Investing for Beginners – Step 5 (Matriculation)

Last week we addressed investors’ expectations, reasonable and otherwise, and the potential to affect long-term success and happiness. Today, we move ahead to “adulting” your money. This step begins once the groundwork has been laid and accomplished in your investment portfolio. Typically, this stage comes when the investable assets are north of $100,000 by a comfortable margin.

At that time, most investors would benefit from establishing a relationship with a fee-only, fiduciary, Certified Financial Planner® (CFP® ), organized and operating as a Registered Investment Advisor (RIA). Many RIAs have minimum account sizes, but most will accommodate at no cost an investor who requests a meeting to discuss his or her situation. Some planners will take on smaller accounts held by serious, dedicated savers and investors. There are also planners who work on an hourly basis.

Expect a visit with a CFP® to include a comprehensive overview of your own situation, as well as an education regarding investment risk and return. Today’s financial software is very advanced, measuring your personal risk profile, your long-term goals, and planning portfolio design and construction to best fill your expectations. We suggest meeting with at least three fee-only planners or planning firms before making a decision. A long-term relationship is based on trust and respect, which must exist on both sides.

As a direct result of an initial meeting (Van Wie Financial refers to our initial discussion as the “Suitability Meeting”), further diversification should be justified and implemented. As we explained earlier, there are seven fundamental Asset Classes, and the goal should be to select assets from as many of those classes as needed to satisfy expected risk and return goals. This is integral to a comprehensive personal financial plan.

No longer is a financial plan in the form of a written document with pretty pictures, graphs, and charts, nicely bound in a three-ring binder and placed in a drawer in the den. Instead, modern software is online, accessible, and flexible enough to accommodate a changing life, changing markets, and a changing world.

Many recent studies have shown that a relationship with a fee-only CFP® produces investment results well in excess of the fees paid to that planner or firm. Don’t limit your own future by shying away from paying a professional advisor. Fees are normally deducted from the investment account, and do not require the client to write periodic checks out-of-pocket.

Van Wie Financial is fee-only. For a reason.

Last week we addressed investors who have accumulated sufficient assets to have diversified into positions in Bonds and Foreign Stocks. No longer should these investors be considered novices, but they are far from experienced. As their accounts grow, more diversification can further spread their risk, as well as improving their chances of long-term success.

Today, we are examining expectations among investors. This may be the most controversial subject we have discussed to date. Many an investor is unhappy today because of his or her unreasonable expectations. Having an understanding of long-term investment returns and principles may save a lot of future headaches.

Things you need to understand include:

• You will not “beat the market,” so don’t try (more on this below).
• Individual stocks are very risky. Good things happen to bad companies, and bad things happen to good companies. Spread the individual stock risk through diversification.
• Annuities are not investments, but rather transfer-of-risk products. This does not mean that they are useless by any means. They solve certain problems for certain people, but are historically over-sold.
• Commissioned salespeople are not required by law to place your interests ahead of their own. Fiduciaries (such as Van Wie Financial) are required to place your interests first.
• The market always over-reacts to events, so don’t be a lemming and blindly follow. Greed and fear, when acted upon, cause investors a great deal of pain.
• Losses feel worse than gains feel good, so minimize losses for long-term success.
• Make a plan before you invest. A “starter” plan can be simple, but it must remain flexible to accommodate growth and changing personal situations over time. A Financial Plan is not a document; it is a process.

“Beating the market” implies that your personal returns would be higher that the major market indices, which are comprised only of Domestic Stocks. You may outperform common market indices over a short time period, but don’t count on doing that for too long. A reasonable goal for investors involves understanding and accepting both a targeted return, and corresponding risk, over a long time period.

The Dow-Jones Industrial Average represents only 30 very large companies. The S&P500 Index contains 500 large company stocks, and the NASDAQ Composite contains a motley assortment of over 2500 company stocks. They sample only the first of our seven Asset Classes, Domestic Stocks. True diversification into several asset classes renders irrelevant any direct comparison between stock indices and an investor’s portfolio.

Nest week we will discuss the necessary relationship between risk and return in various portfolios.

Van Wie Financial is fee-only. For a reason.

