Moment on Money

If I Had a Hammer

Prospective clients will often ask specific questions about specific products. They may ask "What do you think of annuities?", or "What is the best type of Life Insurance?"  Sometimes the client is looking for clarification, and other times the client is testing to see if my opinion matches theirs.

Answering the questions of a client who is looking for a clearer understanding about a product is straightforward. A large part of my role is to take complex situations and tools and presenting them in a way the client understands. I always wonder what answer the client who is testing me wants to hear. Are they philosophically opposed to that product? Have they heard conflicting viewpoints? Are they testing my product knowledge?

My answer is almost always the same, regardless of the product at issue. The products we use are simply tools, and tools are neither good nor bad. I have no bias for or against any tool... as long as it is used properly. For example, a butter knife would be a lousy tool to cut down large trees, but a chainsaw at your dinner table is equally inappropriate. Each tool has its place. Used in the proper manner and with the proper safety measures it can make a tough job much easier. Used improperly it can be downright dangerous.

What would you think if you went into a hardware store and their answer was always the same?

What tool should I use to drive this nail?     A hammer.

Turn this screw?      The same hammer.

Tighten this bolt?     I'd use my hammer.

Fix my plumbing?     You have got to love hammers.

Sounds pretty silly. That is one of the reasons I can not understand why some pundits make blanket statements such as "Always buy term life insurance" or "Never buy load funds." The only absolute is there are no absolutes.

Of course if all you have is a hammer, then everything starts to look like a nail!

Boys and Power Tools... photo on Flickr by TMJR

stop! hammer time! photo on Flickr by Rakka

Carnival of Personal Finance #102

What is a Carnival of Personal Finance? In short, it is a showcase of blog posts considered to be some of the week's most interesting and informative within the broad spectrum of personal finance. Published weekly, this week you can find the 102nd edition at Money Smart Life with a musical theme.

Understanding Universal Life Insurance, posted here at Moment on Money (May 17th) was included in this week's carnival.

Some other interesting posts that are a part of this carnival:

• Inflation Predictions from 1978
• Why You Need More Than An Index Fund
• Start Saving For Retirement Now
• Is Your Portfolio Diversified?
• Can I Rollover My 401(k) While Still Employed?

Photo on Flickr by faz..

A Good Rule of Thumb

I generally do not subscribe to rules of thumb but there is one I use all the time.

The Lazy Man and Money blog recently ran a series of posts titled Compound Interest Week complete with a chart to compute the length of time it takes for your money to double at a specific interest rate. I'll take his word that his chart is correct, because my easy rule of thumb comes close to the same values. I wish I was smart enough to have thought of this rule, but I can not take credit for it. In fact, it is in every business textbook I have taught from!

The rule is simple and is known at the Rule of 72. To use it, simply take an interest rate and divide it into 72. The result is the number of years it will take for your money to double. For example, you have $25,000 in your 401(k) and you plan on retiring in 32 years. If you can average 9% returns (remember the problems with using averages), 72 divided by 9 is 8 so your money will double every 8 years. Eight goes into 32 four times so your money will double four times. That is, $25,000 doubled is $50,000, which doubled is $100,000, which doubled is $200,000. Pretty easy to do in your head too!

All Financial Matters puts an interesting twist on the Rule of 72 by introducing the Rule of 114 (time for your money to triple) and the Rule of 144 (time for your money to quadruple).

With a little imagination, you can find all kinds of uses for the Rule of 72. Divide 72 by your estimated rate of inflation and it will tell you how many years it will take for your purchasing power to be cut in half. How many ways will you use this rule of thumb?

Before I get your comments about the inaccuracy of the rule, it is close enough. Keep in mind that we are usually estimating our rate of return and chances are our actual experience will be different anyway.

Photo on Flickr by PetroleumJelliffe

A Reader Asks... #1

Dimes asked, "Are you a fiduciary? What is a fiduciary?" and those are both excellent questions.

In fact, this is a hornets nest that was metaphorically kicked by the Pension Protection Act of 2006 (PPA). Signed into law last year, the PPA defines who has fiduciary responsibility (and liability) but the PPA never defines the term fiduciary!

