depending on their lifestyle.

Umbrella insurance policies are inexpensive assuming you have adequate limits on your existing policies.  It will be a good opportunity to review all your liability limits and make appropriate changes to protect your assets.   A competent insurance person can help guide you in determining the best coverage for your situation.

Schedule it today!

Why we survey our clients and what we do with that information

It’s no secret that businesses make mistakes. We’ve made our fair share of them, and we took a long, hard look back at these mistakes to see if there was something we could learn.

We realized that we were making decisions with the best of intentions, but within a small vacuum. Often times, these changes were spurred by client feedback, but that feedback represented only a small portion of the client base, or wasn’t really the root-cause of the client concerns.

To keep this from happening again, we made a substantial commitment about two years ago – to regularly survey our clients and collect feedback about how well they think we’re doing. About once a year, we send each and every client who has access to email a brief electronic survey. While we do ask a few specific questions, we often find the most benefit in providing the opportunity to give open-ended feedback. It allows our clients to start a conversation about what would make working with Merriman an even better experience.

When we started this process, we all got in a room and thought about the things we don’t like about receiving a survey. The number one issue that came up was that we don’t think anyone reads these things. We made an internal promise that this would not be the case for our surveys, and we have kept that promise.

I read every single comment provided, and a group of people in our Marketing department read, classify and analyze these comments, ultimately making recommendations to the business based on this feedback.

In the first two years of surveying, we have learned a lot. We have made changes to how we work with our clients as a direct result of the feedback we’ve received. Here are some of those changes:

  • Our advisors send more information to our clients than ever before, including articles on our products and services that are specifically designed for our clients only.
  • Educational materials we provide to the public as part of our education outreach sometimes go to clients before being posted to the web for everyone to read.
  • We started a client advisory board, where we meet face-to-face with a rotating, small group of clients to better understand some of our survey feedback, collect new ideas and fine-tune things we’re working on.
  • We began offering information via Twitter and Facebook as new ways to keep people up-to-date about investing, our services and educational products.

There’s a lot more to come.

Please, take the time to respond to our surveys, and know that we read and appreciate every response we receive. The data we gather helps me and the rest of the team make decisions that ultimately keep you satisfied and on the right path with your investments.

Fancy seeing you here

Recently my wife and I took our children to Disneyland. From Seattle the trip is a quick two-hour plane ride and a short ride to the resort. As fast as the trip appears on paper, I always worry about taking young children on a plane where there is no place to go if that all-too-familiar tantrum occurs.

With that thought in mind, we boarded the plane early to allow the children to get settled into their surroundings before we have to take off. As the kids were working out who was going to sit by the window, I sat in my aisle seat across from them and wondered who would be joining me by my window.

As I stepped into the aisle to allow two people to join my row I looked up to see a fair-haired little boy, about two years old, and his father—my client. “WOW” escaped my lips. Of all the places and all the times to run into a client…and to think we’d end up sitting in the same row! The coincidence did not end on the plane. He was also traveling to Disneyland, where he was meeting his parents (also clients) and staying at the same hotel.

It is a real treat to be able to visit with clients by accident like this. When they are in the office or on the phone, a lot of the time it is all about business. Yes, we hear great vacation stories and sometimes even see pictures, but to just visit for the sake of passing two hours on a plane was great.

I truly enjoyed watching his young son playing, looking out the window and just being himself. It is so rare that my clients get to meet my family or that my family gets to meet one of my clients.

The plane ride passed uneventfully, which is fantastic considering we had three children under the age of six between our families. We had a pleasant conversation and decided to meet up during our stay. I was really looking forward to it—his parents are also my clients and this would be the first time I would meet them in person.

Sunday morning we met up in a play area near our hotel. There was a slide, rope bridge and a lookout tower to keep the children occupied while we talked casually, sharing stories about the kids and mostly just enjoying the moment.

It is so rare for me to see my clients and enjoy their company in everyday life. I believe it strengthens the most important part of what we do at Merriman and that is building relationships. Without that, we would not be in business.

My client is adding another precious child to his family soon. I treasure opportunities like this to be a part of their lives. I hope the relationship lasts so I can help them with college questions and offer assistance with other important life events.

RMDs and Charitable contributions

If you have IRA accounts and are over age 70 ½, then you probably know about the Required Minimum Distribution (RMD) rules. These IRS rules require you to take money out of your retirement accounts each year, whether you need the money or not.

This money could be spent or re-invested back into a taxable investment account to allow it to continue to grow. Some people deposit this money to their checking account, and eventually use it to make a charitable contribution to the charity of their choice.

Fortunately, the government recently extended a provision through 2011, which allows individuals over age 70 ½ to exclude up to $100,000 from their gross income if it is paid directly from an IRA to a qualified charity. In addition, that excluded amount can be used to satisfy the RMD for the year.

This could potentially be a much more tax-efficient way to make charitable contributions than by depositing the RMD amount in your bank account and then writing a check for charity. If you’re a Merriman client, we can help you complete the paperwork accordingly, just give us a call.

To find out more information on this valuable topic, please discuss with your CPA or read this article from the IRS.

Coming to Seattle for a meeting with your advisor?

Is it time for your review?  If that means a drive into the city for you, then why not make a day of it?

There’s the usual shopping and lunch, but how about a stroll through a park? Seattle neighborhoods offer some wonderfully-urban, free outdoor experiences. Here are two of my favorites.

Capitol Hill’s Volunteer Park has been around since the late 1800s, but it was between 1904 and 1909 that the famous Olmsted Brothers formalized the design with lily ponds, a wading pool and a music pavilion. The park is also known for its conservatory, built in 1912, which houses flowering plants from all over the world and a collection of orchids (over 600 varieties).

The Volunteer Park Water Tower, built in 1906, is built on the high point of Capitol Hill (elevation 444.5’). If you climb the 106 stairs to the top, you are rewarded with a small exhibit about the Olmsted Brothers and their work on the Seattle parks system.

Belltown offers up the Seattle Art Museum’s Olympic Sculpture Park. From this inner-city oasis you have views of the Olympic Mountains, Space Needle and Mt. Rainier. You can also walk right down to the waters of the Puget Sound and dip your toe. Sculptures on display include works by recognizable names like Alexander Calder (Eagle, 1971) and Louise Bourgeouis (Eye Benches I, 1996-1997).

And there is that great Claes Oldenburg and Coosje van Bruggen Typewriter Eraser, Scale X. I love that sculpture. And to think kids today don’t even know what a typewriter is/was, let alone a typewriter eraser!

The gardens of the sculpture park are based on four archetypal landscapes found in the Pacific Northwest. A valley, a grove, a meadow and the shore are all represented. The result is a setting loved by the art set and outdoorsy-types alike.

Next time you’re in town for your review, take a moment to smell the flowers.

We are green as we update our logo

Here at Merriman we take our commitment and responsibilities for managing your investments earnestly.  Because remaining true to our commitment for sustainability and being a carbon neutral firm is so important to us, we made a responsible decision when updating our logo. You may see some variation in our stationary when you receive correspondence from us in the near future. Our logo on our letterhead may be updated, but you may see our old logo on the envelopes. Rest assured this is a conscious choice on our part because we feel passionately about not wasting resources. Whenever possible we reduce, reuse and recycle – it is not a catch phrase around here, it is something we all value and live by.

We ask that you please pardon us if we are wearing mismatched socks for a little while. We plan to responsibly exhaust our existing supply while integrating our new supply of printed materials.

We’ll say it again: The choice of assets can make a big difference.

There was an interesting article in the Wall Street Journal from March 8, 2011 called “Why Small-Cap Funds are Lagging.” It cites a study by Credit Suisse showing that “small-cap funds have increasingly been investing in companies larger than their category name would indicate—and the average fund is underperforming its benchmark.”

The article goes on to say “The average market capitalization of a company in a small-cap fund was about $3.1 billion at the end of 2010, compared to the average market cap of the benchmark Russell 2000 index of about $1.3 billion. The $1.8 billion gap between the two is the largest since September 2008.”

“In 2010, the average small-cap fund lagged the Russell benchmark. The average small-cap fund gained 24.3%,” compared with 26.85% for the Russell 2000. “In February, just 27% of Russell 2000 core funds beat the benchmark.”

At Merriman, we use Dimensional Fund Advisor (DFA) funds for a variety of reasons, including their lack of style drift and their expertise in buying small cap stocks. The weighted average market cap in DFA’s U.S. Small Cap Portfolio is $1.24 billion, much closer to the market cap of the index than the small-cap funds cited in the study.

In 2010, DFA’s U.S. Small Cap fund returned 30.70%, handily beating the Russell 2000. In February 2011 it returned 5.61% versus the Russell 2000 return of 5.48%.

Style consistency and expertise are important considerations when choosing funds.

The benefits of a review meeting with your advisor

Working at Merriman has many great benefits because of the importance this company places on taking care of its employees creating a truly unique work environment. But one benefit that is often forgotten about is the fact that we also get to take advantage of our own services. It is so awesome to work at an office so rich with knowledge. I love sitting down with my own advisor, Phuc Dang, to go over my savings and expenses. Having a third party review my financial situation is extremely helpful – Phuc always finds a little something I missed, and can point out ways to use or save my money more wisely.

One of my many responsibilities at Merriman is to send out a friendly reminder to our clients when it is time for their review. A common response is that everything is going well with their accounts and therefore a review is not needed. While it is great that our clients are comfortable in knowing they are investing wisely, it’s also important to make sure you’re living fully. These reviews are a great time to touch base with your advisor and go over the sometimes forgotten little things that could make your situation that much better.

When you get the reminder that it is time to come in for your review, remember this is an opportunity to live fully not just invest wisely. Your advisor is here to look at the whole picture, not just your portfolio and returns. The work you do with your advisor should not only be about your financial situation, but also your quality of life.

To read more about what you might talk with your advisor about in a review meeting, read this post from Elaine Scoggins on the things we can help with.

Lessons learned in a market downturn

It was not that long ago when the equity markets were down over 50%, buy-and-hold investing had been declared dead, and many investors had little faith that the markets would recover during their lifetime.  Two years later the equity markets have risen significantly.  Many investors may not understand why as the recovery has occurred during a period of soaring deficits, major bank failures, increased tensions in the Middle East, rising prices for oil and gold, and uncertainty over the financial stability of the European Union.

This article by David Callaway offers lessons that many investors have learned during this most recent downturn:  The market has always recovered without the ability to see nor predict the turning point until after the fact. Buy-and-hold investment strategies are not dead, and investors who stayed the course through thick and thin did quite well. Diversification works, and diversified portfolios have helped to capture the best of market movements.  Quite possibly the most important lesson we can all learn is that as the daily noise of the news grows louder and louder, often times the best thing we can do is tune it out.

Revisiting the “outlandish” predictions of the late 1990s

Here’s a little blast from the past.  Remember the “DOW 36,000” guy?  I guess sooner or later, they all come to their senses and realize that a well-balanced and thoroughly diversified portfolio with periodic rebalancing makes the most sense.

Read more about how we invest at Merriman.

What I have learned from clients

Everywhere I have worked, I have had the pleasure of talking directly with clients. About 18 months ago, we embarked on an ambitious program of surveying our clients on a recurring basis. When we launched the program I set out to call everyone who responded to the survey to, at the very least, thank them for taking the time to share their thoughts with us.

Most of my calls were a joy to make. It was fun to bask in the happy, supportive comments of our satisfied clients. I learned how much they enjoy working with their advisor, listening to our podcast or enjoying the freedom that comes from having a partner to help you manage your money.

This process also gave me a chance to learn some fantastic things from the lengthy conversations I had with the handful of dissatisfied clients who responded. Here are some gems from those calls:

  • Financial professionals measure relative performance and, while that is important, it’s ACTUAL performance that puts your child through college or allows you to retire.
  • It is not enough to quietly take great care of you. Doubt can creep in, particularly during times of market volatility, and more communication from us helps ease that doubt and reminds you that you’re in good hands.
  • We may not be the right investment philosophy for you. Or maybe we once were, but your philosophy has changed over time. We still believe strongly in what we do. Rather than being frustrated with us for not changing our investment philosophy, let’s find the right program together.
  • You may not fully understand what we do. This can lead to frustration and dissatisfaction.

The biggest lesson for me has been this: You can learn invaluable lessons by listening to the things people are struggling with, happy about, and would like to see from us as a firm. These conversations are the spark that helps me and the rest of the team make decisions to keep our clients as satisfied as possible.

I want to hear from you, satisfied or not. Send me a note: greg@merriman.com.

A refresher on capital gains and losses

This time of year, most of us are thinking about taxes.  But with Congress frequently changing the tax law, it’s not always easy to remember how specific rules are applied.  Fortunately, the IRS has published a recent list of tax tips relating to capital gains and losses to help remind us of some of those rules.  You can check out the list here.

It’s a great refresher for all of us!

Strategies for recovering from market downturns in retirement

This article from T. Rowe Price provides some examples of prudent and not so prudent strategies for recovering from a severe market downturn in retirement. The study cited in this article once again illustrates how making wholesale portfolio changes during such a time can be the very worst idea, while keeping the focus on reducing portfolio withdrawal rates is optimal.

The only thing I would add is this: Because not everybody can significantly reduce their living expenses during a market downturn, although most can do so more than they think, this is yet another reason why it is so important not to enter retirement undersaved or without a comfortable level of emergency cash reserves. To do otherwise is a big gamble.

College and university visits with kids

When I was growing up I always knew I would go to college, though I don’t remember setting foot on any campus until I was a teenager. To my mind, nothing could have been more natural.

Now I know better. Many perfectly capable adults don’t get a college education even though they could find a way to pay for it. I think one reason is that college just isn’t part of their experience while they’re young. But when young people don’t seriously think about colleges until they are in high school, they are missing a great opportunity. So are their parents.

I’m going to see that my granddaughter, now 6, doesn’t miss that opportunity. Over the next 10 or so years I’ll make sure she gets ample exposure to campuses. By the time she is done with high school, she’ll feel at home on a campus filled with young people having fun while they follow a huge variety of interesting pursuits. Whenever I have her for an excursion, I’ll try to find a nearby campus with something interesting going on. I’m pretty sure we’ll find much more than just classrooms and laboratories.

When I began thinking about this, I worried that after the museums and libraries, my granddaughter and I might get bored. So I spent a couple hours of easy “research” using Google and Bing. Totally at random, I chose seven colleges and universities. For each, I typed the name of the college and the word “events.” That was all it took to unlock a world of interesting things going on.

At one university, in addition to basketball, volleyball, football and a swimming/diving meet, I found an art exhibition with works by Picasso, Chagall and others and a Rick Steves travel lecture. At another I found a violin recital, a wind symphony concert, an all-day campus game called “humans vs. zombies,” a tamale feed, final exams (fortunately I can skip them), and a bring-your-own-computer-games party.

A state university’s scheduled events offered domestic and international film festivals, family language classes, a career fair, a Native American crafts show, fiction readings, and a dance marathon. Elsewhere I found a lecture in a planetarium, a symphony orchestra concert with the university’s children’s choir, an improvised play delivered in the style of Shakespeare, and an opera version of The Grapes of Wrath.

At a university in Tacoma I found an evening of (I am not making this up) kayaking in the university swimming pool. A small liberal arts college in Boston offered a multimedia fairy tale about a janitor, apparently inspired by a Hans Christian Andersen story.

If I could find all this at just seven institutions, imagine what else is out there. And don’t forget community colleges, which offer all the same types of things, usually on a smaller scale.

Any parent can follow my simple plan. When the family travels to a new city, get in the habit of checking out colleges as naturally as movie theaters and sports parks. Older children can do the finding on their laptops and smartphones.

I know I have merely scratched the surface of campus activities, and I’m looking forward to digging deeper with my granddaughter. Over the next 10 years or so, I think this cultural smorgasbord will be as good for me as for her.

Working with Merriman

Custodians like Schwab sometimes have separate departments for managing “retail” accounts (for people working directly with Schwab) and “institutional” accounts (for people, like our clients, who work with an investment advisor). Often, these different departments have different forms that do exactly the same things.

I recently got a phone call from our representative at Charles Schwab (the custodian of many of our client accounts), and they received a form that the client sent in on their own to add a feature to their account. Unfortunately, it was a form for the retail side of Schwab which does not allow the investment advisor—Merriman—to act on what the client was trying to set up.

In this case, Schwab was fortunately able to do what the client needed, but I had to send the client another form with the investment advisor information so Merriman could help the client with this feature in the future.

Our clients pay us to manage their accounts, and we want to help in any way we can. If a client wants to add a feature to their account we encourage them to come to us so we can avoid this type of confusion. As a client, it’s always best for you to call us first to get the best out of your account.

If it isn’t broken, don’t break it

In my experience, there are a lot of successful companies that get things right and there are a lot of profitable companies that get things wrong. At Merriman we like to think of ourselves as a successful business with predominantly happy clients, yet we are desperately seeking feedback. Why? We figure that, while it’s always important to know when clients are upset with us, it might be even more important to know what makes them especially happy with us. It helps us know what NOT to change.

All too often I have visited a favorite service provider and been disappointed that they changed the one thing that differentiated them from their competitors in their field.

We are certainly not immune to this problem. As I look back to learn from our mistakes, I often see a pattern:

  1. We are changing something in the name of “improvement.”
  2. We get input from our colleagues in the firm, or perhaps from outside “experts.”
  3. We fail to get accurate feedback from our clients.

Change is important. A company like ours needs to innovate to prevent stagnation, and to continue to provide top-notch service to our clients. But changes should be grounded in good data. It is for that reason we continue to ask our clients for feedback on how we are doing, how we can improve and what matters most to them.

We read the responses, and take them very seriously. You might think we focus entirely on the few dissatisfied clients who respond, but I learn a lot from the satisfied clients too. I learn what not to change, and that can be critical as we continue to try to improve our service offering.

I encourage you to respond and give feedback to all companies you work with. While some may not be able to, or choose not to respond to your feedback, I have learned that if you don’t speak up you will never get the service you want.

As for Merriman, I want to hear from you about our services, employees, and products. That way I can continue to keep my finger on the pulse of what matters most to people, our clients and our friends.

Send me a note: greg@merriman.com.

Investments at Merriman include people, too

For the past eleven years, Scott Rothman has been a part of Merriman. When he started with us in March of 2000, Scott was originally part of our marketing efforts. Scott recalls his job as primarily answering phones and setting appointments. The company has grown quite a bit since the year 2000, and so have Scott’s responsibilities.

Moving from answering phones into our client services department, Scott has become a household name for many of our clients. They have gotten to know him over the years and come to trust his reliability when it comes to taking care of their needs. This is only one of the many reasons Scott was recently promoted to manage our client services team.

Although Scott has transitioned into a management position, he wants everyone to know he is still available anytime. His true passion has been and still remains taking care of our clients.

Scott is the latest Merriman employee to be promoted from within, but is certainly not the only person who has truly grown within our firm. Of our current 38 employees, eleven of them have transitioned into a new role or taken on additional responsibilities during their tenure.

Tenure is also a good indicator as to whether people are enjoying their work and take pride in what they do. For those of you who enjoy statistics (I’m not usually one of them, by the way) I gathered some interesting data. We have seven people who have been with us for more than five years, five people who have been here more than ten years, four at more than fifteen years, and three that have surpassed the 20 year mark. Our founder still has the longest tenure, at 27 years.

We take investing in our employees as seriously as we take investing for our clients. It is truly enjoyable to watch the growth of our people as we strive to do the very best for our clients.

Barron’s chooses Dimensional Fund Advisors as “Best Mutual Fund Family” for 2010

Dimensional Fund Advisors (DFA) is the manager of all the equity mutual funds we recommend to our clients. In today’s issue of Barron’s, DFA was ranked the best for 2010 in a special report on “The Best Mutual Fund Families.” You can read the full article at Barron’s website, but here are some excerpts:

Dimensional Fund Advisors, whose quant[itative] funds operate almost like indexes, was in precisely the right markets and watched its pennies.

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Of course, it’s impossible to time stock- and bond-market changes and the strategy that’s paid off for the best big fund families – as well as investors – is a diversified one. Our No. 1, DFA, is a global asset manager that oversees $206.5 billion in all and owns a mind-boggling 13,000 stocks, or about 70% of the world’s publicly listed equities. Because DFA’s investment process is purely quantitative, it doesn’t have the option of succumbing to fear in the face of adversity. It certainly helped that DFA focuses much of its attention on some of last year’s highest-performing equity areas – value, small-cap and emerging markets.

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The privately held firm (Arnold Schwarzenegger is an investor) also is known for keeping a lid on costs that can rob shareholders of performance points, steering clear of some foreign markets where it doesn’t believe funds can get a fair shake on prices.

Congratulations to DFA!