For the past couple of weeks, we have chronicled the steps that new investors should take to begin investing for the long term. Review those Blogs if you are catching up and interested in one of the most important aspects of “adulting” – preparing for personal long-term financial independence. Today we further explain the reasoning behind our recommendations in the last two Blog entries.

Last week we addressed investors who have accumulated between $50k and $100k in long-term investment assets. While technically no longer ranked novices, these people are unlikely to have a good understanding of the fundamental goals of portfolio diversification. In a previous Blog, we addressed the “why” aspect, so today we will begin explaining the “how.”

As we noted last week, the investing universe is comprised of 7 fundamental classes of assets; Domestic Stocks, Domestic Bonds, Foreign Stocks, Foreign Bonds, Cash (and Equivalents), Real Estate, and Hedges. Most are self-explanatory, and we will deal with hedges in a future Blog.

“How” to include more Asset Classes in a portfolio requires an understanding of some basic mathematical principles. In this case, the term in the spotlight is “correlation.” When two variables move together, they are called “correlated.” The closer movements are to each other over time, the higher the correlation. When two variables move in opposite directions, they are called “inversely (or negatively) correlated.” The “correlation coefficient” scale runs from -1.0 to +1.0. A diversified portfolio seeks to achieve a correlation coefficient that is low, or even negative.

As markets move, a low correlation means that as some items go down in value, the portfolio does not go down as much, if at all, because other assets may rise. Over time, multiple Asset Class portfolios will generally experience smaller losses then a 100% stock portfolio. When resultant declines are lower, and the recovery period shortened. Regaining lost ground quickly is the essence of long-term successful investing success.

The novice investor who has accumulated shares in a broad market Exchange-Traded Fund (ETF – see last week’s Blog for explanation) is participating only in the first Asset Class, Domestic Stocks. Somewhere between account values reaching $50,000 and $100,000, it is time to add at least one other Asset Class. As discussed last week, this is generally done by introducing bonds in the portfolio.

We also mentioned that our current interest rate environment is not conducive to holding a large percentage of bonds. Therefore, to enhance diversification, we must choose yet another Asset class. Right now, we are interested in Foreign Stocks. Again, we are not suggesting placing a large percentage of Foreign Stocks in a portfolio; about 10% is enough to influence results.

In the Foreign Stock Asset Class, we often use actively managed mutual funds, as fund managers have more time and expertise to make their stock selections. When contemplating any mutual fund, be sure to do some research. Begin by only looking only for “no-load” funds, meaning there is no sales charge to buy or sell shares. Look at the track record of the managers, the reputation of the affiliated company, and the internal costs of the fund itself. There is much to learn, but learning and adhering to the fundamentals will improve your chances of success.

Van Wie Financial is fee-only. For a reason.

Last week we chronicled the steps that a first-time investor should take in order to “dip a toe in the market.” We explained that Van Wie Financial has 2 goals – protecting novice investors from unscrupulous brokers and insurance salespeople, and maximizing beginners’ probabilities for long-term success. A quick review of that Blog will highlight the fundamentals, including creation of an Emergency Fund, and selecting a custodian for your money.

Today we address novice investors who have accumulated substantial funds in their investment accounts. For these people, it is time to begin the process of diversifying holdings. While there is no absolute threshold for beginning to diversify, having about $50,000 of investments should trigger the planning process, with implementation at or before the $100,000 threshold.

Diversification for diversification’s sake is not convincing, so it seems important to explain when, why, and how it should take place. In a previous Blog, we addressed the “when” aspect, so today we will address the “why.” The investing universe is comprised of 7 fundamental classes of assets; Domestic Stocks, Domestic Bonds, Foreign Stocks, Foreign Bonds, Cash and Equivalents, Real Estate, and Hedges. Most are self-explanatory, and we will deal with hedges in a future Blog.

The novice investor who has accumulated shares in a broad market Exchange-Traded Fund (ETF – see last week’s Blog for explanation) is participating only in the first Asset Class, Domestic Stocks. Somewhere between account values reaching $50,000 and $100,000, it is time to add at least one other Asset Class. This is generally done by introducing Domestic Bonds. Again, we look to mutual funds and Exchange-Traded Funds to simplify our diversification goal.

