The sophisticated investor

I have had some real thought-provoking meetings over the years and have consolidated some of them into the following story.  To make a better story let say our potential clients name is Bob. (Name not changed to protect the innocent, that’s one of the real names and he’s not innocent).  

He made clear that he’s a research guy, always does his homework and knows what he’s doing.   He believes the way to riches is to follow the “trends”.   He goes along with conventional wisdom and doesn’t buck the trend.  He doesn’t like to take risk and says he’s a moderate investor.   Bob starts out our meeting by telling me how the system is out to get the little guy. 

He asks me if I remember the tech stocks in the 90’s and says “It was all rigged, a total conspiracy. You remember all the tech stock pumping and dumping that went on?  Wall Street was saying how great this “new business model” was, while at the same time sending internal emails around saying what junk the stuff was”. Bob says “I was maxed out on margin (like I was supposed to be) when they pulled the rug on me.”  At this point I’m just listening, not offering any thoughts or advice.  Bob goes on to say “My broker was a jerk; I kept getting these margin calls and had to sell just when I should have been buying. Well I finally fired him and took what I had left and started researching my next opportunity”.

“The next big trend was Real Estate; I wanted to actually feel what I owned. No more high flying stocks for me. Charts of single family homes have always gone up, year after year, housing doesn’t go down. The market in Florida was the hottest so I bought three homes in Tampa; actually they were condos, (converted apartments) with the idea of selling in a few years when they appreciated”. I thought to myself…Oh; this is going to turn out bad.

 Bob said “The finance company gave me a low interest rate because I put 20% down and did a balloon mortgage. The broker said I’d never see the balloon because I could refinance before the rate increase took effect. He also said I would be able to recoup the 20% down payment during a refinancing, using a cash-out option, because those condos were sure to continue appreciating at 15% per year. That was in 2005.”

We all know what happened next…

“By 2009, I was so underwater that I turned those houses back to the bank. They had a term for it in those days, it was called jingle mail and I put the keys in an envelope and mailed it to the bank.   I lost my down payment plus the money I put into the condos. The appraisers said the houses were worth $250,000 each when I bought them. Those crooked bankers! They should all be in jail. The entire financial system is rigged against the little guy. It’s such a rip-off.”

 OK so I’m thinking, life can’t get much worse for poor Bob so maybe I can make a suggestion here. I say “Bob have you ever considered”…but he interrupts me and says “Screw it. In 2011, I converted all my money into gold. It’s obvious the global financial system is in ruin. Central banks are printing money like confetti, government spending is out of control, we have political gridlock like we’ve never seen before, don’t even get me started on Europe, and who knows what Japan is doing with their currency.  It’s a race to the bottom, and the only asset that is going to hold its value is gold.” And life just got worse for Bob.

“I got in at $1810 per ounce. That was high, I know, but the Fed is killing me. Their manipulation of interest rates to stimulate the economy is pushing unemployment lower, pumping up stock prices, and artificially forcing up consumer confidence. That’s slamming gold prices down. They should abolish the Fed. They’re a bunch of idiots!”

Here’s where I saw my opening and said “Have you ever considered index funds? You would have done really well since 1999 if you owned a diversified portfolio of low-cost stock and bond index funds and just rebalanced them.” And what was his response? 

 “Diversification is for people that don’t know where to invest, so they just buy lots of stuff hoping to get lucky, and Index funds are for people who don’t know anything about investing, but thanks for the suggestion.” Then he said, “Can you believe the huge bond bubble we’re in? Even Warren Buffet is avoiding bonds. I’m currently researching some triple-leveraged Treasury bond ETF’s put out by Goldman Sachs that short the market…”

Bob and I do not work together.  He’s looking for a much more sophisticated advisor.