A team approach – what it means for you

At Merriman, one of our main goals is to provide exceptional service to our clients and place their needs first. One of the ways we do that is by supporting our clients with an entire team of people. As a client of Merriman’s, you’ll work with your Financial Advisor, of course, but you’ll also have the help of Client and Support Services Representatives, as well as Research and Finance staff. We at Merriman believe this team approach is a benefit you’ll feel far and wide.

When you call our office during business hours, our Support Services staff will personally answer your call. Imagine your advisor is either in a consultation or company meeting and all you need a simple request fulfilled. Anywhere else, you’d be sent to voicemail, regardless of how urgent your request is. How frustrating is that?

At Merriman, you’ll be given the option to speak to our Client Service team. There are very few things this team can’t help you with, and with a group of four people willing and ready to help, there’s almost always someone you can speak to right away.

This group supports our advisors in all aspects of your account management, except trading and giving financial advice. In fact, most of our clients’ requests for account maintenance activities (things like address changes, distributions, requests for forms and general questions) end up on their desks!

So next time you call us, if your Financial Advisor is busy, ask for your Client Services team. If it’s something they can help you with and save you the time waiting for a call back, they’re happy to do it!

Is rampant inflation an upcoming problem for the US?

I am a buy and hold investor, but two recent lectures by Niall Ferguson, a Harvard Economic-Historian, make a strong case for the impending economic collapse of the United States. He predicts default and/or rampant inflation and suggests re-allocating one’s portfolio to a mixture of gold and foreign investments. I can already hear you saying “no, this time won’t be different, America will recover”, but I suppose I just wanted to hear it straight from the source. Any words of wisdom would be most appreciated.

At any given time, it is not difficult to find somebody professing to know the short term future of the economy or the capital markets.  Quite often these people are highly regarded professionals armed with plenty of data to support their claims.  And quite often they are wrong.  History is replete with examples of how investors made wholesale changes in their portfolios based on excessively optimistic or pessimistic predictions, only to regret it deeply after the opposite occurred.

We believe that the future is fundamentally unknowable, and thus cannot be predicted with any precision. We believe investors could use their time and energy and brainpower much more effectively by controlling what they can control instead of trying to predict what cannot be predicted. We do this for our clients and with our clients by maintaining portfolios that are designed to address a wide range of economic and market climates, including inflation.

When we evaluate predictions that are in wide circulation or that are made by authorities we respect, we believe it makes sense to consider how a portfolio might protect an investor if the prediction materializes — and if it does not.  When we think about both of these possible scenarios, quite often we find that the logical solution is to maintain a portfolio that is well-balanced and thoroughly diversified.

Like you, we also have faith in the capital markets, and because the future cannot be known in advance, we are always quick to acknowledge that any given prediction may actually occur.  The problem, of course, is that we cannot know that until after the fact, no matter how obvious or compelling the prediction may seem at the time.  The important consideration for most people should be this: If they radically alter their well-balanced and thoroughly diversified portfolio based on a prediction, can they accept the financial and emotional consequences if the prediction fails to materialize or even if exactly the opposite occurs?

We certainly saw a lot of failed predictions over the last three years, yet most people who maintained their 50/50 or 60/40 portfolios through it all experienced significantly lower levels of volatility during the decline and participated very meaningfully in the recovery.  By contrast, many investors who dramatically altered their portfolios based on predictions made with table pounding certainty experienced all or most of the decline and in many cases were out of the market on the sidelines when the great market recovery of 2009 and 2010 got into gear.

It is also interesting to look back and ask how many experts, if any, predicted anything like that robust recovery. And if you had read or heard such a prediction in January or February of 2009, after a huge, depressing market slide, would you have recognized it as valid? Would you have invested your money in the stock market at that time?

Traditional vs Roth 401(k)

Do you have the Roth 401(k) option available to you?  If so, it may be worth looking into.  The following table compares the features of a Roth 401(k) to those of a traditional 401(k).

Traditional 401(k)Roth 401(k)
Annual contribution limit$16,500 ($22,000 for participants age 50 and above)$16,500 ($22,000 for participants age 50 and above)
Matching contributionsAllowed. May be combined with employee contributionsDeposited separately in a Traditional 401(k) account. Taxed when withdrawn
Tax status – employee contributionsMade with pre-tax dollars; deductible from current incomeMade with after-tax dollars; not deductible from current income
Tax status – withdrawals after age 59½Taxable as ordinary incomeNot taxable
Mandatory withdrawalsRequired minimum distributions start at age 70½Required minimum distributions start at age 70½
Best for


Employees who need the current tax deduction, who will make withdrawals within five years, or who will be in same or lower tax bracket in retirementEmployees who do not need the current tax deduction, who will not make withdrawals for five years or more, or who will be in higher tax bracket in retirement
ConcernsAll growth in the account, including capital gains on equity investments that would qualify for favorable capital-gains treatment if earned outside a retirement account, are taxed at ordinary income ratesIf tax rates decline, early payment of taxes will have been counter-productive; requires giving up more current income to maximize employer match

MarketWatch: Why investors shouldn’t break with muni bonds

MarketWatch recently published an article providing some prudent perspective for those investors considering abandoning their muni bond investments. Read the full article here.

Paul Merriman profiled in The Oregonian

Merriman founder Paul Merriman was interviewed in The Oregonian about 401kHelp and the free education we have been providing investors with since 1983.

Get the full article here.

2010 year in review from Dimensional Fund Advisors

Dimensional Fund Advisors, the manager of many of the mutual funds in our client portfolios, wrote this comprehensive economic and investment review of the year 2010. We hope you find it as interesting as we did.

Working with clients beyond the office

Many clients are surprised to learn that about half of our clients reside outside of Washington State. Although we have only one office in downtown Seattle, we are able to bridge the distance gap by using an online tool called WebEx.

When combined with the typical communication channels of phone, email, and fax, WebEx offers our clients a robust interactive experience without the need to ever step foot into our office.

Through WebEx, I can share my computer screen with clients anywhere in the world as long as they have an internet connection. It provides for a more interactive meeting because we can look at the exact same thing on the computer screen, and clients can see my mouse pointer move in real-time when I highlight a certain section of a report, chart, or graph. WebEx is extremely easy to use; there is no advanced setup needed and we can usually get a new user up and running in less than five minutes. It’s so easy, in fact, that I’ve been able to use it with clients who have very little computer knowledge! Best of all, WebEx doesn’t cost a thing for our clients to use.

So, the next time you schedule a meeting or review with us and you will have internet access during the meeting, be sure to ask us about WebEx. Of course, we always enjoy meeting clients face-to-face, and we encourage you to stop by when you’re in the Seattle area.

You can take a quick 3-minute tour of the free WebEx tool by clicking here.

Can annuity gains be offset against capital losses?

Can annuity gains be offset against other ordinary capital losses if I want to get out of a variable annuity-since you recommend against them?


The short answer is no. All gains inside an annuity, including capital gains, are taxed as if they were ordinary income. (This is one of the reasons we don’t favor annuities.) Therefore, you won’t have those gains available to offset capital losses.   The article “Fixed Indexed Annuities: Perfect product or a rip-off?” provides some additional insight into the world of annuities.

Why go green?

You may have notice our employees email signature, We are proud to be a carbon neutral firm and a partner with Carbonfund and SeattleClimatePartnership.

When we decided to look at sustainability and become a green organization in 2007, the goal seemed vast. I think a lot of people feel this way when they begin the process of leaving a carbon neutral footprint. A carbon footprint is the total amount of greenhouse gases produced to directly and indirectly support human activities, usually expressed in equivalent tons of carbon dioxide (CO2).

The City of Seattle’s Climate Protection Initiative was formed by Mayor Nickels and pledged that Seattle would reduce greenhouse gas (GHG) emissions to 7 percent below 1990 levels by 2012. To carry out the policies and to achieve the reduction Mayor Nickels approved the creation of the Seattle Climate Partnership. We have volunteered to be part of this program and committed to become a green organization.

Our former CEO, Jeff Merriman-Cohen launched our green initiative and was heavily involved in the early steps to becoming a green organization. Colleen Lindstrom, our new CEO, shares this passion which is contagious here at Merriman.

Once we mastered the basics of reducing, reusing and recycling we thought of bigger and broader ways we could function with sustainability within our space. We were inspired to implement green concepts into our design and architecture of our office space, from DIRTT walls to recycled ceiling tiles and motion-sensor lights.

We continually foster and encourage green living at the office and at home. Our employee recognition program called “Caught You Green Handed,” encourages employees to think and act green. The prize they receive is a green product they can take home, enabling them to continue their green behaviors outside of the office. We are continually looking for ways to be good stewards of the earth and this year we started composting in our kitchen.

We post weekly green tips on our company intranet to keep the concepts fresh and in the front of our minds. We use re-usable picnic cups and plates for 40 employees and their family members at our annual company picnic. We deal with the inconvenience of bringing dirty dishes back to the office for washing because it’s the right thing to do for our environment.

For all our efforts, we still leave a carbon footprint. We choose to off-set our remaining footprint through Carbonfund.  A carbon offset represents a reduction in carbon dioxide (CO2) somewhere else, like a renewable energy or reforestation project, to balance out the emissions you cannot reduce

We are very fortunate that our CEO is passionate about sustainability and wants to inspire positive change. Through real-world examples we are able to help our employees make the world a better place for all its inhabitants.

Bloomberg Businessweek: Retirement Looms: Time to Get Nervous

Elaine Scoggins is quoted in this article on the financial headaches that come with preparing for retirement.

Read the full article here.

A quick tip: sign up for electronic delivery

There is a long-running joke in the financial services industry that when a client opens an account, a tree is sacrificed in their honor. Unfortunately, there is a lot of truth in that statement.  Both Charles Schwab and Fidelity are required to provide you with important disclosure information in addition to your regular monthly account and transaction confirmation statements.  All of these reports are designed to help provide you with important and easy ways to review your portfolio.

Fortunately, you may choose to receive this information electronically.  We encourage our clients to sign up for electronic delivery of monthly statements, trade confirmations and fund materials, such as prospectuses and annual reports.  This will save you time and energy when going through your mail.  If you need assistance with setting up any of these features, please do not hesitate to call your advisor or client services representative.

Additionally, Charles Schwab and Fidelity have provided us with the following feature guides to better help you understand your custodial account statements. If you have any questions, please call our office at 1-800-423-4893.

Schwab feature guideFidelity feature guide

Is there a formula for happiness?

With the new year upon us, many of us will be wondering how we can make 2011 a happier year than the one that has come to a close.

The book, “Stumbling on Happiness,” contains a story about a Dutch mathematician named Bernoulli, who in 1738, thought he’d discovered a simple mathematical formula that could predict happiness.

Putting his formula into non-mathematical terms, you simply take any decision you are pondering and predict the probability that this path will give you pleasure.  He believed that if you used this to guide you at every fork in the road, you would be able to achieve lasting happiness.

Alas, there was only one problem with Bernoulli’s equation:  We human beings have a heck of a time successfully predicting, i.e. imagining what will bring us pleasure and what won’t.  Although we may believe we want something, when we finally get it, it often doesn’t make us nearly as happy as we thought it would.

Or we get something we want and it makes us happy, but then we raise the bar for our future happiness:  I’m happy now that I have X, but I’ll be REALLY happy when I get Y.

Although Bernoulli’s formula proved to be far too simplistic, he was correct in realizing that wealth and possessions, in and of themselves, don’t ensure happiness.  In fact, he believed that the more of anything we come to possess over time—dollars, houses, cars, you name it—the less these things make us incrementally happier.

So what, if anything can we take away from Bernoulli’s theories on happiness?  Is there anything practical that would help each of us live happier lives in the New Year?

Happiness is such a deeply personal and complex subject, that I’m not sure any broad, sweeping conclusions can be extracted from his work or anyone else’s for that matter that would apply to all of us, all of the time.

But what I have learned about happiness in my own life is this:  it isn’t located out there somewhere in the distant future.  Nor is it something I should keep waiting to achieve as I once believed when I was younger.

Rather it is here for me to experience every single day of my life if I want to, in the most simple moments:  the rich aroma of coffee beans as I pour them into the grinder in the morning, the sound of a friend belly laughing on the phone, a text message from my daughter or husband saying they miss me, and the warm sunlight on my face during a walk around the lake near my home.

These are just the ones from yesterday that I recall.  These kinds of pleasurable moments happen every day in abundance and all I have to do is slow down to notice them, even some of them, to considerably raise my level of happiness.

Being a little rusty on my high school algebra, I won’t try to convert this into a mathematical formula.  But I think you get the picture.

I still admire Bernoulli though for attempting to find a formula for happiness.  These few sentences taken from the end of the book sum up nicely his place in history:

Daniel Bernoulli dreamed of a world in which a simple formula would allow us all to determine our futures with perspicacity and foresight.  But foresight is a fragile talent that often leaves us squinting, straining to see what it would be like to have this, go there, or do that.  There is no simple formula for finding happiness.

To that last sentence I would add this: except stopping to appreciate the small daily pleasures that happen to us all—one moment and one day at a time.

To our Merriman clients, our friends, and our readers, we wish you many of these moments in the new year!

We answer the phone when you call. It’s that simple.

I was recently the victim of fraud.  Someone got my credit card number and sold it.  Then someone charged $1,000 worth of groceries to it in Madrid, Spain.  I ran through a range of emotions during this experience, but do you know what the most frustrating thing was?  When I went to report it, to talk to the financial institution involved, it took forever to get to a real person.  I had to remember PIN numbers and wade through “press one for this” and “press two for that.”  It was awful.

This is a perfect example of why we have a person answer the phone here at Merriman.  On the first ring Heather, Richard, and Donna stand ready to answer.  By the third ring Kim, Heather, and Scott (and soon Mischa) are standing by.  If there’s a fourth ring, then everyone’s phone is ringing.

Well, it is a little more complicated than that.  We measure the time it takes us to answer the phone in seconds.  We track how long it takes us to answer the phone and how long you are on hold.  That’s how important your call is to us.

So if you call and ask to speak to your financial advisor and he or she is not able to come right to the phone:  Tell us what you are trying to get done (move money, get a balance, discuss a recent news article).  We will get you connected to someone who can help.

Here is more information on identity theft, from the Attorney General’s office. This brochure has information to help you protect yourself.

Are dividend-paying stocks good bond substitutes?

A rose by any other name would smell as sweet.

With bond yields so low, is it a good idea to substitute dividend-paying stocks for bonds? Some would say yes, since dividend-paying stocks yield more than some bonds, and have more upside potential.

However, I don’t think this is a good strategy.

Obviously, dividends are an important component of stocks’ total return. From 1930 through October 2010, for example, dividends provided 45% of the annualized percentage gain of the S&P 500. Dividends also help sustain portfolio income when interest rates are low.

But there’s no getting around the fact that stocks, including dividend-paying stocks, are generally more volatile than bonds. Substituting dividend-paying stocks for bonds will lead to a higher risk portfolio.

Let’s take an example of how volatile dividend-paying stocks could be. We’ll look at three exchange traded funds (ETFs). The first is SPY, which tracks the S&P 500.

The second is SDY, which tracks the S&P High Yield Dividend Aristocrats index. This index starts with the entire U.S. market excluding the smallest 10%, and then chooses the 50 highest dividend-yielding stocks which have consistently increased dividends every year for at least 25 years. The dividend yield on SDY was 3.24% as of 12/27/10.

The third ETF is IEI, which tracks the price and yield performance of the Barclays Capital 3-7 Year U.S. Treasury Index. The recent 30-day yield on IEI was 1.65%, as of 12/23/10.

The stock market peaked October 9, 2007 and reached its subsequent low on March 9, 2009. This table shows what happened to the prices of the three funds (adjusted for dividends) between those two dates:

TickerChange in price from 10/9/07 to 3/9/09
SPY-55.2%
SDY-53.5%
IEI14.3%

Investors with all-equity portfolios incurred large losses. The emotional turmoil persuaded many of them to exit the market and, in most cases, miss out on the better times which eventually came around.

Every investor should determine an asset allocation, most likely including bond funds for stability and safety. The exact allocation is usually based on a variety of things, including the investor’s time horizon, current assets, desired future goals, and risk tolerance.

Once that asset allocation is determined (for example, 60% stocks, including a wide variety of U.S. and international stocks, and 40% bonds), the investor should periodically rebalance the portfolio to get back to those predetermined weights, without making major tactical shifts between the asset classes.

A rose by any other name is still a rose, and a dividend-paying stock is still a stock—and should be treated as such.

Employees are clients, too

I have a great job. Every day I have the opportunity to interact with some of the brightest, most interesting, and thoughtful people I know. Appreciating this environment is quite easy because I haven’t always had such a great experience. For many people I know, work is just that – work. One of the first sayings I heard while training for the world of human resources was that people don’t quit their jobs, they quit their bosses. I reflected back on my own career and concurred this was indeed the case. I was determined to learn from my experiences and try to avoid repeating the mistakes I observed elsewhere. Most people enjoy what they do, as long as they like the people they work with and feel appreciated.

At Merriman, we constantly look for ways to create great experiences for our clients. As Director of Human Resources, I have very little direct interaction with Merriman clients. I do, however, have my own set of clients – the great people who work at Merriman. Human Resources indirectly has an impact on Merriman’s clients by ensuring our employees are well taken care of. Because we give great care to our internal clients, they can take great care of Merriman clients.

Lauren Gauntz is my awesome HR counterpart. Both Lauren and I understand that our job is to make sure we hire great people who are fantastic at what they do and make sure they enjoy coming to work every day. We have a thorough hiring process to help keep turnover to a minimum. We have high expectations of our staff, and in turn like to reward them for their efforts. We know that all of this ultimately translates into great experiences for our clients.

I asked around to see what people appreciate most about working here and loved the fact that I heard so many different answers. Some appreciate the flexible work hours; others love the fact that our leaders truly value their input and recognize they are contributing to Merriman’s success.

The overwhelming theme in all the answers I heard was “great people”. We hire talented, passionate people who believe in what we do. Our staff members support one another in many different aspects of our lives and do everything we can to help each other. Our most recent new hire, Mischa Bellarin, noted that “everybody on the roster is an incredible person”.

Another recurring theme was the shared passion we all have for putting our clients first. Lauren and I want our employees to know they are extremely valuable assets, just as clients of Merriman want to know they are exceptionally valuable to us. So an occasional pancake and egg breakfast, made fresh by the HR department, is an easy thing to do to put a smile on my clients’ faces. The newly added ping pong table doesn’t hurt our cause either.

Is it time to buy commodities?

Commodity prices are rising again, led by sugar, copper, corn, wheat, and silver. Demand from emerging countries is the typically-stated reason, with an assist given to the Federal Reserve recently announcing a second round of quantitative easing (a euphemism for printing money).

Whenever you read about soaring commodity prices, it’s usually too late to profit from the trend. Traders have already factored the latest news on supply, demand, weather, and trade policies into futures prices. This is the simple reason why we avoid a commodity allocation in our client portfolios.

There are actually a few more complicated and subtle reasons to exclude commodity funds. If you’re interested in those reasons, read this article I wrote in January 2008: “Why We Still Don’t Favor Commodities.”

Since writing that article, commodity investors have only experienced gut-wrenching volatility and losses. Now the media is starting to notice and write about the fallacy of these funds – one of my favorite articles on the topic was published in Business Week. Read it here.

Making a difference in our community

We recently rolled out a new community volunteer program. In this program, we’ve given each Merriman employee up to 100 hours per year of company-paid time to use for volunteering with the charitable organization of their choice. We are very excited about the possibilities for our company and our employees to have a positive impact in our community.

I have mentioned this new program to friends and colleagues, and I’m getting a consistent response – shock! They are amazed that Merriman would approve such a generous program. So I wanted to take a minute to blog about why this is great program from the company’s perspective.

Our employees are delighted about this program. Studies consistently show that happy employees are more productive. This increased productivity will offset many of the hours we are allocating to charitable volunteer time, while making each of us happier and more fulfilled.  Happy employees are also more loyal, staying much longer with their employer.

Our clients have consistently told us one of their top priorities is to continue working with the same team of people. Our clients value their relationships with their advisor, client service rep, our fantastic front desk crew, and the other folks they talk to here at Merriman.  Programs that make our employees want to work here forever are great for our clients. And having happy clients is great for Merriman.

One of my priorities is to create the best team of people who will take the best care of our clients. The kind of person that is drawn to Merriman because of our community volunteer program is the kind of person I want to work with. They are the kind of people our clients want to work with.

Rolling out the new program has generated a positive energy in the office as people have brainstormed how they would use their volunteer hours. It’s been very engaging, and employees are excited to volunteer for new organizations. We have one large group talking to Habitat for Humanity, making plans to volunteer as a team. I’m certain each of us will learn new skills and develop new contacts.

I know our employees are out in the community telling their friends, families, and fellow volunteers what a great place Merriman is. And that is a great thing for Merriman too.

Honestly, approving the community volunteer program was an easy decision, and I’m confident that our clients and the company will benefit as much as the community. I love that kind of win-win!

