Piedmont Financial Advisors

When it comes to investing, it appears that Generation Y has chosen to continue carrying the torch of human irrationality.  Case in point from this Reuters story “Generation Yikes: Why young savers are avoiding stocks“:

But Diane Casaretti is no rube. She’s a successful marketing rep in Stamford, Connecticut, and in her career has worked with many Wall Street banks and brokerage houses. But she’s made a conscious, rational decision: Stocks just aren’t for her.

 

“My parents always invested their money in the stock market, and all my friends’ families did too,” says the 26-year-old. “When the whole thing came crashing down with the financial crisis, that’s when I said, ‘No way am I comfortable with this.’ To me it just doesn’t seem logical, that you could save all that money and then potentially lose it all down the road.”

 

It’s a refrain that you’re hearing more and more these days – and not from risk-averse seniors, as you might expect, but from those just starting out in their working and investing lives. Even with decades to go until retirement, and plenty of time to rebound from market collapses, many young Americans don’t trust the stock market with their savings.

 

Take a recent Investing Sentiment Survey by Boston-based money managers MFS Investment Management. The poll discovered that 29 percent of people say they will never be comfortable investing in stocks – a shocking number in and of itself. But among Generation Y investors under 31, that number spikes to 52 percent.

This isn’t really an unexpected development. Fear and its counterpart, greed, are a strong, deeply ingrained emotions. I don’t expect young adults, who have limited life experience, to respond any differently. But making investment decisions based on these emotions is a mistake and quite often lead to terrible results. Moderate amounts of risk-taking (not zero) combined with reasonable diversification (large-, small-, international-stocks + short and intermediate bonds) can lead to solid returns over time. Avoiding stocks completely, especially for someone that is 30+ years from retirement is a mistake of epic proportions.

If you’re like a lot of people, the start of a new year has you taking a fresh look at your life and thinking about what the year has in store. Will you finally learn Spanish? What about learning to play that guitar that’s collecting dust in your closet? Will you get promoted at work and get a pay raise? Or are you hoping just to keep the job you have? Who will get elected President? How much Mayan end-of-the-world nonsense talk will you have to endure? Will the Indianapolis Colts take Andrew Luck as the number one draft pick? There are lots of things, important or otherwise, to either look forward to or to dread.

Do you think/worry about the financial markets or is it just me?

Around this time of year there is an overabundance of predictions of what the our financial future holds — stories about the direction of the economy and financial markets are no exception. Call it an occupational hazard, but as a financial advisor, I tend to read an unhealthy amounts of this “news”. As usual, the predictions are all over the board. Some market pundits warn of impending economic doom or at least a long and bumpy recovery; others think that we are on the front end of a massive bull market. These prognostications can sometimes be informative as discussions about the (perceived) state of the world can help you increase your knowledge, but mostly they’re a waste of time. Why?

Because they are likely to be wrong.

Most people, even professionals, are terrible at predicting the future

If you get 10, 100, or 10,000 people to make a prediction about the future, a few of them are bound to be right. The incorrect predictions are almost always forgotten. Steven Dubner, the author of book Freakonomics, says “if you look at academic study, one after the next, it turns out that even experts are only nominally better than a coin flip.”

So what can an individual do to make better financial decisions, especially investing decisions?

1. First understand

Broadly speaking, there are three economic conditions that can exist:

• Inflation
• Deflation
• Prosperity

The goal of an investment plan is to (1) provide reasonable protection in the event of either inflation or deflation and (2) provide an opportunity to participate during times of prosperity.

2. Have a plan and take action

Forget the predictions or trying to guess what might happen — focus on the things you can control:

1. Costs – work to keep investment, trading, and tax costs low
2. Diversification and risk – trying to earn a big return by making concentrated bets is a bad idea. Hold a reasonable mix of diversified mutual funds/ETFs and bond funds.
3. Cash buffer – you never know what life is going to throw at you so always be prepared by having at least 3-6 months of living expenses set aside in cash
4. Goals – know what you’re saving for — retirement, college, a new house — and invest appropriately

So practice some selective ignorance when it comes to the market predictions that the media pumps out and focus on the what you can control. It will make you be much better prepared for whatever does come true. It could be the best New Year’s resolution you make.

