Investment Help

If you are seeking investment help, look at the video here on my services. If you are seeking a different approach to managing your assets, you have landed at the right spot. I am a fee-only advisor registered in the State of Maryland, charge less than half the going rate for investment management, and seek to teach individuals how to manage their own assets using low-cost indexed exchange traded funds. Please call or email me if interested in further details. My website is at If you are new to investing, take a look at the "DIY Investor Newbie" posts here by typing "newbie" in the search box above to the left. These take you through the basics of what you need to know in getting started on doing your own investing.

Monday, January 31, 2011

3 Quotes to Understand

How to Lie with StatisticsWhen I give presentations, and even when I talk with potential clients, I like to start off with quotes. The reason is simple. Numbers and graphs can easily be manipulated. I learned this years ago when I picked up a copy of "How to Lie With Statistics" by Huff. Instead of the numbers, I like to start by bringing  the experienced, wise people right to the table and discussion.

Warren Buffett: "Most investors, both institutional and individual, will find the best way to own common stocks is through an index fund that charges minimal fees.  Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals."

Notice that he is talking about institutions as well as individuals. He is not just talking about you and me using index funds; he is also talking about the huge state pension funds like CALPERS and the state of New York fund, the large union funds, and so forth. Think about this:  these funds have staffs comprised of Harvard and Wharton Business School graduates. They are paid big bucks. And Buffett is saying that still these institutions should use index funds. And they do!

I don't know about you, but this tells me a lot.

Benjamin Graham, coauthor of Security Analysis : "If I have noticed anything over these 60 years on Wall Street, it is that people do not succeed in forecasting what's going to happen to the stock market."

Security Analysis: The Classic 1934 EditionThe first thing that jumps out here is the "...60 years..." This is a lot of years watching the stock market. Appreciate that Security Analysis is considered a bible by value stock investors, and Graham himself was Buffett's mentor. His statement boils down to this:  if your advisor is trotting out all kinds of fancy charts and talking about getting into and out of the market on the basis of an economic forecast, he/she will not likely earn better than the market return. Graham doesn't say it, but you can take this to the bank:  they will charge you a lot for making the attempt and leave you with a smaller nest egg in the bargain.

Jack Meyer, head of Harvard University's endowment fund: "The investment business is a giant scam.  Most people think they can find fund managers who can outperform, but most people are wrong.  You should simply hold index funds. No doubt about it."

Meyer doesn't mince words. He is heading up one of the institutions Buffett was talking about. Imagine the investment managers who have made presentations about their investment approach to him over the years. Why is the business a scam? Simply, it over-promises and under-delivers.

Sunday, January 30, 2011

Howard County's 2nd Annual "Passport to Financial Literacy"

This Saturday at Howard Community College "makingCHANGE," a local non-profit financial education organization, is presenting a free financial literacy event. RW Investment Strategies is a sponsor, and I will be manning one of the 20 stations that young people will stop at. Each station is a financial decision point. What kind of occupation will you pursue? How much will it pay? How will you afford transportation? How much do different kinds of cars cost? How do you finance? How much does a college education cost? How much does a house cost? What is a mortgage and what does the monthly payment amount to? As the children go through the stations, they have a passport that will be stamped. One lucky child will win a laptop!

Imagine the pain the country could have avoided if everybody had examined the last question several years ago!

There is a lot of talk about increasing financial literacy. This is an event that actually does something about it. I hope to see you there!

Saturday, January 29, 2011

Middle East in Turmoil - What Should Investors Do?
"The country has gone to ruin,” Mona Abdelaziz, 30, who said that she holds a journalism degree and works selling tissues by the roadside, said in an interview yesterday at a protest in central Cairo. “Everything is expensive. How will my son marry, get an education, set up a household? There are no jobs, only for a select few. We have no hope.” 

Perhaps the smartest man I ever knew once told me there is only one economic principle - "people want to earn a good wage."   This plays out over time on a global basis. Most people are content to have the opportunity to raise their family in a setting where they are treated with respect. This, of course, bumps up against the small percentage of those who are power hungry and somehow feel they are entitled to live above the laws and economic circumstances that govern most of the world.

Egypt,, of course is a special problem for the U.S. because, once again, the U.S. finds itself on the wrong side. It says one thing and does another. And the world understands this. We continue to prostitute ourselves for oil.

The Black Swan: Second Edition: The Impact of the Highly Improbable: With a new section: "On Robustness and Fragility"What about investments? How is this going to turn out? How to respond to the quantum jump in uncertainty? Is this a Taleb  Black Swan? Is this Thanksgiving day for Taleb's turkey?

The answer is nobody knows. The violence could spread, thereby putting further pressure on oil prices and markets. At this point, this seems the likely course. Market observers remember well the East Asian contagion of 1997.

Or, Mubarak could step aside and someone of intelligence gain control and markets rally. Not likely, but possible.

As a DIY investor, you have an advantage over most investors. You have a thought-out asset allocation plan. You understand that markets are choppy and that the consistent rise over the past several weeks is temporary. You know your exact asset allocation. You understand you are in one of two boats - you are either in the accumulation phase or the decumulation phase. You are either building up your nest egg or you are drawing a paycheck off of it.

You've anchored your asset allocation  to your age. If you are 65 years old, you started at 65% bonds and added bonds, if you are risk averse, or reduced the percentage in bonds, if you are a risk taker. You understand that, if the events in the Middle East are keeping you up all night, you need to increase your exposure in fixed income. You saw the value of bonds on Friday in protecting portfolio assets. AGG, the Barclay's aggregate bond index exchange traded fund (ETF), rose .15% as the S&P 500 fell 1.79%. CSJ, a shorter maturity corporate bond ETF, rose .01%.

For the retiree, this is a point where the percentage in bonds could be increased by 5% to add a bit more protection in case this market continues South. Even with Friday's large drop, the S&P 500 is up for the year.

But what about the accumulator? You see the present situation a bit differently. You are alert to a possible opportunity to pick up equities at lower prices. You are poised to take advantage of  "dollar cost averaging" - the buying of more shares with a given amount of money at lower share prices. You are monitoring the market developments with an eye towards possibly increasing the allocation to your 401k, especially if you are more than 5 years away from retirement. Like the retiree, though, you are constantly taking your pulse. If it is racing, hold off on increasing exposure and maybe even reduce equity exposure a small amount.

The fact of the matter is that no one knows where we go from here. The global economy was in an uptrend before the riots in Tunisia started. Investors were slowly gaining confidence after the debacle in 2008. Now confidence has again been shaken. We know that the Great Recession weighs heavily on investors' minds. The important point to remember is that drastic portfolio shifts in these types of situations are typically harmful. Taking a small step to reduce volatility at the beginning of a potential downturn can be a useful calming step.