The world of Domestic Bonds is very complex, and includes (among others) Corporate Bonds, Government Bonds, High-Yield (“Junk”) Bonds, Municipal Bonds, and a host of others. Equities are owned until sold, whereas bonds are owned until maturity or until sold, whichever comes first. Most bond types are issued in differing maturities, which means the amount of time until the issuer buys them back varies from issue to issue.

Complexity in both stock and bond markets is the reason we advise novice investors to buy funds that are created and maintained by experts. There are not enough hours available in any given day for a novice to become a successful “do-it-yourself” bond investor.

Returning to portfolio diversification, the easiest way to add bonds to an existing portfolio is to allocate a portion of future purchases to a Bond Fund of the investor’s choice. While Van Wie Financial does not recommend any particular Bond Funds, we would limit Bond Fund purchases to perhaps 10% for the time being.

In coming weeks, we will be getting into the why and how of diversifying into not just Bond Funds, but other Asset Classes as well. For now (given the low interest rate environment), we suggest keeping your Bond Funds short-term, and minimal in percentage of overall assets.

Van Wie Financial is fee-only. For a reason.

Welcome to the complex and exciting world of investing. The purpose of this introduction is to provide a “how-to” for (mostly young) people who have never invested in the stock and bond markets. Van Wie Financial has 2 goals – protecting novice investors from unscrupulous brokers and insurance salespeople, and maximizing beginners’ probabilities for long-term success. After all, the goal of investors is to achieve long-term Financial Independence.

Creating simplicity from the complex is never easy, nor could it ever be complete. However, our “getting started” outline should give the novice a framework for laying the cornerstone of a lifetime plan. Let’s get started, from absolute scratch.

• Start saving and investing young; start today if possible.
• The first step is to accumulate a “Rainy Day Fund” of at least $5,000 for people ages 30 and under, and $10,000 for those over 30, in a credit union or bank.
• Once that has been accomplished, open an investment account.
• Investment account types include Traditional IRA, Roth IRA, 401(k), 403(b), Brokerage Account, and a few others.
• The account type is completely independent of what assets are held in the account.
• The type of account you need depends on your particular situation, but if you are earning under about $75k annually, most likely a Roth IRA will best serve your short-term and long-term needs.
• Your account requires a custodian, which is a large, well-known financial powerhouse, such as Schwab, TD Ameritrade, e*Trade, Fidelity, etc., with a website of their own.
• Obtain a User ID from your custodian, and set up your password for anytime, anywhere access to see your balance and activity (this should all be free).
• Fund the account with whatever cash you have available, then add to it as you can, leaving your “Rainy Day Fund” intact.
• We suggest buying one of many Exchange-Traded Funds (ETFs) that mimic the entire domestic stock market, including SPTM, IWV, SCHB, or others.
• Buy as many ETF shares as you can with the funds you deposit over time.
• Repeat until rich. (OK, it isn’t quite that easy, so next week we’ll get into more complexity for accounts that have been growing.)

Note the term ETF, or Exchange-Traded Fund, above. These investments trade like individual stocks, except that each ETF purchase contains fractional shares of many different stocks or other securities for diversification, much like mutual funds. For comprehensive definitions and explanations of all financial terms, we suggest Investopedia.com.

Van Wie Financial is fee-only. For a reason.

The U.S. Government realized many decades ago that too many Americans were not properly preparing for a financial future in retirement. Social Security was never intended to be the source of all retirement income. The traditional Pension Plan was neither universal nor financially secure due to underfunding. One of the surest signs that Washington, D.C. recognized impending problems was passage of the Employee Retirement Income Security Act of 1974 (ERISA). ERISA recognized and started correcting funding problems in the nation’s Pension Plans. That was followed in the early 1980s by a dramatic reform of Social Security.

In a Revenue Act passed in 1978, Section 401(k) was introduced into the U.S. Tax Code. Section 401(k) did not create a new type of Retirement Plan, but rather modified the already-existing Profit-Sharing Plan. Originally, Profit-Sharing Plans, which are defined contribution plans, only allowed employers to contribute a portion of profits into individual accounts for their employees. The addition of Section 401(k) allowed employees to defer part of their own salaries to that same account.

