It is a reality of our daily lives that many of our endeavors are shrouded in jargon, complexity, and mystery. This is of course a natural and necessary byproduct of living in a complicated world. The terminologies for discussing computer programming, performing medical procedures, or flying an airliner (just to name a few) must be unique to themselves.
The world of finance and investing is no exception. Jargon looms at every turn: P/E ratios, Book Value, EBITDA, PEG Ratio, TTM, MRQ, Earnings Per Share (EPS), Diluted EPS, Exchange Traded Fund (ETF), Closed End Fund, No-Load Fund, and on and on and on. The mind reels at the prospect of understanding it all. It comes as no surprise then that many people hire someone to manage investments for them. But this raises a critically-important question:
Does the customer clearly understand what the person they have hired is actually doing?
If the answer is “no”, then there could be problems. This may seem contradictory. How could the customer understand what the advisor is doing if there’s so much complexity and specialized knowledge involved? After all, he’s the expert. While this is true enough, it is nonetheless my contention that the spewing of jargon can act as a smokescreen for investment professionals — or for any professionals, for that matter. If customer John Doe is overwhelmed by the sheer complexity of an advisor’s proposed plan and awestruck by his technical prowess, John may be less likely to question the process and more likely to doubt whether he can grasp the subject or have any useful input. This of course plays nicely into the hands of the professional. Needless to say, however, it’s totally wrong.
The details of investing might be complex, but the strategic overview should be transparent, rendered in plain language, and clearly understood. A deep resonating gong of “common sense” should resound in a client’s mind as an advisor is talking: “These are the portfolio strategies we are implementing…” GONG. Yes, I understand them.
“This is how we plan to implement them with your portfolio…” GONG. Yes, that makes sense to me.
“Here is how we get paid for managing your account…” GONG. Yes, that’s totally clear.
And so on and so forth for every question a client might have about how their money is going to be managed. Is it liquid? Can I withdraw funds at a moment’s notice? What are the investment expenses? How is progress monitored and reported? All these and more should have clear, unambiguous, common-sense answers.
All the best,
We all have a relationship with debt in some way, shape, or manner. Like other relationships in our lives, it can be complicated. Let’s examine this creature and look at some of the basics for “safe handling” of debt.
First, why would I say that we all a have relationship with debt? Well, the neighborhood school was financed with bonds, a form of debt, which determines in part how much tax you pay. In the past decade and a half there have been two major economic upheavals due in large part to debt: the 2000 tech bust which was fueled by reckless financing of internet and technology start-ups, and now the housing & real estate bust following an unsustainable bubble, also fueled by debt. These debt-fueled booms and busts in turn influence inflation, interest rates, unemployment, investment performance of your retirement accounts, property values, taxes, and more. With all of that said, even if you are debt-free and use only cash for purchases, the use of debt by others pervades your life.
With so much apparently beyond our control, what can we do? First, it’s useful to visualize your family finances as a business entity, regardless of what you actually do for a living. The goal of “Your Family, Inc.” is to increase its value (net worth) and profitability (income). What will contribute to these goals? What will hinder them? I’m going to focus here on cars and houses because these are high-value items that have a significant influence on a family’s finances.
Unless you use your vehicles in a genuine money-making endeavor, they are a negative force on your balance sheet. They lose value steadily, and they cost you to insure and maintain. Having a loan on the car compounds this because you are paying interest on an object that is losing value; this increases the total cost of ownership significantly. Answer: pay cash for your ride. “What?!” you say, “I couldn’t possibly drive the car I wanted if I had to pay cash.” Exactly. Drive what you can pay cash for — not what you’ve set your heart on. There are a multitude of resources which can help you go about buying a good used car.
Now, take what you were paying on your car every month and save up to buy a rental property, or put it in your IRA, or increase your 401(k) contribution. Make a choice that has the potential for appreciation in value rather than guaranteed depreciation in value and your net worth will benefit.
Owning your home
A house is a place to live, not an investment per se. Shocking, I know. While houses can be good investments, that should not be your expectation. If you take the cost of taxes, repairs/maintenance, upgrades, interest costs on your loan, insurance and all other incidental costs of ownership, the “investment value” of your home declines dramatically.
One of the big advantages of home ownership is the effect of “fixing” the costs. Rents rise with inflation whereas the cost of your loan is fixed on a 30 or 15 year fixed loan, and as your income rises (hopefully) and inflation takes its course, your cost of ownership falls in relation to other rising expenses. So don’t go and ruin it with an adjustable rate loan, or refinancing in a way that increases the balance significantly.
The debt lesson for today: ditch the car loan to help increase Your Family, Inc.’s future net worth and “fix” the house loan to improve your profitability.
It’s your money. As an intelligent, enterprising person, you could manage your investments on your own, no doubt about it. However, whether you do actually manage them — or want to — is another matter entirely.
Regardless of whether you’re flying solo, using the services of an investment professional, or both, you should be able to answer the following questions clearly and concisely:
- What is your strategy in specific terms?
- How is this strategy being implemented?
- How do the items in your portfolio contribute to your strategy?
- How are performance outcomes being monitored, reported, and acted upon?
- How are you paying for the services?
- Are costs and compensation clear, obvious, transparent, and specifically reported/disclosed?
Last things first…
All investments have a cost, and all portfolios cost money in some shape or manner. For instance, say that you get a “no-load” mutual fund. If you do this, you’ll avoid the initial commission a broker would charge. However, you’ll still incur all of the annual operating costs associated with the fund, which can be considerable. An overseas small company fund (typically more expensive) could push 3% per year in fees, which is a lot. Does this mean you shouldn’t own one of these investment vehicles? Of course not, but “no-load” can still equal high-cost. You need to be aware of what these costs might be.
In the same vein, let’s say you’ve owned mutual funds through a brokerage for years. You haven’t bought anything new for a while, so there appear to be no costs. Not true! Mutual funds always have ongoing costs and usually pay an ongoing commission to the broker over time, known as “trailing fees” or “trails”. The amount varies, but is often 0.25% per annum, or $250 on each $100,000 invested. Other operating costs are then added on top of this, so it’s really far from free. This is all disclosed in the fund’s prospectus, of course — which I’m sure you read cover-to-cover last time it came in the mail, right? I jest, of course.
Next item — performance. Just because a portfolio underperforms the Market for a particular interval of time does not necessarily mean that something is wrong. If it’s an even 50/50 split between stocks and bonds and you compare only to the S&P 500, it’s really not an accurate comparison. You need to compare to a 50/50 composite. Even then, this might still be a case of “apples to oranges”; however, you do need to get some sort of measure, whether you are a do-it-yourself investor or working with an advisor. At minimum, you should know the following:
- Point-to-point (quarterly, year-to-date, etc.) returns
- Cash inflows/outflows per quarter
- Index comparisons; your account vs. stock & bond indices
Finally: strategy and implementation. These will vary enormously from one person, business, or entity to another. The key here is clarity and specificity, not merely “I want the account to get bigger.” Well, of course — who doesn’t? A more specific, well-defined goal would be something like, “I want my portfolio to provide financial security and an income stream for my special-needs child.” Having a concrete frame of reference will immediately start to define what kind of investment offerings should and should not be in your portfolio.
If you cannot answer these questions with relative ease, you should begin looking for answers. Give me a call/email and I’ll help you get started.
All the best,