Disclosure:  This post is for educational purposes only. Individuals should do their own research and consult their advisors before making investment decisions.

Friday, January 28, 2011

What is GDP?

To do a poor man's overview of the macroeconomy, you need to know 3 things:  GDP, inflation, and the unemployment rate. With a nice tie and the ability to riff on these 3 magnitudes, you are ready for a stint on CNBC. Throw in a couple remarks about foreign exchange, especially the Yuan, and they might offer you a guest commentator spot.

But what exactly is GDP (if you're a former student of mine I hope you don't need to keep reading), and why do markets care?

Incidentally, the advance estimate of 4th quarter GDP is released today at 8:30 am. There are two revisions to the advance estimate based on more complete data released at a later date. To find out what economists expect (you should know this if you're headed for the CNBC studios), go to the Bloomberg calendar. There you find that real GDP (GDP after taking out the impact of inflation) is expected to increase 3.5%, and the inflation measure derived from the data (called the GDP deflator) is expected to show an increase of 1.5%.

GDP Source:Bloomberg

Scroll down at the Bloomberg site and you'll see a graphical presentation of both of these magnitudes, useful for gaining a longer term perspective. The graph shows the "Great Recession" as a sharp dip and then the sharp spike off the bottom that economists are talking about today--and that stock market investors are cheering on.

So what exactly does GDP measure?  By definition, it is the market value of all final goods and services produced within a country over a given period of time. The reason we look at "final goods and services" is to avoid what is called double counting. When you buy a car, the value of the car includes what the car company paid for the tires, sound system etc. To count these separately, and then the value of the car, would include their values twice.

Notice that the focus is on the rate of growth and not the magnitude. For those who need to know, GDP totals approximately $15 trillion. To gain some perspective, it takes a bit over 31 years to reach a billion seconds and 1 trillion is 1,000 billion. To look at GDP from another perspective, it would $15 trillion to buy all the goods and services produced in the U.S. over a 12-month period. That's some big bucks - even to the likes of Warren Buffett and Bill Gates.

In interpreting the growth rate of real GDP (which is the important magnitude), there is a sort "Goldilocks" thing going on - you don't want it too hot or too cold. If the growth rate goes above 5%, say, for a protracted period, people worry about inflation. At much less than 3.5%, the worry is deflation and a possible recession and the loss of jobs. Because the U.S. is job challenged at the moment, the higher the better for the GDP growth rate!

Thursday, January 27, 2011

How to Calculate Time Weighted Return

Bowser in the Snow
DIY investors need to know how their investments are performing. Many don't. I know because I ask. And when I do, many times, I get a non-comprehending look back. Some of you know that I get on the soap box from time-to-time and rant and rail about knowing investment performance. Too many times I've seen people say their advisor is doing great because he or she made him x number of dollars in the last 3 months. It seems to be news to some people that making 6% when the market or benchmark makes 8% is actually not a good thing. I know it's percentages, and I know percentages are about the point where a goodly percentage (see can't get away from it!) of the population started to hate math; but it is important to deal with them  to assess performance.

Over decades, a small under-performance can subtract a lot  from a portfolio.

Thankfully,  the portfolio calculation is getting easier by the minute. The technology that does all the work is spreading. In fact, a recent post on Schwab's Performance Calculator described how easy it is to get performance for both portfolios and benchmarks at their site.

Still, as a member in good standing of the "although I can multiple 2 numbers using a calculator it is still worth knowing how to do without a calculator" fraternity, I think those investors not totally allergic to math should know how to calculate performance. Again, with today's technology this is easy.

To begin, pick out the accounts you need to do the calculation for. This is easy on most discount brokerage sites. For example, if you have 5 accounts (2 brokerage accounts, a Roth IRA, and 2 traditional IRAs) and you just want to track performance for the IRAs, you can set up a grouping for these 3 accounts and call it "IRAs" or even "My IRAs"(pretty clever naming, huh?). If you want, of course, you can do the calculation for all accounts.

If there are no additions or withdrawals to the accounts, all  we need to do is divide the ending portfolio value by the beginning value. For example, if the accounts totaled $1,000 and now are at $1,200, we've made 20%--we're doing great!

Actually not so fast - hold the smiley face. If the benchmark (passive portfolio we are comparing ourselves against that is typically made up of market indices) is up 30%, we actually haven't done that great.

But what about cash in and cash out? Maybe we deposited $200 into one of the IRAs! This is where the concept of time-weighted return (TWR) comes into play. The trick is to calculate return to the point before the deposit and then calculate return starting from the point after the deposit and multiply them. This is called linking. This approach measures how the investment performed and is independent of the cash flows.

Some Math

Let's look at a simple example:

Start with $1000 and assume it grows to $1150, at which point you put in $300 and it grows to $1725. What is your TWR?  Easy:
1150/1000 = 1.15
1725/1450 (we've added the 300 deposit to the 1150) = 1.19.
Multiply and get 1.3685 and the TWR is 36.85%.

To go one step further, suppose this was over a 2-year period. Then you may want to convert to an average annualized return. This is easy:  just take the .5 root of 1.3685 and get 1.169. Thus, on  an average annualized basis, you made 16.9%.

A little bit of thought reveals that some care needs to be taken when looking at TWR. Suppose you start with $1,000 and it increases to $1,200, at which point a deposit of $10,000 is made and at the end of the period the portfolio is $11,200. You made a 20% return on the smaller amount and a 0% return once the $10,000 was in the account. 

For my clients, I handle all of this very simply. I get daily valuations of portfolios. This actually only takes a few minutes a day. Then at the end of the month, I look at the history of the accounts (again only a few minutes); and if there are withdrawals or additions, I make the adjustments. If the client is with Schwab, of course, I don't have to worry about any of this.

Wednesday, January 26, 2011

Want to be Warren Buffett But Too Lazy?

Not that many years ago, it seemed that every kid on the basketball court wanted to be Michael Jordan. They worked hard, in their imagination, at recreating his game-winning shots. But, as many basketball coaches/motivators were fond of pointing out, not one-in-a million were willing to do what it takes to be a Michael Jordan. His work ethic in the weight room and at practices was legendary. At practice, he insisted that the best defender on the team (Scottie Pippen) be on the side that he was scrimmaging against. He always wanted to go against the best.

Security Analysis, Sixth Edition (Leatherbound Edition)
In the same way in the investment field, there are many who want to be the next Warren Buffett. But how many are willing to do what it takes to be a Warren Buffett? Buffett talked his way into Columbia Business School to study under the legendary Benjamin Graham. Classmates said he knew Graham and Dodd's "Security Analysis" classic better than the authors did. Question:  How many are willing to do what it takes to be Warren Buffett? How many of you know the text better than the authors?