I do agree with a lot of what the Bobs of the world are saying.  In short if you play with Wall Street you will lose, the game is rigged against the small investor. We have seen over and over where Wall Street has made huge bets, only to pass the loss on to their customers, and pay themselves huge bonuses. As an individual investor you are not going to beat Goldman Sachs, JP Morgan, Citi Group or any of the too big to fail Banks/brokerage firms/gambling houses. Not only should you not play with these crooks, in my opinion, you should never do business with them at all. If our government cannot reign in the terror spread by our TBTF banking system then it becomes necessary for us as individuals to vote with our feet! If you believe the fees at BOA are ridiculous, then don’t do business with them!  Find a local community bank that knows how to deliver value to you, not just take from you.

To invest without Wall Street is not as hard as you might think. Simply look for investment funds with very low cost. I like to stay below .2 for an expense ratio. You will find more and more low cost funds are available as many in the investment community are fed up with high cost low return investing, pushed by Wall Street. You find these funds at Vanguard, and Fidelity, some Exchange Traded Funds from iShares, to just name a few, there are more out there.

Academics overwhelmingly agree that the best way to invest is though a diversified portfolio of low cost index funds that match the performance of the global financial markets. Virtually every unbiased study on the subject comes to the same conclusion – buy and re balance a basket of low cost index funds. The evidence is irrefutable.

When investors realize these facts, the truth about Wall Street becomes clear, and a path to better investing becomes apparent.  Bob needs to do some more research.


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Why we Invest in Bonds

This last May I attended a conference in San Diego put on by our favorite brokerage firm, Shareholders Service Group.  I had a great time, learned a lot and was able to put faces to the people I speak with daily. I’ve spent the last month going through the information and have the following thoughts about our keynote speaker Dr. Christopher Gezcy, Academic Director of the Wharton Wealth Management Initiative & Adjunct Professor of finance at the Wharton School.  Basically Dr. Gezcy, who is an expert in portfolio diversification, says that we need to lower allocations to fixed income and invest in “alternative Investments”.

Now most of us can not invest in “alternative Investments” even if we wanted too.  They have extremely high minimums (a million dollars) the expenses are ridiculously high, often over 3%, are approved only for accredited investors, which we will all be, as soon we win the lotto.  But from an academic point of view Dr. Gezcy is correct – Alternative Investments do add great diversification to a portfolio.  Alternatives are usually called hedge funds, or long/short funds. I hate to disagree with a PhD from Wharton, whose IQ makes mine look puny, but here is what I think.

It’s hard to find anyone these days that likes fixed income investments.  One of the main concerns I often hear about is the so called “Bond Bubble”.  Interest rates today, while up slightly in recent months, are still close to an all-time low, thanks to the FED Bond buying, and poor demand on the part of borrowers in our sluggish economy. The fear of owning bonds has reached an unprecedented and in my mind unwarranted level. There is still good reason to own bonds in your portfolio.

Even PIMCO bond guru Bill Gross sent out a warning in a recent Investment Outlook newsletter, sayingthe staggering amount of debt in the United States has created a “credit supernova” that could crush the bond market as the global credit bubble “is running out of energy and time.”  Now, I don’t know exactly what that means but is sounds very dire, and somewhat astronomical.

Warren Buffett doesn’t like the idea of having a fixed allocation to bonds either. During a CNBC financial news network interview, Buffett said “It’s silly to have some ratio like 30%, 40%, or 50% in bonds. They’re terrible investments right now.”

Many advisers are quick to point out the protection bonds offer from a falling stock market. In general a fixed allocation to bonds will cushion the blow of falling equity prices. That happens sometimes, but not always. During the 1970s, higher inflation pushed bond prices down right along with stock prices. Both markets suffered together.

The biggest factor discouraging the use of bonds now is the fact that they will most likely lose money even if interest stay where they are. About a month ago a 5-year Treasury bond was yielding about 0.8%. However, the real return rate is closer to -1.2%. This is the return you get after inflation and before taxes on interest income. The after tax rate of return is even worse.

With bonds, we find ourselves in a situation where there is talk of a price bubble; diversification isn’t guaranteed and we’re sure to lose money. Finding someone who likes bonds today is like finding someone who likes throwing rocks at a hornet nest.  I don’t enjoy bee stings, and I’m certainly not enjoying the low rates on bonds.  Yet I do believe there is a good reason for most people to own bonds.