Performance: Time Weighted Return vs. Internal Rate of Return

If you happen to ask me, “what is my rate of return?”   I’ll probably answer your question with another question, “which return and why?”  This response usually results in a very cross look shot in my direction.  But, actually there are different measures of return and many investors are unaware of their subtle, and some times not so subtle, differences. Understanding what each of these returns is designed to measure and how they differ will help you make better informed financial decisions.

In the financial industry today there are three measures of return that are frequently used; Simple Rate of Return (SRR), Internal Rate of Return (IRR) and Time Weighted Return (TWR). These measures of return may sound interchangeable but they are actually very different in how they calculate performance.

First, let’s look at a SRR. This is the easiest return to calculate and understand.  It is simply the percentage change in market value.  The SRR is most commonly used to calculate the performance of a benchmark or index where there are no cash flows that affect the underlying performance.  A SRR, although easy to calculate for a benchmark, cannot accurately measure the return of an individual’s investment portfolio.  This is where IRR and TWR come into the picture.

The IRR, also commonly referred to as the dollar weighted return, is the measurement of a portfolio’s actual performance between two dates, including the effects from all cash inflows and outflows.  Because cash flows are factored into the calculation, greater weighting is given to those time periods when more money is invested in the portfolio. By this definition, the IRR of a portfolio can be significantly affected by both the size and timing of any cash contributions or withdrawals.

The IRR does provide a meaningful measurement of the absolute growth of a portfolio.  And, it is a valuable tool for determining if a portfolio is growing enough to meet a future need or a specific investment goal.  However, it is not an effective measurement tool for analyzing the long term performance of the portfolio’s underlying assets or comparing your investment manager to a different investment manager or market index.  For periods longer than three months, the IRR can be greatly affected by factors beyond the control of your investment manager.  This is where the TWR becomes a more meaningful measurement tool.

The TWR captures the true investment performance by eliminating all the effects of capital additions and withdrawals from the portfolio. Simply stated, the TWR is the return on the very first dollar invested into the portfolio.  This makes the TWR a more meaningful measurement of performance when used to analyze the underlying performance of the portfolio’s assets or comparing your investment manager performance to alternative investments.

The method used to calculate the TWR is derived by dividing up the performance period into shorter sub-intervals, such as one month.  Each sub-interval can be further divided into intervals based on the date of any cash inflows or outflows.  Then, the IRR is calculated for each of these sub-intervals.  Finally, the individual IRRs are then linked together with equal weighting (not dollar weighted) to derive at the portfolio’s overall TWR.

The TWR allows an investor the ability to accurately evaluate the true performance of the underlying assets and your investment manager, not just the return on the dollars you have invested in the portfolio. This may sound like a very subtle difference, yet, the IRR and TWR can be significantly different, even for the exact same period of time. It is important to understand the differences so you can make investment decisions with the best information available.

Recommended reading – NY Times: A Dying Banker’s Last Financial Instructions

Here’s what Mark Metcalf has to say about a recent article from the New York Times, “A Dying Banker’s Last Financial Instructions”, in which ex-Wall Street salesman Gordon Murray talks about a better way to invest:

Not only is this a powerful article about life, but it just happens to come with some top-notch investment advice.  While “The Investment Answer” differs slightly around the edges from Merriman’s investment approach, it is very much in line with our philosophy, and I would recommend it highly to anybody in search of a prudent way to invest.

What Nora Ephron can teach investors

Last Sunday, an interview of Nora Ephron appeared in the New York Times.  I’m a big fan of hers because she’s overcome many personal and professional challenges throughout her life.  And although most of us will never be nominated for an Academy Award, we all have challenges to face and overcome.

Ephron is perhaps most famous for winning three Academy Awards nominations for Best Screenplay: “When Harry Met Sally,” “Sleepless in Seattle”and “Silkwood.”

She’s also a film director and the author of several books.  Her most recent book, “I Remember Nothing,” is No. 7 on the New York Times non-fiction best-seller list and trending upward.

Asked if she would next be working on a movie, book, or play, she replied, “The most satisfying thing is not to have to choose, not to have to rely on any of them for anything — to make a living or anything else.”

That pretty well sums up the goal of people who come to investment advisors while they are still working.  They want help figuring out how to achieve the freedom to choose how to spend their time.  Some of them will likely choose to keep working even after they no longer have to. Others will hang up their working lives and follow their passion, whatever that is.

I especially liked Ephron’s description of her idea of a perfect day: “Good weather and a walk in the park.  I don’t ask for much.”

Though her fame and wealth can open doors that most of us will never go through, she has come to understand that the simple things in life often bring the most pleasure.

What financial questions can Merriman help with?

The other day a friend asked me a good question. If she became a Merriman client, what exactly would we advise her about?

Like many people, she is very smart and has a successful career. But also like many people, she’s not sure she has made the best decisions about her money.

“First and foremost,” I told her “we will manage your money to make sure it’s doing the best job possible of helping you achieve what you want in life. So one thing we’ll talk about is how your investments are doing.”

Beyond that, there isn’t any formal agenda for each meeting with a client. The topics are set by whatever is on the client’s mind.

Often people want to talk about how much money they will need to retire, how to withdraw their money to make it last a lifetime, how much emergency cash to keep on hand, and how they should invest other assets we don’t manage.

We often spend time determining the best age to start taking Social Security or discussing the best way to save for a child’s or a grandchild’s education. Sometimes, we refer clients to another professional who specializes in estate planning, mortgage financing, insurance, or other areas.

In short, we’re here to give guidance on most anything that affects our clients’ lives financially. When in doubt, we encourage them to just ask us.

Interest rates and bond portfolios

As anyone who has recently refinanced a mortgage knows, interest rates are near historic lows. Low interest rates are good for borrowers, but not so good for lenders. This is important to remember because investors who buy and own bonds are lenders.

To help illuminate the risks and rewards of owning bonds, here are five key concepts that are worth keeping in mind.

Concept #1: Future interest rates are difficult to predict

Academic researchers have shown that movements in interest rates are difficult to predict. In fact, prestigious Wall Street economists have come up with widely differing interest rate forecasts when looking at the same information.

Current interest rates could remain low because of the weak economy, or they could rise because of Treasury actions, future inflation, or other factors. Any such increase could happen very gradually or quite suddenly. We don’t think it makes sense for long-term investors to position their fixed-income portfolios based on interest-rate forecasts.

Concept #2: Increases in interest rates hurt bond prices

This is part of the most fundamental equation of fixed-income investing. Rising rates make existing bonds less attractive, causing their prices to fall. The longer the maturity of the bonds, the more pronounced the effect. In other words, 30-year bonds will react much more negatively to rising rates than five-year bonds.

Concept #3: There is no free lunch.

Investors who are worried about increases in interest rates can buy three-month Treasury bills, which have a very low yield of 0.15%. These investors sacrifice yield for safety.

Those who seek higher fixed-income yields can either take more interest-rate risk (by buying longer-term bonds) or take more credit risk (by investing in corporate bonds instead of Treasuries).

Concept #4: Our bond choices are meant to reduce overall portfolio risk

Safety, not yield, is our top fixed-income priority. Our equity portfolio tilts toward value and small-cap stocks, which have returned more than growth and large-cap stocks over time. However, higher expected return is associated with higher volatility. Since the equity holdings in our portfolio can be more volatile than the Standard & Poor’s 500 Index, we want the bond side of our portfolio to be very safe.

That’s why we hold short-term and intermediate-term Treasury and agency securities. Short-term securities protect against inflation and intermediate-term bonds add incremental yield. In tax-deferred accounts, we also include Treasury Inflation Protected Securities (TIPS) for added inflation protection.

We avoid longer-term bonds, which have more interest rate risk, and corporate bonds, which have more credit risk.

Concept #5: Buy mutual funds, not individual bonds

We invest in bond funds instead of individual bonds. It’s true that investors can buy individual Treasuries and TIPS directly from the U.S. Treasury to avoid the expenses of mutual funds. However, we believe it’s worth paying bond funds’ relatively low expenses in order to gain their advantages: much greater diversification, greater liquidity, low transaction costs, professional management, convenience, and automatic reinvestment of interest.

Conclusion

We have carefully constructed the fixed-income part of our portfolios to provide what we believe is the right combination of stability, income, and inflation protection. We don’t believe it makes sense to change this composition based on unreliable interest rate forecasts.

The most pre-Thanksgiving snow since 1985…and we’re open!

Despite the snow and icy conditions in the greater Seattle area, our office is open today until 1pm PST. We can handle any trades, money requests, questions or concerns, but we are operating with reduced staff so please be patient with us and be sure to leave a message if our main-line voicemail picks up.

Stay safe and warm!

What is a fiduciary and why should I care?

You may have heard the debate over “suitability” versus “fiduciary duty” and wondered “What do those things even mean? Does it even matter?” Well I’m here to tell you: It does matter. It determines whose interest comes first: yours or your financial advisor’s.

So first off, what does it mean to have a fiduciary duty? In the simplest terms, a fiduciary duty is an obligation to act in the best interest of another party. A fiduciary relationship is one of complete trust and utmost good faith. In fact, the term fiduciary comes from the Latin words “fiducia” which means trust and “fides” which means faith. A fiduciary is expected to be extremely loyal to the person whom he owes the duty.

Many types of professionals owe a fiduciary duty to someone – for example, lawyers to their clients, trustees to the trust beneficiaries, and a corporation’s board to its shareholders. As an investment advisor, Merriman has a fiduciary duty to its clients. As a fiduciary, we are required to act solely in the best interest of our clients.

It’s something we take very seriously. We look for the best investment opportunities we can find for our clients and avoid investing in products that have extra fees and service charges. It’s the reason why our advisors do not receive sales commissions, and we are not compensated by any outside mutual funds for investing money in their funds.

Unfortunately, advisors who are not fiduciaries are not held to such a standard. It’s perfectly legal for them to put their own interests first, and their interests may be very different from yours. Broker–dealers, for example, currently work under the suitability rule which only requires them to make recommendations that fit the customer’s financial situation and risk tolerance, but doesn’t require them to put the customer’s needs first.

Let’s look at what this means in practice. Suppose that you have two funds to choose from: Fund A, which charges a 5% upfront sales load, or an essentially identical Fund B, which is no-load. In the first case, 95 percent of your money is invested in the fund’s portfolio. In the second case, 100 percent of your money is invested in the fund’s portfolio. Fund B is a better deal for you.

If you are working with a broker, he can sell you Fund A, as long as it’s within your risk tolerance, without breaking the suitability rule. And, he is earning himself and his company a nice commission at your expense!

On the other hand, an investment advisor who has a fiduciary duty would be required to recommend the no-load Fund B precisely because it is the better option for you, even though Fund A would be more profitable for himself and his firm. A fiduciary, as you can see, must put your interest first, and that is something that should definitely matter to you!

Because fiduciaries are held to a much higher standard, it is important for you to seek advice only from people who have a fiduciary duty. Currently there is debate over whether broker-dealers should have a fiduciary duty. We think they should, and hopefully someday soon this will happen. But in the meantime, here are a few questions you should ask someone you are considering hiring as your financial professional:

  • Do you have a fiduciary responsibility that applies to the advice you will give me? What does this mean to you and your company?
  • Do you sell any products for which you earn a commission or any other compensation that’s not paid by me?

For more ideas, please read our full list of questions to ask when interviewing an investment advisor.

Wall Street Journal: Seven smart money moves for the holidays

Elaine Scoggins gives tips on how to get the most for your money this holiday season.

Get the full article here.

A year-end tax planning checklist

As a CPA, I receive various newsletters to help keep me informed on tax issues and developments that may affect our clients.  Each year, I receive a year-end tax planning checklist from Thomson Reuters which I find to be very useful.  This year, I wanted to share the checklist with everyone in case some of these year-end moves can save you taxes.

Year-end moves for individuals

  • Increase the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little for this year. Don’t forget that you cannot set aside amounts to get tax-free reimbursements for over-the-counter drugs, such as aspirin and antacids (2010 is the last year that FSAs can be used for nonprescription drugs).
  • Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, then buy back the same securities at least 31 days later.
  • Increase your withholding if you are facing a penalty for underpayment of federal estimated tax. Doing so may reduce or eliminate the penalty.
  • Take an eligible rollover distribution from a qualified retirement plan before the end of 2010 if you are facing a penalty for underpayment of estimated tax and the increased withholding option is unavailable or won’t sufficiently address the problem. Income tax will be withheld from the distribution and will be applied toward the taxes owed for 2010. You can then timely roll over the gross amount of the distribution, as increased by the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2010, but the withheld tax will be applied pro rata over the full 2010 tax year to reduce previous underpayments of estimated tax.
  • Make energy saving improvements to your main home, such as putting in extra insulation or installing energy saving windows or buying and installing an energy efficient furnace, and qualify for a 30% tax credit. The total (aggregate) credit for energy efficient improvements to the home in 2009 and 2010 is $1,500. Unless Congress acts, this tax break won’t be around after this year. Additionally, substantial tax credits are available for installing energy generating equipment (such as solar electric panels or solar hot water heaters) to your home (this break stays on the books through 2016).
  • Convert your traditional IRA into a Roth IRA if doing so is expected to produce better long-term tax results for you and your beneficiaries. Distributions from a Roth IRA can be tax-free but the conversion will increase your adjusted gross income for 2010. However, you will have the choice of when to pay the tax on the conversion. You can either (1) pay the tax on the conversion when you file your 2010 return in 2011, or (2) pay half the tax on the conversion when you file your 2011 return in 2012, and the other half when you file your 2012 return in 2013.
  • Take required minimum distributions (RMD) from your IRA or 401(k) plan (or other employer-sponsored retired plan) if you have reached age 70 1/2. Failure to take a required withdrawal can result in a penalty of 50% of the amount not withdrawn. A temporary tax law change waived the RMD requirement for 2009 only, but the usual withdrawal rules apply full force for 2010. So individuals age 70 1/2 or older generally must take the required distribution amount out of their retirement account before the end of 2010 to avoid the penalty. If you turned age 70 1/2 in 2010, you can delay the required distribution to 2011, but if you do, you will have to take a double distribution in 2011—the amount required for 2010 plus the amount required for 2011. Think twice before delaying 2010 distributions to 2011—bunching income into 2011 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels.
  • Make annual exclusion gifts before year end to save gift tax (and estate tax if it is reinstated). You can give $13,000 in 2010 or 2011 to an unlimited number of individuals free of gift tax. However, you can’t carry over unused exclusions from one year to the next. The transfers also may same family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.

It’s RMD time here at Merriman

To make the Required Minimum Distribution (RMD) process easier, we recommend having the distribution set up to go out automatically each year so you don’t have to think about it. It’s easy to do, and most custodians provide a number of options. You can specify the day of the year it should be withdrawn and have it sent to you by check, direct deposit, or have it transferred to another taxable account at your custodian.

If you’re a Merriman client and you want to set up automatic distributions to take care of your RMD, please give us a call and we’ll help you set it up.  To learn more about RMDs click here.

MarketWatch: 5 ways financial advisers fail investors

Elaine Scoggins was quoted in this MarketWatch article  about the importance of good communication in the client-financial advisor relationship.

Get the full article here.

Investing around mutual fund distributions

I have liquid assets that I want to invest in Vanguard Funds using your diversification strategy. Many of the funds pay out dividends at the end of December. My money is sitting in the bank right now. Is it better to wait until January to invest after the dividends are paid, or is now far enough ahead that the dividends won’t create a penalty?


If your time frame is from now to the end of the year, there is no way to know now whether you should invest at all. If markets go down between now and December 31, you are better off with money in the bank. If markets go up, you are better off investing.

If you are a long-term investor with a view out some years in the future, then the real issue is whether your cost will be lower now or after December 31. There again, there is no way to know. The swings of the market are likely to have a much bigger effect on this than the tax consequences of “buying” taxable dividends.

If you are willing to ignore possible price changes between now and the end of December, then you can focus on the effect of paying taxes on dividends. Of course, this is only relevant for taxable accounts. For tax-deferred accounts such as IRAs, taxation of distributions is a moot point.

You can’t know in advance exactly how much a fund will distribute. However, if you assume distributions of 3% that will be taxed at a rate of 15%, your tax bill on a $100,000 investment would be $450. That’s 0.45 percent of the investment, a bit less than one half of one percent.

You may be able to learn that the distributions will likely be higher or lower than that, and you might want to postpone investing in those funds with a high expected payout until after the distributions.

However, with approximately two months to go before distributions are likely, I think you need to see this in proper perspective. What might you be giving up in order to reduce your buying costs by one half of one percent? Many times, the market goes up or down more than that in a single day. So how much does it pay to worry about a tax consequence that is essentially no more important than the “noise” of the daily or weekly market creaking back and forth?

So what is the answer? Our rule of thumb is to use mid-November as the cutoff point for investing in funds with expected year-end distributions. The long-term direction of the market is upward, and it doesn’t make sense to remain on the sidelines for long just to avoid a 0.5% cost. In the end, it comes down to this: The short-term future is impossible to predict, and you simply have to make your choice and live with the results. If you are truly a long-term buy-and-hold investor, a 0.5% bump in your cost will not make or break your retirement.

It’s not too late to consider a Roth conversion

The end of the year is a busy time for most of us. Don’t forget to consider whether the Roth conversion might be worth your while. This year’s deadline, December 31st, is quickly approaching.

The income limitations to convert to a Roth have been repealed for this year and beyond, so anyone with an IRA is now eligible. Also, don’t forget that for 2010 conversions only, you have the option of recognizing the conversion income in the subsequent two years (2011 and 2012). This allows you to receive the benefits of a Roth IRA immediately while delaying the tax hit for a few years.

If you convert now and later change your mind, you can “undo” the conversion with a recharacterization—so you are not necessarily locked into the conversion if you do it this year. You have until the extended due date of your tax return (i.e. October 17, 2011) to recharacterize the conversion if you change your mind.

You may consider doing partial conversions—converting just enough each year to use up the rest of a particular tax bracket, like the 15% or 25% tier. Although this requires more work and planning each year, it’s a great way to gradually gain Roth exposure while sensibly controlling the tax impact.

Your financial advisor or CPA can help you decide if a Roth conversion is right for you. You can also find more information on the pros and cons of a Roth conversion in my article “Roth IRAs: To convert or not to convert.”

MarketWatch: Don’t let money break up your relationship

MarketWatch published an article by Elaine Scoggins on how couples can heal when they collide over finances.

Get the full article here.

Casually raising money for a good cause

We are always looking for ways to make a difference in the community. Last October, Donna Conley shared a program her son’s employer, Safeway, put on to raise money for charity—allowing employees to “buy” casual days and donating the funds to a good cause.

It was an easy decision to adopt a similar program at Merriman. 2009 was a difficult year for many of us, and we wanted to do something for those less fortunate. We chose Northwest Harvest (NW Harvest), a Washington state hunger relief agency, to be the recipient of our fundraising efforts.

NW Harvest distributed food to over 300 food banks, hot meal programs and elementary schools across Washington. By supplying food, NW Harvest allows those on limited incomes to use their cash for medical expenses, housing, transportation costs, utilities, and childcare.

We offered our employees the right to buy casual days for the months of November and December at $3 per day. Merriman matched every employee contribution, dollar for dollar. Through our combined efforts we raised over $1,700 for NW Harvest in 2009.

This November we are back at it and hoping to raise even more than last year. To read more about NW Harvest or make a donation, please click here. If you think Safeway’s idea is good too, please pass it along to your employer and help contribute to a great cause.

What is a hedge fund?

A hedge fund is an unregulated investment company that is available only to accredited investors, those with substantial assets.  Like a mutual fund, a hedge fund pools money and invests it for a common objective.  Its operations can be wider in scope.  Investors typically pay the manager as annual fee based on returns, often 20 percent of profits, plus a management fee.

What is an Annuity?

An insurance contract that takes many forms.  A fixed annuity, usually purchased for a lump sum, promises a regular monthly payment for as long as the owner lives.  A variable annuity combines investment options, life insurance and annuity features in what can become a complex, expensive product.

What are Value and Growth Stocks?

Stocks that trade at low prices relative to their fundamentals, including earnings, book values and other measure are value stocks.  Investors believe a stock is a good buy if it’s likely to return to its normal levels when the market comes to its senses and appropriately prices the stock.  Of course a stock could be underpriced for a reason and thus value stocks are considered more risky than, for instance, growth stocks.

Growth companies exhibit strong earnings growth and high profitability.  They typically retain earnings to invest in capital projects that drive growth.  From a fundamentals stand point growth stocks have a relatively high price-to-earnings ratio.  Google is a great example of a success story for growth stocks.

Although growth stocks are the most popular ones (and almost universally regarded as the safest investments), much research shows that historically, unpopular (value) stocks outperform popular (growth) ones.

What is an Index Fund?