Since I don't see any hands up, consider an easier approach - sort of the video game version, I guess, of recreating a Michael Jordan game winner.

Fund Spy: Morningstar's Inside Secrets to Selecting Mutual Funds that OutperformAccording to Russel Kinnel, Morningstar's Director of Mutual Fund Research, as listed on page 59 in "FundSpy," the following funds  are "Buffet followers:"  the Sequoia fund (SEQUX), Fairholme Fund (FAIRX), Dreyfus Appreciation(DGAGX), Oakmark (OAKMX). Returns over the past 5 years on these funds have ranged from 3.36% to 9.08%. Interestingly, the fund with the highest turnover (71%) (I know...don't ask me how a "Buffett follower" would have a 71% turnover rate)  had the highest return.

Kinnel points out that, as many do, you can always buy Berkshire Hathaway shares.

All of this is out of my "there is more than one way to skin a cat" file. I am a proponent of low-cost index funds as the way to invest for DIY investors for at least 80% of their  retirement funds. The easiest thing in the world is to pick out past winners. As a point of fact, Buffett himself has said,
"Most investors, both institutional and individual, will find the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals."
Disclosure:  I hold none of the funds mentioned here and do not endorse or recommend them. The information is solely for educational purposes. Individuals should do their own research or consult an advisor before making investment decisions.

Tuesday, January 25, 2011

Financial Literacy Tip #3

OK. Now you've got your diploma and you've entered the job force. You are starting to realize that the work-a-day world is a bit different from the Tues. and Thurs. schedule of classes you lined up in your last few semesters. Partying until the sun comes up is over.

What's next? Well, this is where the fun starts and it comes at you fast. One day you wake up, you've got a mortgage, you're married, and, before long, a kid is on the way; so you're fighting for a raise.  A lot is coming at you fast and furious. Navigating this maelstrom is tricky but highly rewarding, if you can get it right.

Tip #3 will point you in the right direction by recommending a book that can be read in a weekend that will put you on the path to making the right financial decisions. It should go without saying that it will help you avoid costly mistakes.

This book will also bail out some of you who will be beating your head against the wall in a few months trying to come up with an inexpensive gift for that young college graduate or any young person entering the work force, for that matter.

But first let us review where we've been. Tip #1 was for the youngsters. Get them forgoing soft drinks when eating out, and reward them with a dollar each time--to be spent however they want. This teaches them the concept of deferred gratification. They soon realize, that by saving up, they can get something really nice that they want. It also teaches the difference between wants and needs. There might come a day where they need to understand that cable TV is a want not a need, and cutting it off can save having to pay outrageous interest rates on credit card payments.

Tip #2 was for the young person with a summer job. That summer job typically means low earnings (and therefore a  low tax rate) and the suggestion is to put part of the earnings in a Roth IRA and get started investing by buying an index fund. The purpose is to get exposed to the investment markets and to give a young person some "skin in the game"  which sparks people's interest, especially teenagers. It makes investing a real world activity rather that a text book abstraction. The fact that time is on the side of the young person provides significant growth potential and makes it even more interesting.

I Will Teach You To Be RichNow for Tip #3. You've got several credit cards; you can't seem to save for an emergency fund; you're trying to manage your investments; you don't know whether to pay your student loan or to increase your 401k contribution. Take a weekend and read  "I Will Teach You To Be Rich" by Ramit Sethi. Mr. Sethi speaks language of young people. He writes with an energetic style that will motivate and will answer many of the questions you have or should have. At the end of the chapters, he has action steps, presented as a six-week program.

For the bailoutees, let me remind you. Put this on your calendar for early May. When you are invited to that graduation party, you'll know exactly what to get the new graduate!

It should go without saying that I wouldn't be recommending Sethi's book if I didn't believe it's also an excellent intro to DIY investing! Happy reading!

Monday, January 24, 2011

Andrew Hallam Goes 100% Indexed

Andrew Hallam "The Millionaire Teacher"
Andrew Hallam, author of the forthcoming book "The Millionaire Teacher" to be published by Wiley, has sold $700,000 of individual stocks and is now invested solely in low-cost index funds. He  invested the entire amount in 3 funds:
  • 40% in XSB-To (the short-term Canadian bond index)
  • 30% in VTI (the total U.S. stock market index, with an expense ratio of 0.07%)
  • 30% in VEA (the low dividend paying first world international index, with an expense ratio of 0.15%)
Many people label this approach "passive investing" and, unfortunately, this is construed negatively by some people. They just feel like they have to try to "beat the market."  For this reason, I refer to it as "evidence-based investing" when explaining it to new clients.  In his post, Andrew, a long-time advocate of low-cost indexing, talks about the evidence presented by John Bogle in "Don't Count On It!" that swayed him to keep it simple with three funds.

Notice the low-expense ratios for the funds Andrew is using, and contrast this with the costs involved with active managers who use mutual funds with an average expense ratio of 1.4% tacked on to their management fee, not to mention other more subtle costs.

DIY investors would do well to examine and think about Andrew's approach to investing and read his book when it is released. Along with his many fans, I am anxiously awaiting it.

Friday, January 21, 2011

Gordon Murray Died

The Investment AnswerGordon Murray died at 60 from brain cancer.  He was formerly a bond salesman at Goldman Sachs, Lehman Brothers, and First Boston. He authored "The Investment Answer."  He is another in the growing list of former Wall Street people who came to see the value of indexing. His thesis conforms with Warren Buffet's remark that, "Most investors, both institutional and individual, will find the best way to own common stocks is through an index fund that charges minimal fees.Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals."

Mr. Murray once said, “It’s American to think that if you’re smart or work hard, then you can beat the markets."  And this highlights a major hurdle for many who think about investing. How is investing different from other endeavors?  We know that, if we work hard and/or are smarter than others, we will go further in our careers. Why isn't investing like that? What is it about the flow of information and how it affects prices that makes investing different?

Books like Mr. Murray's shed light on this question.

Thursday, January 20, 2011

Determine Return on Assets With Schwab Application

How to calculate performance of a portfolio is a question I get quite often. Many times I go through the calculations for time weighted return; but, by looking at peoples' faces, I can tell they don't find this a lot of fun.

But I stress the need for DIY investors to understand performance and to compare against a benchmark. Well, Schwab has put it all together, including benchmark comparisons. Your broker may have a similar freebie online. It is why I urge people to check out all the tools at  their broker's site and putter around a bit.

Let's see how easy it is with Schwab to get performance info.

