Michael Marvin

There is almost never a good time to take care of basic estate planning, but for many people the specter of the process is worse than just doing it.  Here are some very rudimentary steps you can take, and while I would be loathe to suggest you not engage the services of a qualified attorney (because you should), if that reticence is the primary reason for your delay, then it’s best to do some basic things yourself online.

Step 1:  Make a will.  Duh.  If you have kids, do it this weekend.  We all have a crazy relative (some of us more than others), and we’ve all seen our share of crazy judges.  What an insane thing to play Russian Roulette with, huh?  Just make it clear who you would like to be the guardians of your children.  If you do nothing else, do this.  Assets can be squabbled over, and attorneys may be enriched by said squabbles, but nobody’s best interests are served when courts are involved in determining your children’s future.

Step 2:  Create a Durable Power of Attorney for Health Care.  Different states have different forms, but the forms are out there and available for low, or no, cost.  Think Terry Schiavo and that lovely term “persistent vegetative state.”  You may want to hang on by your fingernails or you may want that plug pulled lickety split.  Whatever—just make sure someone out there knows what you want and put them in charge!  [Now, I’m not sure I’d put the same person in charge of my financial affairs as the one making life or death decisions, but that’s just me.  Just sayin’.].  If you don’t remember the Terry Schiavo case, please Google it.  And even those who do might forget that case went on for 15 years.  That is One-Five years. 

Step 3:  Complete an Advance Medical Directive.  This is a companion document to the Durable Power of Attorney for Healthcare, and a very straightforward form (and different by state) that simply tells doctors what life extending measures you want.  For the elderly or infirm, those are often placed either on a nightstand or on the refrigerator in the event an ambulance is called to your home.  Here’s an easy one from the state of Maryland:  http://www.oag.state.md.us/Healthpol/AdvanceDirectives.htm

A few codicils (yes, that’s an estate planning pun—and there just aren’t many of those to be had):  if you really love your family dog (or cat…I guess), you absolutely can ensure they are provided for with a Pet Trust.  Some states don’t have such a provision, but DC, Maryland and Virginia all do. 

Second, there are possessions in your life that have value to you and maybe to others, but they have nominal real value.  Append a letter to your executor specifying your wishes for those items.  It simplifies the will and can always be changed when someone pisses you off.

Finally, put everything in one place!  Call it your “Death Book” if you want to be maudlin.  Put an image of the Grim Reaper on the front so nobody mistakes it for anything else.  You want your loved ones to be mourning you, not riffling through your desk to find account numbers and passwords!

Hey, nobody said this was fun, just necessary.  And valuable.  And time and money saving.  And potentially of real emotional value to your loved ones, and maybe even to yourself, as you work through these steps.  If you’re still not sure of its value, think of the 5,475 days they spent fighting over Terry Schiavo…and get to work!

Though I’ve yet to see my first Rockin’ Santa, I know the holiday season is upon us…if only because Walmart tells me so.  Here’s a different gift strategy for that child or grandchild in your life—the gift of starting a nest egg.   

There are tons of ways to get a youngster started on that savings front, but three are especially worth noting:  the Roth IRA, a 529 college savings plan, and gifting appreciated stock.  This blog is about the Roth IRA.

First, this is the biggest no-brainer out there when you have kids—and you, they or anyone else has the financial ability to give them an early boost by placing funds in a Roth IRA equal to the amount of money that the kid has earned. So, you have an eight-year-old who walks dogs or mows lawns (do kids still sell seeds?)—or designs websites, what do I know?—and makes a few bucks here and there.  Junior doesn’t need a W-2, just a record of the income being earned.

Kids get a little taste of savings, responsibility, investing, inverted yield curves…well, that may be a stretch but you get the point.  

To review, a Roth IRA is the obverse of the traditional IRA—the traditional IRA generally allows contributions to be made before state and federal taxes are paid; taxes are collected when the contributions and earnings are withdrawn later in life.

In contrast, the Roth IRA has no immediate tax benefits because contributions are not tax deductible.  However, the Roth IRA allows for all funds, both contributions and future earnings, to be withdrawn completely free of federal taxes.

Basic rules—there is no minimum age, you gotta earn money and have records, and junior is not required to file income taxes to make a contribution (other than a simple Form 8606).  You generally need to be 59 ½ to withdraw funds without penalty—as long as the account has been maintained for five years.

Parents and grandparents can do this on behalf of the kid as long as the kid earned some money.  In other words, the exact dollar earned doesn’t have to be the dollar contributed to the Roth IRA.  If your child makes a few thousand dollars, let them spend it on candy or clothes if that’s what you want to do, and make the contribution to their Roth on their behalf.

We all know the old maxim that the two most powerful words in the English language are “compound interest.”  A $5,000 contribution put in for a ten-year old, growing at an average rate of 7% a year, would be worth a cool $232,000 at age 65.  Put in $5,000 a year for five years and then leave it alone?  How about a balance of $942,000?  And yes, that’s 100% tax free.