A steady transition to 401(k) Plans ensued nationwide, some by replacing traditional Pension Plans, and others by adopting the new employee salary deferral language into existing Profit-Sharing Plans. The rest, as they say, is history. 401(k) Plan growth has been rampant. In recent decades, many Americans have responsibly provided for themselves, and will not become a burden on society.

Guided by self-proclaimed Democratic Socialist, Bernie Sanders, Biden recently published the Biden-Sanders Unity Task Force Recommendations, which is a policy statement for the Democrat Party in the 2020 Presidential election. Biden’s retirement plan recommendations include (a) reducing pre-tax contributions to the lesser of $20,000 or 20% of pay, and/or (b) expanding the current Saver’s Credit to relatively lower earners ($19,500 for singles, and $39,999 for couples).

Overall, Biden’s Tax Plan, which allows smaller deductible retirement plan contributions as a main component, will further tax Americans between $3.5 Billion and $4 Billion over 10 years. Most of this new revenue will come from higher-earning Americans and Corporations. Taxing corporations and wealthy people does not create jobs, and in fact, has an opposite effect.

Lowering deductible contribution limits, or even decreasing tax savings from current limits, could never enhance the stated government role of helping Americans provide for their own futures. Biden claims that his proposal will reduce “income inequality” for Americans. We disagree.

Van Wie Financial is fee-only. For a reason.

The Monday Morning Quarterback: This type of investor is very good at pointing out how he should have been invested over the last year or quarter. He will look at returns for different asset classes or stocks over that time period, pick the best performing one, and then question why he wasn’t invested 100% in that. This type of investor will never be happy with their portfolio performance and will never be happy with a financial advisor.

The Nervous Nelly: This type of investor is always worried that the market is overvalued when it is doing well and will never bounce back when the market is doing poorly. There are no market conditions that look good to the Nervous Nelly, and any drop in the market, no matter how small, will warrant a call to their financial advisor. Sometimes, even a drop in the futures market, which they have decided to check at 5:00 AM, will warrant a call to their advisor. This type of investor is typically better off in an annuity or in bonds and CDs when yields are high enough to buy those products.

The Know It All: The know it all hires a financial advisor simply run ideas by the advisor that they are sure are correct. They do not want advice, and they certainly do not want you to manage their money, they just want you to bless their (usually poor) decisions that they have already made. The Know It All not only makes bad choices for themselves, but with the approval of an advisor they feel confident doing so. When it does not work out in their favor, lawsuits can result. Avoid the Know It All as a client at all costs.

The Return-Chaser: This type of investor always wants to re-balance their portfolio, but in reverse. They would gladly sell all asset classes that have underperformed over the quarter and buy everything that did well. Many individual investors fall in this category. In the short-term, this type of investor can perform very well. In the long-term, this type of investor will end up under-diversified and under-performing a balanced portfolio.

The Newsletter Subscriber: This type of investors pays money to follow a guru of some kind, or many gurus in some cases. Because they have shelled out $12.99 per month, they are obligated to follow all investment advice from said guru, no matter how sound the logic or reason is behind the advice. Meanwhile, their financial advisor, who they are paying more than $12.99 per month, takes a back seat to said newsletter.

The Unicorn: These are my favorite type of investors because they have never gotten a trade wrong, they have never made a mistake, and they were getting along just fine without you or anyone else helping them. They bought Amazon, Facebook, and Google at the IPO and never sold, and they shorted tech stocks in 2001. Their account has crushed the S&P every year for 30 years. And yet here they are sitting in your office, looking for a financial advisor. I wonder why.

Elections have financial consequences is a variation on a theme we have heard many times in recent political rhetoric. Presidential election cycles generally present clear choices, and 2020 is certainly no exception. As individuals, which side we support depends on our own economic circumstances and political persuasions. While sometimes the choices may seem a bit cloudy, this year the contrast is startlingly clear.

While Biden’s individual and corporate tax plan is out in some detail, Trump’s overall plan contains only generalities so far. Yet, a clear choice is presented, due to the fundamental approach taken by the two proposals. The former plan increases taxes on people and corporations, and the latter reduces taxes for nearly everyone. Take a preliminary look at the differences.

