Financial Freedom Blog

This article, originally written in September 2005, is republished with minor editing.

The last time I remember seeing someone wearing a leisure suit was at the Wagon Wheel restaurant in Dahlonega, oh, probably ten years ago. It caught my attention because nobody else wore leisure suits at that time. They had been out of style for at least a decade. But this fellow didn’t care. He seemed to be perfectly happy.

In my business, I see some portfolios with out-of-style investments. People sport them around, just as happy as they can be.

For example, investors can get emotionally attached to an individual stock. They’re not holding it because of performance. Nor does it meet an objective investment criterion such as earnings growth, dividends, price momentum, or valuations—no, they keep holding it because it is already there.

Back to my analogy…They just keep wearing it because it’s in the closet and can’t stand the thought of dumping it. They keep sporting around this hideous, double knit, polyester, whatever…hoping that maybe, some day, it will become fashionable again.  

In the mean time, growth opportunities are passing them by while the countdown to retirement marches on. 

The fear of change paralyzes some investors in a time warp. Becoming comfortable with the status quo is often an investor’s worst enemy.     

So, here are some tips on investment fashion.   

1. Sell off some of the highly valued assets while there are buyers paying the high prices. Technology and large company US growth stocks in years 1999 and 2000 had historically unsustainable returns and enormous valuations. Scaling back, at the least, was in order. This is a lesson we can use to our advantage. 
2. Consider selling or exchanging expensive investments. For example, variable annuities with total annual expenses (M&E, management, and riders) as high as 2.5 to 3% are not worth the cost, in my opinion. There are often better alternatives.
3. Diversify. Getting the right quantity and mix of stocks, bonds, cash, etc. is critical. Unless you know for certain where the next big upward move will be (and no one does), cast a wide net. Too much concentration in any stock, industry, or asset class is risky.
4. Focus on performance. Every investor should know the historical returns and risk associated with his/her portfolio—not just the individual investments inside. Choose a method of money management that has demonstrated  strong, consistent, long-term results.

Does your portfolio need a makeover? Don’t you think it’s time to dump the leisure suit and slide into an Armani? You’ll feel much better about yourself. 

This article, originally written in May 2005, is republished with minor editions. 

One of the greatest financial planning tools our benevolent representatives in Washington have ever granted us is the Roth IRA. (Half sarcasm, half sincerity)

The Roth IRA allows after-tax money to grow tax free. (Remember an IRA does not refer to the investment—it refers to the tax treatment. You can have all kinds of savings and investments inside your IRAs. Also remember, IRS eligibility requirements apply. You also must have earned income to contribute and higher income levels can limit your contributions.)

With a Roth, there are no Required Minimum Distributions (RMDs) at age 70.5 as with traditional IRAs.

Also, consider the tremendous tax-free wealth building potential for your heirs by “stretching” the Roth.

Having a bucket of tax free money in retirement can also give you some control over your taxable income when you are drawing from your assets in retirement. This could make a significant difference in the amount you are taxed on social security  income.

Why wait until April of next year to make this year’s contribution? Invest early in January and get a 15.5 month tax-free advantage. If you do this every year, the compound growth on the tax savings can be significant.

This article was originally written in June 2005. 

Years ago at an investor’s conference, I heard a successful investor start his speech by raising a $1 bill and ask what it was worth. After a few responses from the audience, he explained that the proper reply would be to ask “When?” A dollar bill today is worth a dollar. That same dollar, fifty years from now, would be worth $289, if it earned an average 12% annual compounded rate of return. So when you spend that dollar on something frivolous, you could be giving up $289 later. 

The speaker at the conference also visited schools, teaching 4th graders these basic principles. Here is one of the illustrations he used as best I remember it.  

You start a lawn service, cutting grass. Starting with a pair of scissors, it takes you 20 hours to cut your first yard for $40. But you don’t spend all the $40. After 20 jobs, you have saved enough to buy a basic push mower. Now you can complete more jobs because you can do them much faster. Not spending all the revenue, you eventually invest in a small fleet of top-of-the-line mowers and hire workers to do the mowing. For each job at $40, you receive $10 per job, which produces a substantial passive income. 

All this was possible because all along the way, you saved a portion of the income and invested it. 

In this great capitalistic country of ours, too many Americans are letting the power of capitalism pass them by.   Save and invest! Make your money work for you, so you won’t always have to work for it.

When I wrote in mid-July 2007, the Dow Jones Industrial Average had reached 14,000. In mid-August, it had dropped to under 12,700. On January 21st, when I wrote again, the index had sunk to 12,099. Last week, the Dow closed at 12,266.