The usual caveat here, folks:  I’m a CFP®, not a doctor, dammit.  And I’m not a CPA either, so consult a tax advisor.

A while back I wrote a piece on the three facets of risk, focusing on the need, the ability and the willingness to take risks.  

It is the willingness part of the puzzle that can prove vexing for financial advisors—and can be the undoing of individual investors who fail to appreciate it.  Because one’s willingness to take risks can be unduly influenced by factors that should have no relevance to the question of how willing one is to taking risks!

Anyone who has ever filled out a “risk tolerance” questionnaire knows how difficult they can be to answer with precision.  “On a scale from 1 to 10, how much risk are you willing to take to achieve a higher return?”  (oh yeah, and 10 equals “a lot,” does that help?!).  Absent any context, it’s a brutal question to answer.

Even with context it’s hard.  In fact, sometimes context itself can make the question even more elusive.  Enter the “recency bias.”  The recency bias is the tendency to think that trends and patterns that we observe in the recent past are likely to continue into the future.  Such biases block the ability to buy when stock prices decline and sell as they rise—because the recency bias leads us into thinking that down markets will continue to go  down and upward trending markets will continue to rise.

Ask yourself how much risk you are willing to take after many consecutive months of a rapidly rising stock market, and you will come up with a far different answer to the identical question if the market had tanked the previous year.  Neither answer is right.  Or, perhaps, they both are right.  

Folks sell at the bottom because they are convinced the market will continue to decline, and they fail to sell near the top because of the inaccurate belief that the market will just keep on rising.  The “buy low-sell high” maxim is a wonderful theory, but real-world biases such as this one make it exceptionally difficult to implement in the absence of a plan!

Defining all facets of risk is such a critical aspect of building an investment portfolio, yet the very definition of risk changes constantly, and it's often easier for an objective outsider to help us see the truth without bias.

Interested in learning more?  Anything written by Paul Thaler (The Winner’s Curse) or Daniel Kahneman (Thinking, Fast and Slow) are fascinating looks into this and other biases that can make managing one’s own money so very difficult.  

You are always welcome to contact me to discuss these and other issues that impact your financial health.  I'm always available to help.

I read an interesting article in one of the financial planning trade rags the other day entitled, “Advisors Need to Talk About If, Not When, to Retire.”  So that’s what I’m going to do!

In one of the greatest movies of all time, The Shawshank Redemption, Morgan Freeman exhorted Tim Robbins to, “Get busy livin’ or get busy dyin’.”   For many, the whole concept of planning for retirement seems like an exercise in the latter.  And that just ain’t so.

After 13 years of talking with middle-aged folks about planning for retirement, the one thing I found to be almost universally true is that virtually no one has the stereotypical retirement in mind.  I’ve yet to have one person who wants to move to Florida, buy white polyester pants, yell at kids walking on their lawn and b**ch about the government.  It’s a graphic image, to be sure, but it just doesn’t fit most folks.

The danger in this scenario comes when the inability to envision retirement leads to a lack of planning for getting old—a condition which seems to affect us all.  Here is an idea that might help you get over that hump (not mortality, but retirement planning):  think about retirement not as a place to hang out before you meet your maker, but as a place when income security gives you full flexibility to do whatever it is that you want to do!

If you’re in your 40s and 50s you are likely in your prime earning period of life.  It may well be that you no longer even enjoy what you’re doing, or at least you’re liking it less than in years past, but you’ve gotten to a point where changing jobs would be financially ruinous for you and your family.

I have a very successful client who works in public relations.  This client has been spectacularly successful by any reasonable financial metric and cannot conceive of leaving his current status—at least not until he reaches his definition of income security.

How do I define the phrase income security?  At its base level, it means the ability to do whatever you want without being concerned about the financial cost or benefit.  Teach school, volunteer, dig ditches—whatever your version of a fulfilling, enriching life, is, income security allows you to do just that.

Here’s the other version of “retirement” that most 40- and 50-year olds can envision:  let’s say you like what you do, you just want to do less of it.  Perfect!  Income security may mean that rather than working 50 or 60 hours a week, you work 10 or 20 hours a week continuing to do what you love.  The American Psychological Association shows that those who work past traditional retirement age suffer 17% fewer major diseases and less physical decline than those who retire “on time.”

So get your kids through college, pay off major debt, create the nest egg that you and your advisor have deemed appropriate to maintain the lifestyle you want in retirement…and then don’t retire!  Or do.  Getting to the point where you can confidently say, “I can do whatever the hell I want” may be the ultimate financial goal.

What steps are you taking to get to that place?  A different way of thinking about retirement may help you get over that hump…and help you to get busy livin’!

If you ever wonder whether there are lots of folks who have a better handle on the markets than you or I do, we need only look back to 2013, when the Nobel Prize in Economics was awarded to three folks.  One was Eugene Fama, most closely associated with the theory that markets are very efficient and quite unpredictable.  Another was Robert Shiller, who argued that markets aren’t very efficient and can be predicted.  No, seriously.