In previous posts, I showed how  to check out Schwab's models. Getting a model, i.e. deciding on an asset allocation, is where investors should put their effort. They should select a model that fits their risk profile, i.e. one they can pretty much stick with through thick and thin. Many would agree that the biggest mistake many investors made over the past few years was bailing out in the downturn and not participating in the recovery.

 The  model you pick is important for another reason - it will be your benchmark. It will be the ruler you measure performance against to ensure you are staying in line with the market (or "beating the market" if that's your goal).
If you're on Schwab, click the "Portfolio Analysis" tab on the entry page. At this point, following previous posts, you have set up a portfolio combining your accounts. The first three items on the graphic to the left have drop-down lists. Check them out. If you have identified various sub-groupings of your accounts and selected models, you can easily examine their performance. Run the report by clicking "Go" and this is what you get:


Notice performance for the portfolio is over various periods. You can set the periods however you want. At the bottom is the return on the benchmark. In this case, the benchmark was Schwab's "moderately conservative" model.

A footnote immediately below the table specifies the benchmark as "Moderately Conservative was composed of 50% Barclays Capital Aggregate Bond (Fixed Income), 5% Russell 2000 (Small Cap Equity), 25% S&P 500 (Large Cap Equity), 10% MSCI EAFE (International Equity), 10% Citigroup 3 month US T Bill (Cash Investments)."

This, again, is one of those situations where it takes considerably longer to explain than  to do. At the end of the quarter, when you are reading financial news and it talks about the markets, you can, in a few minutes, go online and see your performance.

It goes without saying that this only touches on what the investor can do with this app. For example, there is a nice graph below the table after you have run the report that shows the progress of the account.

It is my understanding that this may not have been made available to all Schwab clients and it may be in the latter stages of testing. If you have it, again, play around with it. It may be exactly what you are looking for. If you don't have it, make a phone call and request it.

Finally, the DIY investor is getting to the point where he or she has necessary tools to manage investments without it costing an arm and a leg.

I am not affiliated with Schwab and present this for informational purposes only.

Wednesday, January 19, 2011

What is the Debt Ceiling?

First off, it is a ceiling we bump up against every few years and it has to be raised. The choice is whether we go off the cliff or survive to fight another day. Sort of like early 2009 when the Treasury and Federal Reserve were guaranteeing and buying everything in sight to prevent another Great Depression. Basically, bumping up against the ceiling presents a great opportunity for our elected officials to pontificate against excessive spending and the need to live within our means as an interlude to their spending like crazy.

Currently the ceiling  is at $14.3 trillion. Treasury Secretary Geithner needs it raised because he is the one doing the borrowing, and he has the spectre of a U.S. default if it isn't. Rating agencies even talk of lowering the credit rating on U.S. debt. We all know how well they've done their job in recent years.

Again, this three-ring circus of raising the limit happens every few years; and when it does, Treasury bond holders look at each other and wonder if the U.S. could default. These days this includes the Chinese and others who have lent us the money by buying Treasury bills, notes, and bonds so we could buy their goods. On occasion, these debt ceiling episodes have been like the final seconds of a NCAA final four game with the ball bouncing on the rim. But, the fact that we are still here and haven't gone the way of Iceland, or Ireland for that matter, tells you our elected officials have always raised the limit so they can go on with their spending.

Usually, all of this is good to get politicians really good sound bites and bond holders blood pressure rising. This time is, however, a bit different because the partisanship has ratcheted back up and the Republicans are desperate to be seen as tightfisted with taxpayer money. Furthermore, the federal deficit exceeds $1 trillion and other countries, importantly those holding our debt, are questioning our fiscal management.

IMHO, there is no question that it needs to be raised. The American people, I believe, would prefer that Congress increase it without a lot of fanfare - but realistically, as long as there are cameras and microphones we know that won't happen. Nevertheless, holding down the rhetoric would be greatly appreciated. Most importantly, a line in the sand should be drawn. Barring a major war or a significant spike in the unemployment rate, the debt limit should not be increased further. To approach the level of GDP is ludicrous. Today we have prime 21st-century examples of what happens to countries whose debt gets out of control.

Tuesday, January 18, 2011

What's Up With Inflation?

The most recent CPI report was greeted with a yawn despite some potentially ominous signs. The overall CPI-U (CPI for All Urban Consumers) rose +0.5% for the month of December and +1.5% for the 12-month period. The 12-month number is below the implicit Fed target of 2%. Take out food and energy, and the numbers are even softer - +0.1% for December and  +0.8% for the 12-month period.

Thus, if you stayed home and fasted you were not, apparently, much affected by inflation in December or, for that matter, the whole year.

It should be noted for the record that the general population is having a hard time believing these numbers. Tell most people that inflation is practically not existent and they will look at you like you're crazy. But then again, most people eat and drive and use energy in all sorts of forms.

But the past is the past, and what we are interested in is seeing if there is not some investment insight from all of this, i.e. could inflation increase more than expected?  I happen to believe so. Let's go back to the early 1980s when the situation was flip flopped. Here is a graph of the period 1975 to 1982 of the CPI:

Source: Economagic

In the early 1980s, right after Volcker's so-called "Saturday Night Massacre," in which he changed monetary policy from controlling interest rates to controlling the growth rate of the money supply, prices started falling and nobody believed it. Why? Because, as shown in the graph, inflation had consistently ratcheted upwards as shown by the red line which is the year-over-year change in the CPI. But people who were actually shopping for groceries were seeing the prices start to come down.

In fact, I attended a meeting of money managers in downtown Washington D.C. right around this time, at which a prominent economist from Merrill Lynch took a poll from the podium on how many in the room believed that inflation would fall. If you squint as you look at the graph, you see that inflation was at approximately 12.5%. As I recall, only 1 or 2 hands went up out of maybe 60 investment manager attendees!

Source: Economagic
The rest, of course, is history as can be seen in the graph on the left, which shows the CPI since 1980.

I present all of this because it seems to be the flip side of what we are experiencing today. Most economists see no inflationary pressures in the near future.  Although energy costs are rising, they aren't seen as a problem. In fact, the last time oil rose above $100/barrel, supply eventually drove it back down. Investors should note there was also another development - the nastiest economic downturn since the 1930s. Today oil is rising, and we are at the beginning of a global economic recovery.

The bottom line of all of this is that I believe investors need to be careful in here because inflation could come sooner and be more feisty than expected. It is important to look at investments and question how they will perform if this turns out to be the case. In particular, longer term fixed income instruments could be problematic.

Better safe than sorry!