For decades, taxing corporations has been indoctrinated into Americans’ minds, and codified into the U.S. Tax Code. Some of us believe that no corporation ever pays taxes, because their customers actually pay the tax through increased costs of products and/or services. That said, the current political argument is about higher or lower corporate taxes. Will higher rates cause corporations to move more jobs overseas, or will higher rates generate more government revenue at home? Biden favors higher rates for corporations and for some people; Trump stands for lower tax rates for corporations and for most people.

Biden’s proposal calls for raising individual rates on everyone making over $400,000 annually, “coincidently” the salary of the President. Trump wants lower rates for middle class earners, and possibly for those in the higher brackets as well. Hidden in Biden’s Plan is a provision from the Tax Cuts and Jobs Act of 2017 (TCJA). Under TCJA, current individual rates expire after 2025, after which personal tax rates will rise. Trump would freeze today’s individual rates past 2025, just as the corporate tax rates were made permanent in TCJA.

Also included in the Biden Plan are increases in the Payroll Tax and Capital Gains Tax for high earners, a reduction of the tax benefit from itemizing deductions, and a large increase in Corporate Tax rates. “Take-home pay” is estimated to decline for all income levels.

Biden’s plan is estimated to cost taxpayers $3.4 Trillion (12 zeros) over 10 years. This money would have to come out of the pockets of Americans and corporations. It is estimated to lower the Gross Domestic Product (GDP) of the country 0.4% by 2030, which is too far in the future to be accurate. Strangely, it is estimated to increase the GDP by 0.8% in 2050. Forecasting over ridiculous time periods is absurd, and appears to be 100% political. Most of us would like to know what the economic impact of either proposal would be in the short run, more than anything that may happen in decades.

An old adage says that, “figures lie, and liars figure.” In Washington, D.C., economic impact plans utilize static “scoring” (cost estimating) to project the costs and benefits of economic proposals. Unfortunately, the real world reacts in a dynamic fashion, meaning that people react differently to changes in their financial environment. This renders static scoring essentially useless. We prefer to look at past results, which are as illuminating as they are routinely ignored by politicians.

President John F. Kennedy knew that cutting tax rates would increase tax revenue, because economic activity increases dynamically. When Congress went along with his proposed tax cuts, Kennedy reiterated that, “lowering taxes was the surest path to full employment and lower deficits.” Kennedy was correct, and it worked every time it was tried.

I am willing to re-test that theory in 2021.

Van Wie Financial is fee-only. For a reason.

Last week we discussed misconceptions regarding funding the Social Security System. This week we shift to Medicare, where even more financial misconceptions may be found. Being the political season, some Presidential hopefuls are consistently misleading potential voters by making impossible promises. Among the most egregious is, “free healthcare for all,” which is touted in various boastful campaign promises. Others specify, “Medicare for everyone,” without mentioning the individual and/or public costs involved.

In order to understand the financial irresponsibility of providing Medicare for all, we must understand what Medicare currently costs, both to the enrollee and to the government. Most current enrollees do not have a clear picture of what they are paying personally for basic Medicare coverage. Even fewer understand the total annual cost to government. Total Medicare costs were $750.2 Billion (9 zeros) in 2018 alone. Here is the breakdown of funding sources for Medicare:

• Payroll Taxes – 36% ($270.1 Billion, 9 zeros)
• Federal Government General Fund – 43% ($322.6 Billion, 9 zeros)
• Medicare Premiums – 15% ($112.5 Billion, 9 zeros)
• State and Local Government, plus Taxes on Medicare Benefits – 6% ($45 Billion, 9 zeros)

In that same year, 17.8% of Americans were enrolled in Medicare. Covering everyone would therefore cost about 5.6 times more, or $4.2 Trillion (12 zeros). Extending “free” Medicare coverage to people who have not yet qualified for enrollment would raise spending numbers beyond imagination. Medicare costs are estimated to increase at an annual rate of 7.4% for the next 10 years, assuming we continue to cover only qualified participants.