I recently read an article from personal finance guru Dave Ramsey entitled “How The 30-Year Mortgage Robs Your Future.” In this article Ramsey makes several claims about 30-year mortgages, such as they “enabled borrowers to buy more house than they could afford” and they cause people “to give up the opportunity to be a millionaire.” Are theses claims really true?

I say no.

Let’s look at the not-so-obvious, but massively misleading problems with Ramsey’s statements.

Missing the whole story

Ramsey states “the difference between a 15- and 30-year mortgage with a 6% interest rate on a $225,000 home is $144,000 over the life of the loan.” It is true that you would pay $144,000 more in interest on a 30-year mortgage. What Ramsey fails to tell you is that the monthly payment on the longer 30-year mortgage would be about$550 less per month. If you take this $550 and invest it monthly over 30 years (assuming 8% annual return compounded monthly) , you would end up with about $819,700 and you would own your home.

Bad math

Let’s review another Ramsey claim:

“What if you invested that $144,000? Invested as a lump sum, it would grow to a million dollars in just 17 years. You’d have $2.5 million in 25 years. On the other hand, what if you invested your house payment for 15 years after you paid off your 15-year mortgage? One year later, you’d have a million bucks. Ten years later, you’d have $3.5 million.”

There are multiple problems here, but I will point out two. First, if you have the 15-year mortgage, your monthly payment will be about $1,899 per month. Once the mortgage is paid off, that cash would now be available to save for retirement. Investing $1,899 monthly for the next 15 years would give you about $657,000 (assuming an 8% annual return compounded monthly), $162,700 less than using the 30-year loan. How is this possible you ask? It is primarily due to compound returns working their magic over a much longer period of time.

Second, there is Ramsey’s claim of turning $144,000 into $1,000,000 in 17 years. While theoretically and mathematically possible, there are two problems. One, Ramsey’s example is comparing 15-year versus 30-year mortgages.  Nowhere in his example is there a “lump sum” of $144,000 available to invest. Second, to turn $144,000 into $1,000,000 in 17 years requires an annual compounded return of 12%! This is a totally ridiculous and completely misleading assumption to make (one, which I’m told, Ramsey has been making for years). Keep in mind that the S&P 500 has only returned on average about 10% per year over the last 50 years. If you had a diversified portfolio of stocks and bonds your average annual return would be even less than 10%, with the benefit being less dramatic ups and downs in your portfolio.

Now I understand that many (many!) people bought and financed houses that they truly could not afford, but the 30-year mortgage was not the problem. The true problems are well known:

• home buyers borrowed too much based on their income
• home buyers took out loans that were too risky (e.g., interest only loans, ARMs, etc.)
• home buyers did not make large enough down payments to provide a margin of safety if the need to sell arose
• homeowners did not have a proper cash buffer to cover living expenses, including the mortgage, in the event of job lose or other reductions in income

Dangerous recommendations

Ramsey seems to be recommending you get a 15-year mortgage, pay off your house, then begin saving for retirement.  In my opinion, this is just plain bad advice and hazardous to your financial health.

Problem #1: at the end of 15 years all of your net worth would be tied up in one asset: your house. This is terrible from a diversification perspective.

Problem #2: At the end of your 15-year mortgage you would own your house, bu you would not have any retirement portfolio.  You would be house rich, but cash poor!

Problem #3: as previously mentioned, you are only allowing for the effects of compounding and growth to occur over 15 years versus 30 years, which is a more risky proposition.

