Who, what, where, when, why and how

Old fashioned journalists were taught to answer who, what, where, when, why and how in every news article they wrote. The answers to the each of the six questions provided a reader or listener with the essentials of the story. They framed the journalist’s role as a reporter, rather than a commentator. Personal bias was taboo. The story was to speak for itself. The journalist’s role was to give voice to truth and trust the reader to make proper inference.

Every investor should don the mantle of Edward R. Murrow and ask the hard questions, both of themselves and of their advisor, to insure they have an investment strategy grounded in truth and built for the long-run.

Here goes:

Who. Do you prefer to go it alone, or do you value the services of an investment professional? The answer to this question is not as simple as you might think. All investors have personal bias that may blind them to implementing the ideal strategy for their needs. The adage “A man who represents himself has a fool for a client” strikes at the heart of the problems many do-it-yourselfers will encounter. No one conceives of asking the pilot of an airliner to “scoot over and share the cockpit” when they board a plane because they once read a book on flying a 747. No one rejects anesthesia during open heart surgery to provide advice to their surgeon. The majority trusts professionals to employ years of experience and specialized training. The majority acknowledges the expertise of a pilot or lawyer or CPA or doctor within their specialty.

Unfortunately, very few workers in the field of personal finance embody the same standards and ideals of a doctor or a CPA. A recent article by syndicated financial columnist Scott Burns reports there are 250,000 people in the U.S. who call themselves “financial advisors”, yet a scant 13,000, totaling only 5% of the group, are actually Registered Investment Advisors who have “a sworn fiduciary duty to put your interest first”. Mr. Burns continues, “What does this mean for most of us? It means about 95 percent of all the people who are called ‘financial adviser’ are working on commission”. Commissions cloud judgment and influence advice. Commissions are designed to incent a salesperson to sell profitable products. It is easy to understand why so few financial advisors are deemed professionals worthy of trust. It is also vital to insure who you trust is worthy of your trust.

What. The universe of investing is vast and as varied as its participants. Who to trust is only the first step. What to invest your hard earned savings in is equally important and often determined by who you engage for advice. Stocks, bonds, cash, mutual funds, commodities, real estate, options, hedge funds, insurance contracts, annuities, life-settlements, limited partnerships and various exotic schemes all scream for your time and attention. Most investors appreciate the importance of diversifying their investments to minimize the risks of any single stock or market segment shredding their finances. Prudent investors recognize the difference between true diversification and simply buying numerous “hot products” to increase their returns. Be leery of money making schemes that lack oversight or regulation. The SEC provides oversight to protect investors by insuring free and fair market practices abound, not to limit your “opportunities” or squelch your profits. Transparency, full disclosure, liquidity, secondary markets and consumer protection mechanisms are the hallmarks of safe investing. Use caution and common sense when selecting the tools to build your investment fortune.

Where. Keep your investments safe by knowing who should, and how should not, have custody of your funds. Always use a reputable and regulated custodian for your money. Reputable custodians insure your assets against fraud or theft. Reputable custodians offer transparent access to your accounts. They provide performance reports you can easily read and understand. They openly disclose all fees and aggressively control costs to enhance their value to you. They allow you to terminate custodial agreements and professionally and quickly facilitate the transfer of your assets to a new custodian of your choosing. One of the quickest ways to lose everything you have is to entrust its safekeeping to the wrong person or entity.

When. It is the long-run that defines a true investor. Gamblers and speculators seek short-term rewards and quick riches. Investors develop long-term strategies based on personal goals, future needs, risk tolerance and time horizons. The sooner you start and the longer you persevere with the right advisor, using the proper investments, housed with a trustworthy custodian, the greater your chance of significant returns. The Lord of the Rings author J.R. R. Tolkien may have first wrote “Little by little, one travels far” referring to Hobbits, but the security and success of your investments may very well thrive in your embrace of the same sentiment.