Bonds, with all their problems, provide an important portfolio function. They give protection against a certain type of risk — the worst type of risk — a risk than can permanently devastate a retirement account. A risk that is building every day as the stock market hits new highs. A risk that ultimately crushes many investors during steep stock market slides. OK enough suspense.

A bond allocation helps protect a portfolio from its owner.

Nothing causes investors to forget history faster than a bull market in stocks.  As stocks hit new highs and portfolio values rush to higher valuations, memories of bear markets float away like balloons at the county fair.

Investors become brave when markets are moving up and the bears have been trampled. How people felt during the past bear market is a distant memory. Some even start believing those four fatal words that eventually cause so much capital destruction in a portfolio: this time it’s different.

Perhaps it is different this time, but people aren’t different. If a person couldn’t stomach a high allocation to stocks during the October 2007 to March 2009 market meltdown, then they won’t be able to handle the next one.  It’s not different this time.

Holding too much in stock and selling when stocks are down is so much more costly than holding a lower allocation (and rebalancing) through a complete market cycle. It’s better to invest less and hold on than to invest more and panic sell.  This is why bonds belong in our portfolios.

Bill Gross may be right that bonds are in a bubble and Warren Buffett may be right that they’re a terrible short-term investment. I believe a bigger danger lurks for investors who follow short-term advice and shift their portfolios from bonds to a higher stock allocation.

Investing in bonds is a hedge against bad investment decisions. They may not earn a high return going forward and may even lose some in the next down market, but I believe the psychology of holding bonds will stop some people from doing the wrong thing at the wrong time. A portfolio with a fixed bond allocation helps reduce behavioral risk and leads to a higher probability for long-term success.

I’d rather throw rocks at a hornets nest than invest in a hedge fund.  At least my pain will be temporary.

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Medicare supplements versus Medicare Advantage plans

As efforts to improve the Medicare insurance system progress, it seems that the confusion only gets worse.  In any given city across the U.S. there are literately dozens of insurance companies offering a hundreds of different policies to supplement, or replace the original Medicare plan. For most seniors, reaching the age of sixty five means having to confront this monster and make decisions that will greatly influence your wealth, your health and your well being.  One of the decisions to be made is; “Do you need a Medicare supplement or a Medicare Advantage Plan?” Let’s take a look at some of the differences.

Medicare Supplements

Medicare Supplement policies are designed to cover the “gaps” in coverage left by original Medicare.  These gaps include deductibles, coinsurance, co pays and extended hospital stays to name just a few. Supplement policies are sold by dozens of companies across the country and prior to 1992 all had different coverage’s and premiums. In an effort to make decisions easier for seniors the federal government standardized Medicare supplement plans.  The standardization makes every Medicare supplement’s benefits the same regardless of which company you purchase from. For example, if two different insurance companies offered a Plan D, the benefits would be exactly the same. The only difference would be in the plan premiums and the level of customer service. The plans were labeled with sequential letters. As of June 2010 we have plans A through N. Not every plan is available in every state and plan M and N were just recently added. To add to the already confusing topic, plans E, H, I, and J will no longer be available to buy. If you already have Plan E, H, I, or J, you can keep that plan. What plan to choose depends on how much and what type of coverage is needed.

Medicare supplements work in conjunction with Medicare Parts A and B.  When a doctor or hospital submits a bill, Medicare will approve (some of it) and pay its part. After that, the supplement will pick up whatever portion of the bill it was designed to pick up. Next, the insured is responsible for the balance, if any.  A good supplement will pick up all of the deductibles and most, if not all, of the coinsurance or co-payments.

One problem with supplements, are the plans premiums. The premiums on a supplement can be expensive, especially for someone in good or near good health. Medicare beneficiaries in poor health or are regularly hospitalized can benefit greatly from supplements. However, paying those premiums may not be worth it for those seeing a doctor a few times a year or only carry the insurance in case they may need it. Plus, the premiums go up every year.