A Better Solution

Owning a home, particularly for most middle class folks, can be a great way to help build wealth, if it is done properly. First, buy a home using these rules:

1. Don’t buy a home if you don’t plan to live in it for at least 5 years
2. Buy a home that is no greater than 2 – 2.5 times your gross annual income
3. Put down a 20% down payment, if at all possible
4. Pay cash for closing costs – don’t roll them into your mortgage loan
5. Maintain emergency cash reserves that can cover 1 – 2 years of mortgage payments for protection against loss of income due to job loss, disability, etc.
6. Get a 30-year, fixed rate mortgage, as this can help hedge against housing inflation

The second step is to invest for your future on a regular and automatic schedule. Set an amount to save on monthly basis – the difference between what you would pay on a 15-year mortgage versus a 30-year mortgage is a good start.

Building the equity in a home while at the same time building your retirement nest egg is a much better strategy.

Brent Perry, CFP®,

Originally posted 5/27/11

by Brent Perry, CFP

Investing for your future can be challenging. There is a lot of financial information and advice on the television, internet, and in magazines which can often be overwhelming.  Because individuals are often inundated with financial advice they may make mistakes that can be costly to their long-term financial health.  Below are six common investment mistakes and how to avoid them.

1. Buying individual stocks. Most investors don’t have the time or persistence to keep up with the rapidly changing business environment in which an individual company operates.  Avoid buying individual company stocks based on tips or recommendations.  Instead, when looking at investments, focus on building a diversified portfolio of mutual funds that is appropriate for your age, goals, and individual situation.
2. Not investing at all. Not saving and investing means that you are not taking advantage of market growth and compounding interest that long term investing provides.  While market performance can vary widely from year to year, history has shown that investing in a diversified portfolio provides growth over the long term.  Individuals that make a monthly commitment to saving and investing are positioning themselves for financial stability later in life.
3. Timing the market. Market timing is when you buy or sell assets by attempting to predict future price movements.  While there may be the occasional success with market timing, the vast majority of individuals using this strategy experience losses.  Avoid reactionary investing based on hype surrounding economic and industry news.
4. Not setting goals and tracking progress. By not setting goals and tracking progress, individuals run the risk of not having enough money for retirement.  Setting realistic financial goals, such as the percent of income to save per month, helps to make goals easier to achieve.  Goals should be written and progress should be reviewed at least once per year.
5. Lack of investment diversification. Generally this means owning a few individual stocks or having a large exposure to a specific sector.  Proper diversification means owning many different types of stocks and bonds so one isn’t over exposed to a particular company or industry. This strategy helps to reduce risk.
6. Withdrawing money from a 401(k) or IRA before retirement. Removing money from these types of accounts before retirement means you not only have to pay income taxes and a penalty, you reduce the savings you would have accumulated if the money was left in the account. Money you put in a retirement account should never be accessed unless you are truly in dire-straights, such as potential loss of your home or major family illness.  As a general rule once your money is in a retirement account, assume it is not available to spend until retirement.

Specific investment and saving strategies are unique to each individual and vary depending on each person’s situation. Individuals that take the time to identify financial goals and are disciplined about investing and saving in the short-term have a greater likelihood of long-term financial success.

Jane Bryant Quinn, the well-known personal finance writer, published the article “Do-It-Yourself Financial Freedom“ in the April 2010 edition of the AARP Bulletin.  The article listed a dozen ways to improve your finances for those approaching or in retirement.

1. Get rid of debt.
2. Build a better budget.
3. Increase your savings.
4. Wise up on investments.
5. Keep your job, if possible.
6. Do whatever you can to keep health insurance.
7. Be smart about Social Security.
8. Be smart about retirement funds.
9. Put off reverse mortgages.
10. For regular income, consider immediate annuities.
11. Work with a financial planner.
12. Move in with your kids.