Monday, January 17, 2011

Financial Literacy Tip #2

When your child earns enough to report taxes, consider starting them on a Roth IRA.  If $2,000 can be put into a Roth from a summer job, say, or even from an on campus job, a good start can be made in learning investing.  An approach I would recommend would be to open up an account at a discount broker that has zero commission exchange traded funds, like Schwab.

With the $2,000, I would consider putting half into a domestic equity fund such as SCHB.  Today SCHB is priced at $31.26, so approximately 30 shares could be bought.  With the remaining $1,000, I would consider an international stock fund such as SCHF, priced at $28.09.  Approximately 35 shares could be bought at this price.  The number of shares, of course, should all be figured out by the child - it is part of the financial literacy learning.

At this point, having invested, your child has plenty to work with on the investment front.  He or she can learn about the dividend yields of the funds, how to find out when the dividends are paid, the holdings in the funds, how exchange traded funds are different from individual stocks and so forth.  As time goes by, even the return on the funds can be calculated.

The Elements of Investing
Excellent Book by Giants in the Investing Field
To reinforce the hands-on learning, when the holidays come next December, give your child a readable book on investing like "The Elements of Investing."  At this point, the information in the book will seem highly concrete to the young investor.

Two specific payoffs come from this activity.  First, when he or she is initially faced with making choices for their first 401k, they will have considerable experience under his/her belt . In fact, they will be able to assess the quality of a company 401k before they take a job.  Does it have high expense funds and poor investment choices?  They will be able to answer this question.

A second payoff is that the fund has a lot of time to grow.  If this is started at the time the child is 16, for example, from proceeds of a summer job and grows at a compound rate of 8%/year, then at age 65 just the initial $2,000 will have grown to $86,000!  Even with inflation, this will be real money and, to boot, available tax free, if you believe (huge assumption) the government won't change the law on Roth IRAs!

Disclosure:  This information is for educational purposes.  Individuals should do their own research or consult an advisor before investing.  I own the funds mentioned.

Sunday, January 16, 2011

What is a P/E ratio?

When you stop and think about it, mankind has invented many clever ways to compare various objects. We have scales to weigh things, numbers to count things, and even graphs to show how one mathematical function behaves relative to another one.

Consider comparing a basketball foul shooter who has made 79 out of 108 free throws versus one who has made 67 out of 80, just by looking at the raw data. The raw data isn't much help. What do we do?  Simple - calculate successful shots on a percentage basis. The first shooter has made 73%  of her shots and the second shooter has made 84% of her shots. Thus, we can conclude that the second shooter is a better foul shooter.

Rene Descartes
In the same way,  Rene Descartes (the very same "I think, therefore I am" philosopher) invented the cartesian co-ordinate system which opened up the field of analytical geometry by enabling mathematicians to visualize and compare geometrical figures and functions, by putting them into the same plane.

In the field of finance, DIY investors compare different investments. On the fixed income side, investors have to determine whether a 9-month certificate of deposit paying  a CD rate of 3.5% is a better investment that a bond with a 2-year maturity that has a yield- maturity of 4.1%. To compare the two, the investor puts the yields on a comparable basis.

P/E Ratio to Compare Stocks

In the stock market, the main tool for comparing two stocks is the P/E ratio - the ratio of price-to-earnings. Simply, the higher the P/E ratio, other things being equal, the more expensive the stock. In other words, the more an investor has to pay for a dollar of earnings.

The P/E ratio is a starting point. The next step in comparing 2 stocks would be to ask why the higher P/E ratio stock should be considered. To the investor, it is like asking why he or she should go to the movie theatre that charges $10/show rather than one that charges $8/show. Obviously there could be good reasons - the higher priced theatre has more comfortable seating,  less expensive refreshments, and so forth.

In the same way, there are good reasons sometimes to prefer the higher P/E stock--the most important being the prospects for growth. Simply, companies viewed as having good growth prospects will tend to have higher P/E ratios. Apple Computer will have a higher P/E than Procter and Gamble.

To get a P/E ratio is easy. One way is to go to Yahoo Finance! and put in the stock symbol. For example, if you put in the symbol for Apple Computer, you find a P/E ratio of 23. Notice that this is based on the trailing 12 months of earnings (ttm). Earnings used in P/E ratios are for various periods, and the careful investor needs to ascertain the exact measurement for earnings. Sometimes it's expected earnings, sometimes it is normalized earnings, and so forth. Clearly, in comparing two companies, the DIY Investor needs to be sure he or she is making an apples-to-apples comparison.

P/E Ratio to Value Market

P/E ratios are not just used to compare two companies but also to assess the overall market. Here, for example, is a mention of P/E, in an excellent article on P/E by Paul J. Lim, and its relationship to inflation in this morning's New York Times:

Indeed, since 1871, the market’s P/E has hovered between 17 and 18, on average, in periods when inflation has grown at an annual rate of 1 to 3 percent. That’s well above the current P/E of about 13. 

The writer here is pointing out that, during periods of inflation similar to what is being experienced presently in the U.S., investors were paying more for a $1 of earnings (17 to 18x) compared to today at 13x.

Investors who delve into market forecasts and the use of P/E in the overall valuation of the market eventually will come to the Shiller P/E, developed by Yale professor Robert Shiller. This P/E is based on the last 10 years and is adjusted for inflation.

Saturday, January 15, 2011

Laugh Out Loud!

  From Jonathon Lyon (Thanks Jon!)

These are from a book called Disorder in the American Courts, and are things people actually said in court, word for word, taken down and now published by court reporters that had the torment of staying calm while these exchanges were actually taking place.

    ATTORNEY: What gear were you in at the moment of the impact?
    WITNESS: Gucci sweats and Reeboks.

    ATTORNEY: Now doctor , isn't it true that when a person dies in his sleep , he doesn't know about it until the next morning?
    WITNESS: Did you actually pass the bar exam?

    ATTORNEY: The youngest son , the 20-year-old , how old is he?
    WITNESS: He's 20 , much like your IQ.

    ATTORNEY: Were you present when your picture was taken?
    WITNESS: Are you shitting me?

    ATTORNEY: So the date of conception (of the baby) was August 8th?
    WITNESS: Yes.
    ATTORNEY: And what were you doing at that time?
    WITNESS: Getting laid

    ATTORNEY: She had three children , right?
    WITNESS: Yes.
    ATTORNEY: How many were boys?
    WITNESS: None.
    ATTORNEY: Were there any girls?
    WITNESS: Your Honor, I think I need a different attorney. Can I get a new attorney?

    ATTORNEY: How was your first marriage terminated?
    WITNESS: By death..
    ATTORNEY: And by whose death was it terminated?
    WITNESS: Take a guess.