Medicare Supplement Pros:

  • There are no networks, Medicare Supplements are not HMO’s or PPOs If a doctor, hospital or medical facility accepts Medicare, they accept all Medicare Supplement Plans.
  • No need for a referral to see a doctor or specialist. The doctors generally don’t deal with the Medicare Supplement Company, they submit their claims to Medicare, Medicare pays their part, and then Medicare sends the balance to the Medicare Supplement Company to “Pay the Rest.”
  • Medicare Supplement Insurance pays “after” Medicare pays.
  • There are generally no co-pays when services are rendered.
  • With standardization (plans A through N) you can compare prices from one company to another and know you are comparing the same exact coverage. (Plan F with one company is identical to Plan F with every other company)
  • Other than the premiums, there are generally no additional out of pocket costs throughout the year
  • Medicare Supplement Policies are “Guaranteed Renewable”. As long as you continue to make the premium payments, you can never lose the coverage
  • If you move to another city or state, your Medicare Supplement policy moves with you.

Medicare Supplement Cons:

  • The average monthly Medicare Supplement policy premium is around $150.00.  Some Medicare Supplement companies offer BIG discounts for things such as No tobacco use, married, spousal discounts, female discounts and others. If you work through an independent broker, he/she will likely be able to help you locate a Medicare Supplement that does offer these types of discounts.
  • Even if you never visit a doctor or hospital during the year, you still pay the monthly premium.
  • Medicare Supplement policies usually do not include Prescription coverage. You need to get a separate Medicare Part-D plan to cover your prescriptions.


Medicare Advantage Plans

Medicare Advantage Plans are a result of the government outsourcing Medicare duties such as administration, claims processing etc. to private insurance companies. What actually happens here is that Medicare contracts with private insurance companies and pays them a “subsidy” to take care of people in a specific geographic area. Let us say For example, that it costs Medicare $100 per senior to administer Medicare in Jackson County in Missouri. Medicare contracts with a private insurance company and says it will pay the company $75 per senior in Jackson County to administer Medicare and pay all claims coming from those qualified for Medicare. The insurance company must provide everything Medicare covers plus extra benefits. Everybody wins here. Medicare saves money, the insurance company receives more clients and the policy holder pays less for more benefits.

Medicare Advantage plans pay “INTEAD” of Medicare.  A Medicare Advantage Plan provides Medicare-covered benefits for relatively low premiums and Medicare pays them to provide Medicare-covered benefits. In other words, Medicare Advantage Plans work in place of Medicare. Types of Medicare Advantage Plans include Health Maintenance Organizations (HMOs), Preferred Provider Organization (PPOs), and Private Fee-for- Service Plan (PFFS). Deductibles, co-pays, and additional premiums may be required for certain services and not all doctors are covered as “in network.” You typically choose your doctor from a network.


Medicare Advantage Pros:

  • Low monthly premiums (Average is about $50/month) some as low as $0.00
  • They can be offered with No Monthly Premium to you, because Medicare takes your $96.40 monthly Medicare Part B premium and gives it to the Medicare Advantage Provider. Medicare also pays Medicare Advantage companies additional funds to help cover your Medicare expenses (the money that was deducted from your pay check throughout your working career).
  • If you don’t go to the doctor much, then a Medicare Advantage plan could save you more money over the course of a year than a Medicare Supplement, since the monthly premiums are generally much lower.
  • Some Medicare Advantage plans include prescription coverage. These are called MAPD plans.
  • Some include additional benefits such as coverage for dental (routine cleanings) and vision (routine checkup) health club memberships.