But here’s the thing:  in my opinion, they are both right!  [And if folks want to send this to the judges in Stockholm you have my permission.]

In the overwhelming majority of times, markets are mostly efficient.  While the business media often ascribe reasons for stocks rising or falling in any given day, here’s the reality:  they are giving us the excuse, not the reason.  Markets go up and down every day for hundreds of reasons and there is little value in trying to figure out “why” the market declined over a few hours or a day.  You often find correlation, but rarely find causation in short time frames.

But there are times that markets are exceptionally inefficient.  We witnessed that during the so-called “flash crash” in 2010 and to a slightly lesser extent on Monday (August 24), when the Dow Jones Industrials fell nearly 1,100 points at the open, only to close at 15,871, five hundred points above the lowest drop.  The market was rational, right up until the point when it wasn’t.  And when it wasn’t was your and my best chance to profit.

On Monday, GE was at $19.37 at 9:31AM.  Thirteen minutes later, it was at $24.04, a gain of 24%.  In 13 minutes.  Was there something that happened to General Electric or its balance sheet or its earnings or its product sales over those 13 minutes?  Not a thing.  It was sheer panic, causing boatloads of shares to be dumped on a market that had very few buyers.

We were net buyers in the first few minutes of that memorable morning.  And it stunk!  It was miserable; we placed an order and wanted to upchuck our breakfasts.  But when the mania of the moment clears we, as investors, were rewarded by traders who see the price of many things but the value of few.

You and I don’t get many chances like we did Monday morning.  And if we find “the bottom,” it means we’re both lucky and good.  At the core, it means we paid less for a company Monday—a lot less—than that identical company was trading just a few days earlier.  Doesn’t mean it guarantees success, just that it gives us a better chance at it.

I’ll take every chance at long term success I can find.  How about you?

A few weeks ago I wrote about some of the reasons why you wouldn’t want to invest in your company’s 401k plan.  The primary reason, by a long shot, was when the costs of the plan outweigh the benefits (sing along with me:  “if your expense ratio starts with two, then you, my friend, are screwed.”)

What about the poor sap who has been a loyal and active participant in his or her plan for decades?  Well, there may be a way out—and this way out may be attractive even for participants whose 401k plans are even “just okay.”  The way out goes by the enticing name of In-Service, Non-Hardship Employee Withdrawals, or just plain old in-service withdrawals.

In a nutshell, this allows employees who have met certain minimum standards to withdraw part or all of the vested balances in their 401k plan and roll it directly into their IRA.  In doing so, the yoke of the plan—whether it be high fees, limited investment choices or both—can be removed.  

Importantly, you can still participate in your 401k plan if you so desire.  But if you roll a substantial portion of the existing balance into an IRA, while the fee percentage may be the same, the financial hit to you would be lower.  Let’s say your fees are 2% a year, with a $1 million 401k balance you’ll pay $20,000 a year, but only $200 a year for a $10,000 balance.  The percentage may be the same, the amount differs greatly.

In addition to reducing your annual fees, most companies you might consider for an IRA such as Fidelity, TD Ameritrade or Etrade, charge little or nothing annually and have thousands of investment options with very low (or even no) annual fees.  If you want, you can also invest in individual stocks and bonds, something generally not available within most 401k plans.

Eligibility criteria differ, but for many plans this option is available for employees over 59½ and with at least  five or 10 years at the company.  A quick note:  if you are between the ages of 55 and 59½ and are considering withdrawing funds from your plan, an in-service distribution may not make sense, as you have greater flexibility to withdraw from a 401k plan without penalties during those 4.5 years than you do with an IRA.

Folks, a big caveat here:  this is a very significant financial transaction:  before doing anything other than pondering, talk with your financial and tax advisors.  This is not something you want to get wrong.  There are other possible fees and expenses such as charges by the 401k company to distribute, potential loss of protection from creditors of your 401k/IRA assets, possible penalties if you have an annuity within your 401k (though I surely hope you do not!), etc.  

Your 401k plan is a vehicle for tax-efficient savings….but hey, a hearse is a vehicle too, and I have little interest in being in one.  Look closely, and realize there may be alternatives!   

A recent Wall Street Journal article about Jeb Bush focused on his retirement plan contributions.  According to the article, over the last five years the former Florida government was able to contribute an average of $350,000 (before taxes) a year into his retirement plan.

Small business owners who have strong cash flow and who find that the $53,000 a year (for 2015, $59,000 if 50 or over) they can make in 401k and profit sharing contributions is easily achievable and want to do more should seriously consider a plan similar to Jeb's, known as a cash balance pension plan.

Pension plans must provide benefits to all employees who meet the eligibility criteria, so sometimes this makes sense and sometimes not.  Here's a particularly juicy example.  Let's say you're a 60 year old dentist with a 28 year old assistant (we'll call her Flossy).  You earn $400,000 and Flossy makes $35,000.  You're maxing out the 401k and profit sharing plan for $59,000 in contributions, and you're giving Flossy $2,500 in profit sharing and safe harbor contributions.