    ATTORNEY: Can you describe the individual?
    WITNESS: He was about medium height and had a beard
    ATTORNEY: Was this a male or a female?
    WITNESS: Unless the Circus was in town I'm going with male.

    ATTORNEY: Is your appearance here this morning pursuant to a deposition notice which I sent to your attorney?
    WITNESS: No, this is how I dress when I go to work.

    ATTORNEY: Doctor , how many of your autopsies have you performed on dead people?
    WITNESS: All of them.. The live ones put up too much of a fight.

    ATTORNEY: ALL your responses MUST be oral , OK? What school did you go to?
    WITNESS: Oral...

    ATTORNEY: Do you recall the time that you examined the body?
    WITNESS: The autopsy started around 8:30 PM
    ATTORNEY: And Mr. Denton was dead at the time?
    WITNESS: If not , he was by the time I finished.

    ATTORNEY: Are you qualified to give a urine sample?
    WITNESS: Are you qualified to ask that question?

    And last:

    ATTORNEY: Doctor, before you performed the autopsy, did you check for a pulse?
    WITNESS: No.
    ATTORNEY: Did you check for blood pressure?
    WITNESS: No.
    ATTORNEY: Did you check for breathing?
    WITNESS: No..
    ATTORNEY: So, then it is possible that the patient was alive when you began the autopsy?
    WITNESS: No.
    ATTORNEY: How can you be so sure, Doctor?
    WITNESS: Because his brain was sitting on my desk in a jar.
    ATTORNEY: I see, but could the patient have still been alive, nevertheless?
    WITNESS: Yes, it is possible that he could have been alive and practicing law.

Friday, January 14, 2011

How Did My Investments Do?

True story.  In early 2009, an investment advisory firm was telling its clients they hadn't done too badly.  Although their portfolio was down 30%,  the S&P 500 was down 37%. Some of you are thinking that the problem is the portfolio was down 30%.   Although -30% isn't good, it isn't the problem.  The problem is that these clients were invested according to a model that was 70% equities and 30% bonds. A -30% return for this allocation was the problem.

A simple, no-brainer, DIY approach that invested 70% of assets in SPY (a low expense S&P 500 ETF) and 30% in AGG ( a low expense bond market ETF) returned -24% in 2008.

Thus, the advisory firm had not only performed badly; they had performed horribly.  That's the problem.  The bigger problem is that clients walked away not knowing they had been horribly served.

The issue is just as prominent when the market rises.  I was looking at an account statement this week for a variable annuity that had risen over 11% from 10/2/09 to the present.  The client was satisfied.  But over that period, the S&P 500 returned in excess of 27%!  The annuity, of course, had other investments; but still, it was clear, once you knew what happened to markets, that the annuity's sub account costs (and other assorted fees too numerous to mention) had taken a huge chunk out of the return.

These examples touch the surface of a widespread problem, in my view.  Simply, many investment clients are walking around with poor performance and don't know it .  They are unaware.  They don't know what questions to ask.  Many of them think they are doing fine.

Maybe it isn't a problem if you don't know.  The guy getting on the plane doesn't have an issue until he finds out you paid $200 less for your ticket and you're sitting in first class.  Maybe this is an "ignorance is bliss" issue.

Actually, many start to ask questions and look at performance more closely when markets drop.  Many others go along assuming "the professionals" know what they are doing.  Bad assumption!

My suggestion is for clients to pin down advisors on the benchmark their portfolio will be measured against ahead of time and to insist that the comparison be presented in all reports.

Incidentally, I know of one prominent advisor who insists his firm invests in so many asset classes they shouldn't be measured against a benchmark. All I can say is good work if you can get it!

One company is seeking to remedy this.  I've mentioned MarketRiders before and how their service helps DIY investors at a reasonable cost by specifying ETFs to buy to meet their portfolio objectives.  They have gone a step further and are publishing performance data on various allocations in what they call the "Portfolio Report Card."  The press release  describes this enhancement to their product.

As discussed in a previous post, I believe MarketRiders is worth checking out for the DIY investor.  Again, I am not affiliated with MarketRiders.

Thursday, January 13, 2011

A Trip to Walgreen's - A Lesson in Financial Literacy

Personal Finance Workbook For DummiesI will be participating in the "Passport to Financial Literacy" event at Howard Community College on Saturday, 2/5. Thus, my thoughts have turned to children and financial literacy. Parents understand the need to raise financial literate children and are seeking answers on how to do it and when to start. The following on a trip to Walgreen's from the "Personal Finance Workbook for Dummies" provides considerable insight:

"The Woman was unloading a small grocery cart at the checkout counter with the help of her sons. Her daughter was carrying a fistful of coupons. I overheard the woman enthusiastically tell her children that because of a special on tuna fish, they were able to buy six cans for the price of three. They also took advantage of many other two-for-one specials, and the mother was very alert to share this fact with her children. The children picked up on the mother's enthusiasm and were excited with their accomplishments.

After all the purchases were rung up by the cashier, the woman asked her daughter to hand their coupons to the cashier. When the receipt was produced, all the kids huddled around their mother to see the results of their shopping adventure. They discussed the receipt together, and once again, the mother enthusiastically stressed exactly how much money they saved with their coupons. The daughter yelled, "Yeah . Mommy!" with the same kind of joy and excitement that you would expect when winning a Little League baseball game. And this was just a trip to Walgreen's."

Many times people think they need special training to help children become financially literate. This example shows this isn't true. All families handle money and make decisions regarding money. Spending a little extra time with young children to explain these processes goes a long way. 

The next time, for example, you go to the bank, take a few moments and go inside. Explain to the kids what you are doing. A visit to the bank, like a visit to the grocery store, can be a big adventure for young children.
It'll pay off in the end and could turn out to be your best investment!

Wednesday, January 12, 2011

Is This a Bubble, or What?

Page 14, Journal of Financial Planning, January issue:

People are coming in to buy 50 or 100 coins at a time, which is pretty hefty for individuals, It is just not rich people , either. A lot of people are putting 30 to 35 percent of their net worth in gold, they are scared to put money in paper assets.

       Mark Oliari, chief executive of CNT Inc., a Massachusetts coin broker, New York Times

Tuesday, January 11, 2011

Financial Literacy Tip #1

Many times when people find out I'm a financial advisor they ask  for a financial literacy tip.  How can they help their children become more financially astute?

One I like goes as follows.  When children are young and the family is eating out, offer them a choice between ordering water or the usual soft-drink.  Tell them if they order water, then you will give them $1.  Explain to them they can spend the dollar right away or save it up and get something they really want that costs a bit more.  They catch on pretty fast to the idea that it pays to save, which in itself is a great lesson.  In fact, the whole lesson of deferred gratification is extremely important.