Well, these are interesting times. Many people are fearful. When fear is in the air, we can be anchored by the truth of what we have learned from history. The saying applies, “Those who do not know the mistakes of history are doomed to repeat the mistakes of history.” Here are some things we know.

We know that owning shares of companies (stocks) has helped investors significantly out-pace inflation over long periods. Stocks have averaged annual returns of over 10% historically (Morningstar Stocks, Bonds, Bills and Inflation).

Loanership (bond and CD investing) does not deliver the returns of ownership over the long run. The downside to stock returns is they are not consistent in the short run. Returns are variable. They are volatile. One year in a 100% stock portfolio may be down 10%. The next year may be up 20%. But over longer periods, the returns tend to hover more tightly around their historical, positive, double-digit averages.

So, the goal is to lower volatility as much as possible without sacrificing too much return. This is the art and science of portfolio management. We should be asking “How can I get the most return for the least amount of volatility?”

• We know that investing in a diversified mix of US and foreign companies lowers volatility.

• We know that avoiding concentrated positions in individual stocks by choosing baskets of stocks from different industries eliminates unsystematic risk–specifically company risk (the risk that a particular company’s decline could wreck your portfolio).

• We also know that high dividend paying stocks lower volatility.

• We also know that bonds and cash equivalents lower volatility, but also lower returns. So we add these to stocks based on a person’s age and risk tolerance to reduce volatility.

• We know that to eliminate all volatility is to predestinate ourselves to pitiful returns and a lower standard of living in the future. In other words, we know that some volatility is the price we must pay for higher returns and a better lifestyle during retirement.

The paradox principle of scripture applies to investing as well as life: We must die in order to live. We must sacrifice now in order to be rewarded later. In investing, we must be willing to sacrifice short term price stability and predictability for a more prosperous future. For those who understand this and are patient, they are rewarded. For those who are impatient and make decisions based on fear, they will lose their reward.

You must not judge your wisdom by short term results. The tortoise will always beat the hare over the long haul. This is a race that must be run with patience. The next short term move is unknowable, but the market has always trended up over the long run. People go to work, solve problems, and companies make profits. And this has happened throughout all sorts of financial crises and wars, including two world wars over the last century.

Remember, the media loves to report negative news rather than positive. As they say, “If it bleeds, it leads”. Good news is boring. Bad news sells. So if you watch the news and read the headlines, as most of us do, be careful to think independently and get more unbiased news with it. And when you see your portfolio going down instead of up, remember that this is natural, normal, and expected. When stocks go on sale, that is not the time to sell. It’s time to buy. If you needed the money now, you wouldn’t have invested in stocks to begin with. Your goal for your retirement nest-egg is to provide income over a 20 year or more period. If your retirement money is predominantly in cash and bonds, that is a long time to let the silent killer, some call invisible “black ice”–inflation–eat away at your purchasing power. And making good market timing decisions consistently has proven to be impossible.

If you have a well engineered financial plan, you must not faint and jettison the plan when times get tough. If you do, you may not accomplish your long term goals. It is during these times, that we prove if we are deserving of the long-term benefits of ownership investing. Those who run and hide in cash during market downturns do not deserve the higher returns rewarded to the real owners of companies who stay the course.

Also remember that the stock market is a leading indicator of the economy. It anticipates problems ahead. Often times, by the time we realize we are in a recession, the market is posting positive returns in anticipation of future economic growth.

The market today has, I think, to a large degree, anticipated a recession, and when fear and pessimism are prevalent, risk has been accounted for and prices are discounted accordingly. I’m not saying the market has bottomed out. Nobody can predict that. But as you will read in Dr. James Paulsen’s March 2008 commentary, https://www.wellscap.com/docs/ecomonic_and_market_perspective/EMP_0308.pdf , prices look quite attractive now. Assuming you have a well designed portfolio, instead of selling stocks now, you need to hold them. If you have cash on the side, earmarked for five years or longer, now is a great time to get it invested. Five, ten, fifteen years from now, you will be glad you stayed the course.

1. Shelter up to 25% of your pay (up to $45,000) from 2007 taxes using a SEP IRA if you are a small business owner or self employed. The 2007 deadline is April 15th, 2008.

2. Deduct up to $5000 per person if you’re at least 50 years old ($4000 under age 50) for 2007, using a traditional IRA. 2008 contributions can also be made now. Limits for 2008 have increased to $6000 if you’re at least 50 years old–$5000 under age 50. The deadline for 2007 contributions is April 15th, 2008.