Medicare Advantage Cons:

  • They are NOT standardized. There are hundreds of different varieties of MA plans. Consumers really need to read the fine print to make sure they know what they are getting.
  • MA plans are NOT guaranteed renewable. The company can discontinue the plan at the end of any year. You would then need to get another plan.
  • Even if they accept Medicare, doctors do not have to accept MA plans.
  • Your primary care physician may accept the plan but a specialist that you are referred to may not.
  • Most MA plans have co-pays for almost every visit to a doctor or hospital. For example many will have something like: $20 for doctor visit. $35 for specialist, $250/day for first 5 days of hospital stay.
  • There is generally more paperwork for the consumer. Many co-pays are a percentage of the Medicare approved amount, which is not known until after the bill has been submitted to the Medicare Advantage provider, so you will be billed for your co-pay at a later date, sometime several months later.
  • If you move to another county or state, the plan you have may not be available in that area and you will need to get another plan.
  • If you have a particularly unhealthy year, out of pocket costs could reach your “Out of Pocket Maximum” which could be $4,000-$5,000 or more.

To get more help on deciding on the various options available to you visit . There you will find tools and resources to help with the decision and tame the monster. I especially found the “Medicare & You 2010 handbook” very useful.

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Stock market crises are normal – don’t panic

Once again we find ourselves faced with extreme market turmoil; the Dow Jones Industrial average dropped 12 percent in the last week-and-a-half, including 513 points on Thursday alone. This is not unusual, crises happen more frequently than most of us care to remember. In other words this is normal market behavior.  You could refer to this type of market movement as a “fat tail” event meaning the market experiences far more large gains and large losses than would be expected under a normal distribution curve.

These fat tail events and the frequency of this market turbulence, is the reason behind the markets high return also known as the “equity risk premium” (the return investors demand in compensation for taking the risk).  Turbulent markets are when you earn the greatest returns (for taking risk when others are no longer will to do so); it’s just that you don’t know it at the time.  As a recent reminder, from May 2010 to July 2010, the S&P 500 Index fell almost 15 percent. By the end of the following April, it had risen more than 33 percent. In other words, the key to success is to have a plan that anticipates bear markets and then have the discipline to stay with the plan.

Your portfolio has been designed with market turbulence in mind. The following are some of the “built–in” protections we all have in our portfolios.

1) Liquidity since this crisis is financially driven, there’s the potential for markets to once again “seize up” as they did during the Lehman crisis. Hopefully this will not happen, but if it does, we have cash available and short term Government bonds available to draw upon if necessary. For those of you drawing from your portfolio for retirement income, Cash/Short term bonds are available to cover your expenses for the next five years – no worries.

2) Quality Fixed Income  When markets experience this type of turbulence,  all risky asset classes tend to move in the same direction, (the correlations will rise to one) so it is very important that we have high quality fixed income assets, enough to dampen the portfolio’s risk to an acceptable level. This is why we do not use junk bonds (high yield bonds) or low quality bonds in our portfolios.

3) Asset Allocation No one knows when, if, or even how this crisis will be resolved, therefore you should review your investment plan to determine if you’re taking more risk than you have the ability, willingness or need to take. Taking too much risk leads to not staying with the plan and experiencing permanent losses. Getting the risk right, is always the hardest part of investing and the most important.  If you have questions about this or are feeling especially nervous about staying with your current allocation, please give me a call, we’ll work it out.

There’s a tremendous amount of uncertainty in the markets as well as the world. Making sure your portfolio is appropriately tailored to address these concerns is your best safeguard. We are as well prepared as we can be for exactly this type of “fat tail” event.  I look forward to buying cheap stocks at some point, to rebalance our portfolios.

I realize that just believing in something doesn’t make it true, but I believe:

  • Capitalism will survive. Talk of the end of the US is silly.
  • Investors in general will do the wrong thing. Even those that claimed they learned a lesson in 2008 and 2009, may not be as brave as they thought they were two weeks ago.
  • Volatility is good. Sure, it hurts, but it also allows for more rebalancing by buying low and selling high to those investors following their human instincts, and not a well thought out plan.
  • There truly is opportunity in every crisis, although it may be difficult to find.

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The Effects of Government Intervention on your Portfolio And how our portfolios prepared for it.