Wikopedia defines fiduciary this way:

A fiduciary duty is the highest standard of care imposed at either equity or law. A fiduciary is expected to be extremely loyal to the person to whom they owe the duty (the "principal"): they must not put their personal interests before the duty, and must not profit from their position as a fiduciary, unless the principal consents. The fiduciary relationship is highlighted by good faith, loyalty and trust, and the word itself originally comes from the Latin fides, meaning faith, and fiducia.

In 2005 the The Certified Financial Planner Board of Standard Inc. started the process to update the Standards of Professional Conduct. A key issue in this update is the standard for duty of care. The proposal is to replace the current “reasonable and prudent professional judgment” standard to a requirement that a CFP® professional “shall at all times place the interest of the client ahead of his or her own.” For CFP® professionals providing financial planning services, the duty of care would be raised from the current duty to “act in the interest of the client” to the “duty of care of a fiduciary." The proposal defines fiduciary as "one who acts in utmost good faith, in a manner he or she reasonably believes to be in the best interest of the client."  The CFP Board of Standards Board of Directors is scheduled to meet this month and review the last round of comments regarding the proposed revisions. If approved, the new Standards of Professional Conduct are anticipated to be effective January 1, 2008.

To further complicate matters, the Securities and Exchange Commission (SEC) Rule 202 already states that Registered Investment Advisor's (RIA) and their representatives (Investment Advisor Representatives or IAR) have a fiduciary responsibility to clients.

I am not an attorney and feel very unqualified to comment on this battle of legal details. But I do like the CFP Board of Standards definition. I have held myself to that standard since I started in this business over 17 years ago.

Am I a fiduciary? I suppose that depends on the context to which you are using the fiduciary standard. I am an IAR and always provide my advise in line with clients interests and relative to their goals.

Dimes, if that does not answer your question please let me know. I fear I may have raised more questions than I answered. Such is the nature of gray issues.

Photo on Flickr by johnxlovessheep

Volatility Revisited

We have already discussed the concept of investment volatility and compared two investments with different average returns. Let's revisit volatility but this time we will add a new caveat... we will compare investments with the same average return.

Here are three hypothetical investments, each with a 10% average annual return. Which would you choose?

Did you choose C? Most (risk tolerant) people do. After all, seven of the fifteen years are 15% gains or more and there are only three years with a loss. If you invested $100,000 in C you would have approximately $357,000. Not bad but you would have made $27,000 more if you chose B and a whopping $59,747 more if you chose A! Don't believe me? Here is the breakdown.

Remember, the average return on all three investments is 10% so we also need a measurement of the volatility. That measurement is standard deviation. The higher the standard deviation, the more volatile the investment. The standard deviation of A is 2%, B is 12%, and C is 16%. When the anticipated returns are the same, it is best to chose the lowest volatility. Consistency of portfolio performance over time generally provides better long term performance than more volatile portfolios despite the same average annual return.

Now for the lawyer talk... This is a hypothetical illustration and is not indicative of any particular investment.

Fat Doctors and Skinny Chefs

The saying "Never trust a fat doctor or a skinny chef" is all about credibility. Does a fat doctor practice healthy living? Does a skinny chef really eat the food they prepare? Truth is, maybe they do... but it can sometimes be hard to believe.

When a client asks "Do you own this investment?" I used to worry about how to respond. How much should I share with my clients about my family's financial situation? In one regard, I ask some very personal financial questions and I expect my clients to be open with me. Is quid pro quo reasonable?

I have decided it is not. At least not to the same degree. After all, I would be suspect of a doctor who does not ask me to undress in an effort to respect my privacy... but I do not want them to "show me theirs". But if the doctor is taking a similar medication, I am okay with them sharing their experience with on it.

So now when I am asked if I own a specific investment or insurance product, my response is honest but limited. If I do own it I will tell them, but I keep my specifics private. If I don't own it, I will again tell them and explain that my financial situation and their financial situation are different. The key to my advise has to be based on if I would own the recommended product if my situation was the same as theirs.

Photo on Flickr by davemorin

Golden Eggs and Geese

Here is a question for you. If you had a goose that laid golden eggs, which would you insure? The goose or the eggs?