An index fund is a mutual fund that is constructed to mirror the components of an index such as the S&P 500 (large companies).  Other indexes include the Russell 2000 (small companies), MSCI EAFE (foreign stocks in Europe, Australia, and the Far East), and the Lehman Aggregate Bond Index (total bond index).  By nature index funds encompass a passive investment style.  There is no active stock picking.  Stocks are deleted when they no longer are part of the index.  If, for example, a company grew from a small cap stock to one of the largest 500 companies in the US it would move out of the Russell 2000 index and into the S&P 500 Index.  Index funds are usually less expensive to own and more tax efficient than actively managed funds.

What is Market Capitalization?

The technical formula to determine market capitalization for a publicly owned company is share price times the number of shares outstanding.  Most people know it better as it relates to large, mid, and small company mutual funds.  The following parameters are generally accepted to determine the categorization of a given company:

Large-cap: Greater than $10 billion
Mid-cap: $2-10 billion
Small-cap: Less than $2 billion

Another way to look at market capitalization is as it relates to different countries.  On December 31, 2009 the total world market capitalization equaled $28.6 trillion.  The largest component of this figure was the United States taking up $12.1 trillion or 42% of the total.  The next two largest countries were the United Kingdom and Japan each weighing in at about 9%.  To put it back in the perspective of an individual company Microsoft has a capitalization of $269 billion.  This is roughly equivalent to the economies of Hong Kong and South Africa.  Per the above guidelines Microsoft would be considered a large cap stock.

What is a REIT?

Real Estate Investment Trusts are a collection of properties such as apartments, office buildings and shopping malls that are bundled together and sold as a security.  Their income is derived from rents on those properties.  One of their defining characteristics is the requirement to distribute 90% of their income to investors.  Doing so allows them to reduce corporate income taxes by passing the taxation through to investors.  It is this characteristic that makes REITs better suited for tax-deferred accounts.  REITs greatly reduce the monetary barrier to invest in real estate. They also create liquidity and when sold through a mutual fund diversify your real estate investment holdings.

How should I invest CD proceeds at age 60?

I inherited a CD a few years ago which is coming due soon. It is worth about $54,000 and has paid a good interest rate that I don’t imagine I could match today. I need to reinvest this money in something relatively safe (I am 60 and can’t afford to lose the money). But I also want some growth potential because I won’t be retiring for another five years or so.  What would you suggest?


There is no “right” answer to your question. It’s entirely a tradeoff between the safety you want and the return you want. Any attempt to achieve growth carries with it the risk of losing some of your principal. At the same time, if you try to avoid losing any principal, you won’t get much of a return and you could run the risk of losing purchasing power to inflation.

So how does one deal with this dilemma?  First, be thankful that you have this money and that you have received decent interest on it.

Beyond that, your best guidance will come from looking at the time frame of your intended investment.

One possible point of view is that you are 60 and have presumably five or six years before you retire. That time horizon is too short to count on the stock market for gains.

A second possible point of view is that you are 60 and presumably have 25 to 30 years left to live – a relatively long time for this money to keep working for you. Over that time horizon, you need the prospect of growth to stay ahead of inflation.

Here’s how to decode that into a decision:

If you expect to spend this money in five or six years when you retire, or if it would make a good permanent emergency fund after you retire, then keep it in short-term bond funds and money market funds. That way you can be pretty certain it will be there for you in 2015 or 2016.

If on the other hand you will add this money to other savings in a retirement portfolio that’s meant to provide income for 25 or more years, then you should invest the proceeds of this CD similarly to the rest of your retirement portfolio. (This, of course, assumes your portfolio is well diversified, with enough fixed-income funds to keep your risk in check.)

How to avoid the worst mistakes investors make

In our investment workshops, we always discuss the biggest mistakes investors make. In this article, Paul Merriman identifies 18 examples in hopes that you will learn from other peoples’ mistakes so you won’t have to learn them yourself – the hard way.

Are exchange-traded funds just derivatives in disguise?

I have tried to invest in all the asset classes you recommend, and mostly I am using ETFs. I hear so much these days about the dangers of derivatives that I wonder if that’s what ETFs are. I like what’s in them, but I know they are more complex than owning individual stocks, and I don’t understand exactly how they work. I don’t want to find out 20 years from now that I’m not holding anything real, only some kind of derivative that’s worthless.


You are correct that derivatives can be highly risky investments and should be used only by people who thoroughly understand them. Most exchange-traded funds are not derivatives; to understand that, you have to know what a derivative is.

A derivative is a contract between two parties who agree to take certain actions depending on what happens to the value of some underlying asset. The derivative does not represent ownership of the asset, only an agreement.

A share of stock, a share of a mutual fund and a share of an ETF that invests in stocks or bonds, on the other hand, represent ownership of a real asset.

One common example of a derivative is a futures contract that allows a farmer to lock in a price for a given quantity of a crop before harvesting the crop. The other party is someone who wants certainty about the cost of that crop at a specific time in the future. The contract lets both parties know what they can count on regardless of what happens to the market value of that crop in the interim.

Like mutual funds, most ETFs are baskets of securities, usually stocks or bonds, that let individual investors participate in the ownership of those securities. Unlike mutual funds, ETFs are traded on stock exchanges and can be bought and sold throughout a trading day at prices that are constantly changing to reflect supply and demand.

When you buy shares of an ETF, you are an indirect owner of that fund’s portfolio. You can sell or buy shares at any time. This gives them excellent liquidity.

Most ETFs and mutual funds do not utilize derivatives.   Both are relatively straightforward and inexpensive ways to own a large basket of securities. However, there are certain ETFs like those that invest in various commodities, which may gain their exposure through derivatives.

Am I using your monthly income bond fund recommendations correctly?

I am retired and have my IRA invested with a conservative 40% equity allocation in the Vanguard equity funds you recommend. For the fixed-income part of my portfolio, I’m using the four funds you suggest for monthly income. This is because I plan to take out the income next year, and I want to build up that part of my portfolio with higher-yielding funds. Am I making a mistake doing this?


Unless you have an above-average ability and willingness to accept price volatility in your portfolio, I think you could be making a mistake. Your overall allocation and the wording of your question suggest that you see yourself as cautious. So it is important to understand that these two bond allocations are quite different.

In general, we build our portfolios to take risks on the equity side, where we believe risk is more likely to be rewarded, and avoid as much credit risk as possible on the fixed-income side. Accordingly, the fixed-income part of our Vanguard Tax-Deferred Portfolio is made up exclusively of U.S. Treasury and agency securities in order to stabilize the overall portfolio and mitigate the effect of falling equity prices.

On the other hand, our Vanguard Monthly-Income Portfolio is aimed at investors who seek higher yield and who can afford to accept substantially higher risk. Our Web site describes this portfolio is one designed for investors who want to generate income without withdrawing principal.

In order to generate higher income, 75% of this portfolio – and apparently 45% of your total portfolio – is made up of corporate bond funds.

The monthly income portfolio has nearly twice the expected current yield of the fixed-income part of the tax-deferred portfolio. However, the credit quality of securities in the monthly-income portfolio is significantly lower than those in the tax-deferred portfolio. This raises the risk that the value of this portfolio could decline at a time when stock prices were plunging.

In 2008, when equities suffered significant losses, having the fixed-income part of your portfolio in government bonds almost certainly would have helped you stay the course. I doubt that you would have been comfortable with the majority of your bond portfolio invested in funds with higher levels of risk.

I would recommend you reexamine your needs and the level of risk you are willing to take to accomplish them.

Should I make peer-to-peer loans?

I’m a young investor and want your thoughts on peer-to-peer lending. Sites like LendingClub.com are pretty open about returns, default rates, etc. Based on the past three years, this has been a pretty reliable way to get an approximately 10% compound return. I realize that peer-to-peer lending doesn’t have the 70-year history of stocks and bonds, but what do you think about making it a small part of my portfolio?


Over the last several years, peer-to-peer lending (P2P) has been growing in popularity. One P2P Web site, Prosper.com, has nearly a million members. Popularity does not necessarily mean an investment is worthy of your consideration.

P2P is an alternative means for individuals to borrow and lend directly from and to each other, supposedly cutting out financial intermediaries such as banks. The activity is arranged through Web sites as Prosper.com and LendingClub.com. The sites typically charge loan servicing fees averaging 1% annually.

So what’s not to like?

For starters, think about the concept of adverse selection. In the insurance industry, this principle holds that if people are given the choice to buy insurance or not to buy, only people who really need coverage (and therefore those who represent bigger risks) will buy it. In the world of lending, borrowers with excellent credit are likely to rely on conventional sources, while those with poor credit are drawn to alternatives such as P2P.

What this means to you is that you will be lending money to people who may not qualify at banks, credit unions or credit-card companies. This means you, as a lender, are taking a higher risk and will expect a higher return. The 10% figure that’s been quoted on the Internet should be an important clue.

Consider that interest rates are so low that established, legitimate businesses can only dream of getting 4% on their savings with a bank. If those businesses thought they had a good chance of being paid back while collecting anything close to 10%, so much money would rush into P2P that individuals like you might be shut out.

The high rate of return quoted is a strong indication the money is going to a pool of relatively risky borrowers who can’t get loans without offering extraordinarily high interest. This is the basic risk-reward principle at work. Higher risk is associated with higher potential returns.

In the United States, P2P loans are unsecured, and information about the borrowers is relatively limited. Various Internet sites report that default rates on such loans range from 15% to 20%.

For all these reasons, I would advise against P2P loans. I can see the temptation, but the fundamental truths of investing have not been repealed. If something seems too good to be true, it probably is.

If, as a young investor, you should want to take smart risks in order to make your savings grow over time. The most reliable way to do that is by investing in the equity markets through mutual funds. Their long history, the large amount of available information and oversight of government regulatory agencies are all on your side. You will not have any of those allies in P2P lending.

2009 news year archive

November 8, 2009

Elaine Scoggins, Client Experience Director at Merriman, is quoted a recent Business Week article about five mistakes to avoid when investing in stocks. » Link to article

October 30, 2009

Elaine Scoggins, Client Experience Director at Merriman, points out five warning signs of when you are caught up in a market bubble. » Link to article

August 25, 2009

Lowell Lombardini-Parker looks at the importance of keeping your legal information up-to-date. » Link to article

August 16, 2009

Merriman financial advisor Tyler Bartlett is quoted in the Chicago Tribune about how inflation will affect investors. » Link to article

July 7, 2009

Director of Research Larry Katz looks at the choices investors can make to improve their odds of successfully retiring without running out of money. » Link to article

June 22, 2009

Merriman advisor Mark Metcalf responds in an open email to a client about fear and how in tough times can shake our confidence, and yet it is often after these tough times that we emerge in a better place than we were before. » Link to article

June 1, 2009

Merriman advisor Aaron Spencer offers advice on how volatile emotions can undercut the best money-management practices. » Link to article

June 1, 2009

Elaine Scoggins, Client Experience Director at Merriman, offers insights into various traps and pitfalls that can come from too much loyalty to an employer’s stock. »Link to article

May 19, 2009

Merriman financial advisor Cheryl Curran writes about Suze Orman and her concerns with Suze’s investment advice at the Index Universe. » Link to article

May 21, 2009

Meriman’s Director of Research Larry Katz discusses the nature of inflation and how your investment strategy can help protect you. » Link to article

March 23, 2009

Merriman financial advisor Jeremy Burger examines the the details of fixed annuities and why these complex products are often time not what they appear. » Link to article

March 16, 2009

Meriman’s Director of Research Larry Katz looks at the current trend to move to US Treasury bonds and how that works with fixed-income investing. » Link to article

January 30, 2009

Meriman’s Director of Research Larry Katz examines the value of bootstrapping to help evaluate the potential success of the accumulation and distribution phases of investing. » Link to article

2008 news year archive

December 31, 2008

Larry Katz, Director of Research, discusses the markets at the end of the year in An unpleasant year bites the dust. » Link to article

December 31, 2008

Elaine Scoggins looks at the impact of a financial windfall and some considerations you might want to think about if you suddenly found yourself with a winning lottery ticket. » Link to article

October 28, 2008

Merriman financial advisor Tyler Bartlett quoted on Bankrate.com. » Link to article

October 10, 2008

Tom Cock featured in KIROTV.com news story. » Link to article

October 27, 2008

Merriman advisor Eric Jonson looks discusses a couple of issues to consider regarding account rebalancing. » Link to article

October 10, 2008

KOMO 4 News interviews Tom Cock about the Volatility Index. » Watch

October 9, 2008

Elaine Scoggins quoted in The New York Times. » Link to article

October 2, 2008

Elaine Scoggins quoted on cnbc.com. » Link to article

July 2008

Merriman listed as one of the Best Companies to Work For 2008 in Washington CEO magazine.

June 27, 2008

Financial advisor Paresh Kamdar looks at the role of emotions and market timing and how investors can ultimately miss out by sitting on the sidelines. » Link to article

June 20, 2008

Larry Katz, Director of Research, discusses oil prices and impacts on investment portfolios. » Link to article

June 20, 2008

Merriman financial advisor Laura Wood examines an often times overlooked reason to have a financial advisor. » Link to article

May 2008

Sound Investing chosen by Money Magazine as Best Money Podcast. » Link to article

February 28, 2008

The Seattle Times interviews financial advisor Cheryl Curran. » Link to article

February 4, 2008

Market Watch looks at “Lazy Portfolios.” » Link to article

January 14, 2008

Dennis Tilley, Director of Alternative Investments, outlines why Merriman does not currently favor the commodities market. » Link to article

January 14, 2008

Elaine Scoggins quoted in Business Week. » Link to article

What annuity option should I choose?

I am approaching the age of retirement after a career in teaching, and I have a couple of options for taking my pension. One option is to take a single life annuity benefit of $1,040 per month. The other option would give me a lump sum of $35,320 plus a reduced monthly benefit of $793. Which one would be better for me?


The best answer will depend on your unique set of circumstances. A general rule of thumb is to base this choice on your life expectancy. If you live for many years, you’ll collect more by taking the larger annuity. If you live for relatively few years, you’ll collect more with the lump sum.

There are two main risks involved in this choice. One is that you might live a very long time. The other is inflation. Unless your annuity payment is protected by a cost-of-living adjustment, inflation will erode your monthly income over time.

The first risk is one you can transfer to your employer or, quite likely, an insurance company from which your employer will buy an annuity contract. Your monthly payment will continue no matter how long you live.

The risk of inflation is harder to deal with. If you assume inflation of 3.5 percent, after 20 years that $1,040 payment will be worth only $522 in 2010 dollars.

You can partly offset that inflation risk by taking the smaller payment and the lump sum, which you can invest. You could supplement the lower monthly payment by withdrawing $247 every month to equal the $1,040. In order to sustain those withdrawals for 30 years, you would need to earn a 7.5% annualized return on the lump sum. That would require the moderate risk level of a balanced portfolio. If your return were higher, you could withdraw more in order to keep up with inflation.

In the end, the choice you’re facing is a balancing act that depends on how long you expect to live and how comfortable you are in making investment decisions.

Inflation and our Merriman bond portfolio

Here’s an article we recently mailed to Merriman clients, addressing some inflation questions that we felt our FundAdvice readers may also be interested in:

Some investors are concerned about the prospect of future inflation, based on fiscal and monetary measures the U.S. government has taken to respond to the recent market crisis. However, other metrics suggest that moderate inflation will continue. These include current inflation, bond market indicators and worldwide excess capacity.

Merriman’s recommended bond portfolio is structured to provide a reasonable level of protection against inflation.

The Fed’s view

The Federal Reserve, in a statement on April 28th said, “With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.”

Notwithstanding this reassuring if somewhat abstruse statement, there is considerable debate about whether higher inflation will result from the fiscal and monetary actions the federal government used to curtail the market plunge from October 2007 to March 2009. Inflation is the nemesis of bond investors. An increase in inflation will cause an increase in interest rates and decrease the value of bonds. Conversely, if interest rates were to fall because of lower inflation, bond prices would rise.

What factors impact inflation and how is our bond portfolio structured to handle inflation risk?

Consumer Price Inflation

Increasing inflation can be caused by a variety of factors.

Increase in demand due to higher private or government spending causes demand-pull inflation. Government spending has ballooned, to combat the deep recession. In fact, the federal deficit as a percent of nominal GDP, at -9.9 percent as of 4/30/2010, is the worst it has been since the depths of World War II. This could lead to higher inflation down the road.

An increase in the money supply (too much money chasing too few goods) causes monetary inflation. The Federal Reserve has greatly expanded the amount of money in the system to help combat the recent crisis, and this could also lead to higher inflation.

Other types of inflation include cost-push inflation, caused by a large and sudden increase in the price of significant goods and services, such as the price of oil, and increasing inflationary expectations, where sellers increase prices and workers demand higher wages based on expectations of higher inflation.

Will the large increase in government spending combined with the Federal Reserve’s flooding the system with liquidity cause an increase in inflation? That’s tough to say. Without trying to forecast future inflation, here are some reasons that inflation may stay under control:

  • The federal government, which says it is concerned by the large deficit and debt levels, may be able to cut the deficit and debt over time to more sustainable levels.
  • The Federal Reserve has been very creative in battling the huge uncertainty caused by the economic crisis by injecting liquidity into the system. It may prove just as competent in withdrawing liquidity from the economy to prevent higher inflation.
  • The U.S. unemployment rate is currently at 9.9 percent, compared with 4.7 percent in October 2007. High unemployment is generally associated with lower inflation.
  • The industrial capacity utilization rate in the United States is currently 73.7 percent, about 7 percentage points below the average from 1972-2009. Higher inflation is more likely when industry is running near capacity, not when there is excess, unused capacity.
  • The increasing production of low-cost goods in China and other developing countries has led to lower prices for U.S. consumers, and this should help limit inflation.
  • The increasing use of the Internet has allowed consumers to efficiently search for the lowest-priced goods, which could also help keep prices in check.

It is difficult to forecast future economic factors and their impact on inflation. Instead of trying to forecast future inflation on our own, let’s see what current inflation is, as well as the market consensus for inflation, using both surveys and the bond market.

The 12-month change in Consumer Price Index (CPI) through April 2010 was 2.2 percent.

The Livingston Survey is the oldest continuous survey of economists’ expectations, currently averaging the outlooks of 39 forecasters. The most recent survey, in December 2009, shows that the average expectation for CPI over the next 10 years was 2.4 percent, down from 2.5 percent from the June 2009 survey.

Another way to measure the market’s expectations for inflation is to compare the yields of regular Treasuries and Treasury Inflation Protected Securities (TIPS). TIPS are Treasuries where the principal and interest payments increase with the increase in CPI. The investing public would generally only buy TIPS if they thought they would get at least the same total return as regular Treasuries. Yet the yield on TIPS is lower than that of regular Treasuries. The difference in yield is an indicator of the market’s inflation expectation.

Ten-year Treasuries currently yield 3.29 percent. Ten year TIPS yield 1.28 percent. The difference in yield is 2.01 percentage points. If inflation for the next 10 years is 2.01 percent, the TIPS holder will get the same return as an investor in regular Treasuries. If inflation is greater than 2.01 percent, TIPS will have a total return greater than regular Treasuries.

To summarize current and forecasted inflation, the 12 month increase in CPI through April was 2.2 percent. The 10 year forecast for CPI is 2.4 percent based on a survey of economists, and 2.01 percent based on TIPS.

Of course, inflation could end up being higher or lower than expectations.

Portfolio Structure

Our recommended portfolio has multiple asset classes which can help protect investors against inflation. First, as described in our article “Inflation: will your investments protect you?,” various asset classes in our recommended equity allocation, including small cap, small cap value, emerging markets and REITs, may perform well in an inflationary environment.

Second, our bond allocation is structured to provide some degree of inflation protection.

The two figures below show our recommended bond portfolio for tax-deferred and tax-managed accounts. The last column shows duration, which is a measure of interest rate sensitivity. Bonds with longer duration have greater interest rate sensitivity. For example, a bond fund with a duration of three years will have an estimated loss of 3 percent if interest rates across the board increased by 1 percent immediately. A fund with a duration of five years would have an estimated loss of 5 percent if all interest rates went up by 1 percent immediately. TIPs are indexed to inflation, but they are sensitive to changes in real interest rates (interest rates after subtracting inflation).

Tax-Deferred AccountsSymbolPercent of BondsMaturitiesYield to MaturityDuration
DFA Inflation-Protected SecuritiesDIPSX20%5-20 years1.26%7.9
Vanguard Short-Term TreasuryVFISX30%1-4 years1.10%2.1
DFA Intermediate Gov't Fixed IncomeDFIGX50%5-15 years3.18%4.8

Tax-Managed AccountsSymbolPercent of BondsMaturitiesYield to MaturityDuration
DFA Intermediate Gov't Fixed IncomeDFIGX15%5-15 years3.18%4.8
Vanguard Limited-Term Tax-ExemptVMLTX40%2-6 years1.60%2.5
Vanguard Intermediate-Term Tax-ExemptVWITX45%6-12 years3.10%5.5

We do not recommend TIPs in tax-managed accounts since the increase in principal, which will not be received until maturity, is taxed each period, meaning that investors are taxed on income before they receive it.