In the United States we have capital markets that operate more or less freely. The two exceptions to complete free market operation are regulation and intervention, the former being necessary in some measure and the latter being superfluous. Regulation is necessary for the simple reason that human beings can’t be trusted to act in the common good with regard to money. We can debate this ad infinitum but facts are facts and some regulation is necessary to ensure equality in access to capital markets and to prevent certain market participants from taking unfair advantage due to their size or their political influence.

It is my belief, that once a proper regulatory system is in place and working, any further government intervention will not only be wasteful and expensive, but will in fact do more harm than good. Large-scale interventions such as we have seen recently with the financial sector bailout have resulted in massive increases in public debt without a corresponding benefit to the public responsible for paying it back. Quite to the contrary, government intervention in almost all cases has benefited specific players, in effect circumventing the very regulation intended to prevent this possibility. The bottom line is that intervention has worked for the benefit of those with money and influence at the expense of those without. This is clearly a situation that must not be allowed to continue.

All is not lost however for those who pay attention to the free market’s reactions to intervention and the ultimate consequences. No matter how much some want to believe that the government can save us from ourselves, ultimately the free market will regain control. While governments are intervening, markets tend to use the excess capital provided by taxpayers to (1) generate profits in excess of normal for those sectors targeted by the intervention (think financial sector), and (2) push excess capital into the formation of new bubbles. What the government is trying to do in effect is maintain the status quo in the standard of living by replacing private capital formation with government capital (funded by taxpayer debt).

The expectation is that ultimately business activity (private capital formation) will resume at some point and excess tax revenues will allow for the repayment of the taxpayer debt. It all sounds plausible in theory but we are faced with one large looming problem that is going to bite us in the derriere. The original standard of living, which the government intervention is intended to maintain, was artificially inflated because of past Government interventions. Much of the GDP growth from the period of 2000 to 2008 was inflated by leveraging the mortgage and housing market. This was coupled with a perversion of the financial sector where ‘profits’ were being created out of thin air without ever producing anything but paper backed by paper, backed by inflated asset values. So the intervention has focused on maintaining a phantom standard of living that was never actually supported by real economic fundamentals.

Now that we have seen the crux of the problem, let’s take a look at how free markets have reacted so far. With the massive government intervention thrown into the capital markets, we have seen (1) a string of record profits by the financial sector (with corresponding bonus checks for the great job they’ve done), and (2) inflation of certain asset values (with the effect of allowing specific players preferential capital market access). There is of course no free lunches, much of the benefits accorded the financial sector have come at the expense of others. When the Federal Reserve continues to keep interest rates near zero %, banks who can borrow at these preferential rates buy 10 year treasury notes, effectively loaning the money back to us at 3.5 % or higher. The “savers” who rely on returns from lifetime savings to maintain their existence, suffer with rates near zero. The longer rates stay low, the more suffering for those who are disciplined at saving. The banks also begin to devise schemes to profit from low rates instead of acting like banks and stimulating the economy (which is the reason they are provided preferential borrowing rates in the first place).

These schemes will no doubt hurt all of us in the longer term, either by causing more problems in the financial system when rates rise or alternatively continue to hurt the ‘disciplined savers” of society (and by proxy all of us) if rates stay low. Those least able to take risk are being put in an untenable position; A recipe for trouble in America all over again.  The message is clear: as long as you can afford to lobby Washington, you’ll be OK, if not, too bad.

The magnitude of the bubble we have just experienced both in terms of capital (money) and time tells me that some reversion to the longer-term mean is in order. While government intervention can indeed modify free market behavior in the short term, there has been no historical evidence that longer-term market dynamics can be suppressed. What that means is that the process of asset devaluation, which began in 2007, will at some point continue. The massive government intervention will most likely have hurt rather than helped the average citizen and the ramifications of that may lead to social discontent once the realization sets in about how using taxpayer funds did not bring better opportunity for most. The only way out of this terrible boom and bust cycle is to allow the free markets to work.