When I am teaching my college students, they always tell me they would insure the goose. After all, as long as you have the goose the eggs are replaceable. This metaphor works well for looking at your insurance. You are the goose... well, your ability to earn an income is the goose. In fact, the younger you are your ability to earn an income may be the most valuable asset you have. It is the income you earn which will provide all your wants and needs ... the eggs. As long as you have income your eggs can be replaced.

So why do most people insure the eggs and leave the goose unprotected? We insure our home, car, and jewelry and ignore disablility income protection and life insurance.

Need a bit of motivation? A few days ago we cited poor cash management and risk management as two of the biggest causes of financial failure. Insuring our goose is part of both.

Goose photo from Flickr by maverickapollo. Egg photo from Flickr by Dizzy Girl.

What your financial planner wishes you knew

Inspired by What your child's doctor wishes you knew...

Suggestions to make your financial planning session more productive:

• If you think it may be relevant - bring it. I am often asked by new clients what to bring to our first meeting. My answer is fairly mundane. I ask them to bring all their most recent tax returns, any statements, and anything else they think I would want to know about it. I am sometimes surprised at what they bring. It is often helpful and I never would have known to ask in advance for things related to unique situations.
• Keep records. If you are not sure what you need to keep, keep it all. Then bring it in and we will go through it together. Some records are replaced when obsolete (like a year to date statement). Others need to be kept for a long while (such as a year end statement of an investment you still own).
• Use your professionals as a team. Your accountant, financial planner, and attorney all have different knowledge sets and perspectives. But often the work done by one professional affects the others. One characteristic of a professional is knowing their limitations. At a minimum we all need to know who is on the team and what you are comfortable with us sharing about you.
• Jot down a list of your main questions and concerns. Rank them by importance. Then we can focus on your priorities.
• The best time and place to meet is at my office and during business hours. I am more than happy to make arrangements to meet at the time and place most convenient for you. But at my office and during regular business hours I have all my resources at my fingertips.
• Share your thoughts about the concepts presented. There are far too many alternatives for me to present them all. Not all aspects of a concept may appeal to you. Let me know what parts you like and dislike. There may (or may not) be an alternative which is closer to your ideal.

Photo on Flickr by manogamez

The Sound of Silence

In the early 1990's a cousin of mine was living and working in Japan. I happened to be at his parents house one day when he called home. Today we take global communication for granted, but 15 years ago the technology paled in comparison.

I had the opportunity to talk to him for a few minutes and it was weird. You would say something... there would be this long pause... and then finally he would reply. It was explained to me that it took time for my signal to bounce off the satellite to Japan, for him to reply, and then his signal to bounce off the satellite before I could hear it. You had to learn to be patient to have an effective conversation.

I am writing this post on May 9, 2007 ... but you may not see it for several days to weeks. In fact, Moment on Money has not gone even gone live yet! That is because as a Registered Representative, I follow all the NASD rules and guidelines which include having my broker/dealer approve all material before public release. I welcome the oversight as the rules were established to protect you. If you are interested in learning more about them, here is an interesting blog about Securities Regulation.

I tell you this because it reminds me of that overseas telephone call years ago. I must be patient, but you will respond. You also need to know that if you are waiting for a response or comment from me, its coming. Thank you for your patience.

Photo on Flickr by Soon

No Argument Required

I am kind of disappointed. My perception has always been that financial bloggers were, in general, always writing about how financial planners are unnecessary. This post was supposed to be the financial planners defense.

To prepare, I wanted to find a bunch of posts where the authors said "You don't need a financial planner" or "Why pay someone to do what you could do yourself?" I searched and searched and could not find very many credible posts to that effect. What I did find were many posts saying just the opposite! Most financial bloggers, who are not financial planners, understand the value added by a professional planner. For example:

• Life Guru wrote Financial Planners - The Good Ones Earn Their Pay
• The Skilled Investor writes If personal finance is difficult for you, carefully hire a good financial and investment advisor
• Nina Smith, (I find her to be a great author) who writes for both Blogher and Queercents, followed up on her post  How to Pick a Financial Planner with When Do You NEED a Financial Planner

A friend of mine used to say, "If the horse is dead, dismount" so I will spare you my wonderfully prepared analogy.

Photo on Flickr by derfel_ie