This exercise can morph further into a valuable lesson on the difference between wants and needs.  Incidentally, the family that puts $1 aside every time they eat out will not only save on dentist bills (sorry Dr. Goodman!) but have a bit of money after several years to apply towards college.

The Marshmallow Experiments 

In the early 1970s, Walter Mischel, of Stanford University, studied deferred gratification formally by performing what are referred to as the "marshmallow experiments."  He offered young children a marshmallow but told them that, if they could wait 15 minutes before eating their marshmallow, he would give them a second marshmallow.  Then he left the room and observed them via a two-way glass.  Some couldn't resist and gave in; others folded their hands, looked the other way, and waited patiently to get the second marshmallow.

In follow-up studies decades later, it was found that those who waited did much better in many areas, including school work, social adjustment, etc.  In general, they were found to be living much more satisfying lives all around.

What are your best financial literacy tips?

Monday, January 10, 2011

Friedman Revisited

The  Biz of Life is posting a series of videos from Milton Friedman's "Free to Choose" broadcasts. When we lost
Friedman we lost a giant.  He definitely shaped my views.  I read his "Capitalism and Freedom" many years ago and marveled at what was then provided by the government that could be more efficiently produced in the private sector.  It has gotten considerably worse, of course, as the years have gone by.  Hayek describes where we were headed  in The Road to Serfdom: Fiftieth Anniversary Edition .

Along these lines, I have often thought that we should produce an ongoing list of government produced goods and services that can and are produced more efficiently by the private sector.

For example, at every single library branch in the county where I live, there is a collection of DVDs of just about every TV series made.  Want second season Sopranos?  It's at the library.  How about fitness?  We have a community center where seniors can join for something like $25 lifetime membership.  The public schools have fitness centers that rival the best you can find in the private sector.

What this all boils down to is the same mistake that a lot of people make. People sometimes live as if they are millionaires when, in fact, they are nowhere close.  Society is trying to do the same thing.  Just like individuals max out their credit cards to appear wealthy, our country borrows from China to fund goods and services we can't afford.

Friedman and Hayek had this pegged decades ago.

Good to Know

  • U.S. GDP is projected to rise +2.6% in 2011 (68 forecasts collected by Bloomberg) versus +1.5% Euro region, +1.3% Japan, +2% U.K.  The relative performance is expected to push the dollar higher.  On 11/4 the dollar index stood at 75.631.  Today it is 7.3% higher at 81.17, a welcome development for foreign investors in US. markets.  Rising interest rates and the expected stronger performance of the U.S. markets are expected to push the dollar higher over the first half of 2011.
  • The real yield on the 10-year Treasury has risen to 2.18% from 1.46% at the end of Oct.  The real yield is the difference between the nominal yield and the expected rate of inflation.  An easy way to track it is by taking the difference between the 10-year Treasury note and the 10-year Treasury TIPS (Treasury Inflation Protected Security).  The difference between the two is roughly the rate of inflation that will result in equivalent performance of the two securities.  In other words, if inflation is greater than 2.18%/year  over the next 10 years, an investor will do better in the 10-year TIP.  Both of these yields can be found at Bloomberg (scroll down to get the TIPs yield).
  • There will be 3 Treasury auctions this week.  A 3-year note on Tuesday, 10-year note on Wednesday, and a 30-year bond on Thursday.  The pattern recently has been that the middle auction (the 10-year this week) has had the most problems.  In the background, ongoing problems in Europe should provide demand for the issues; but there is a report this morning that primary dealers have significantly reduced Treasury holdings that should get investors' attention.
  • University of Maryland professor Morici had an op-ed piece in The Washington Post this weekend (I couldn't find a link to it - sorry) arguing that job creation will be anemic until we get our Trade Deficit under control.  He argues that the stimulus increased economic activity but much was in the form of imports from China.  He continued his case for a tariff on Chinese goods if they are going to persist in holding their currency below market levels.
  • The International Trade data will be reported on Thursday and the CPI on Friday.

Sunday, January 9, 2011

AAII Baltimore Presentation

Yesterday's AAII/Baltimore Chapter meeting featured a talk on "Retirement Income planning" by Michael Anselmi Jr. of Morgan Stanley Smith Barney.  It turned into more of a discussion rather than a structured presentation, and a couple of subtle issues were raised.

First off, by a show of hands, it was determined that more of the audience were retired government than probably most people expected.  Their pension and medical benefits puts them in a different boat than most retirees.

Secondly, Mr. Anselmi stressed the need to figure on spending as much in retirement as in one's working years.  One of the audience members pointed out a subtlety different way of looking at it.  He said he retired and figured out a conservative income by looking at his social security, pension, and a reasonable withdrawal rate from his "nest egg."  He then lived within his means.  This, he said, is how he did it throughout his working years.  To me, this is a bit different from the way financial planners tend to look at the problem.  Let me explain a bit further.
A financial planner will seek to determine how much a person is spending in his working years.  Next, s/he will estimate sources of income in retirement.  Then s/he will try to figure out how to get that level of income.  So, suppose the number is $90,000, adjusted for inflation and all of that, and suppose you need to get there; but when everything is considered, you are not quite going to make it.  What then?  The solution is to take more risk.  On average, if you take more risk, i.e. increase allocation to stocks, move bonds into high yield bonds, etc., the software will spit out results to get you to where you want to be - at least on paper.  This is how financial planners tend to approach the problem.

The viewpoint expressed above, I believe, is somewhat different.  It is more along the lines of saying I can conservatively generate $80,000, so that's what I'll do; and I'll learn to live on $80,000.  Trying to reach $90,000 entails some risk (no matter what the Monte Carlo results produce), and this alternative pushes back against taking that risk.

The discussion also brought out that retirees are probably more flexible than financial planners give them credit for.  At least this particular audience indicated an awareness of constantly reevaluating and making adjustments in down markets.

Mr. Anselmi did point out that retirees spend more when they first retire, then it falls off, and picks up again in their 80s due to medical costs.

A third point had to do with sequence of returns, a subject the audience was well aware of.  Relying on averages can be harmful to the retiree.  Most people have seen the diagram of the river crossing where the water on average is 3 feet deep, but most of the way the depth is 2 feet with one spot at 8 feet.  Walking across, the person drowns.  In the same way, relying on past results, that show markets return 8% on average, can be harmful if the lowest returns occur in the first few years of retirement.

There was some mention of variable annuities but, on the whole, audience members didn't seem to have much interest - understandable in a crowd that does its own investing.

The meeting also discussed long-term care insurance, assisted living facilities, and different investments for generating income in retirement.