In this example, you'd be able to contribute an additional $197,000 in pre-tax retirement savings.  Here's the thing:  because the contributions are based on both age and salary, your required contribution for Flossy?  An extra $525.  I've had clients who have been able to put away more than $300,000 a year in such combinations, thus reducing their annual tax bill by as much as $140,000.

Another attraction to this plan:  unlike more traditional pension plans (think GM), these can be run for 5-10 years or so, and upon termination the assets can be rolled directly into one's IRA.  This effectively takes a defined benefit plan and turns it into a defined contribution plan, and the burdens of running a pension long-term are effectively terminated.

As with everything involving the Feds, this is not an easy plan to manage, but its complexity simply requires hiring an actuary, so while it adds in total fees for the plan, it greatly simplifies its creation and monitoring.

There are fewer and fewer tools available to make significant tax-advantaged savings.  If you're the owner of a very successful business (even as a sole proprietor) and your advisor hasn't looked at a cash balance plan for you find out why.  It's an excellent tool.

OK, I'll admit it - I'm a risk freak.  

It's not that I love to take a ton of risk in my life (though some wonder whether surfing, downhill skiing, hang gliding and scuba diving are appropriate activities for someone in his 50s); it's that I contemplate the concepts of risk. A lot.  

That is not a typo. It's the concepts of risk, plural. There are at least three facets of risk that merit consideration: need, ability and willingness.

With the Fed's current zero interest rate policy, almost all of us need to take risk to accomplish our retirement objectives. The so-called "risk-free rate of return" is 2.4% per year (fully taxable), which is what the US government gives you for lending it money for 10 years. After taxes, you are probably guaranteed to lose only a little purchasing power over that decade after inflation in factored in. [Yes, that's right: risk-free means almost certain guarantee of losing real value in your investment!] All other things being equal, you'd need to take more risk. 

To fully understand your own need, think about what you want your money to do for you, and when you want it done. Want to retire at 65 with $10,000 a month in living expenses? Fine, that requires a certain amount of risk. Retire at 52 with $20,000 a month? No problem - as long as you have $15 million or want to assume a risk profile that makes climbing Mt. Everest look like a walk in the park.  

The ability to take risks reflects where you are in life. If you're 28 and starting a job, you have all the ability in the world to take as much risk as you would like. But if you're nearing retirement, or facing health challenges, or are living paycheck to paycheck, you simply do not have an ability to take much risk.

Need and ability are fairly quantifiable and objective. The challenge comes in assessing one's willingness to take risks, and this is where most uncertainty lies. Your nest egg, at its most bare, is there to give you peace of mind that you are able to do what you want when you want. But if there's so much risk in the portfolio that you're stressed when the Dow drops a few hundred points... well, that kind of defeats the purpose of peace of mind! [I'm reminded of the investor during the crash of '08 who told me he slept like a baby: woke up crying every few hours curled up in a corner.] 

Ask someone their long term risk tolerance when the market has been down six months in a row and you'll get a markedly different answer than you would when the market is roaring ahead (recency bias). Or notice reticence to change? That's status quo bias. Oh, there are plenty more, but here's the takeaway: understanding risk requires time and patience, and a recognition that it's a dynamic concept.   

The riskiest approach? Not knowing how much risk you need to take, you're able to take and that you're willing to take!

We have all been told since our first job that saving for retirement through the workplace makes sense. By deferring a portion of your salary while you are working, you can not only make solid and notable strides toward funding your future, you can save on your taxes today.

That's because 401(k) plans - and their less well-known sister, 403(b) plans - are "pre-tax" plans. If you made $140,000 and deferred $15,000 to your company retirement plan, you would be taxed as though your salary was $125,000. Any gains in the plan are not taxed until you begin to withdraw funds, presumably later in life when you are retired. Chock that one up to the "no brainer" category, right?

Well, yes and no. [There are no yes or no answers in this field; it's why economics is called the "dismal science."] Nine times out of ten you will want to take advantage of this type of tax-deferred savings. At an absolute minimum, if you work for a company that matches any of your own contributions, by all means you should participate - failing to do so, at least to the maximum of the company match if you can, is equivalent to throwing away free money.

Let's talk about two of the times (there are others) when you may want to reconsider using your 401(k) as a primary retirement funding vehicle (if you work in the Pentagon, we'll call this your PRFV). The second is more prevalent, so skip ahead if you're time constrained. 

The first instance where it makes sense to forgo a 401k is if you are nearing retirement and you expect your marginal tax rates to stay the same or increase in retirement. Remember, long-term capital gains and qualified dividends are generally taxed at lower rates than income, so if your salary is lower (or maybe you've gone part-time), and your tax rates will increase in retirement because of Social Security, a pension or other income, take the tax hit now and pay lower rates than you would later, in retirement. Remember, all funds (whether original contributions or gains) withdrawn from a 401k or 403b and non-Roth IRAs are subject to ordinary income taxes at the state and federal level at the time of distribution.