Why. Few people seriously consider why they are investing for the future. A financial roadmap outlining your goals and objectives will serve you well as your traverse your financial landscape. Make a list of the top three or four goals you want to achieve (i.e. college for your children, pay off your house, a trip to Antarctica, $6,000 a month in retirement income). Your goals are your destination. Your roadmap clarifies your path and keeps you on track.

Use the acronym S.T.I.R. to chart your course.

S stands for Savings. Are you saving enough to achieve your objectives? If not, make the appropriate adjustments. You may need to save more, save less or alter your goals.

T is for taxes. Uncle Sam demands his cut. Are you employing every available strategy to reduce current or future tax costs?

I stands for inflation. Purchasing power, not account size, is the only game you should care about. Inflation robs you of purchasing power. Many people fail to account for the ravages of inflation when planning their investment strategy. Don’t make the same mistake.

R is for return. What are your returns? Will they allow you to meet your goals? Returns and risk are always related. You need appropriate risk to achieve the appropriate return. Know your comfort level. Minimizing your risk may cause you to fall short of your dreams. Too much risk may force you to jump ship. Tiger Woods knows the only way to win a tournament is to show up and give it your very best. If the pain of short-term risk forces you to abandon your plan you will abandon your chance of holding aloft your championship trophy.

How. This is where most people start the journey, at times to the exclusion of every other important question we’ve discussed. Focusing on ‘how’ before reconciling the vital importance of who, what, where, when and why is a primary reason why the average investor made only 4.3% annually over the past 20 years compared to the S&P 500’s annualized average return of 11.8% per year during those same 20 years.

Bad advice from the wrong ‘who’ will sabotage your returns. Buying the wrong ‘what’ because of fear, greed or a biased commission-driven sales pitch from the wrong ‘who’ will sabotage your returns. Failing to protect your money by placing it with an inappropriate custodian opens a Pandora’s box of high costs, poor service, huge risks and the threat of fraud that will sabotage, if not decimate, your returns. Short-term speculation is an alluring game, but the statistics always favor the house and “you ain’t the house”. Defining your goals and formulating a coherent roadmap to achieve your goals is critical to your success. As the saying goes, if you don’t know where you’re headed, any road will do. Avoid detours. Stay on track. Have a plan. Follow your plan.

Which brings us back to the question of how. Seventy years of academic research into how markets work and how investors behave should make this question self-evident. Unfortunately, it has not. A legion of commission-driven product hawkers does not want you to understand, let alone embrace, the truth.

Embrace the fundamental truths. Markets work. Risk and reward are related.

Build internationally diversified, low cost, structured asset class portfolios ideally tailored for your comfort level. Favor stocks over bonds. Favor value stock asset classes over growth stocks. Favor small stock asset classes over large stocks. Invest for the long-run. Harness the astounding power of compound interest to achieve your goals. Buy, hold and rebalance regularly, as needed, to keep your portfolio in balance. Use short-term market volatility to your benefit by consistently saving and adding new funds to your portfolios through all market conditions. Use low-cost, passively managed, structured asset class building block funds to create your portfolios (we believe Dimensional Fund Advisors (DFA) currently offers the smartest building-block funds available).

‘How’ is hard. It takes expertise, critical thinking and patience to do ‘how’ well. It takes courage and discipline to ask tough questions and do things right. But oh, how savory is the reward.

Would you want it any other way? I doubt Edward R. Murrow ever did. Neither should you.

Clarify Your Values

Decide What You Stand For
What are your values? What do you stand for? What are the organizing principles of your life? What are your core beliefs? What virtues do you aspire to, and hold in high regard when you see them demonstrated by others? What will you not stand for? What would you sacrifice for, suffer for, and even die for? These are extremely important questions that are only asked by about three percent of the population, and that small minority tends to be the movers and shakers in every society.What are your values? What do you stand for? What are the organizing principles of your life? What are your core beliefs? What virtues do you aspire to, and hold in high regard when you see them demonstrated by others? What will you not stand for? What would you sacrifice for, suffer for, and even die for? These are extremely important questions that are only asked by about three percent of the population, and that small minority tends to be the movers and shakers in every society.