Within the tax-deferred account, 20 percent is allocated to TIPS, where the principal and interest increase with inflation.

Another 30 percent is allocated to short-term Treasuries. In an inflationary environment, as these bonds mature, they are replaced by other bonds with presumably higher interest rates, to reflect the higher inflation rates.

Half of the bond portfolio is invested in securities which either adjust explicitly with inflation or else adjust quickly to higher interest rates.

The other half of the portfolio is in slightly longer securities, with an average duration of 4.8 years. Note that we avoid the longest bonds of 20-30 year maturity, which may be hit hardest by an overall increase in interest rates. There is a substantial pickup in yield of 2.08 percent between the Vanguard Short-Term Treasury fund (VFISX) and the DFA Intermediate Government Fixed Income fund (DFIGX), going from 1.1 percent to 3.18 percent. This is due to the somewhat longer maturities in the DFA fund, and the fact that the DFA fund invests in both U.S. Treasuries and U.S. agency and other securities with AAA ratings.

Inflation Increases

What if inflation increases, from the current 2.2 percent to 3.2 percent? First, a little more inflation will likely raise home prices, which could improve people’s confidence and the overall economy. Also, if higher inflation is caused by a pickup in hiring, consumption and stocks could benefit.

What would happen to the performance of DFIGX, relative to VFISX, if inflation increased from 2.2 percent to 3.2 percent? On a total rate of return basis, the higher yield of DFIGX would help offset the lower prices caused by higher interest rates. Assuming all interest rates increased by 1 percent immediately, DFIGX would lose around 4.8 percent in its principal value, versus an estimated loss of 2.1 percent on VFISX, a difference of 2.7 percentage points. Over the course of one year, DFIGX would generate 2.1 percent more in income. So, over one year, DFIGX would underperform by an estimated 0.6 percent, if interest rates rose by 1 percent immediately, which is very unlikely.

For an investor, in a 60 percent equity/40 percent bond portfolio where DFIGX was 20 percent of the total, this underperformance from DFIGX would decrease the portfolio’s return by only 0.12 percent.

Deflation

In many ways, deflation is worse than moderate inflation. If consumers thought that prices would be lower in the future, they would not buy things today. Companies would also postpone purchases and investment. This delayed consumption and investment could cost jobs and hurt stock prices.

While bond prices are hurt by inflation, they are helped by deflation. If interest rates decrease with deflation, it helps the longer bonds the most. In this instance, DFIGX could be the best performing fund in the bond portfolio.

Final Thoughts

There are certainly reasons to be worried about potential future increases in inflation. There are other forces, including a hopefully vigilant Federal Reserve, excess capacity, and global competition, which could help keep inflation at more moderate levels.

We do not know what future inflation will be. What we can do is calmly and comprehensively think about the potential impact of various scenarios in advance, and then construct an overall portfolio which we believe will perform satisfactorily under different economic environments.

How should I allocate my taxable investments?

Several articles on your site refer to taxable and non-taxable portfolios. I don’t see examples of how to allocate taxable accounts. I have approximately equal amounts in taxable and tax-deferred accounts, and I’m looking for help in allocating the taxable one. I am in my middle 50s and plan to work for at least another 10 years. How should I allocate the taxable portfolio?


Of course we believe that taxable accounts should have the appropriate allocation to fixed-income funds. We do not make specific bond-fund recommendations due to the many variables involved in choosing the best mix for any individual investor. For example, municipal bonds are appropriate for some investors and not for others, depending on their tax brackets; and if you’re going to invest in muni bonds, the best funds depend on your state of residence.

Those considerations aside, for fixed-income funds in a taxable account, stick with short-term and intermediate-term government bond funds.

Some advisors recommend that you concentrate your tax-efficient asset classes (equities) in taxable accounts and your more-heavily-taxed assets, such as fixed-income funds, in your tax-deferred accounts. This way, you don’t have to pay taxes every year on interest income from the bond funds.

From a strictly tax standpoint, this makes good sense. But it can cause problems later when it’s time to rebalance or withdraw money for living expenses in retirement.

To understand why, consider that most retirees deplete their taxable accounts first, letting their IRA, 401(k) and similar accounts continue to grow with taxes deferred.

To describe an extreme situation, imagine that you retired with a taxable account exclusively in equities and a tax-deferred account exclusively in bond funds. As you took more and more money from your taxable account (equities), your overall allocation would move more and more heavily to fixed income, gradually taking away the equity funds that you need to keep up with inflation.

After a few years of this you might have a serious asset-allocation problem.

You could solve that problem in the tax-deferred account by selling equity funds and buying fixed-income funds. However, that is an act of rebalancing that might or might not be comfortable.

You could also solve that by starting to withdraw some of your income from the tax-deferred account in order to keep a balance of equities and fixed-income investments. But doing that would reduce the long-term benefit of the tax deferral.

Which approach is best for you? I don’t think you should put yourself in a position where you’ll have to choose.

My advice is to make sure you have proper asset-class diversification, whether that’s 60 percent equities, 50 percent equities or some other percentage. Then use the same balance in each account. This will help you maintain the right level of risk and avoid exposing yourself to large market losses that you cannot afford.

Do I need bonds at age 30?

I am 30 years old and invest fairly aggressively. I have been advised to keep 10 to 15 percent of my portfolio in bond funds, but that seems to me like a waste. I can’t see that 10 to 15 percent in bond funds will do me much good except to satisfy some formula. Am I missing something?


Your long-term strategic asset allocation decision should not be based solely on your age.  You should also consider your financial ability and emotional willingness to withstand volatility.

Some of our clients who are 70 and older are quite comfortable with 70 percent in equities and 30 percent in fixed income. Other clients in their 30s feel that is about as aggressive an allocation as they can handle.  Everybody is different, and a big part of a financial advisor’s job is to help clients determine a suitable asset allocation based on their unique circumstances.

You sound like someone who is willing to accept greater risk and volatility in hopes of achieving a higher rate of return, and an all-equity portfolio could be the appropriate choice for you.

The likely reason you have been advised to invest a small part of your portfolio in bonds is that history indicates that such a portfolio has tended to deliver similar returns to an all-equity allocation, with reduced volatility.

Indeed, it is interesting to note that in the 10 years ending March 31, 2010, the composite of our tax-deferred buy-and-hold all-equity portfolios achieved an annualized return of 5.74 percent, while similar portfolios with 80 percent in equity earned 6.1 percent. The 80/20 portfolios experienced less volatility as well: 14.16 percent, vs. 18.2 percent for all-equity portfolios.

Every period is different, of course, and future returns cannot be known or controlled.  What we can control are our asset allocations and our saving and spending habits.

An all-equity allocation may be suitable for you. However, I hope this helps you realize why some people have advised you to at least consider maintaining a small exposure to bonds in your portfolio.  Ultimately, the choice is yours to make based on the best information you can get plus a realistic evaluation of your circumstances and risk tolerance. Good luck.

Lessons learned in the lost decade

You have probably heard the past 10 calendar years described as a “lost decade” in which investors essentially got nowhere. But even though this period didn’t exactly usher in a bountiful new era for investors, I think “lost decade” is a misleading characterization, because many investors did reasonably well.

In this article I want to look back over the past 10 years through the 20/20 prism of hindsight and see what we expected and what we learned.

Lesson One: Reality often has little to do with what investors expect

The future is always unknown, and predictions are notoriously unreliable. Anybody who, 10 years ago, had accurately predicted even the biggest events of the decade that we just experienced would not have been taken seriously.

But that didn’t stop people from trying to foretell the future.

Investors polled in 2000 said, on average, that they expected the S&P 500 Index to grow at 20% per year in 2000 through 2009. That was seen as a more realistic pace than the 28.6% annual growth in the index from 1995 through 1999. Many people thought it was quite unnecessary to diversify much beyond that index.

The reality: The S&P 500 Index had an annualized loss of 1% from 2000 through 2009.

Lesson Two: Hot performance can fizzle out quickly

In the first months of 2000, large-cap stocks, especially those specializing in technology, were all the rage with brokers, commentators and many independent advisors as well. Millions of investors were eager to cash in on the popular success stories that were being created by young high-tech companies. Many people tried to make their fortunes through a new phenomenon known as day trading.

Many brokers and investment advisors regarded Janus, which specialized in technology and other growth stocks, as the No. 1 mutual fund family for long-term investors.

But reality moved in quickly, and boom turned to bust.

Microsoft stock, then a bellwether of technology stocks, lost nearly two-thirds of its value in the year 2000 – and struggled for the rest of the decade without ever regaining even half that lost value.

As for Janus, the company’s flagship Janus Fund, according to Yahoo.com, lost nearly 55% of its value in 2000 through 2002 and had an annualized loss of 4.4% from 2000 through 2009.

Lesson Three: Use massive diversification to spread your equity risks

For many years we have recommended what we now describe as massive diversification on the equity side of the portfolio. Our advice was not popular 10 years ago, but we said investors could not know what asset classes would perform the best in any future period. Accordingly, we advocated owning many kinds of assets that had beaten the S&P 500 Index over long periods of time.

In 2000, U.S. large-cap stocks like those in the S&P 500 Index made up only 12.5% of the equity part of the portfolios we managed for our buy-and-hold clients. We advocated indirect ownership not of 500 stocks but of 10,000 or more, through mutual funds that invested in U.S. and international stocks, big stocks and small stocks, value stocks, growth stocks and emerging markets stocks.

This turned out to be good advice. The composite of our all-equity buy-and-hold accounts returned 5.4% annually for the decade, after fees and expenses, vs.  -1% for the S&P.

Today: Our recommendation remains unchanged. Diversify massively, and don’t try to chase recent performance.

Lesson Four: Think small-cap stocks

For more than 15 years we’ve been recommending that investors hold small-cap stocks in addition to large-cap ones. In the decade of 2000 through 2009, this turned out to be good advice. In those 10 years, the Dimensional Fund Advisors Micro-Cap Fund, the small-cap fund we used for client accounts, had a compound annual return of 6.3%.

Today: Even though we know that small-cap stocks won’t shine in every year or every decade, we still recommend them.

Lesson Five: Invest in value

For many years we have been recommending value stocks in addition to growth stocks, and this turned out to be worthwhile advice. DFA’s large-cap value fund compounded at 4.4% during the decade. The DFA small-cap value fund rose 9.1% annually.

Today: The underlying rationale for value stocks hasn’t changed, and we still overweight our portfolios with funds that invest in them.

Lesson Six: The world is full of opportunities

For many years we have recommended international stocks, including large and small, growth and value plus a slice of emerging markets. Our 50% weighting in internationals was much higher than most professionals recommended then or now. We said that even if international stocks didn’t return more than their U.S. counterparts, they would most likely reduce the volatility of an equity portfolio.

Based on the returns of DFA funds we use in our clients’ accounts, this turned out to be good advice. International small-cap value stocks compounded at 11.3%, compared with “only” 9.1% for U.S. small-cap value stocks. Small-cap international stocks rose 8.7%, vs. 6.3% for U.S. micro-cap stocks. International large-cap value stocks were up 6.7%, vs. 4.4% for U.S. large-cap value stocks. DFA’s emerging markets fund was up 9.5% annually.

Today: The world is increasingly linked financially, and it’s foolish to think that excellent investing opportunities stop at the U.S. border. We’re still committed to having half our equity holdings in international funds.

Lesson Seven: Most investors need fixed-income funds

A decade ago, we knew that even our unusually broad equity diversification wouldn’t be enough to protect investors from major bear markets. We said investors needed fixed-income funds to get that protection.

Twice in the past decade, all-equity investors paid a high price for being without this protection. In 2000 through 2002, our tax-deferred composite all-equity buy-and-hold accounts lost 18.3% (a cumulative loss), vs. a loss of only 6.5% for similar accounts with 60% equities and 40% fixed-income.

In 2008, our composite of all-equity accounts dropped 41.7%, vs. only 23.2% for those with 60% equity.

Today: Many investors in their 20s and early 30s may be able to safely skip fixed-income funds. But anybody who’s in sight of retirement, and certainly anybody who’s already retired, should mitigate the risk of the stock market by owning fixed-income funds.

Lesson Eight: Stick to conservative fixed-income investments

Ten years ago, our clients’ fixed-income exposure was limited to government issues with up to five years’ maturity. This relatively conservative posture provided a lot of protection. Over the past few years we have fine-tuned our fixed-income portfolios. Now we use funds that invest in Treasury Inflation Protected Securities (TIPS) and intermediate-term government funds as well as short-term ones.

Lesson Nine: Moderate-allocation portfolios can be very attractive

About half of our buy-and-hold clients have accounts with portfolios in which either 50 or 60% is allocated to equities. This moderate approach can provide an appealing combination of growth potential and downside protection.

In the past decade, the composite of our 50% equity accounts grew at a rate of 5.6% annualized. They suffered a worst-12-month loss (March 2008 through February 2009) of 25%, which was greater than we expected 10 years ago. Fortunately, that loss was followed by last year’s strong recovery.

For comparison’s sake, as noted above, the S&P 500 Index lost 1% per year and had a worst-12-month loss of 43.3%.

A decade ago, we believed that our 60% equity accounts would produce a return similar to that of the S&P 500 Index. Fortunately, we were quite wrong on this point. Our 60% equity portfolios compounded at 5.5% while the S&P 500 was in the losing column. The worst-12-month loss on 60% equity portfolios was 30.5%.

Today: We still believe that many investors can meet their long-term  needs with 50 or 60% in equities, at substantially less risk than that of the Standard & Poor’s 500 Index.

Lesson 10: Bear markets just keep coming back

A decade ago we told investors they should expect serious bear markets, with losses of 20% or more, every four to five years. We were right. The past decade included two nasty bear markets.

Actually, we were more right than we wanted to be. In the 20th century, the average loss of bear markets was about 30%. The first two bear markets so far this century had average declines of about 50%. Ouch!

Frankly, we are tired of bear markets, and we’d just as soon not have two more in the coming decade. But we are unlikely to get our wishes in this regard. We remain committed to helping investors stay the course through whatever storms the market hurls at them.

Lesson 11: Mutual fund families aren’t all equal

Ten years ago we expected that do-it-yourself investors who followed our asset allocation recommendations would do better using Vanguard’s funds than using Fidelity’s. They did.

According to the Hulbert Financial Digest, our recommended all-equity portfolio at Vanguard had a compound return of 4.1% in “the lost decade;” the comparable return of our all-equity portfolio at Fidelity was 2.3%.

We also believed that DFA funds, which we use in our client accounts, would do better than Vanguard funds even after management fees and trading costs. They did. Compared with the 4.1% annual return at Vanguard, our all-equity DFA portfolio (as noted earlier) grew at 5.4%.

Today: I believe that DFA’s many advantages will continue to give it the edge over Vanguard, even after our management fee. Fidelity and Vanguard are both good fund families. But I still think it’s valid to expect Vanguard’s lower expenses, greater diversification and lower reliance on active management to beat Fidelity’s offerings.

Lesson 12: Investment strategies continue to evolve

Our recommendations today are very close to what they were 10 years ago, although as noted above, we have fine-tuned our fixed-income recommendations. Our client accounts now include some specialized funds in emerging markets that are not available at Vanguard or Fidelity. And we have added U.S. and international real estate investment trust (REIT) funds to our equity mix.

In addition, our clients have the benefit of some DFA funds that did not exist 10 years ago, funds with fewer transactions, lower costs and higher tax efficiency.

Our recommendations are based on decades of research into what’s most important to long-term investors. They’re the best we can do right now, and I’m certain they will continue to evolve.

What should investors do today?

If you are a Merriman client, you have the benefit of massive diversification in your portfolio. We’ll do our best to steer you away from investment fads. We’ll continue to seek the best ways to make your money work for you. Perhaps most important, we’ll help you figure out how much risk is appropriate for you, and we’ll keep your investments fine-tuned to that risk level.

My charge to you as an investor is essentially unchanged from 10 years ago:

Find solid long-term advice and follow it. Put contributions, withdrawals and rebalancing on automatic pilot if you can. Manage your risk and manage your emotions.

Live within your means (and keep saving money if you’re not yet retired).

And finally, keep the faith. I know this is often challenging, but one of your most important jobs as an investor is to maintain your confidence in the long-term future of our economy and of the economies around the globe.

Once you have all that under control, your job is to live your life fully. That’s what I plan to do in this decade, and I hope you will too.

How do I allocate my 529 for two children?

I am saving money for two children who are heading for college. One will start this year, and the other will start in six years. I have saved approximately $20,000. What asset allocations would you recommend in these 529 accounts at Vanguard?


First, I have to say your children are very fortunate to have a parent who supports them in this way.

To address your question, I assume you have two separate 529 accounts, one for each child.

With a total of $20,000 saved for two presumably four-year college educations, I do not believe you can afford the risk of losing what you have set aside. Some people might be tempted to invest in equities for a student, who is starting this year, in the hope of growing those savings over the next three years.

However, I believe you should expect any growth in that account to come from additional savings you can add, not from market gains.

So, for the student who starts college this year, you should start by separating whatever you will have to pay this year and keep that in cash. With the rest of the balance in that account, I would split it 50/50 between Vanguard’s short-term fixed income fund and short-term cash reserves. I realize this is very conservative, but take it from me: You will not be a hero to your son or daughter if you lose this money in the stock market.

The student who starts in six years has more time, and some of the money is likely to remain invested for nine years. Over that length of time, there is a pretty fair probability of some stock-market gains, though their magnitude is totally unpredictable.

I would still take a very conservative stance and rely on yourself and your child to add savings over the next nine years. Accordingly, for this account I suggest an allocation of 50 percent in Vanguard’s short-term fixed-income fund, 30 percent in short-term cash reserves and 20 percent in global equities.

One way to think about this is by time horizons. One quarter of the money in the one account has a time horizon of zero years (needed in 2010). The second quarter has a time horizon of one year and the third quarter has two years. The final quarter has a three-year time horizon. Three years are not enough to have much confidence in the stock market, even with the best diversification.

In the other account, 25 percent will be due in six years, 25 percent in seven years, 25 percent in eight years and the last of it in nine years. For this money, I think it is reasonable to seek some stock-market gains.

As your second child gets closer to needing the money, I suggest you gradually make the allocation more conservative. By the time of the first tuition payment, 2016, this account’s allocation should mirror the one that I’m suggesting for the student who is starting this year.

The point of getting a college education is learning, and I suggest you use this issue to teach your children a few basics about saving and investing. By setting up these accounts in the first place and seeking expert advice about the investments, you are demonstrating some important lessons from which your children can benefit. Here are a few:

1. Live below your means, so you can save for important future needs. This is obvious to you and me, but young people don’t always embrace this. If you can instill this attitude as a habitual way of dealing with money, your children will benefit enormously over their lifetimes.

2. Make sensible investment choices. You make it a priority to make sure the money you saved is there when needed.

3. You have thought about what might go wrong and did your best to protect this money. You could talk with your children about what might happen if half or more of this money were lost in a stock market downturn. What would that do to their available options?

4. Seek outside advice instead of making seat-of-the-pants decisions.

5. Keep your costs low (Vanguard) and your taxes low (a 529 plan).

Finally, you are casting a vote of confidence in your children’s future, and you are backing up that vote with a financial investment. Your two children may take this for granted now, but I’m betting someday they will come to appreciate this a lot.

Why are you such big fans of index funds?

If you compare the Fidelity Low Price Stock Fund to Vanguard’s small-cap and mid-cap index funds, you will see Fidelity’s three-year, five-year and 10-year performance leaves the index funds in the dust. Fidelity’s fund is a small to midcap blend fund. If it’s so easy to find funds that do much better than index funds, why do you recommend index funds? If actively managed funds make you more money in the end, you’d be better off rather than worrying so much about expense ratios and turnover. Please answer my question. I am getting different answers from every advisor.


The debate between active and passive management has been going on for decades and will probably continue to do so. In the end, you must decide for yourself what to believe and what to do. I’ll give you my perspective plus some resources that show you why we believe in passive management.

What you have done is very easy. You have looked at the past and determined what you should have invested in, at least in this category of assets. If investing were that simple, everybody would do it, and we’d all be wealthy. The problem is you cannot invest in any past track record.

What you have not done is look into the future to see what the winners will be over the next three, five or 10-year period. Countless studies have been done trying to find a strategy or formula linking past performance with future performance. So far, that elusive link hasn’t been found.

As you have discovered, there are many salespeople and analysts out there telling you they can help pick the best active fund managers. They can describe the process these managers use, and the selection screens through which they put their managers. They can assure you that if a manager doesn’t perform, they will replace that manager.

The chosen managers most likely have excellent track records, and the appeal can be enticing. If you are interested in the pitch, you can ask to see their actual client results. More useful would be to ask which managers they were recommending in the past and how those managers did after the recommendation. In other words, what is the track record of the person who’s making the pitch to you?