The second and more likely reason why you might hesitate to fully participate in your company's 401k plan is fees. A long-time client of mine just switched jobs, so we were reviewing his new plan and found that the annual expense ratio for the "right" investment portfolio was at least 2.28%. That is utterly outrageous; although sadly, it is not uncommon. [There's a ditty in here somewhere:  "If your plan costs start with two, you, my friend, are screwed!"]

So how much is "too much"?  The first thing to know is that small plans - those with total assets of less than $10 million - are more expensive, simply because the plan maintenance costs are spread over fewer employees. A recent Deloitte Consulting study for the Investment Company Institute found that the typical annual fee is 0.67%, but for small companies the average cost is 1.27%. A similar study by the trade magazine Plan Sponsor showed the average plan cost for a plan with 50 participants and $2.5 million in assets was 1.46%. 

The good news is that the figures are declining, mostly because of regulations that now require making information on expenses available. The bad news is that a whole lot of smaller companies have not taken the time to look at their plans to see what they and their employees are paying. Two types of folks are happy about that: (1) the insurance companies and large brokerage houses, which are often the ones who are charging the usurious fees; and (2) plaintiffs' attorneys, who are seeing this employer breach of fiduciary duty as ripe pickings for class action lawsuits. [If you own a company with a 401k plan, then you are a fiduciary, and that's a high standard! This email address is being protected from spambots. You need JavaScript enabled to view it. to see if you are at risk!]

Mark my words: there will be a spate of lawsuits in the coming years that relate to exorbitant fees in 401k plans. If you are a fiduciary, please take a look at your plan - for your own sake and for the sake of your employees. The 401k world is changing, don't be left behind!

If you are not an employer fiduciary, but you're interested in reviewing your 401k holdings (and expense ratios) or consider other retirement planning, call me. I'd be happy to take an objective look and let you know if you are doing all you can to prepare for a successful retirement.

Until a few weeks ago, few people outside the advisory world could tell you what a fiduciary standard is, much less why it mattered. But since April, when the Department of Labor proposed a new fiduciary standard for anyone giving retirement investment advice, the term and its impact on consumers have been the talk of the town. 

As a fee-only planner and a proud member of NAPFA (the National Association of Personal Financial Advisors) and FPA (the Financial Planning Association), both leaders in promoting fiduciary standards to serve the needs of consumers, I've been dedicated to the fiduciary standard of serving in my clients' best interests my entire career. But the whole discussion has me thinking about the other attributes that define a great advisor, and why working with a professional often makes such a significant difference in the retirement outcomes for individual investors. It's true that fee-only planners receive no commissions for the products we recommend. But that's only part of the picture, and there's so much more to the story... 

Many of the clients who walk in my door for the first time are couples who have hit a turning point in their finances. More often than not, one spouse has taken the lead in managing their money, and there's been a "last straw" that broke the do-it-yourself back of the couple's money management. A poor investment. A tax disaster. A layoff. The reasons are many, but the outcome is the same: they need an expert to turn things around. To begin the conversation, I ask two key questions: "When was the last time you lost sleep over money?" and "When was the last time you had a fight about money?" Inevitably, the answers I receive cut to the crux of their unique issues. The last straw if you will. And it helps me better understand their sensitivities, their goals, and, perhaps most importantly, their differences. When it comes to money, no two couples are alike, and no two couples define success in the same way. This is precisely why customized investment management is so vital to helping every investor reach his or her own financial "success." 

Whether you've experienced your own “last straw” or simply want be sure your portfolio is optimized for success (however you define it), you can count on an experienced fee-only advisor to explore the following questions—questions that are often overlooked by non-fiduciaries and do-it-yourselfers alike:

1. What's the annual cost of your portfolio?

The exciting part of investing is watching your assets grow. But it's easy to forget about the small details that can eat away at that growth. Even small expenses can have a big impact on your outcome—tens of thousands of dollars worth—over the long term due to the power of compounding. A professional advisor dives into the details to be sure your nest egg is as cost efficient as possible by working to keep fund management fees, taxes, transaction fees, tax preparation costs, and other expenses to a minimum. 

2. Is your portfolio tax efficient - today and post-retirement?

Taxes are typically the largest expense to anyone's savings. So even when your assets are growing nicely, if your portfolio isn’t designed to be as tax efficient as possible, it may not be climbing as high or as quickly as it could be. A professional advisor knows how to mitigate taxes within your portfolio by balancing gains and losses and carefully allocating assets (read more on this in my April 15 blog), as well as how to be sure your accounts are tax diversified so you’re paying the taxes you do pay at the optimal time, both before and after retirement.