Every current Medicare enrollee pays monthly premiums, but most have never stopped to figure exactly how much they pay. This is largely because monthly premiums are blindly deducted from their Social Security benefit payments. Does this mean that everyone who is proposed to be added to Medicare prior to becoming age-qualified will get a bill for their monthly premiums? Recent political promises fail to mention this possibility, implying that “free Medicare for all” means the public would pay. Do you believe it?

As to benefits, consider the cost of actual healthcare services. Medicare doesn’t pay 100% of medical expenses. Every recipient has an annual out-of-pocket deductible and a co-pay (generally 20% after reaching the deductible) on service costs. Further, many services are not covered by Medicare, and others are covered at a low rate. Will “free Medicare” eliminate deductibles and co-pays? If so, how could we afford the costs?

In real life, nothing is free. Someone will have to pay, and you can rest assured that if you are reading this blog, that “someone” will likely include you. If it sounds too good to be true…….. (complete the sentence).

Van Wie Financial is fee-only. For a reason.

Ida May Fuller; a name that made history. The date was January 31, 1940, and the check in Fuller’s mailbox in Ludlow, Vermont was from the U.S. Social Security System. Ida May had recently retired as a legal secretary when she received the first ever Social Security benefit check in the amount of $22.54.

Fuller had worked for 3 years under the newly established Social Security System, and had paid in (through the Payroll Tax Deduction) a total of $24.75. Her first payment was the smallest check she would receive in 35 years of collecting benefits, having lived to age 100. She collected $22,886.92 tax-free during those 35 years. At the time, Social Security benefits were not taxed as income. That was a promise the U.S. Government made to us at the time; no taxes, ever. We now know what that promise was worth, as Social Security benefits are now taxed according to income, with higher income earners taxed on 85% of benefits received, at their marginal tax rate.

For decades, more people were working and paying into the Social Security Trust Fund than were collecting monthly benefits. Funding for the System was based on ever-increasing contributions from payroll deductions. Of course, it helped that life expectancy at the time was under 63, and the earliest benefits could be claimed was at age 62. The Social Security Trust Fund was flush with money, and growing monthly.

But that was then, and this is now. Life expectancy has grown steadily, with babies born today expected to live 78 years, on average. Coupled with a huge Baby Boomer generation retiring, with no concurrent increase in employment, the Trust Fund has been shrinking.

Recent proposals to make temporary cuts to Social Security Payroll Taxes made me uncomfortable, as any decrease in funding would bring the System closer to insolvency. Today’s Trump proposal calls for a 4-month Payroll Tax reduction of 6.2%. Obama implemented a similar reduction in 2011, and then extended it through 2012. Politicians loved the Obama Plan, and now detest the Trump Plan. They cite the reason (excuse) that it would cripple the ability of the Trust Fund to pay ongoing benefits. I initially agreed, until a little research changed my mind.

Most of us assume that Social Security is funded by only one source; the Payroll Deduction. That assumption is, however, incorrect. There are actually three funding sources. Payroll deductions are supplemented by the amount of income tax Americans pay on their Social Security benefits. Thirdly, when a “special situation” arises, Congress reimburses the Trust Fund from General Revenues.

These reimbursements have been used many times, including reimbursement of the Payroll Tax Holiday in 2011 and 2012. For some reason, politicians today can’t seem to remember that this process is simply “business as usual.” We suspect that the nearness of the next Presidential election plays a role in their collective amnesia.

Most Americans agree that the coronavirus pandemic required stimulative action by the government, and that has been done. Unfortunately, the stimulus expired, and there has been no replacement. Both sides are in “lockdown” mode, refusing to negotiate with each other. Losing are the remaining workers who were displaced by the nationwide economic shutdown last spring. Sadly, although they claim to be talking again this week, there is no end in sight.

Several days ago, the Trump Administration announced that the 2020 voluntary Plan would be implemented immediately. Yet, the whining continues, citing the “Big Lie” regarding insolvency of the Trust Fund. Now you know the truth, and you should be able to see through the smokescreen. What you will find is politics at its worst.

For the record, I understand that the “Trust Fund” has been spent and replaced by government “I.O.U.s,” but they are as good as the American Dollar is printable by the FED. It’s all we have for now.

Van Wie Financial is fee-only. For a reason.