Let’s look at the Fidelity Low Price Stock Fund, which as you point out has done well. We know now that it outperformed its benchmarks. We had no way to know this in advance, when the knowledge would have done us some good. As Paul Merriman has said many times, “There is no risk in the past,” because we know how the past turned out.

Of course, it’s equally true that we don’t know how well index funds will do. There is one very important difference that you need to understand. Actively managed funds are trying to beat the market. That’s how they attract money. Index funds do not try to beat the market; they accept the returns of the market.

Many academic and industry studies compare active and passive management.

Back in 1991, William F. Sharpe wrote an important paper called “The Arithmetic of Active Management,” in which he states, “Because active and passive returns are equal before cost, and because active managers bear greater costs, it follows that the after-cost return from active management must be lower than that from passive management.”

That, of course, did not end the debate. Eugene F. Fama and Kenneth R. French also discuss this topic in the DFA Fama/French forum on the Dimensional Fund Advisors web site.

As I mentioned, many studies seek clues to future performance based on past performance. In February, Vanguard published a new paper titled “Mutual fund ratings and future performance,” which concluded, that it’s extremely hard to find a quantitative system that accurately predicts future mutual fund performance.

Because many investors rely on Morningstar’s ratings of one to five stars as likely indicators of future performance (something we don’t recommend), Vanguard took a look at that. The researchers found that less than 40 percent of the funds ranked as five stars outperformed their style benchmarks in the 36 months after achieving that rating.

Investors who choose a five-star fund presumably hope that the fund will continue to have that ranking. Vanguard found that fewer than half the funds ranked as five stars still had that ranking one year later.

In the mid-1980s, Morningstar began publishing its star ratings, which were and are still based on risk-adjusted past performance. Morningstar publishes a wealth of data on the funds it covers and has always encouraged investors to consider multiple factors before investing. The company has never encouraged investors to use only the ratings to indicate or predict future performance, although many investors do just that.

Morningstar itself did a study, published in December 2008, looking back at funds that had its highest rating in 2003. Five years later, in the summer of 2008, the average five-year ranking of those former five-star funds in the domestic equity category was only 3.07: just barely above average.

We believe that most investors can achieve their long-term goals by accepting the returns of the markets without incurring the higher costs of active management. However, every investor must make that choice.

NY Times: When Not to Pay Down a Mortgage

Elaine Scoggins, our Client Experience Director, is quoted in this New York Times article about paying off your mortgage.

Get the full article here.

Roth IRAs: To convert or not to convert

As a financial advisor and CPA, I often receive tax questions from my clients.  One that has been coming up a lot in the past year is: “Should I convert my non-Roth retirement plan (401(k), traditional IRA, 403(b) or 457(b)) to a Roth IRA?”  The question isn’t surprising, given the new rules that took effect January 1 for Roth IRA conversions.

The short answer, which should not surprise you, is: “It depends.”

The issue is complex, and the answer for one person can be radically different from the answer for someone else. Converting might be a boon, a mixed bag or a mistake, all depending on your circumstances.

It’s worse than that, because the only way to make sure you’re making the right choice is to know some variables of the future which simply cannot be known.

My bottom-line advice is to seek professional advice from your tax advisor, your financial advisor or your tax attorney before you take the plunge.

A word of caution

The difficulty with Roth conversions, like the difficulty for many tax strategies, is that the right answers cannot be known in advance. You usually cannot know your future income for sure. You cannot know what Congress will do to the tax code. And you cannot know future tax rates. In each case, the best you can do is guess.

We can analyze potential outcomes until we’re blue in the face, but the fact remains that the future is never certain.

Let me also say upfront that as a tax accountant, I’m trained to help clients find ways to defer taxes.  A Roth conversion turns that approach on its head by purposely accelerating tax payments.  And once a conversion is done, it cannot be undone except within a short window of time, generally only until the extended due date of the tax return for the year in which the conversion occurred. Therefore, you should be very comfortable with the tradeoffs of a Roth conversion before you do it.

Roth IRA basics

Most people are familiar with traditional IRAs: contributions are generally tax-deductible, the earnings grow tax-deferred, and distributions are taxed as ordinary income in the year of withdrawal.  In a traditional IRA, the owner must, beginning at age 70 ½, make mandatory withdrawals called required minimum distributions, or RMDs. By contrast, Roth IRA contributions are not tax-deductible. But there is no tax on earnings in the account and withdrawals are tax-free as long as the owner meets certain requirements.  Roth IRAs are not subject to RMDs.

From a tax perspective, traditional IRAs let you save on taxes now and pay taxes later, presumably at a lower tax rate after retirement. Roth IRAs require you to pay taxes now, but you get to earn tax-free (not just tax-deferred) income in the account.

Roth conversion basics

When you convert a traditional IRA into a Roth IRA, you must pay taxes all at once on the whole amount that you convert. This isn’t something most people are eager to do. And until now, Roth conversions have been restricted to taxpayers with modified adjusted gross incomes of $100,000 or less.  This has blocked many people from converting.

New rules for 2010 and beyond

Starting in 2010, the income restriction on Roth conversions will be repealed. An article in the Journal of Financial Planning suggested that more than 13 million investors would become eligible for Roth conversions for the first time in 2010.

Congress also included a special bonus for taxpayers who convert in 2010: They can choose to defer the tax effect of the conversion to the years 2011 and 2012. (As the law stands now, this affects only 2010 conversions, not those made later.) On the surface, this seems like a pretty good deal: Get the benefits of a Roth IRA now and pay the taxes later.  Unfortunately, it’s not quite that simple.

TIDE: Taxes, Inheritance, Diversification and Estate planning

When I help clients decide if a Roth conversion makes sense for them, I try to cover four areas: taxes, inheritance, diversification and estate planning.  I call this my “TIDE” analysis.  No single factor will control the decision, but taken together these four factors can give clients a reasonable handle on the pros and cons for their situation.

Taxes

Taxes are often the driving factor for most people who consider Roth conversions.  Unfortunately, it’s also the most complicated variable to predict accurately, because the outcome depends on income and tax laws, either of which can change drastically.

Generally speaking, you are likely to benefit from a Roth conversion if you will be in a higher tax bracket when you withdraw money from the account. You can pay taxes at your current (lower) rate and avoid taxes later at the higher rate you anticipate. You can manage your tax exposure through partial conversions over multiple years so that you don’t have too much additional income in one year and bump yourself into a higher tax bracket.

Why might you be in a higher tax bracket when you begin to draw on your IRA assets?  For one thing, you might have higher income in retirement that could move you into a higher tax bracket. For another, Congress can always raise tax rates.

Most of us who are currently working are unlikely to have more income in retirement than we have now. This makes us poor candidates to consider conversion based on tax savings alone.  But those who are not presently working or are retired and on fixed incomes have a much higher likelihood of benefiting from a Roth conversion.

For many people, the possibility of future tax rate hikes by Congress is a real concern.  Given the current level of government borrowing, the huge budget deficits, and the problems plaguing entitlement programs such as Social Security and Medicare, it is not difficult to imagine higher tax rates down the road.

In fact, income tax rates are scheduled to increase significantly in 2011. The current tax brackets of 25 percent, 28 percent, 33 percent and 35 percent will revert to their pre-2001 levels of 28 percent, 31 percent, 36 percent and 39.6 percent, respectively, next year.

This means that if you convert in 2010 and elect to defer the taxes on the conversion until 2011 and 2012, you could (depending on other items that affect your tax return) have to pay those taxes at a higher rate than if you paid them this year. In light of this, some people may be willing to pay taxes at current rates in order to hedge against potentially higher rates in the future. Personally, I think a Roth IRA can be a great tax-rate hedge. But as with all hedged bets, you might win and you might lose.

When thinking about taxes, we must also consider what higher income can do to the multitude of deductions, credits, and phase-outs that permeate the tax code.  For those collecting Social Security, this may be especially important, as the increase in income from the conversion may cause more of your Social Security benefits to be taxed in that year. On the other hand, if you don’t convert, your taxable income may eventually increase anyway due to the RMD requirements, potentially causing more of your Social Security benefits to be taxed later.

Another important tax-related consideration is this rule of thumb: Don’t convert unless you can pay the taxes from a source outside the IRA you are converting. This rule will let you keep the maximum amount of money growing tax-free. If you are under age 59 ½, the money you withdraw in order to pay taxes will be subject not only to income taxes but also to a 10-percent early distribution penalty.

To summarize, if you expect your income to increase in retirement, or if you expect (or want to hedge against) higher future tax rates and if you have enough assets outside your IRA to pay the additional taxes, then you may be a good candidate for a Roth conversion.

Inheritance

A  Roth IRA can be a very efficient tool for wealth transfer.  Because they are not subject to minimum distribution requirements, Roth IRAs can continue to grow undiminished by withdrawals during the owner’s life, thereby leaving a much larger asset to the IRA beneficiary.  Furthermore, this beneficiary will enjoy completely tax-free distributions from the Roth.

If you’re intending to leave a legacy to grandchildren, you may find this a particularly attractive vehicle because inherited IRAs can be distributed over the beneficiary’s life expectancy. With the presumably long life expectancy of a grandchild, required distributions should be relatively small, allowing this asset to keep growing tax-free for many years.

Diversification

Accountants often find it a good idea for retirees to have a diversified pool of assets to draw from. This means withdrawals from some sources (401(k) plans and traditional IRAs, for example) are taxable while those from other sources (Roth IRAs) are tax-free.

If you convert only some of your IRA assets, you will have more flexibility to control your taxable income without having to reduce your cash flow.  For example, you could draw just enough from the taxable pool to stay within a certain tax bracket, meeting the remainder of your cash needs from your non-taxable assets.  If tax rates increase, you could use more Roth assets to avoid the higher rates.  If rates stay the same or decline, you could tap more of your taxable assets.

Estate taxes

If you are fortunate enough to have a sizable estate subject to estate tax (i.e. individual estate over $3.5 million or joint estates over $7 million in 2009), Roth conversions should be high on your list of financial tasks to consider this year. By prepaying the tax on an IRA through a Roth conversion, you can reduce your taxable estate by the amount of that tax.  This in turn would reduce your estate tax burden at death.

With estate tax rates as high as 45 percent, the potential estate tax savings here will almost surely outweigh all other considerations.  Depending on what happens with estate tax legislation this year, Roth conversion planning to reduce estate taxes could become a much more important issue.

Apply TIDE to your goals

Unfortunately, there is no magic formula to help you know for sure what is your best move. Every situation is different, and only you can determine which of these factors are most important to you.  A thorough analysis of these issues with a competent professional can definitely help you weigh the pros and cons, but at the end of the day, you have to live with the consequences.

Nevertheless, the removal of the Roth conversion limit is a wonderful opportunity for some people to put themselves in a better tax situation. Although the future is uncertain, it is not completely unmanageable.

Buy Treasuries directly or through a fund?

What is your opinion on buying Treasury securities directly from the Treasury website vs. using Treasury mutual funds?



The short answer is that in the end we believe  most investors will be better off buying Treasury securities through mutual funds rather than directly. But each source has its pros and its cons.

The main advantage of buying directly from the Treasury is that you avoid mutual fund costs, which can erode your returns. However, buying directly involves some obstacles that may or may not be significant to  you.

If you want to sell a Treasury security before its maturity, you will have to meet a minimum holding period and pay a nominal transaction fee on the sale. If you buy directly, you’ll be responsible for tracking maturities and reinvesting principal and interest. If you delay reinvesting these amounts, your return may suffer while your money is in cash.

The main advantage of owning Treasury securities through a mutual fund is convenience. Unless you choose to receive interest and/or principal payments in cash, a fund will reinvest those amounts at the current interest rate. In a mutual fund, you can buy and sell whenever you like without a minimum holding period.

In the final analysis it is up to you. If you can reliably manage the interest and principal payments, then you can save money buying directly from the Treasury. If you’re willing to pay for these services, consider using an exchange-traded fund or a low-cost fund such as those offered at Vanguard.

What happens to your 401(k) when you leave your job?

Whenever you leave a job, whether it’s your choice or not, there are many details and changes competing for your attention, and it’s easy to overlook the disposition of your employer-sponsored retirement plan such as a 401(k), 403(b) or 457.

You don’t actually have to do anything, but doing nothing is usually not your best choice. Making the right choice can let you add many thousands of dollars to your retirement nest egg. Making the wrong choice can unnecessarily squander some of your savings to the tax man and deprive you of future earning power.

You may get some very general guidance from your employer. But employers are prohibited by law from giving you specific advice. The custodian of your retirement plan (Vanguard or Fidelity, for example) has little incentive to overcome a basic conflict of interest: Even though your investment options will be restricted if you leave your money where it is, that’s exactly what your custodian hopes you will do.

This is a choice you need to make on your own. Fortunately it’s neither complicated nor difficult.   In addition, you don’t have to do it immediately (although the lack of a deadline is a mixed bag if it leads you to procrastinate and then become complacent).

Here are your basic choices:

  • Do nothing. Leave your money in the current plan, assuming that is allowed. This is the option that is most often taken because it’s so easy.
  • Roll your assets over into a plan offered by a new employer, if you have one. This option is OK but it’s not likely to be the best one.
  • Cash out your account and use the money to pay for the transition from your job to whatever is next for you. This is usually the worst option.
  • Roll the account into an IRA. You’ll wind up with what’s called a Rollover IRA. This is likely to be the best option for the majority of people.

Now let’s look at each option in a bit more detail.

Leaving the money where it is

If your balance is at least $5,000, your current employer cannot force you to withdraw the money.

What’s good about this: Obviously, it’s easy. Until you withdraw it, your money will continue to be sheltered from taxes on capital gains, dividends and other income. If you stayed at your job at least until your 55th birthday, you can withdraw money without paying a 10 percent IRS penalty. That’s something you can’t generally do in an IRA until the year you reach age 59 ½.

What’s not so good about this: The biggest drawback to this option is that, because it requires you to do nothing, it can lead you to forget about your retirement plan. In that case you may stop managing it, rebalancing it or even paying attention to it. Unless you keep your old employer updated with all changes of address (something you’re not likely to do otherwise), you may stop receiving investment statements. This makes it even easier to forget about the plan and harder to withdraw money when that time comes.

Your investment choices will continue to be limited by what’s available in your current plan. You won’t be able to add money to the account, and you could be charged additional fees for trading and rebalancing after you are no longer an employee.

Rolling over into a new employer’s plan

This seems like a very logical choice, though it is not available in every new plan.

What’s good about this:  You can have all your employer-related retirement savings in one place. Potentially you will have access to the rolled-over assets at age 55 without facing a 10 percent tax penalty.

What’s not so good about this: Your investment choices will be limited to what your new employer’s plan offers. In addition, once you make this move, you can’t change your mind and undo it.

Liquidating the account into cash

When you’ve just stopped getting a paycheck, this might seem the most attractive option. In the long run, it’s likely to be the worst one.

What’s good about this: You will have cash to support yourself and your family when you may need it a lot. This may reduce the psychological sting, especially if you’ve been laid off unexpectedly.

What’s not so good about this: Practically everything.

In the short term, you’ll be hit hard by taxes and possibly penalties as well. Whatever amount of savings you liquidate will be added to your taxable income. This could bump you up into a higher marginal tax bracket. In addition, if you’ve not yet reached age 59 ½, you’ll pay a 10 percent penalty to the IRS. Here’s how that might look: If you cash out $50,000 from a 401(k) account and you’re in the 20 percent tax bracket, $10,000 is gone immediately. Add the 10 percent penalty and you now have only $35,000, or 70 cents on the dollar that you thought you could spend. If you are subject to state income taxes, you could pay 8 percent or $4,000, reducing your spending power to $31,000, or just 62 cents on the dollar. Ouch!

In the long term, you will have given up something you can’t get back again: A chance to have money (let’s assume $50,000) growing in a tax-deferred account for your retirement. If you’re 20 years away from retirement, that $50,000 could grow to $233,000 by then, assuming a growth rate of 8 percent. So I ask you: Is it really worthwhile to have $31,000 now at the cost of $233,000 later? You may think so in the moment, but I am willing to bet that 20 years down the road you will wish you had found some other way to deal with your immediate situation.

Moving the assets into a Rollover IRA

This, in my opinion is the most flexible and potentially the most advantageous of the options.

What’s good about this: The biggest advantage of this choice is that it gives you thousands of investment options from which to choose. That will let you get your asset allocation just the way you want it and do so in the most cost-effective manner.

In addition, you will have a wide choice of custodians. If you have other accounts at Fidelity or Vanguard or T. Rowe Price, you can have your Rollover IRA managed there as well. Having all your investments under one umbrella can cut down on paperwork and make it easier to see the big picture all at once.

Furthermore, if you have sufficient outside assets to pay taxes, you may be able to convert some or all of your retirement savings to a Roth IRA, with its tax and estate-planning benefits. The details of that are beyond the scope of this discussion, but it’s worth discussing with your tax advisor or your financial advisor.

What’s not good about this: In a 401(k), you may be able to borrow against your savings in an emergency without an immediate tax hit. You can’t do that with a Rollover IRA. (However, borrowing 401(k) funds is a risky and potentially expensive option that should not be used except as a last resort.)

If you traded actively inside a 401(k), you may have done so with only minimal trading fees, if any. In an IRA, you’ll have to pony up for those fees if you continue a pattern of  trading.

In relatively rare cases, a 401(k) account may contain highly appreciated company stock. If this is your situation, be sure to consult a tax advisor before you make your move. Otherwise you might bump into some unexpected and unpleasant tax consequences.

Depending on the size of your account, you might not be able to diversify as well as you want to. Inside a 401(k), you are typically exempt from minimum investment requirements per fund, and even with relatively small balances you can diversify well. But in an IRA, you might find that per-fund requirements limit you to only a few funds. This is worth checking out before you take the plunge.

As you can see, your best choice isn’t necessarily obvious. Nevertheless, I believe the best option for most people is the Rollover IRA, and the worst is turning a 401(k) into cash. Before you make your decision, consult with your financial advisor.

Who gets your assets when you’re gone?

I want to tell you a story about how a woman’s simple negligence cost her kids nearly $500,000.  After 30 years of marriage, a woman I will call Mary Smith found herself in a failing marriage that was heading for divorce court.

Her only major financial asset was a rollover IRA that had started as a 401(k) account shortly after she graduated from college and started a career in sales. As she advanced, she was able to put more and more money into the account; by the time of her impending divorce, her IRA was worth about $500,000.

As she contemplated her divorce, she was fairly confident that she’d walk away with at least her IRA. Her two children, Sarah and James, had recently graduated from medical school; each of them had substantial student loans. Mary told them she would help with the loans by using some of her IRA to pay down their loan balances at the rate of $12,000 per year for each of them. She made good on her promise by making the first payment.

Then tragedy struck. Early in the divorce proceedings, she was killed in an automobile accident.  Mary’s lawyer had given her a list of documents to bring to their second meeting, including beneficiary designations for her IRA. But she never made it to that second meeting.

As they grieved the loss of their mother, Sarah and James were stunned to learn that the IRA now belonged to their father, from whom they had been estranged and who many years earlier had been designated as the beneficiary of the IRA.

Sarah and James asked their mother’s lawyer if they could stake a legal claim to the IRA. His response was simple: No.  In this case, the beneficiary designation was the final word. To further clarify the point he told them that even if Mary had changed her will to leave the IRA to them, the beneficiary designation would have trumped the will.

Lessons

Perhaps the most important lesson here is to be aware that legal documents you may have signed many years ago can have big consequences.

That means it’s smart to review these documents periodically to make sure they reflect your current wishes. It certainly makes sense to review your designations after major life events such as a marriage, divorce, birth or death. Updating contact information is a good part of this periodic review.

Some aspects of estate planning are complex and require the services of an attorney. But designating a beneficiary – and changing that designation – is as easy as filling out and signing a form.

Who you designate as your beneficiary is entirely up to you.  There are a few things to keep in mind.

A minor can inherit financial assets but cannot legally control them. If you intend to leave assets to a minor, name a custodian or guardian who can manage the assets until the beneficiary reaches the legal age of maturity.

You can designate a contingent beneficiary to receive the property in case the primary beneficiary is unable to do so. This is a good idea, and ideally it should be part of an overall plan for distributing your assets at your death. If no contingent beneficiary is designated for a retirement account, your will determines what happens to the account.

Many people are fairly sure who is named as beneficiaries on their accounts.  But sometimes they are wrong. Even if you’re certain, it never hurts to get a copy of the documents from the custodians of your accounts. If necessary, your financial advisor can help you nail down this information.

Designating your beneficiaries is only one part of estate planning, but it’s an important one. Before you meet with an attorney to prepare or review your will, make sure you know who you’ve designated as beneficiaries for your IRAs, 401(k) accounts and insurance policies.