All are very important points to carefully consider.  One point that I will shamelessly highlight is #11 – Work with a financial planner.  Mrs. Quinn makes a point of mentioning the Alliance of Cambridge Advisors (www.acaplanners.org), of which I am a member.  The Alliance of Cambridge Advisors is one of the best independent, fee-only, personal financial planning groups in the country, in my humble opinion.  If you find you are unwilling, unable, or simply uninterested in getting your finances in order, a Cambridge advisor can help.  You do not need to be “rich” to work with an Cambridge advisor.  In fact, nearly all Cambridge advisors offer services to clients without minimum assets, income, or net worth.

So how does a financial advisor get mentioned in a nationally-distributed personal finance magazine? Offer the magazine editors one of your photogenic clients, of course. And because we all know that my mug wasn’t going to make it on the cover!

To read the article that accompanies the cover, click here.

Thanks to my client Ryan Brady for taking off time from his real job to be a male model for a day. And thanks to Kiplinger’s Personal Finance Magazine for featuring a young professional on the cover, reinforcing the importance of starting early when saving for retirement.

Recently, I rented a car to drive while on vacation.  I don’t rent cars very often and it had been a couple of years since I’d last rented one.  Being a financial planner and a tight-wad, er, I mean, frugally-minded, I typically put on my best defense against the sales pitch that occurs just before one actually gets to drive away in the rental.  You know the sales pitch right, where you are asked if you:

…would like to upgrade your car from mid-size to standard? (Umm, no, don’t need room for 6 people and 2 dogs, it’s just the two of us.)

…would you like to have a GPS device so you don’t get lost? (No thanks, I know how to read a map.)

…would you maintain the standard liability coverages that come with the car?

That last question is the kicker; it’s the insurance question.  But the sales person (and they are sales people first, customer service people second), doesn’t even use the word “insurance” when explaining it to you.  The way the question is phrased makes you want to say “yes, of course I want the standard coverages”.  And in my haste to get my most recent vacation started, I nearly did say yes to this question.  That could have been a costly mistake for me as the insurance coverage being offered cost more that the cost of renting the car.  And the rental company’s insurance was unnecessary as I was covered by a combination of my own personal auto insurance and liability coverage through the credit card I used to rent the car.

Insurance needs when renting a car

It’s important to understand what insurance you do need when renting a car.  Not having proper coverage could leave you exposed to a very large bill should an accident occur.  Here are the coverage areas you should be aware of:

1. Liability coverage (for damage to you cause to other things and people while driving the rental car)
2. Collision coverage (for damage to the rental car)
3. Comprehensive coverage (for theft of rental car)
4. Theft of contents (loss of your stuff stored in the rental car)
5. Loss of Use coverage (loss incurred by the rental company because they can’t rent their car while it’s being repaired)

You might be thinking “uh oh, I’m not sure all of my bases are covered here.”  Well, you can relax because all of your bases probably are covered.  Let me explain.

Liability Coverage

When you rent a car, liability coverage is included as part of the rental agreement, but typically only at state minimum levels.  Beyond those levels, your personal auto insurance liability coverage will kick-in, so there is no need to buy additional coverage from the rental company.  You will want to be sure to verify this with your insurance company.  If you don’t have auto insurance, then you might consider increasing the liability limits offered by the rental company.

Collision & Comprehensive Coverage

When the rental car agent asks if you want to buy their insurance coverage, they are most likely asking you about collision and comprehensive coverage, also known as a collision damage waiver (CDW).  If you have collision and comprehensive coverage on your personal policy, then you don’t need to buy the CDW.  However, if you don’t have collision coverage, then consider coverage provided by your credit card at no cost to you.

I have a Capital One Visa card and I only have liability insurance on my car (I don’t need full coverage since my care is 15 years old).  My auto policy provides me with liability coverage and my Capital One Visa provides me with collision and comprehensive coverage.  Capital One does have some restrictions: the rental cannot be for more that 15 consecutive days; coverage doesn’t apply to renting trucks, RVs or luxury cars, etc.  Click here to see the official coverage offered by my credit card company (terms starts at the end of page 5).  Note, you must pay for the full amount of the rental on the card to get the credit card’s coverage.