Saturday, January 8, 2011


Bonds are a challenge for many DIY investors.  DIY investors go through the asset allocation process, perhaps by using one of the many asset allocator tools on line, and end up facing a percentage - 30% bonds.

Now what?

In times past, with yields at more normal levels, the DIY investor could buy a total bond market ETF indexed against the Barclay's Aggregate Index, such as AGG or BND, and be done.  The Aggregate Index is matched versus the entire bond market with maturities exceeding one year.  It includes Treasuries, Corporates, Agencies and Mortgage-Backed Securi ties. It is the bond market's equivalent of the S&P 500 in stocks.  In the past, these various parts of the bond market would have offered what was viewed as decent yields (more on this below).

If the DIY investor wanted some background on bonds, he or she could go to a book like The Strategic Bond Investor: Strategies and Tools to Unlock the Power of the Bond Market or a website like

Today,; yields are near historically low levels but there are more opportunities to explore.  The DIY investor can invest, for example,  in  an ETF that indexes the high-yield market like JNK, or an ETF that is indexed to shorter maturity corporates like CSJ.  Moving away from the basic bond market, there are Master Limited Partnership ETFs, like AMLP, or even a trust preferred stock ETF like PFF .

With this bewildering array of choices, how should the DIY investor respond?  First of all, it is important to always remember that, to get incremental yield, you take on additional risk.  This is a fact of life in the world of investing.  Thus, even though you are diversified among issues by investing in ETFs, it is important to diversify among investment types.

My approach is typically as follows.  Suppose an investor has $1.0 million and the allocation model comes up with the 30% bond allocation as mentioned above.  Then the DIYer is targeting $300,000 initially to bonds (or fixed income).  Many times I would recommend 50% of this allocation, i.e. $150,000,  invested in AGG or BND.  Then I would put $15,000 in the other parts of the bond market like JNK and AMLP.  I would put 10% in CSJ, etc., even though the bonds in CSJ are already in AGG.  The reason here is that I am recommending a shorter overall maturity posture in the bond market on the belief that yields are likely to rise.

Are Yields Attractive?

DIY investors sometimes have difficulty thinking in terms of real yields.  The real yield is basically the difference between the nominal yield and the rate of inflation.  Simply, if we get a yield of 3% for one year and inflation is 1%, then the real yield is 2%.

In the early 1980s, yields were double digits as was inflation. In fact, for much of the period, real yields were negative, meaning that funds invested at these rates could buy less after a year than at the beginning of the year - even with the earned interest.

From this perspective, yields do not look horrible today.  The key, however, is to keep an eye on inflation.

Friday, January 7, 2011

MarketRiders - A Resource

As most of you know, I believe that most investors are best served by investing in low-cost, low-turnover, highly diversified, index mutual funds or exchange traded funds.  Many market stalwarts support this approach including Warren Buffett, John Bogle, William Bernstein, Charles Ellis, and Burton Malkiel.  This indexing approach rests on considerable evidence showing that active managers, after fees, fail to outperform the market.  This is because their fees and hidden costs are significant; and markets are basically efficient, meaning that prices rapidly incorporate publicly available information.

My service is unique in that I offer to teach investors how to manage their assets with this approach.  I either give them direction or initially manage their assets and then, when they are comfortable, turn over management to them.

MarketRiders is an online site that follows the indexed approach and offers software (approximately $100/year subscription services) or low-cost management services (flat fee of $495/year/account).  Some DIY investors will find this to be exactly what they are looking for.

Their website is extremely well done, and they lead the investor  through the process and underlying philosophy quite well.  I recommend that all investors considering this approach to the market at least spend some time on their site.  Again, it could be the exact fit you are seeking.  Please note that I am not affiliated with them and, if anything, could lose potential clients to them.

From my perspective, I have the question of whether this process can be commoditized to the extent implied by the MarketRiders approach.  They do have counseling available, and maybe this overcomes my objection; but in many cases, the key in the overall investment approach is fitting in goals and extraneous items that are client specific. For example, some clients own real estate or have the likelihood of receiving a sizeable inheritance in the next few years.  Some want to leave an inheritance, and others are fearful of running out of money.  Some need considerable guidance on simplifying by combining accounts and locating investments appropriately.  All of these figure prominently in the overall investment program.

In summary, check out this resource.  If interested, try the free trial.  It very well could fit your needs.

Thursday, January 6, 2011

Do You Have a Good 401(k) ?

Many times a couple has to decide the best place to make their retirement fund contributions - in the husband's or wife's 401k or an IRA? And the answer depends on the quality of the plans, company matches, etc. To help answer this question, BrightScope provides an online 401k rating service as described in this Yahoo! article: "How Good Is Your Company's 401(k ) Plan?" by Carla Fried. BrightScope examines fund costs, investment choices, company generosity as well as other key features relative to a peer group. For each peer group, it shows a comparison relative to the best, worst, and average plans.

Generally, a couple will first want to make contributions to take advantage of the company match. After that, they may consider, if feasible, contributing to IRAs and taking advantage of low-cost index funds. Finally, they can max out on the better 401k plan, etc.

It should be stressed that it is easy to get a plan rated. Plan administrators just need to get readily available documents to BrightScope. Carla Fried lists the steps a plan can take to improve their plan and what participants can do in the meantime.

Wednesday, January 5, 2011

Opt in/Opt out ?

Not long ago I was in a meeting of community college professors and a concerned professor raised her hand and asked, "What do professors do if a student sleeps during class?".

I responded that I thank the student and let them know that if they, or any of their friends, are willing to spend $300 to put their heads down on a desk and sleep for an hour and 20 minutes to let me know and we can get a classroom anytime. This, of course, got some laughs and, somewhat surprising to me, a number of professors agreed with me. Of course some were appalled.

I think I am beginning to feel pretty much the same way about the whole opt in/opt out issue as it pertains to 401k participation. For those not familiar with the issue, behavioral economists have found that the simple change of requiring people to check a box if they don't want to participate in the 401k increases participation. In other words, if you have to take action to participate in the plan, some people won't participate. Sort of like having to get up off the couch to change the channel when we can't find the remote. We all know that there are some people who will watch the same channel for hours.

OK. So opt in is great? I disagree. I think plan sponsors/human resources need to work harder to explain to employees the benefits of the plan and educate participants on responsible steps to take to have a secure retirement. Participants need to understand that they will be 65 years old some day. They need to understand compounding. They need to think about where they will get an income when they are no longer in the work force. After that, it is the responsibility of the participant to take action.

Yahoo Finance has a good article today on "How Good Is Your Company 401(k) Plan ?". It references BrightScope which rates plans and compares them to their peers. It is a useful tool in getting action on reducing fund costs, improving investment options, etc.