How Financially Literate are You? No, Really…

April is Financial Literacy month in America.  The real impetus behind this effort of a whole month of promoting financial literacy is to increase awareness around the subject.  Espousing healthy financial habits are just as necessary as having healthy eating and physical habits.  Can it be said that Americans care as much about their physical health as their financial health?  The jury is definitely out on that according to a 2014 survey by Wells Fargo (the 3rd largest bank in the US measured by assets).  Let’s cover some of the topics that might be helpful as you gauge your own level of financial fitness.

Q. Should I work with a financial planner?

A. I would imagine this is probably one of the most pondered question.  But first let’s discuss why anyone would normally seek professional advice on a subject.  It usually has to do with the degree of importance of the subject.  I very well may choose to look at a YouTube video to change out a toilet seat, but I wouldn’t very well use YouTube to figure out how to do a root canal (especially on myself!).  Usually finances are a subject that becomes so much more emotional than changing a toilet seat or a root canal.  Why?  Possibly because it is through your own hard work that you’ve earned the money you have so there is an emotional attachment to it.  In exchange for irreplaceable minutes and hours, money was earned and now to entrust someone else with its direction is a little counter-intuitive.  I think that acknowledgement of this natural barrier is key.  Only after that hurdle has been crossed, can an individual assess whether or not their investment and financial goals warrant professional help.  However, since with most things, better results are obtained through accountability and support (e.g. having a gym buddy) the answer is usually “yes”.

Q. What things should I prioritize when it comes to financial planning?

A. This is really subjective and person-dependent.  Young married couples with small children will probably consider college planning and life insurance important components of any plan.  Empty nesters or singles won’t need much or any of either.  High net worth individuals may really be concerned about keeping the bulk of their investment earnings and avoiding unnecessary taxes.  As you can see, this really is dependent on the stage of life that you are in. However, working with an investment professional will at least start a conservation about what is most important and prompt you to think about how all of your goals can fit together in a cohesive plan.

Q. Should I be debt-free before I start my financial plan?

A.Becoming debt free is usually part of a financial plan. Per the Wells Fargo survey: “Only a third of adults have some type of financial plan or a simple household budget in place, which means most Americans don’t have the roadmap needed to improve their financial health.” So since most people operate without a budget this obviously exacerbates being in debt.  Notwithstanding, it may just complicate things to hire someone just to tell you that.  However, getting out of debt only takes time and discipline.  Consider that at the most basic level, earnings can be spent only two ways:  current and future consumption.  Debt accumulates when future consumption has been combined with current consumption instead of delayed.  The only way to fix the problem is to reverse the process which means to start delaying future consumption.  Then, all the deferrals can be focused on paying down the existing debt.

Q.How can I tell if I’m underinsured? I have coverage through my employer, but I’m unsure what happens if I become unemployed.

A. First, we need to discuss what types of insurance may be necessary.  Leavingproperty and casualty insurance aside, life, medical and disability are the big three that most people need.  Typically, employer coverage is adequate when it comes to medical and disability.  More often than not, they are offered as part of the compensation package and can be too expensive if purchased privately.  In the event of unemployment, medical insurance can be obtained through COBRA (the most expensive) or you can be covered by the Affordable Care Act (less expensive than the former).  Lastly, life insurance may be offered by your employer, but typically this is the area in which most individuals are under insured.  Because of the relatively low cost of coverage, it usually makes sense to have your own private policy in addition to what your employer offers.  Why?  Because the consequence of having too little insurance in the event of a death likely means you are unable to replace the income of the deceased wage earner.  So for a relatively small expense, healthy individuals can purchase plenty of coverage to avoid that possibility.

The value of developing a thorough, actionable financial plan goes way beyond the amount you will pay to a professional (if you choose to go that route) and is something worth considering on your path to better financial health.

Invest Wisely!

Let “Un-Common” Sense Prevail

Sometimes I allow my mind to wander on topics such as, if different successful personalities were able to implement some of their strategies for our nation or the economy as a whole.  For example, what if Congress were required to exemplify the financial discipline Dave Ramsey espouses?  Or , what if all defined-benefit plans were converted to defined contribution plans with Ray Dalio’s “All-Weather” strategy?  Or what if the MD&A (management’s discussion and analysis) required by the SEC in financial statement disclosures used the same vernacular as Warren Buffett’s plain-vanilla, conventional wisdom shareholder letters?  In my opinion, these are just fun things to think about as I contemplate alternative outcomes and consider other perspectives.

I have taken some excerpts from the last time I listened or read all three of these guys and thought I would suggest one takeaway from what seems to be “unconventional” conventional wisdom and apply to investment strategy.  Here is what I came up with:

From Mr. Ramsey….

Just in case you are not familiar with his show format, he answers calls on air from all types of people.  The calls represent a good sample of the American population that have a similar message:  “how do I get ahead”.  Ramsey’s message is:  human capital is your greatest asset and wealth-building vehicle, so maximize it by delaying gratification and staying out of debt.  It is very simple.  I find it difficult to believe this simple principle could not be applied to the US budget by our Congress. But then again, absent from Mr. Ramsey’s strategies are entitlement and laziness.  These are two elements that will destroy any disciplined plan quickly.  One of his mantras, “live like no else, so later you can live like no else” has the making of something ethereal instead of practical, but yet it is.  One can only fix the problem of overspending (either personally or nationally) when you spend no more than you make.  The Ramsey mindset does not allow any tolerance for consumption beyond your means. Why?  Because eventually, the consumption for which you cannot pay for today becomes a future liability for which you will have to set aside future earnings to pay for which will decrease the amount you have to invest.