3. Are your investments as diversified as they need to be?

Everyone talks about diversification - especially after a market crash - but few understand how to truly analyze a portfolio to ensure it's taking on the least amount of risk to accomplish the goals of the individual investor. A professional advisor not only has the knowledge and tools required to complete an in-depth analysis of all assets and holdings, but also how to synchronize that information with specific long- and short-term financial goals. 

Ultimately, investment management is a field where practice may not make "perfect," but it almost always beats out applying casual knowledge and hoping for the best. It's a lot like visiting a family physician - a general practitioner with years of practice and experience treating hundreds of patients - when something goes wrong with your health. You present your symptoms and, using his or her insight and medical wisdom, your MD can usually identify the problem and prescribe a solution. And when the problem lies outside the area of general medicine, the MD has a network of trusted specialists with extensive knowledge of your ailment. You put your trust in your physician because they have in-depth knowledge, extensive training, experience-based insight, and a trusted professional network. 

When it comes to your financial health, would you ask for anything less? 

Need some help to address your own "last straw" and improve your financial health? Call to schedule your financial check up.

What a ride.

The DOW jumped past 18,000 recently, and then, somewhat predictably, has been bouncing around that area ever since. But things have been moving skyward for a while now, and many investors are feeling a bit giddy with the recent bull market. It’s an excitement that makes today the perfect the time to talk about the importance of behavioral finance and its impact on investor psychology.

If you’ve never heard of behavioral finance, it’s a theory based on the belief that cognitive psychology has the power to alter our decision-making ability when it comes to our finances. As a whole, people are rational when it comes to maximizing wealth and striving to create a more comfortable and secure lifestyle, yet it’s surprisingly common for people to make highly irrational decisions when it comes to investing. 

A great example is the recent $500 million Powerball drawing—the fifth largest lottery prize in U.S. history. People around the country lined up in droves to buy lottery tickets in hopes of winning the jackpot. But what are the odds? 1 in 175 million. If that money came in a single, tax-free pot, such an investment may actually be pretty wise. But as taxable “income” that is most often spilt into pieces, the statistical odds of receiving a return on your investment are even more diminished. And when you realize that your odds of being struck by lighting this year is 1 in 700,000, you can see how irrational it is for people to be tossing their money in that direction. Yet millions of people make the choice to “dream big” and add their money to the pot—even when they know how little chance they have of taking home the cash.

It’s easy to look at the lottery as an anomaly. It’s just a game after all. But “dreaming big” may be costing people much more than they realize—especially when it comes to the stock market.

Last spring, James and Maya, a couple I’ve worked with for years, wanted to talk about shifting their portfolio. They felt we weren’t taking on enough risk; that our current approach was much too conservative for them to see the gains they hoped for. They were both hoping to retire by the end of 2016, and they felt more risk was well worth the potential of a greater return on their investment. James had read an article saying that equities were poised to grow for the next two years, and they wanted to take advantage of that market trend.

I wondered if I’d been wrong to steer them toward a level of conservative investing that seemed to fit their ages. Despite how close they were to retiring, everyone has a unique tolerance for risk. Perhaps I’d underestimated their risk tolerance. Maybe, at least for James and Maya, it made more sense to be more aggressive. I suggested they complete a detailed emotional risk tolerance assessment to see where they really stood.

The results were fascinating. The changes they had suggested when they first came in—shifting to 70% equities—would have given their portfolio an extremely aggressive risk tolerance score of 85. Before giving them the assessment, I was able to talk them down to a more tolerable (yet still highly aggressive) score of 69. But although both James and Maya were vocal about their desire to take on more risk, their responses to the questionnaire painted a very different picture. In fact, their combined score for emotional risk tolerance was just 29. While they clearly wanted the potential for gains, in reality, they were both emotionally averse to risk. If the market shifted downward over the next 24 months (and the odds of that happening surely beat the lighting statistic!) they would have been highly uncomfortable with the level of loss they would see.

James and Maya aren’t unique. Richard H. Thaler, a pioneer in behavioral finance, has been studying investor psychology for years. His latest book, Nudge: Improving Decisions About Health, Wealth, and Happiness, is based on his decades of research in behavioral science and economics, and it presents his theories about how we make choices—and how we can make better ones. Another pioneer in the field andwinner of the Nobel Prize in Economics is Daniel Kahneman. His New York Times bestseller Thinking, Fast and Slow explains the two systems that drive the way we think— “fast, intuitive, and emotional” vs. “slower, more deliberative, and more logical”—and the effect of cognitive biases on everything from playing the stock market to planning our next vacation. In both books, the lessons are clear: reducing the role of emotions can help us make better decisions.

Of course, a certain amount of “dreaming big” isn’t a bad thing. As your advisor, it’s my job to be sure the odds really are in your favor. I’m constantly evaluating the latest market shifts and identifying any necessary changes to your current asset allocation, and I strive to keep your approach in line with your personal goals and tolerance for risk. If you feel something’s changed, come on in and take your own emotional risk tolerance assessment. No matter what the results, we’ll build a portfolio that offers much better odds than 175 million to 1—and one that’s tax-favored to boot.