Lastly, if you do have collision and comprehensive coverage on your auto policy and you have a loss, you will be responsible for paying your deductible.  But wait!  Your deductible may be covered by your credit card.  What a deal!

Theft of Contents

If someone steals your stuff out of the rental car, then your homeowners or renters insurance generally will cover your personal items like suitcases, clothes, etc.  Items like laptops or jewelry my not be covered without a policy rider, so be sure to check your policy.

If you do have your stuff stolen and your deductible needs to be paid, it can be covered by your credit card.

Loss of Use Coverage

If you wreck your rental, the car company will want to be compensated for their lost income.  If the car is out of service they can’t make money on it.  Well, a combination of your auto insurance and your credit card will likely cover most, if not all of this liability.  Note that my Capital One Visa includes Loss of Use Coverage.

Be Prepared

The way to save money when renting a car and avoiding being improperly insured (either too much or not enough) is to check your insurance policies and credit card benefits before you step up to the rental counter.  Those sales agents can be persuasive.

Warren Buffett is one of the more interesting people to listen to in the world.  And not because he is the 2nd wealthiest person in the world, but because of the treasure trove of knowledge he shares through interviews and his writings.  His latest writings are from the annual report of his company, Berkshire Hathaway, which were released just a few days ago.  His letter to shareholders are incredible insightful and clearly written.

Listening to Buffett can be fun and exciting, but one may wonder what can truly be learned from a person who’s world, in reality, is much different from the average person.  As luck may have it, the following are a few of Buffett’s thoughts pulled from his recent letter to shareholders, with commentary on how we mere mortals can make better financial decisions.

We will never become dependent on the kindness of strangers. Too-big-to-fail is not a fallback position at Berkshire. Instead, we will always arrange our affairs so that any requirements for cash we may conceivably have will be dwarfed by our own liquidity. Moreover, that liquidity will be constantly refreshed by a gusher of earnings from our many and diverse businesses.

Lesson for mortals:  Always keep a sufficient level of cash or cash-equivalents in order to prevent the ups-and-downs of life from creating a financial catastrophe.  This means at least 10% of your gross income in liquid cash to cover things like a major car repair or the refrigerator replacement.  In addition, you should have a minimum of 20% of your gross income set aside to help insulate you against financial life emergencies such as job loss or a major health expense.

When the financial system went into cardiac arrest in September 2008, Berkshire was a supplier of liquidity and capital to the system, not a supplicant. At the very peak of the crisis, we poured $15.5 billion into a business world that could otherwise look only to the federal government for help. Of that, $9 billion went to bolster capital at three highly-regarded and previously-secure American businesses that needed – without delay – our tangible vote of confidence.

Lesson for mortals: The moral here is a little less obvious as it relates to the average individual, but is one of psychology. Think back a year ago to March 2009. Do you recall how you felt about your job, your investments, and the economy in general? Many, many people were afraid that the world had completely changed for the worse and would never be the same again.  And we are certainly not out of the wood yet, but what was Buffett doing at this time? He was buying. He is a master of containing his emotions and looking at the world in a rational way.  Being prepared in the event of a downturn (e.g., having an emergency fund, not having an overly aggressive investment portfolio) and using rational thought to not panic is certainly a behavior the rest of us can learn from.

…we want partners who join us at Berkshire because they wish to make a long-term investment in a business they themselves understand and because it’s one that
follows policies with which they concur. If Charlie (Munger) and I were to go into a small venture with a few partners, we would seek individuals in sync with us, knowing that common goals and a shared destiny make for a happy business “marriage” between owners and managers.

Lesson for mortals: There isn’t a investing lesson here necessarily. it’s more of a basic life lesson: Don’t associate with people you don’t like. This can mean acquaintances, co-workers, family members, business clients, employers, etc. While it may be impossible to eliminate every negative relationship you have, by working towards surrounding yourself with as many positive relationships, both personal and professional, you will find yourself a happier person.