Sarah and James

Fortunately, Mary’s children fared better than they might have.  The death of their mother brought them and their father closer together. He carried out their mother’s wishes by promising to honor her pledge to give them each $12,000 a year toward their education loans.

In addition, the father completed the necessary paperwork to have Sarah and James named as beneficiaries of the IRA account. Although they unfortunately lost their mother, her wishes were not entirely thwarted.

How to be a smart packrat

Usually once or twice a year I get the urge to organize my filing cabinet, particularly to clean out the piles of paper that seem to accumulate in folders with labels like “pay stubs,” “insurance” and “retirement.”

Part of me – my packrat side – wants to keep all sorts of things I might need in the future. Another part of me wants to have a lean-and-mean paperwork system that will let me quickly find whatever I want. It’s a constant tug of war that probably exists in millions of households.

In a perfect world, we would have instant access to everything without needing to clutter up our desks, our homes, our minds. In the real world, we have to deal with fundamental issues like these: What can I safely toss? What should I keep? How long should I keep it?

I’ll give you some guidelines momentarily, but first a few observations on the evolution of paperwork. A generation ago, paper itself was the essential vehicle for nearly all records. If you didn’t have the paper, you were potentially in trouble. Keeping the canceled paper checks from your bank account was sometimes the only way to prove that you paid a bill. Now, many banks don’t even return your paper checks. Instead, they give you access to them online. Likewise, many bank statements and investment statements are electronic.

A generation ago, most people had to rely on shoe boxes, filing cabinets or (I cringe at the memory) junk drawers for storing important records.  Now the majority of households have personal computers, which are marvelous storage devices.

In the past few years I’ve come to have less and less need to keep monthly paper bank statements in file folders. More and more, I’m finding it’s easy to download those statements to my computer and put them into virtual file folders. Electronic statements don’t poke their corners out of file folders; nor do they suddenly fall to the floor in a jumble. Even better, I can keep them forever, as long as I back up my data to a second hard drive – an important chore that has now become easy to automate.

In addition, my bank, my credit union and many other businesses I deal with seem quite content to keep my records for years, quickly accessible to me with only a user ID and a password.

As a result, the packrat part of my personality finds it easier to part with paper these days.

Still, some paper records remain the gold standard for proving whatever you are trying to prove. So back to the fundamental issues:  What should I keep and how long should I keep it?

Here are common-sense guidelines for some of the most important records we have to deal with.

Taxes

In general, keep your tax returns and supporting documents for at least seven years after the date the return was due. The IRS can audit your return for up to three years for any reason. It has six years to audit you if it suspects you underreported your income by 25 percent or more. There’s no time limit at all if you failed to file a return or filed a fraudulent return.

I find that a copy of one year’s final return plus cancelled checks and other relevant documents usually fit into a paper file folder that fits easily in the bottom drawer of the file cabinet. I tend to keep these folders for a decade before I finally toss them. And before I toss them, I always take out the W-2 earnings statement for permanent safekeeping. If I ever have to prove to Social Security that I had earnings and contributions in a certain year, a W-2 will be a great way to do so.

IRA contributions

Keep all your IRA contribution records permanently, whether or not you deduct them on a tax return. Sometime in the distant future you may be asked or required to prove when and how you made those contributions. Even if you totally use up the IRA and close the account, keep the records.

Retirement savings plans

Keep monthly and quarterly statements for a year until you get an annual statement that contains the year at a glance. If you are contributing to a 401(k) or similar plan, your contributions should show up on your W-2 statement (which, if you follow my example, you will keep permanently).

Keep your annual account statements permanently, too.

Bank statements and cancelled checks

Your bank probably keeps records online for you, and if you absolutely must have a cancelled check you can get it (perhaps for a small fee). Download the statements to your computer and keep them permanently. If you get monthly paper statements, keep them in a file you store next to your tax records for the same year. How long to keep them is a matter of judgment. Personally, I rarely have any need to consult statements after a year; but I tend to keep them for seven to 10 years, giving my inner packrat a small win.

Brokerage and mutual fund statements

Keep brokerage statements for as long as you own securities you bought. Whenever you sell something in a taxable account, the record of the sale belongs in your tax files for that year. You’ll also need the purchase information to do your taxes properly. While more and more financial services firms supply you with cost basis information, you can’t absolutely rely on it. Keep the paper trail.

Mutual fund statements can be handled the same way. Keep your quarterly statements until you get the annual one. Your mutual fund folder should contain annual statements for as long as you have owned the account and quarterly ones for the current year.

Bills (presumably paid) and credit card statements

Here’s a category where you may feel as if you are being pulled in two different directions. If you have a cancelled check or other record to show you’ve paid for something, you should be able to toss the original bill, right? Well maybe, but not always.

Credit card companies are pretty good about keeping statements electronically, and you can probably get records you need for purchases you’ve made over the past year or two. But for especially important items (see below), keep the paperwork.

It’s a good idea to keep bills, invoices and receipts for large purchases that you might someday donate or sell (either transaction might become what tax accountants call a taxable event). In the unfortunate event that you must file an insurance claim for personal property losses, you’ll want to be able to prove what you owned and what you paid for it.

There are no hard-and-fast rules about what to keep and what to toss. Common sense is often a good general guide.  If you can’t find a receipt for a $40 item, it’s not likely to change your life. But if the item in question cost you $4,000, you might someday be very glad to have the paperwork that shows exactly how and when you got it.

Paycheck stubs

Keep them for a year, then toss when you get a W-2 statement that matches what’s on the paper stubs. If there’s a discrepancy, you should ask for a corrected W-2, which is known as a W-2c.

Housing records

Permanent is the right word when it comes to documenting money you spend to buy or permanently improve a house or condominium. Even after you sell a home, you should keep these records, as they might affect taxes you could owe on another principal residence.

Your will and other directives

Many people have their attorneys keep original copies of their wills and related documents such as powers of attorney and health care directives. It’s also a good idea to keep copies at home. And of course be sure anybody who finds them can easily determine where the originals are. Here’s one other thought about your will. After you execute a new will, do your heirs a favor by destroying all copies of the previous one. There’s nothing to be gained by letting your cousin Frank find out that you decided not to leave him your sailboat after all.

As you apply these guidelines to your own life, here are two final principles I hope you’ll keep in mind:

First, make sure your record-keeping system is at least somewhat intelligible to your family or whoever would have to find things if something happened to you. You can do this with a letter in your file cabinet. Place it prominently, perhaps inside a file folder that’s labeled “Read this first.”

Second, remember that the decision to keep a record can be reversed, but the decision to burn it or shred it or recycle it is permanent. So don’t completely ignore your inner packrat.

Nine things to teach your kids

Let’s face it: As parents we know we have learned lots of important lessons, and we wish our kids would pay attention when we try to impart those lessons. And let’s face it: Our kids usually hear what they want to hear and ignore what they want to ignore. (Most of us did the same thing when we were young, but let’s keep that just between us for now.)

Occasionally we parents have a window of opportunity when, for reasons that are sometimes hard to fathom, our kids are in a receptive mood and actually pay attention. When we can, I think we should take full advantage of those opportunities to teach the things that are likely to make a big difference.

Basic lessons for younger children include the concept of saving and the notion (even some grownups never seem to get this right) that you can only spend a single dollar once, so you should choose carefully.

For purposes of this article, I’ll focus on how to instill good investing habits and attitudes in young people who are just getting started with careers and savings. Here are nine lessons I’d love to see them learn.

First: Start saving now. Even if all you have is $50, start. Many potential fortunes have been lost because people waited. Time is the biggest asset that young people have. Time to add to their savings. Time to let those savings grow and compound. A 1,000-mile journey starts with a single step, as you’ve probably heard more times than you can count. One reason you’ve heard it over and over is that this is one of the ways the world really works.

Second: Don’t scoff at taking free money. It sounds pretty obvious, but thousands of your peers will do it this year when they decline to invest in 401(k) and similar retirement plans that offer matching funds. Sign up for payroll deductions as soon as you can and learn to get along without that money. If your account grows at 10 percent a year over a working lifetime of 40 years, $1,000 in matching contributions that you might get that first year could grow to be worth more than $45,000. This is free money. If you “earn” it by saving $1,000 of your own money, you have effectively turned every dollar of your own savings into $90 in the future. This should be a no-brainer.  Just make sure that company match is staying clear of company stock.

Third: You don’t have to be an investment wizard to win. Many of your peers will lose huge amounts of money over the years by trying to beat the stock market. Some will lose their shirts and never recover from their attempts to outsmart the market. Don’t follow their lead. Accept the returns of the market that you can get by investing in cheap index funds. If you start early and keep saving regularly, you are likely to wind up eventually having more money than you need. This will eventually open greater opportunities than you can easily imagine when you’re in your 20s.

Fourth: Don’t run away from bear markets. (Actually, it’s a bad strategy to run away from a real bear, too!) When you’re young, a bear market can be your friend, because it lets you buy assets at lower prices. Another way you can remember this is an old investing formula that everybody pays lip service to but relatively few people actually practice: Buy low and sell high. The only way to buy at low prices is to buy when a preponderance of other investors want to sell. To do this, you have to have long-term faith in the markets; if you have that faith, then welcome the bear. If you don’t have enough faith to be a long-term investor, are you willing to rely on pure luck to be able to afford to retire eventually?

Fifth: This is a derivative of my third point above: Don’t get suckered into taking lots of risk. You’ll be told you can afford to take big risks in order to strike the mother lode. “After all, if it doesn’t work out you have plenty of time to make it back,” they will say. This is terrible advice. Think of that dollar you are saving from your paycheck in your first year, the one that may be worth $90 when your working days are over. You may think you are risking only that $1, but in fact you are inviting the loss of $90. Trust me on this point: When you are older you will wish you hadn’t done that.

Sixth: This is another derivative of my third point above: Don’t load up your investments on what has been hot lately. Many of your peers will do this, but it’s not any smarter than showing off by driving 95 miles per hour on the freeway when you think the troopers are somewhere else. Almost all investors get hooked by the lure of stocks in which everybody else seems to be making tons of money. Young people are particularly vulnerable to this unless they have lived through a bubble and seen the very real pain after a bubble bursts. Take it from somebody who’s been intently studying investments for more than 40 years: Nothing stays hot forever; and when it cools off, you will have little or no warning before it gets cold in a hurry.

Seventh: OK, you’re going to think this point is terminally boring, the kind of predictable talk you’d hear from old people who aren’t in touch with modern life. Don’t put all your eggs in one basket. I’m giving you this advice precisely because I’m very much in touch with real life. Too many people think they can outsmart the market (just as many drivers think they can outsmart the troopers on the highway). They think they understand investing. The problem is that every time they act as if they really understand investing, they are actually proving the opposite. Let me put it simply: When it comes to putting together a portfolio, concentration represents overconfidence at best, ignorance at worst. Diversification represents wisdom.

Eighth: Pay attention to time. I’m talking about the amount of time until you expect to need the money you are saving. If you’re saving for retirement decades in the future, you can afford to take the risk of investing in the stock market – and you should do so. But if you are saving up for a car or a vacation or a down payment on a home, you shouldn’t put that money at risk in hopes of making it grow fast. It might grow fast, but it might also disappear, leaving you with a lot more frustration than you will want. Most experts would agree that savings you expect to need within five years should not be exposed to the risk of stocks. Put that money in CDs, money-market funds, Treasury bills or short-term bond funds instead.

Ninth: Don’t pay for what you don’t need and what might actually hurt you. Seems obvious, right? But you’d be surprised by how many of your peers will squander part of their savings by paying commission-based advisors at firms like Merrill Lynch and Ameriprise. They’ll be three-way losers. First, they could be buying into commission based products that might not be right for them, or that they do not understand with confusing names such as Fixed Index Annuities. Second, they will often be buying advice on how to do the wrong thing, like trying to beat the market. As young investors probably without a lot of money, they will most likely be in the hands of young, inexperienced advisors who are just learning the ropes. Do you really want to pay a greenhorn advisor to get an education at your expense? Third, your peers will give up forever the future earning power of every dollar they pay in commissions. Remember once again that $1 from your paycheck that you hope will become $90 when it’s time to retire.

OK, parents: You may not be able to get your kids to learn and live those lessons. But it’s still well worth your efforts, and here’s why: Even if our kids and grandkids learned only a few of these nine lessons, they would be much less likely to need to come knocking on our doors for handouts. And we’d be more likely to watch them prosper than to struggle. That has to be worth our time and trouble.

Inflation, politics, history and investments

Fear is never far from investors’ minds, especially during tumultuous times like these. Nervous investors will always find plenty of authors, gurus, prognosticators and analysts who are willing and able to feed these fears.

Fear isn’t necessarily bad. It’s one of the two primary psychological forces that drive the market (the other, of course, being greed). When you’re ready to buy an asset, you want to get the lowest possible price. Logically you should hope that the seller is fearful and eager to sell.

Fear can also be useful by reminding us that risk actually exists and bad things can happen when people plunge ahead in spite of warning signs they should be noticing.

However, it’s easy to get carried away and lose sight of the facts. This can happen to even the smartest investors. A case in point is one of my clients (I’ll call him Jim here, though that’s not his real name), a veteran scientist with a distinguished career at a large, successful company.

Late in May, Jim wrote me a brief email. He said he’d been reading a book that suggested the Dow Jones Industrial Average, then trading at around 8,000 and higher since then, could fall to 777. That would be a loss greater than 90 percent.

Jim admitted he didn’t think it will necessarily get that bad, but he said he believed a Dow of 4,000 is possible. “I remember the Jimmy Carter days, and it was not pretty,” Jim wrote, referring to what was then called “stagflation,” the combination of a stagnant economy and high inflation.

Jim asked if I had any ideas about what he should do in the face of those memories and predictions “other than stock up with food and ammo and build a nice bunker to hide out in.” He said gold “is looking better all the time.”

Normally I would have picked up the phone and done my best to talk him down from his fearful perch. But, having a little time available, I decided to research some facts. As a result of that research (with help from Larry Katz, research director at Merriman), I put together an email response.

With Jim’s permission, I’m happy to share that response here in the hope it might help others who are dealing with some of the same fears.

———————————–

Hello, Jim:

Ouch!  4,000 would be bad.  While 4,000 is possible, so is 12,000.  One never knows.  Seriously, I understand your concerns about the policies of the current administration and a potential return to the Carter years of high inflation. These concerns have been expressed by a number of other clients.

Attached is a recent article written by our research director, Larry Katz, that examines inflation and how our portfolios are designed to address this concern.  I would encourage you and Joyce to read it at your earliest convenience.

It’s true that inflation was relatively high and there were plenty of reasons for concern and anxiety while Jimmy Carter was president (January 20, 1977 to January 20, 1981).  But when I look below the surface, the picture I see isn’t quite as dire as what you are seeing.

I was especially interested in how the Standard & Poor’s 500 Index performed and how a 60/40 (stocks/bonds) allocation similar to our 60/40 allocation performed.  In my analysis, I tacked on an additional year (1981) to reflect a second negative year for the S&P 500 and another year of double-digit inflation:

YearReturn of S&P 500Return of 60/40 allocationInflation
1977-7.2%16.3%6.2%
19786.6%18.3%9.0%
197918.4%10.5%13.3%
198032.4%18.2%12.5%
1981-4.9%4.7%8.9%

The compound annual rate of return of the S&P 500 over these five years was 8.1 percent.  The compound annual rate of return of the 60/40 allocation over these five years was 13.5 percent. Annual inflation in these five years averaged 10 percent. Bonds did not fare so well when adjusted for inflation, but the 60/40 allocation still managed to deliver impressive returns.

One important reason was that half the equity part of that allocation was in foreign stocks (as we recommend today), which tend to outperform U.S. stocks when the dollar is in decline. During the Carter years, the U.S. dollar was rather weak; ironically, the weakness of the dollar is a concern of many investors today. Yet that decline can be a boon to investors who own non-U.S. stocks.

Back to your concerns. If you believe the market is going to 4,000, then quite obviously the rational decision would be to get out now. But as you know, 4,000, or any other level for that matter, is not a fact. It’s a belief or a prediction, Jim.

I agree there are plenty of things to be concerned about these days, and I certainly don’t have to remind you of them. Yet there also are plenty of reasons to be optimistic.  For every concern you have, I probably could counter with a reason for optimism, and for every reason for optimism you have, I probably could counter with a cause for concern.  That’s almost always the way it is.

Many investors act as if they know which path the market will take, and they stake their financial futures on their confidence. However, over and over and over again, history shows us that such confidence is seldom warranted.

My colleagues and I believe it’s impossible to know what the market will do in the short term. So we don’t try to tailor our investments to any predictions. Instead, as you and I have discussed many times, we design our portfolios to address a wide range of economic and market environments that may unfold over the long term.

A balanced portfolio of stock and bond funds like you and Joyce have will never be concentrated in the hottest-performing assets at any given time. But just as surely, it will never be concentrated in the worst-performing ones either. We believe that carefully crafted massive diversification is the best way to find the right balance of risk and return.

You mentioned gold. It certainly has been in the news a lot lately. But as the attached article by Larry Katz points out, gold as an investment hasn’t always been the answer in the short run, and it has proven to be a poor strategy over the long term.

So in answer to your question, I guess my answer would be yes, I do have an idea for you. It’s the same idea you have heard from our firm for years, but it’s always worth reiterating.  My idea for you and Joyce is to keep your thoroughly diversified portfolio in an equity/bonds balance that is consistent with your investment objectives.

You are 57 and Joyce is 51.  You need to be exposed to equities to achieve a rate of return in excess of the rate of inflation over time.  As we have discussed, Joyce is a little more risk averse than you, so her allocation is approximately 48/52 (stocks/bonds).  Your allocation is 67/33.  Your combined allocation is 60/40, and it is my opinion that this remains a suitable allocation for you two.

I understand the dynamics of fear. As we have discussed from time to time, I share some of your concerns.  But with all due respect, Jim, I think it would be a serious mistake to let your current concerns and your strong political views determine your investment strategy.  It’s an easy trap, and sometimes I catch myself being drawn toward that same trap. But I hope you’ll remember that regardless of your political beliefs, administrations and political trends come and go.  Countries, economies, capital markets, companies and individuals all evolve over time.  Pendulums swing.

When I entered this business in 1986, the prevailing attitude was that Japan could do no wrong, that America had lost her way and was on the road to ruin.  Remember that?  Remember how concerned some people were when the Japanese bought Rockefeller Center in 1989?  And then it all changed.  Japan imploded, and mutual funds that were focused on Asia declined significantly.

Then in the middle and late 1990s, large U.S. growth stocks were booming so much that it was tough to even have a thoughtful conversation about diversification and asset allocation. Nobody wanted to even consider investing in foreign stocks.  Many people believed that proper diversification required only a couple of Janus funds, an S&P 500 Index fund and a sprinkling of technology stocks like Sun Microsystems, Microsoft, Cisco Systems and Dell Computer. And then came 2000, and everything changed.  Pendulums.

You asked for my opinion, and I’ll give it to you in the knowledge that it’s only an opinion and many people may have different views.

Frankly, I must tell you that I flat-out disagree with the author of the book you are reading.  I believe the world is in the process of recalibrating and, as has happened so many times throughout the ages, the remarkable human sprit will triumph. We will adjust, we will address many of these concerns, and then we will move on to better times.

This belief system requires faith in the future. Mine is based on many years of watching the way that individuals, institutions and even whole societies can emerge stronger after going through extremely unsettling times.

Finally, thanks again for your note. It gave me a good opportunity to ask myself the questions you were asking, and to look once again at what I believe are the right answers.  As always, please do not hesitate to call or email me with questions or concerns of any kind.

Best regards,

Mark

Emotions and the market

With the high volatility in the stock market over the past year, emotions have been running at an all-time high for many investors. Staying on track has become harder than ever.

Although the overall stock market has recovered some of its lost ground this spring, many people are still very spooked by stocks. Unfortunately, that trepidation can lead to decisions that investors may later regret.

Long-term investors have two basic jobs: managing their investments and managing their emotions. You can hire somebody to manage your money — and we think you should. But only you can manage your emotions.

This is important because if emotions get out of control, they can undercut even the best money-management practices.

Straight talk about the economy

I’m no economist, but I’ll give you a few of my observations.

Investors who become obsessed with watching the news about all the problems in our economy can easily become angry and anxious.

We are still in the midst of great financial turmoil. Every crisis can feel worse than the last one. Over the past 80 years our nation has gone through a couple of stock market crashes, a major depression and half a dozen serious bear markets. We’ve survived the 1973 Arab oil crisis, a couple of major domestic political crises, the end of the dot-com technology bubble and numerous wars.

To me, this seems to be a necessary purging process that our society must endure again and again in order to re-stabilize. Unfortunately, each crisis can seem to contain the ingredients for the end of life as we know it. These fears can lead us to over-react, just as a bull market can lead us to think we will soon be wealthier than we ever dreamed.

Just as fish live in the sea and are limited by its boundaries, we live within an economic climate that we cannot escape.