Are your own emotions wreaking havoc with your financial decisions? Let’s set a time to talk about how we can work together to reduce the thrills and up the odds for your financial success.

The financial headlines are exciting these days. The S&P 500 added a whopping 11.4% in 2014. Nasdaq was up by 11%. And the DOW jumped 7.5%.

With these great numbers blaring at you from the bright lights of the news media, you might be asking: “Why aren’t my numbers looking so impressive? What am I doing wrong?”

The fact is, unless you’re willing to bet your portfolio on high-risk, short-term returns, if your portfolio delivered a relatively modest sounding after-inflation return of 3-4% in 2014, it’s likely you’re doing everything right. Here’s why:

A balanced portfolio of 60% stocks and 40% bonds delivers a much more reliable return on investment than 100% stocks. There may not be any fireworks when you see that single-digit number, but remember that the goal is to achieve a solid long-term return—after tax, after inflation, and after fees—all at a reasonable risk based on your long-term financial goals. A well-balanced, diversified portfolio includes four major asset classes, with varying percentages depending on your personal financial goals, time horizon, and other key factors. These four components are:

1. Domestic large-cap equities

2. Domestic mid-cap, and small-cap equities

3. International equities (including global stocks in developed and emerging markets)

4. Fixed-income securities (including bonds)

While it’s true that domestic caps performed undeniably well last year, history tells us that maintaining a careful mix of these four key components (with the riskier equities category decreasing in weight as the time horizon decreases) can decrease risk substantially and deliver a more predictable return over the long term. When comparing a strict S&P 500 to a sample diversified portfolio over a nearly 10-year period from October 2003 to May 2013, the diversified portfolio earned an extra 2.9% annually—at substantially less risk than the equities portfolio.

(Source: Diversification: Why Not Put Everything in Whatever Will Go Up the Most?, Forbes, July 2013)

Hedge funds are a good example of the more risky approach, and there’s a good reason these funds aren’t delivering their touted too-good-to-be-true numbers these days too. Known for their inconsistent (but sometimes high-flying) returns, hedge funds averaged a return of just under 3% in 2014. Just like betting on that long shot at the racetrack, hedging the market is a tricky game—and the more volatile the market is, the trickier the game becomes.

It’s difficult to look away from the thrilling numbers of the major benchmarks— the S&P 500, Nasdaq, and the Dow—in 2014, but it’s important to remember that these highly publicized indexes don’t account for the not-so-little details of taxes, fees, commissions, and inflation, so the actual return to a portfolio isn’t quite what it seems (and really, is anything ever quite what it seems?!). And while the S&P 500 is one of the most watched indicators of performance for large cap equities, it includes only 500 stocks from more than 15,000+ to choose from. These 500 stocks are certainly representative of the overall market, but historically, the S&P has outperformed international developed and emerging-market stocks only three times since 2000, and it outperformed domestic midcap and small-cap stocks only once since 2000. While a $2 Million portfolio invested only in the S&P 500 in 2014 would have gained $228,000, that same portfolio would have lost more than $1.1 million during the great bear market of October 2007 to March 2009. That’s a level of volatility that even the most seasoned risk taker may find difficult to stomach.

Few anticipated such stellar returns on the S&P 500 last year. Perhaps even fewer anticipated the S&P 500’s 38% decline in 2008. If you really are a risk taker—and you’re willing to bet you financial future on the potential of cashing in on the long shot—you may get a good thrill from throwing your savings at the benchmarks. If you’re really, really lucky, you may see a fireworks-worthy return on your investment.

As for the rest of us? We’ll keep moving forward and striving for that nice, comfortable 3-4% each year after inflation, fees and expenses. Our nerves will benefit greatly, and my guess is that our retirement cash flow will be that much more comfortable when the time comes as well.

Is it time to explore changes to your own portfolio?I’m here when you’re ready (just please don’t ask me to place all your bets on the long shots—I don’t have the fortitude).

It’s that time of year when most everyone is breathing a big sigh of relief: tax season is finally over. And no matter how you fared this year, if you’re like most people, you won’t have to think about taxes until next December. The picture is quite different in the world of investment management where, a bit like the sunny beaches of California, there really are no seasons—at least when it comes to taxes. 

A huge part of my job as an investment manager is protecting client assets through tax mitigation strategies. Using the combination of asset allocation and tax harvesting, my goal—year round—is to keep your taxes to a minimum and maintain tax-efficient portfolios. Here’s how it works: 

• Asset Allocation is an ongoing process of balancing risk and reward by apportioning the assets in each portfolio based on the investor’s financial goals, risk tolerance, and time horizon. As a vital process to successful portfolio management, I tackle asset allocation by looking at the unique risk and return of the three main asset classes— equities, fixed-income, and cash and equivalents—and how they “play” together within each portfolio. Balancing assets effectively dictates the growth of your portfolio as well as how your assets are taxed. And because effective asset allocation is determined by your individual requirements, there is no standard solution; every portfolio must be (or at least should be) carefully tailored to take advantage of the opportunities presented by the individual stocks within it, as well as each investor’s specific goals and financial outlook.  