Asset devaluation is a natural part of market behavior and while no one wants to see their assets lose value, you either have free markets or not, there is no middle ground. We constantly rail against China for manipulating its currency and urge them to adopt free market reforms, perhaps we should start following our own advice. Here is what I would hope to see in order to help us get back to equilibrium.

1. Raise interest rates slowly and steadily. It should be apparent at this point to almost everyone that             letting the banks earn record profits does not do a thing for the average American citizen.

2. Stop trying to convince people that their homes will always appreciate and never lose money. The             sooner we get people used to the idea of lower asset values the better we can deal with the crisis to             come.

3. Consider that historically a nation’s currency has been used to‘re-balance’ their place     in global             finance. We must match our true economic output and potential with dollar valuation. If that        means adjusting our currency to reflect our current situation, we need to take our medicine like    everyone else has in the past. Why are we different than any other nation that bit off more   than they could chew?

4. We must acknowledge that our standard of living has been propped up without a firm foundation        and cannot be sustained with current economic prospects. Stop borrowing to try and maintain the       status quo. It will not work and will cost us more in the long run. This is critical to future recovery.

Once the intervention fails the stock market will attempt to adjust asset valuations to match economic realities. That means either a long period of malaise with little forward progress or a shorter but deep corrective action.  I believe we will see the former if the Fed starts to raise rates to a more normal level soon and the latter if rates stay low for too much longer. I’m not sure which dose of medicine is best at this point but we can prepare for both.  In either case when the banks start loaning again, and all the money created starts to circulate, we could also see a period of high inflation.


How you are protected from declining stock values.

For those of you that are retired or very close to retirement, you have five years worth of living expenses in cash and short term bonds. A decline in the stock market will have no effect on the next five years of your life. If we do not see a recovery within five years, you have another three to six years worth of income in intermediate term bonds.

An investment in equities (stocks) always carries the risk of a decline in value.  For this reason any money that you plan on spending within the next five years is not invested in the stock market.  This five year time line gives us the opportunity to buy stocks when others are selling and prices are low, it also gives the markets time to recover, so we don’t have to sell stocks to raise cash for living expenses.

Younger savers have protection of a different sort, your allocation to stocks.  No one working with me has 100% of their portfolio invested in the stock market, that would not be smart investing and we are smart investors.  Your allocation to stocks was determined by your willingness, and ability to take risk. When markets decline we take advantage of the fact that stocks are “on sale”, we sell cash reserves and short term bond positions and buy cheap stocks.  Over the long run, we buy low and selling high.  As you near retirement your allocation to stocks will decrease as you no longer have the need, willingness or ability to take as much risk.


Before we look at investment strategies, let’s review the underlying causes of inflation today.

The monetization of debt refers to using inflation (which reduces the value of each dollar) to pay off the national debt. Paying off the debt with somewhat worthless dollars can be politically expedient. That said inflation leads to many problems for investors holding investments in cash or investments denominated in dollars.

Growth in the money supply is a function of the multiplier effect, which picks up as banks begin to lend money. Right now bankers will tell you that low interest rates do not allow enough profit to justify the risk of loans. But artificially low interest rates will end, as the federal government needs to sell ever more Treasury bonds to fund deficit spending. They’ll need to increase interest rates on those Treasury bonds to make them attractive enough to sell. Higher interest rates will accelerate the multiplier effect as banks again find the risk/return relationship satisfactory to allow them to initiate more loans. More bank loans increases what is called money velocity. With the large numbers of dollars already in circulation, increased velocity will cause the money supply to grow rapidly. It is politically impossible for the new money to be somehow withdrawn from the economy before it causes inflation. Doing so would put us back into another recession. As inflation takes hold, the dollar will be devalued relative to other currencies. The higher cost of imports will add to the inflation we are likely to see in earnest soon.

How your portfolio is protected from inflation

1. Inflation-protected bonds: These provide investors with income and some protection against inflation. Every six month an inflation adjustment is added to the principal. Our investment in this area is the SPDR Barclays Capital TIPS Ticker symbol TIP.