Write Out Your Key Values
When I first began this values clarification exercise some years ago, I wrote out a list of 163 qualities that I aspired to. I think I eventually came up with every virtue, value or positive descriptive adjective that referred to personality and character in the dictionary. And I agreed with all of them. I felt that they were all important and I wanted to incorporate every single one of them into my character.

Focus on Very Few Core Beliefs
But then reality sets in. I realized that it is very hard to learn even one new quality, or to change even one thing about myself, let alone dozens of things. So I scaled down my ambitions and began narrowing the values down to a small number that I could manage and work with. Once I had settled on about five core beliefs, I was then able to get to work on myself and start making some progress in character development.

Select Your Five Key Values
You should do the same. You should write down the five values that you feel are the most important for you to live by. Once you have those five values, you then organize them in order of priority. Which is the most important value in your hierarchy of values? Which would be second? Which would be third, and so on?

Learn to Make Better Decisions
Every choice or decision you make is based on your values. Whenever you decide between alternatives, you invariably choose the alternative that you value the most. Because you can only do one thing at a time, everything you do is a demonstration of what you consider to be the most important at that moment. Therefore, organizing your values in an order of priority is the starting point of personal strategic planning. It is only when you are clear about what you value, and in what order, that you are capable of planning and organizing the other activities of your life.

Action Exercises
Here are two things you can do immediately to put these ideas into action:

First, clarify your core beliefs and your unifying principles. Write them down and compare your life today with the values that are really important to you. How are you doing?

Second, organize your values in order of their importance to you. Which of your values is most important? Which is second? And so on. Do your current choices reflect this order of values?

Quotes of The Day

“Cherish your visions and your dreams, as they are the children of your soul, the blueprints of your ultimate achievements. “ – Napoleon Hill, Pioneer of Personal Achievement Philosophy

Quotes of The Day

“The Chinese use two brush strokes to write the word “crisis.” One brush stroke stands for danger, the other for opportunity. In a crisis, be aware of danger–but recognize the opportunity.” – John Kennedy, 35th President of the United States

Portfolio diversification can minimize stock market risk

Most Americans who invest in stocks know that market volatility and stock price fluctuation are normal and to be expected. They also need to understand that maintaining a diversified portfolio is important. The old adage ‘don’t put all your eggs in one basket’ is still good advice. Anyone in doubt should ask an Enron employee.

Most concentrated stock positions result from equity compensation given to corporate executives that can be in the form of restricted stock, stock appreciation rights and restricted stock units, to name a few. An employee’s concentration in a stock can also add up due employee stock purchase plans or because the company offers its stock as an investment option in their 401(k) plan (the company might even do their 401(k) match by providing company stock).

The problem is that investors can become attached to stocks, specifically their employer’s stocks, and feel that they are being disloyal to the company if they sell some of their shares. It might be that they worked for a large corporation such as IBM or Exxon Mobil and acquired a major portion of their wealth in the form of stock options. Or maybe they just fell in love with their employer’s stock and bought a ton of shares over the years through the Employee Stock Purchase Plan. If, in her will, Aunt Bertha left a large block of Caterpillar stock – something she worked hard for and acquired over 30 years – there could also be a different type of emotional attachment.

Still, it may be necessary to sell some shares to maintain a healthy and properly diversified portfolio. Market losses can be exacerbated when a portfolio holds too much of a particular stock or is skewed heavily into any one market sector. The issue of concentrated positions is compounded if an investor is planning to retire within the next 10 years. They just don’t have time to recover from large share value loss.

Here are some tips to strategically unwind a concentrated portfolio:

Use Share Selection
Share Selection involves liquidating a large portion of a concentrated stock position now and taking advantage of the low 15 percent long-term capital gains rate. Savvy investors will sell the shares with the highest cost basis, thus minimizing overall capital gain.