TAKEAWAY FOR INVESTMENT STRATEGY:  Over consumption: 1) decreases one’s ability to maximize their human capital through investment and 2) increases your chance to accumulate debt.

From Mr. Buffett…

In my opinion, nothing is more refreshing than his transparency and plain talk.  Most financial disclosures I read are fraught with industry-specific terms seemingly designed to hide something from the reader.  Buffett’s words portray an honesty that makes what he is writing “trustworthy”.  Since he understands his investments so well, he explains what he is doing very well.  It probably follows that if you think you understand something but cannot explain it to someone else, you probably don’t know it that well. (smile!) Berkshire Hathaway’s investment philosophy is leaping off the page to the reader and it is “to increase intrinsic value”.  Intrinsic.  Now there’s a word you don’t hear every day.  But this is just like Buffett to use a term from fundamental financial analysis to arrive at a comprehensible message to investors.  I think the message is that when you invest, find a way to maximize cash flow through income earned.  Investment earnings will provide current income to reinvest and thus increase the [intrinsic] value of the enterprise.

TAKEAWAY FOR INVESTMENT STRATEGY:    Focus on the simplest tenet of investing…making money.  Invest in assets that provide current income with the potential to increase in value.  But here’s the caveat:  “If you don’t understand it, don’t invest in it.”

From Mr. Dalio…

In all the interviews I have read or listened to there is one consistent message with Ray…radical honesty.  Although this seems more of a moral boundary than anything, it has proved very useful from a business standpoint.  For Bridgewater Associates, it has been a guiding light to understanding truth.  It allows them to question things that seem to be hidden in “gray” areas and uncover what really underlies their motivations for making a decision.  Not only has this proved successful from a business standpoint, it has helped to build an enviable corporate culture that few have been able to follow successfully.   As the world’s largest hedge fund, they manage approximately $120 billion and have outperformed most investment strategies handily including the S&P 500.  (Just Google their track record).  Pushing one’s self to a modicum of excellence for the sake of delivering superior results can [and should] be everyone’s goal.

TAKEAWAY FOR INVESTMENT STRATEGY:   Always seek alternative perspectives and better ideas than your own.  Don’t be afraid to question what you think you know.

Invest wisely!

The January Effect—Not!

It has been said that although history does not repeat, it surely rhymes.  According to the Stock Trader’s Almanac, the direction of January’s trading predicts the course for the year 75% of the time.  If this is the case, the infamous January effect for 2016 would seem to be ominous for investors, right?  I hope to make the case that with the right approach, investors can likely ignore the performance of their portfolios in January as it only represents yet another cog in the machine.  Long term results in a goal-based investment plan is what investors should covet.

What the January effect is and what its results have been

This article describes the January effect pretty well so I won’t use this blog post to do us.  Suffice to say, the formula is pretty accurate in most years.  However, I believe the power of the effect often gets lost.  I will explain.  The power of the January effect happens to be the depressed pricing of stocks relative to normal levels.  And how do they get to these depressed prices?  Well, typically investors (both retail and institutional) will sell stocks to trigger a taxable event. (You can read more of why this happens in an earlier post.) This tremendous selling pressure results in prices for stocks being lower relative to where they have traded the whole year.  Subsequently, investors realize that prices are lower and do a lot of purchasing in the month of January.  But perhaps the only reason this even happens during this time of year is because the IRS imposes a deadline to claim investment losses as a deduction by December 31st.  My point being that bargain prices can be sought for assets at any time and the power of the effect comes when selling pressure is exerted on the market.

How a goal-specific investment plan will help calm investor anxiety regardless of market performance

So now you may be saying that is great, but how does that help my investment portfolio.  I would argue that it will if you are not trying to trade the market via timing or any other method.  However, if you are investing with a specific long-term goal of gains exceeding inflation along with current income, you can benefit nicely.  I think that most investors fail to realize the merit in this approach because they “chase returns”.  Further, they fall prey to anchoring bias, by focusing on one piece of largely irrelevant information to formulate their investment strategy.  The benefits of using a broader perspective is rarely sought and they subsequently underperform the market.  Whereas, if they approached investment with a goal to earn x% over a set period of time, adjusting for live events and other important considerations they would find much more success.  I have conversations all the time with clients that agree that this approach makes sense, but several obstacles stand in the way of their “follow-through”.  More than likely, their fear of repeating a disastrous loss in the past outweighs the logic of a sound plan for the future.

What you can do to formulate a goal-based plan

Some of the best work I have read on goal-based investing is by Ashvin Chhabra.  His approach is an expansion of modern portfolio theory with the incredible insight to consider what I would call “life checkpoints”.  Each investor has in their mind what would send them into poverty, keep them at their current lifestyle or catapult them into another tax bracket. These three checkpoints provide all the context needed to form a goals-based plan. Incorporating these into an investment plan allows both the investor and adviser to have a language to communicate what defines success.  Rather than it being a number that is basis points above or below a market index, it becomes a way to articulate “how we are doing”.  Regarding Chhabra’s approach, a recent blog sponsored by the CFA Institute read how it “goes beyond modern portfolio theory by shifting investment strategy from a focus on the securities held in your portfolio to a consideration of your personal objectives” — for example, saving for college, retirement, or to start a business.”  These tangible objectives should help to ease anxiety during market turmoil.  Why?  Because if you have set aside enough capital to live on for the next 2-3 years regardless of what the market does, you will rest easier if you see your portfolio going down.  This does not mean you may not need to make an investment plan adjustment, but it should keep you from calling your adviser requesting him or her to sell everything.  Just some food for thought.

Invest wisely.