• Tax Harvesting, or “tax-loss selling,” reaches its peak in the fall when I focus heavily on identifying securities that can be sold at a loss to offset the capital gains tax liability within each portfolio. By limiting the recognition of short-term capital gains, which are taxed at higher federal income tax rates than long-term capital gains, tax harvesting can mitigate current and future taxes, and further diversify your portfolio. For example, an individual’s losses in, say, now-bankrupt Eastman Kodak could be sold to offset his or her gains in Apple. While the transaction may not completely eliminate the capital gains tax liability, it could reduce it significantly. 

   

Of course, there are limitations to these strategies. (Aren’t there always when it comes to taxes?) The tax impact of asset allocation is determined, in part, by the assets held. And tax harvesting is most effective and manageable with individual stocks versus mutual funds. The keys to success are careful analysis of each individual portfolio, a detailed understanding of the individual’s complete financial profile, and detailed forecasting for the market and the tax environment. 

How these factors impact each portfolio isn’t always obvious. For instance, as a former Washington chief of staff, I always have my antennae up for happenings inside the Beltway that may affect our portfolios. In 2013, it made more sense not to offset certain taxes due to the pending increase in taxes as a result of Obamacare.  

Another factor that can shift tax harvesting strategies is the age of the investor. Because estate tax rules calculate capital gains based on the price of a stock on the date of death, it may make sense for elderly investors to hold on to investments that have substantial unrealized capital gains, as this could save thousands of dollars in taxes and add significantly to the legacy passed on to their heirs.

The tax codes are complex (no one has ever claimed that taxes—and tax mitigation strategies—were simple!). But know that when it comes to your investments, “tax season” is a year-round process, and I’m always working for you to keep the bite of taxes at bay. 

Were you hit hard by taxes in 2014? Now is a great time to review your portfolio. Working together, we can identify strategies to help mitigate taxes—not only in 2015, but far into the future of your estate.

If you’ve been paying attention to the financial news, it seems all anyone wants to talk about is how the strong US dollar is bolstering business and boosting the economy. That makes for a great sound bite and gives people plenty of reasons to feel positive about their personal finances, but there’s a lot more to the story.

How strong is too strong?

“Strong” is a word we love to hear when it comes to the stock market. But when it comes to the almighty dollar, things get a bit more tricky. There are times when “strong” can be “too strong.” Here’s why:

•       A stronger dollar gives US consumers and businesses greater buying power in foreign markets. But while we’re all paying less for imports, foreign companies and consumers are paying more for US exports. This means they buy fewer US goods and services—which hampers US economic growth and decreases employment.

•       On the flip side, when the dollar is weak, US consumers and businesses pay more for foreign imports, and foreign entities pay less for US exports. Because foreign companies can afford to buy more US goods and services, US production and employment get a boost.

So how strong is too strong? When the foreign exchange rate reduces US sales. Just ask Procter & Gamble’s CFO. Last week he told CNBC the company expects net earnings to be down 12% in 2015 as a result of the strong dollar. Why? When the dollar climbs high enough to deter foreign purchasing, US exports can be quickly outpriced by foreign bidders. This means that when a manufacturer in Vietnam (a fast-growing player in the global electronics supply chain) is purchasing electronic components, Hewlett-Packard Co.—one of the largest manufacturers in the US—may be outbid by a supplier in China, simply based on the strength (or lack thereof) of the Yuan. It also makes the US a less attractive (read affordable) travel destination for visitors from Europe and Asia, which has a huge impact on our economy.

Balance equals harmony

Ultimately, balance is best. A strong dollar is an important signal that the world recognizes the relative strength of the US economy, so we have that going for us. Cheaper imports and fantastic travel bargains are wonderful, but you have to ask yourself: if a strong currency is so desirable, why are the EU and Japan spending literally trillions to weaken their currencies?

The dollar is going to be what it’s going to be, and only time will tell how this balance plays out. The best thing to do in the mean time is to make the most of the current situation. From a portfolio perspective, I’ll certainly be keeping my eye on commodity stocks and emerging markets that are at some risk due to the strong US dollar, and I’ll continue to watch for new opportunities for growth—both in the US and abroad. In keeping with my long-term approach, I’ll continue to seek, above all, balance.

To take advantage of the strong dollar in a very personal way, if you’ve been itching to take a trip to Europe, this would be a great time to go. Anne and I are setting a good example: we’re heading abroad for a dual celebration of Anne’s 50th birthday and our 20th wedding anniversary. Hopefully we’ll run into you in a little pub in Ireland where we’ll all be getting much more Guinness for our Euros!

Questions about how the strong dollar impacts your own financial outlook? Email me and we can schedule a time to dive into more detail. I’m here to help.