Roll Out into a Taxable Account
Taxpayers may benefit from an important break on income tax when they take a lump-sum distribution from a 401(k) plan. A lump-sum distribution means the entire balance of the account is withdrawn within a single calendar year following a triggering event – you leave your employer, suffer a disability, reach age 59½ or die. (Note that if you leave your employer before you turn 55 and you take a lump-sum distribution rather than rolling the funds into another qualified account, you may be subject to a penalty.)

If the distribution meets the definition of a lump-sum, you may be able to avoid income tax on the net unrealized appreciation (NUA) of the stock of your employer if that stock is placed into a taxable brokerage account and the remaining 401(k) assets are rolled into an IRA. The strategy involves an employee taking a lump-sum distribution of company stock from their retirement plan (upon separation from service) and then paying ordinary income taxes on the stock’s basis. But the difference between the basis and the fair market value—the net unrealized appreciation—is taxed at long-term capital gains rates only when the stock is sold, regardless of the holding period. This can be a better option than rolling the stock into an IRA where all of its value will eventually be taxed as ordinary income.

This special consideration for employer stock held in 401(k) plans only applies to lump-sum distributions, but it could save significant income tax.

Consider a Gifting Strategy
Another good strategy to consider is gifting the stock to children/grandchildren or a favorite charity. Under current laws, an individual can gift up to $12,000 per year, to anyone they choose, without incurring gift taxes. A charitable gift should qualify as a tax deduction. Transferring highly appreciated stocks to a Charitable Remainder Trusts (CRT) allows an investor to receive both a charitable deduction and an annual income stream from the trust.

While in general it is wise to think long-term and give your investments time to perform, that message is sometimes taken to the extreme. Regardless of how it happened, any individual holding that makes up more than 25% of your overall investment holdings is considered a concentrated position. And that position needs to be rectified in order to maintain portfolio health.

Because individual situations will vary, investors should contact their tax advisor about their specific situation.

How long-term investors benefit from increased stock market volatility

Dollar-cost averaging is when you make regular contributions to your investment portfolio. And in cases of a volatile market, those that benefit are long term investors who dollar-cost average. That’s because when the yo-yo of the market swings down, you buy more shares with the same amount of money than you do when the yo-yo is on an uptick.

So as the volatility increases, so do the odds that you will buy more assets at deflated prices.

“Uh, hold on a sec Roland,” you mutter. “I’m nearing retirement so I want to avoid any major price swings in my portfolio.”

Wake up there Sparky! You are still a long term investor so the volatility you experience in the short term is irrelevant. Your money doesn’t know how old you are so start dollar-cost averaging into a globally diversified portfolio of equity positions so you can take advantage of it.

Key Point: Retirement is not the finish line of your financial life and no retiree cashes in their entire portfolio the day they stop working. God willing, you will continue living another 20 to 40 years so market volatility is not a risk, but rather a short term price we pay to maximize our return and be owners with our capital.

But if you are the type of investor that cannot emotionally handle the volatility an all-equity portfolio, here are a few suggestions:

Number One: Align your thinking with how money works in the real world. Don’t focus on the number of dollars in your portfolio; focus on what those dollars will buy you. A good retirement portfolio must put you in a position to outpace inflation and taxes . . . it’s called real world financial safety.

Number Two: If the short term yo-yo bothers you, set aside a couple years worth of income in a special fixed income account; then diversify the remainder of your assets among ownership positions. You know my mantra: Every wealthy investor I know and you know has built his or her wealth through ownership or inherited it from an owner.

But don’t expect market volatility to go away anytime soon.

Over the course of my adult life, I’ve seen all kinds of “black clouds” that make investors moan and complain about the market. Yet through it all, for the last 200 plus years, nothing has derailed the yo-yo from climbing the flight of stairs.

Since you and I have no say in decisions that take place half way around the world, we must continue taking the necessary precautions when it comes to our money.

That means facing reality about how wealth is built and preserved in the real world in addition to taking advantage when the market throws us a bargain.

So here’s my advice:
Stay informed.
Stay diversified.
Stay disciplined.
And be an owner with your capital.