Managing our finances

Some people believe the market and the economy are now on the rebound. Even if that turns out to be correct, the substantial losses of 2007 and 2008 are likely to have long-term effects for many people.

Over the past several months some clients have asked me if the recent declines in their portfolios will delay their retirement. Others who are already retired have asked if they will need to return to work.

The answers of course are different in each case. But in reality, many people may have to postpone retirement or reduce their expectations – or both. And some retirees may need to return to part-time work in order to maintain their lifestyles. These are the cold, hard realities of life.

What we do about these facts can have profound long-term consequences. That’s why I believe that this is an excellent time to consult with your financial advisor to determine what actions, if any, you should take.

Ultimately, I do not believe in giving in to our fears because tomorrow is always a new day.

Managing our emotions

Tough times can require decisions that are difficult, upsetting and unpleasant. The question is: How can we find peace in such troubling times?  For the answers, I don’t have to look any farther than my clients.

When I compare the people I regard as my most successful clients with those who are least successful, one of the biggest differences I see is the ways they focus their attention and energy.

Successful investors tend to focus not so much on today as on a string of tomorrows. In the shorter term, the market is unpredictable and subject to great volatility. But in the very long term, the stock market has had a strong upward bias for a couple of hundred years. I don’t know any reason to think that will change.

This is a key point that’s easily overlooked as investors frantically search for a guru with “right” answers that they hope will bring instant gratification.

Despair vs. facts

Anybody who is inclined to accept gloomy theories and rumors will always find them. You don’t have to look beyond the professional analysts on television and radio, not to mention your neighbors, relatives and friends.

One of the best ways to resist this sea of negativity is to remember the most important facts. Here are three:

  • First, nobody can control the stock market nor accurately predict its short-term movements.
  • Second, even the most reasonable opinions and predictions are only that — opinions.
  • Third, the news media have a huge vested interest in sensationalizing whatever is negative and scandalous. Scare tactics and evocative language can fan the flames of fear while they keep you watching, listening and reading. To put it bluntly, the financial interests of the media are much better served if you are worried than if you are calmly reassured.

How smart investors manage their emotions

Some of my clients have taught me by example how to get through tumultuous times.

One couple told me they don’t allow negative news to control how they feel. The husband put it this way: “I don’t worry about the markets and the bad news, Aaron. That’s what I’m paying you to do for me.” That’s fair enough, and I’m happy to be a surrogate worrywart for him. He and his wife made the conscious choice to focus their time and attention on things that are most important to them, such as their grandchildren and close friends.

Some clients have told me they feel better by just changing channels. I’ve done the same thing, and I’ve recommended to some people that they watch the History Channel instead of CNBC’s non-stop financial commentary. In my view, the former is likely to be much more educational than the latter.

Some clients go farther and turn off the TV altogether. One woman told me that when she starts feeling stressed, she gets out of her chair and goes for a walk. She said that can work wonders for her mind, her body and her spirits.

These are common-sense responses that you’ve probably heard before. But often old advice is good advice, and I think this is one of those times.

What we control and what we don’t

Here’s something another client said to me: “Aaron, I think I have done a reasonably good job of controlling what I can control and making good decisions. The things that I can’t control have been less unkind to me lately than they were last fall and winter. I’m still doing my best to keep doing the right things and adding to my investments. That’s the best I can do right now.”

Neither you nor I nor the president nor the smartest-sounding television analyst can control the stock market. Like the weather, the market is going to do what it’s going to do. Whether they are dealing with the weather or the market, sane people learn to accept that sometimes it will do what we want and other times it will do the opposite.

While we can’t control inflation, political decisions or the market, at least to some extent we can control our habits, our actions, our expectations and our attitudes.

The better you do these things, the better your chances of being a successful investor.

My advice

As far as I can tell, you are much more likely to succeed if you hire a good financial advisor to help you make smart decisions both for the short term and the long term.

When I work with clients, I help them set realistic goals and do the things that are most likely to help them attain those goals. Just as important, I help them avoid making short-term decisions (such as exiting the market entirely or rushing into commodities) that are likely to have long-term negative consequences.

Personally I believe that brighter days are ahead and that someday most of us will look back on the past two years as a very painful period that we managed to get through. Getting to that future won’t be easy. But it will be a lot easier for people who can keep their heads when others seem to be losing theirs.

Suze Orman – Should you listen to her advice?

Suze Orman has become a familiar fixture on the financial beat, with many fans. Among those fans is Merriman financial advisor Cheryl Curran, who nevertheless believes Orman’s investment advice should not be followed. In the following article, she tells why.

When Suze Orman gained popularity several years ago, it was very refreshing to me to see a new face and hear an unconventional voice coming from the financial services industry.

In the still heavily-male-dominated financial industry, I have been especially pleased to see a woman’s advice accepted and taken seriously by people of all ages and in all stages of life, regardless of whether they have a lot of wealth or only a little.

I admire Suze’s wonderful ability to break down complicated products and cut through industry jargon.

However, I think investors need to be wary of the information and advice she dispenses – and the example she sets.

What’s to like about Suze

While Suze is a licensed insurance salesperson, she has been openly critical of complicated, expensive insurance products. She has warned consumers about the high commissions and high costs built into variable universal life insurance products. She has advocated substituting low-cost term insurance and has reminded her readers and listeners that “insurance is not an investment.”

This unusually candid commentary is especially welcome coming from somebody who could profit from selling expensive products but who chooses not to do so because she believes those products are seldom in the best interests of consumers. (I share that belief, by the way.)

When markets are down, Suze encourages people to continue adding to their retirement funds, even when it doesn’t feel comfortable.

In easy-to-follow language, she shows how to make a written plan to pay off debts. As virtually everybody in the financial services business knows, people who follow written plans are much more likely to be successful than those who don’t.

For all this and more, I encourage my clients to read Suze. But I advise them to avoid acting on her investment advice.

What’s not to like about Suze

Suze has made some bad investment calls, especially in the past 18 months, and I don’t know why. Perhaps she is under pressure to become a guru. Or it’s possible that, like many people, she isn’t always able to muster the wisdom, courage and discipline to stick to her own stated beliefs.

Here’s an example: Suze used to advocate buying and holding only index funds, although not with the same degree of diversification that we recommend. Then in June 2008, she was interviewed by Eric Schurenberg, who was then a “Money” magazine editor.

Introducing the interview, Schurenberg said of Suze: “She possesses an encyclopedic command of financial planning and her advice is always clear and generally unimpeachable.”

Despite that glowing description, I think many people who took her advice last summer would find it very impeachable.

In the interview, Suze told Schurenberg that even though all the evidence indicated index funds outperform 80 percent of managed funds, “Today I think you have to be more active.” She recommended exchange-traded funds specializing in emerging markets, U.S. oil and metals & mining.

And what happened to investors who took those recommendations? From the time of her interview in June 2008, these sectors went down 44 percent, 71 percent and 71 percent respectively, through the end of the year. Certainly this was not a favorable period for investing, but her previously recommended funds, Vanguard 500 Index and Total Stock Market Index, dropped 28 percent and 29 percent, respectively, in that same time frame.

Of course anyone who recommends specific investments will be wrong from time to time.  But abandoning a pair of relatively conservative index funds in order to chase volatile sectors with recent hot performance is not remotely close to what I would call prudent advice.

Here’s a second example: In the same interview, Suze said: “You should invest in bonds only when interest rates are going down.”  Now that is a very interesting piece of advice, on a par with “Invest only in stocks that are making money.”

I am surprised that a journalist as supposedly savvy as Schurenberg let that comment slip by without any follow-up, as if it were the most natural point of view in the world.

If Suze understands bond investing (which I have to assume she does), then she must mean that the only valid reason to own bonds is to buy them at a low price and sell them at a higher price. (As you probably know, bond prices generally rise when interest rates fall.)

Investing this way is legitimate if that’s what you are after and if (this is a very big if) you have some system for knowing when to buy and when to sell. Suze of course was not offering any such system.

Millions of investors own bonds with an entirely different objective: to stabilize a portfolio that also contains equities. This is what we recommend. If those investors took Suze’s advice, they would be defeating their own purpose.

By allocating a portion of your portfolio to short and intermediate term bonds, you have a built-in brake system designed to offset some of the losses experienced in a typical bear market.  The only way to do this is to continue to own bonds even when their prices go down. In fact, with periodic rebalancing (which we also recommend), investors should buy more bonds when their prices are relatively low.

Unfortunately, Suze does not seem to appreciate this very important reason for owning bond funds.

Here’s a third example. I think Suze is way off the mark in her recommended allocations between equities and fixed income (including bonds).  Her recommendations are so conservative that I fear they could lead many investors to fall far short of their goals or even run out of money after they retire.

Suze has stated publicly that less than 4 percent of her liquid net worth is in the stock market. Why is this? It cannot be that she’s totally risk-averse, since last year she was chasing oil and mining sectors.

I think it is obvious that Suze has a huge income from being a successful author and entertainer. Her liquid net worth has been estimated at more than $25 million. She can easily obtain plenty of spending money for the rest of her life by investing heavily in zero-coupon municipal bonds.

That’s fortunate for her. But I have to wonder how closely she is in touch with the needs of real-world investors who have limited resources.

There are very important reasons that investors need equities in a portfolio even after they are retired. Unless you have acquired or saved more money than you can ever imagine spending, one of the biggest risks you face is eventually running out of money. A portfolio that’s exclusively or very heavily weighted to cash and bonds magnifies this risk.

Suze’s advice ignores a couple of the obvious facts of life of investing. Over the long run, cash and cash equivalents tend to approximately keep up with inflation, but not to exceed it. This is fine if all you want is a low-risk way to store a given amount of value. But if you are taking more than token withdrawals out of a cash portfolio, the value will inevitably dwindle.

Yet that, in essence, is what Suze seems to be recommending.

For somebody with only a few years left to live, this may work out perfectly. But people typically need to plan for retirement periods of 20 to 40 years. For that, a heavily cash-weighted portfolio doesn’t cut it.

From my point of view, Suze’s investment advice has not been good. It does not seem to be based on a good grasp of some important and fundamental concepts. Furthermore, Suze may be out of touch with the needs of most people who are entering retirement.

My advice to her viewers, listeners and readers is twofold. Appreciate and learn from her “plain English” explanations of financial products and subjects. But don’t follow her investment recommendations and advice. And don’t follow her example.

Fixed index annuities: Perfect product or a ripoff?

Much of the financial industry is hurting these days, and you can bet that Wall Street is working overtime to hook investors in one way or another. Insurance companies are promoting a product that looks (at least to them) like a winner, especially during tough times.

You can barely pick up a financial publication lately without seeing ads for fixed indexed annuities, often called equity index annuities. The ads promise a lot. But does the product deliver the goods?

Many investors seem to think so. An estimated $26.7 billion went into equity index annuities in 2008, according to AnnuitySpecs.com’s Advantage Index Sales & Market Report. I think there are three main reasons. First, they offer downside capital protection at a time when nothing seems to be working for investors. Second, they seem to offer market-like returns. Third, sales representatives are being paid high commissions to push them.

If you haven’t seen or heard the pitches for equity index annuities, you probably will before long. Wall Street has identified this as a profitable product – profitable, that is, for Wall Street.

The Claims

Here’s what you may be told: With a fixed indexed annuity you get a guaranteed minimum rate of return or the return based on an underlying stock index, whichever is higher. What could be nicer? Upside potential and no downside risk. Wall Street would like you to believe that finally somebody has devised a product that’s on your side all the way.

Technically, the claims are accurate. If you wait long enough (think about up to 16 years), you can get all your money back plus some return. However …….

The Reality

There’s an old – and very good – rule of thumb that recommends against putting your money into anything you don’t understand. It’s hard to do that with equity index annuities, which are very complex products. To fully understand them, a doctorate degree in math could be helpful. I recently talked to an investor who was disillusioned after purchasing one of these. If he had understood the details, I don’t think he would have done so.

In December 2008, Forbes magazine told the story of an investor who purchased five equity index annuities for $1.4 million from a sales agent who billed himself as a senior financial advisor. The investor said the agent told him the annuities had a guaranteed minimum 3 percent annual return and said the policies (because annuities are actually insurance policies), which track the Standard & Poor’s 500 Index, had earned 12 percent annually.

The investor described these claims as “music to my ears.”

The reality turned out to be something else. He later learned he would receive only part of any gains of the index, that he would be subject to stiff penalties for withdrawing his money and that the 3 percent guarantee applied to only part of what he had invested, not all of it. Eventually, he also learned that the insurance company had paid the agent a substantial commission, which he estimated at $125,000, to sell him those five policies.

Pesky Details

If you look “under the hood” of these policies, you will find some specific provisions that are likely to cool your enthusiasm. Here’s a sample:

Stock Index: Your return will be based on an external index; it might be the Standard & Poor’s 500 Index or one of any number of other possibilities. But you may not get what you expect. The annuity contract, which requires your signature saying you understand it, may say that the appreciation of the index will be calculated after excluding dividends. Historically, dividends have made up much of the appreciation of stock indexes. Too bad you won’t get them.

Some policies figure your gain by measuring the value of the index on two dates, most likely two successive anniversary dates of your policy. If the index was at 1,000 on the day the policy went into effect and at 1,120 one year later, this method would show a 12 percent gain. A mutual fund tracking the same index would show a higher gain, because the fund owned stocks that paid dividends.

Let’s use some numbers to see how much difference it might make. In positive-return years for the S&P 500 Index going back for the past 20 years, the dividend component made up anywhere from 6.7 percent to 41.4 percent of the total return of the index. In positive years from 2000 through 2008, dividends made up 22.9 percent of the return, on average. In 2004, the index with dividends gained 10.9 percent; without dividends it rose only 9 percent.

Crediting Method: This is where you can discover how a small difference in words can make a big difference in dollars. In perhaps the most complex part of this product, the policy will spell out how the insurance company measures the change in an index. There are many different methods.

Some policies use what’s known as the averaging method which calculates the gain (or loss) in the index periodically throughout a contract year. The table below shows an oversimplified example using monthly measurements of what we will assume is an even, steady gain through the year of 12 percent, from 1,000 to 1,120.

DateIndex
Average1065
December 31st1000
January 31st1010
February 28th1020
March 31st1030
April 30th1040
May 31st1050
June 30th1060
July 31st1070
August 31st1080
September 30th1090
October 31st1100
November 30th1110
December 31st1120

In this calculation, the simple point-to-point change was 12 percent (still lower than the real return of the index with dividends). But as you can see at the bottom of the table, for you that gain was reduced to 6.5 percent, the average of the monthly points along the way.

This is the sort of “fine print” that investors rarely pay any attention to until after they realize that what they expected was something quite different from what they thought they would get.

Cap Rate: Sometimes, the market may go up a great deal – perhaps much higher than the limits specified in your policy. You may find a provision in the contract that limits the highest amount you can ever get. In 2003, the S&P 500 appreciated by 28.7 percent, including dividends. Imagine opening your equity index annuity statement early in 2004 to discover your annuity had been credited only 7 percent. You might immediately call your salesperson or the insurance company, only to learn that your contract has a “cap rate” provision that limits the gains that you will be credited, no matter how well the market does. Once again, you’re out of luck if you were expecting to make significant gains in the really good years.

Participation Rate: Now imagine that after a much more modest year, when the index gained 7 percent, you have been credited with a gain of only 3.5 percent, just half of the index’s total return. The reason: A typical index annuity has a clause that limits how much of the index’s gain you will get, usually described as a percentage of the gain. The example above would result from a 50 percent participation rate applied to an index gain of 7 percent.

Surrender Period: If you owned a financial product for five years, you might reasonably expect to be able to get your money out of it after you finally figured out its flaws. But once the insurance companies have your money under their control, they want to keep it. Enter the detail known as a declining surrender charge. Typically, you can withdraw up to 10 percent of the account in any year. But if you want more than that, you’ll have to pay a surrender charge. Most common is a 10 percent fee for withdrawals the first year, declining by one percentage point per year until the penalty is gone after 10 years. Some policies make you wait as long as 16 years and could charge you as much as 20 percent in the first year.

Guaranteed Surrender Value: Typically you will be promised a minimum guaranteed surrender value if you surrender the product at any time or if the index doesn’t perform well over the term of the policy. This is often stated as a percentage of the premium you paid (for example 87.5 percent) plus some minimum interest rate, usually between 1 and 3 percent. As a result of these provisions, your “guaranteed” surrender value is likely to be less than you might expect.

Here’s another issue you should know about if you buy an equity index annuity in a taxable account: Any capital gains you actually manage to earn from this product will be taxed as ordinary income, not at the lower rate for capital gains. This is not the fault of the insurance company; it’s built into the tax laws. There is also no step up in basis at death like there would be for a stock or mutual fund.

Is This Product Right For You?

Should you invest in an equity index annuity? I don’t think this product is a reasonable substitute for investing in equities. Likewise, it is far too expensive, restrictive and complex to be a good substitute for owning fixed-income funds or having a savings account.

Unfortunately, this product produces more financial heartbreak than happiness, mostly because so many investors are so eager to trust a sales pitch without learning the facts. Like the investor I recently spoke with, many thousands of investors will eventually wish they had followed a simple, old-fashioned bit of advice: Investigate before you invest.

If you think I’m being too negative about fixed indexed annuities, I suggest you check out this product online. Here are three links:

•    From the Securities and Exchange Commission website (and likely to be among the first items to pop up in a Google search of “equity index annuity”): www.sec.gov/investor/pubs/equityidxannuity.htm

•    From the Financial Industry Regulatory Authority investor site: www.finra.org/Investors/ProtectYourself/InvestorAlerts/AnnuitiesAndInsurance/P010614

•    The transcript of a story on Dateline NBC that shows you the “tricks of the trade” among insurance agents. www.msnbc.msn.com/id/24095230/

Fear and your financial future

In this article, Paul Merriman addresses some of the fear-based questions that arise for many investors during tumultuous economic periods.

Ten years of superior performance was no accident

Many investors seem to think the past 10 years were a waste. Early in 2008 the Wall Street Journal declared the years since 2000 “the lost decade.” That, of course, is one possible interpretation of the market’s behavior since it peaked in 2000, stumbled through a severe bear market for about three years, roared back to recovery and then fell into its current slump late in 2007.

A client referred to the previous 10 years and said to me: “We really didn’t make as much as we expected, did we?” It was more a statement than a question. And it made me curious to know the facts.

What I found didn’t surprise me a great deal. But I think it might surprise many people. There are probably a million ways to evaluate the investment returns of the past 10 years, which for this article I am defining as the period from January 1999 through December 2008. If you look hard enough, you can pick through those million prisms and probably find evidence to support just about any point of view you choose.

Knowing that, I decided to be especially careful about the questions to which I sought answers.

What investors “knew” about the future at the beginning of 1999

In early 1998, we were in the midst of one of the greatest bull markets of all time, especially for large-cap U.S. growth stocks. Investing was perceived as easy. Risk was widely regarded as an outmoded concept, and it certainly didn’t stop millions of people from loading up on growth funds and technology funds.

Some investors scoffed at us back in 1998 and 1999 when we told them that getting a 10-percent to 12-percent long-term annual return would be very desirable. To them, we were obviously out of touch with reality. Their “reality” included the “knowledge” that the future lay with the Microsofts and the Ciscos of the world, often all wrapped up in the Nasdaq Index.

If you weren’t there, it’s hard in 2009 to imagine how certain this scenario seemed to be. Do you remember the era of newly minted day-traders? Do you remember the people who invested with cash advances on their credit cards “knowing” they could double their money in a year and pay back what they owed?

What investors “know” about the future at the beginning of 2009

In 2009, to listen to many investors and people in the media, anybody with eyes and ears “knows” that the financial world has fallen apart. People are scared. They don’t want to make commitments, even to portfolios that are demonstrably better than the ones that they already own.

There’s no denying that we have plenty of problems, and I don’t have to remind you of them. Investors are experiencing a lot of raw fear these days, inflamed by the same financial media that only a year and a half ago could hardly contain its enthusiasm about the rosy future described by various investment gurus.

I’m writing about this in order to remind you that the things we are so certain of right now might have little or no value for predicting investment returns over the next 10 years. 

Now for the facts

I want you to look at a two-part table that contains a list of annualized returns from January 1, 1999 through December 31, 2008 and a list of investments that nobody would have believed if I had predicted them at the start of 1999. In the top part of the table are numbers that I know to be accurate. Below is a list of investments, each of which corresponds to one of the numbers above.

Each return in the table assumes an investor made a one-time investment, without adding or withdrawing money. Can you identify which returns correspond to each of the investments described in the lower part of the table?

Table 1: Can you match the annualized 10-year (through 12-2008) returns to the portfolios?

Returns (%)
-3.2
+3.6
-4.6
3.3
-4.2
+4.3
-1.5
+3.3
Investment
Standard & Poor's 500 Index
Warren Buffet
Microsoft stock