2. Non-dollar denominated bonds: Owning bonds denominated in currencies other than the dollar offers a hedge against declines in the value of the dollar. They can provide income and also add diversification. This can be a good hedge on the premise that U.S. inflation causes a devaluation of the dollar. Our investment here is SPDR Barclays International Treasury Bond Index ETF Ticker symbol BWX.

There are many other investments considered a hedge against inflation. No doubt you’ve heard pundits pushing gold or commodities. My problem with most conventional inflation protection investments is that they are too expensive and way too volatile.

We are well prepared for the uncertain future ahead.  The most important lesson history teaches is to stay the course, follow a plan, and re-balance when given the opportunity.  As always if you have questions or concerns please let me know.

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Should current events affect investment decisions?

We currently have many threats or risks in the global economy; the terrorist threat, massive budget deficits, high unemployment, the nuclear threats now presented by Iran and North Korea, and the potential default of Greece and Portugal. There is a lot of uncertainty out there.  So let me pose a question to you: Where do you think stock prices would be if those risks were not present?  I’m going to wager a guess, you’re thinking – higher.  Good answer and I agree.

First, I’ll agree that there’s a heightened risk. Regarding your investments, the important question is: Are we the only ones who know that? Do you believe that the institutional investors who do most of the trading, and therefore set prices, are also aware of these risks? I’m guessing again that you’re saying “of course they know.”

In other words, if you know something, then it seems likely that the market also knows. Therefore, the information has already been incorporated into prices. And it’s too late to act on that information. The only reason to act would be if you believed your crystal ball was clearer than the market’s crystal ball. Unfortunately, as much as we would like to believe otherwise, there’s no evidence that there are forecasters (be they political or economic) who persistently get it right. And that’s why, while we recognize the existence of those risks; we also accept them in return for the opportunity to earn the equity risk premium.

The most sophisticated investors know that the losing strategy is to focus on managing returns, because it can’t be done without a clear crystal ball.  The winning strategy is to focus on the things we actually can control: the amount of risk we take, the asset allocation decision, diversifying the risks we choose to accept as much as possible, eliminating or minimizing unsystematic risks, costs and tax efficiency. And once we have a written investment plan, the winner’s game is to adhere to that plan, ignoring the noise of the market and as much as possible, the emotions caused by that noise.

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Why “FIDUCIARY” is important to you

A fiduciary is required by law to act in his or her client’s best interest at all times.  What you may not know is that the vast majority of those who call themselves “financial advisers” or “financial planners” are not actually subject to a fiduciary obligation.

Under current rules, advisers who are compensated by commissions on the sale of financial products are subject to a lesser standard known as the “suitability rule.”  This regulatory hurdle requires only that the product sold be appropriate for the client (in other words, not too risky) at the time of sale.  In fact, these “advisers” can now sell you products that pay them bigger commissions, without advising you that there might be a far better (and cheaper) alternative for you – it just wouldn’t be as good for them. Moreover, this suitability obligation ends once the transaction is completed.

Registered Investment Adviser’s that have either registered with the SEC or the state in which they do business do have a legal fiduciary duty to their clients.

One of the most important questions you can ask of anyone offering you financial advice is, “Do you have a legal obligation to act in my best interests?”

It is the bright white line that separates those who sit on your side of the table and have a legal obligation to act in your best interests and those who sit on the other side of the table and have no such obligation.

Steven Young Financial Planning firmly embraces our role as a fiduciary for you.  This is not just a regulatory requirement imposed by law; it is part of our culture. Operating as a fee-only firm to fulfill this role eliminates the conflicts of interest that may arise when advice is delivered through commissioned product sales.

To help educate consumers about the importance of the fiduciary relationship between adviser and client, the National Association of Personal Financial Advisors (NAPFA) hosts a website, providing information about the need for a fiduciary standard in the financial services industry as well as a checklist consumers should use in evaluating their own adviser. You will find a wealth of information at

If your friends and family are not working with a fiduciary adviser, please share this information with them.

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