Building a $1,000,000 Nest Egg: Leading Financial Minds Reveal the Simple, Proven Ways for Anyone to Build a $1,000,000 Nest Egg On Your Own Terms

About Aspatore Books Business Intelligence From Industry Insiders

www.Aspatore.comAspatore Books publishes only the biggest names in the business world, including C-level (CEO, CTO, CFO, COO, CMO, Partner) leaders from over half the world’s 500 largest companies and other leading executives. Aspatore Books publishes the Inside the Minds, Bigwig Briefs, ExecEnablers and Aspatore Business Review imprints in addition to other best selling business books and journals. By focusing on publishing only the biggest name executives, Aspatore Books provides readers with proven business intelligence from industry insiders, rather than relying on the knowledge of unknown authors and analysts. Aspatore Books focuses on publishing traditional print books, while our portfolio company, Big Brand Books focuses on developing areas within the book-publishing world. Aspatore Books is committed to providing our readers, authors, bookstores, distributors and customers with the highest quality books, book related services, and publishing execution available anywhere in the world.

The Inside the Minds Series Real World Intelligence From Industry Insiders

www.InsideTheMinds.comInside the Minds was conceived in order to give readers actual insights into the leading minds of business executives worldwide. Because so few books or other publications are actually written by executives in industry, Inside the Minds presents an unprecedented look at various industries and professions never before available. Each chapter is comparable to a white paper and is a very future oriented look at where their industry/profession is heading. In addition, the Inside the Minds web site makes the reading experience interactive by enabling readers to post messages and interact with each other, become a reviewer for upcoming books, read expanded comments on the topics covered and nominate individuals for upcoming books. The Inside the Minds series is revolutionizing the business book market by publishing an unparalleled group of executives and providing an unprecedented introspective look into the leading minds of the business world.

About Big Brand Books Big Brand Books assists leading companies and select individuals with book writing, publisher negotiations, book publishing, book sponsorship, worldwide book promotion and generating a new revenue stream from publishing. Services also include white paper, briefing, research report, bulletin, newsletter and article writing, editing, marketing and distribution.The goal of Big Brand Books is to help our clients capture the attention of prospective customers, retain loyal clients and penetrate new target markets by sharing valuable information in publications and providing the highest quality content for readers worldwide. For more information please visit www.BigBrandBooks.com or email [email protected].

I N S I D E T H E M I N D S

Inside The Minds:Inside The Minds:Inside The Minds:Inside The Minds:

Building A $1,000,000

Nest EggFinancial Gurus Reveal the Simple, Proven Ways

for Anyone to Build a $1,000,000 Nest Egg on Their Own Terms

Published by Aspatore Books, Inc. For information on bulk orders, sponsorship opportunities or any other questions please email [email protected]. For corrections, company/title updates, comments or any other inquiries please email [email protected].

First Printing, 2002 10 9 8 7 6 5 4 3 2 1

Copyright © 2001 by Aspatore Books, Inc. All rights reserved. Printed in the United States of America. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, except as permitted under Sections 107 or 108 of the United States Copyright Act, without prior written permission of the publisher.

ISBN 1-58762-215-7

Cover design by Michael Lepera/Ariosto Graphics & Kara Yates

Material in this book is for educational purposes only. This book is sold with the understanding that neither any of the authors or the publisher is engaged in rendering legal, accounting, investment, or any other professional service. Please seek the advice of your own financial professional before implementing ANY of the methods or ideas mentioned in this book.

This book is printed on acid free paper.

A special thanks to all the individuals that made this book possible.

Special thanks to: Jo Alice Hughes, Rinad Beidas, Kirsten Catanzano, Melissa Conradi, Molly Logan, Justin Hallberg, Jason Nielson

The views expressed by the individuals in this book do not necessarily reflect the views shared by the companies they are employed by (or the companies mentioned in this book). The companies referenced may not be the same company that the individual works for since the publishing of this book.

“What business journals do you subscribe to?”

A study conducted with over 5,000 professionals shows that 82% of these individuals feel that journals are the preferred

type of publication for investing intelligence over magazines, books, research reports and other publications.

Aspatore Business ReviewsEnabling Executives to Innovate & Outperform

The Quarterly Journals Featuring Exclusive Business Intelligence From Industry Insiders

The Most Subscribed to Journals By C-Level Executives From the World’s 500 Largest Companies

Aspatore Investing Review Aspatore Business Review

Aspatore Technology Review Aspatore Entrepreneurial Review

Aspatore Marketing Review

www.Aspatore.com/abr.asp

AVAILABLE FOR THE FIRST TIME EVER ON A NON-INVITATION BASIS

The Most Subscribed to Investment Journal By C-Level Executives From the World’s

500 Largest CompaniesAspatore Investing Review brings you the most important, condensed investing intelligence from industry insiders on the most profitable investment opportunities such as stocks, mutual funds, hedge funds, fixed income opportunities, private equity investments and real estate opportunities-expanding your breadth of investment opportunities, providing you with information previously only available to the world’s biggest investors, and enabling you to outperform.

Aspatore Investing Review is the only way for investors to keep their edge and stay on top of the most pressing investment trends and opportunities. Each Aspatore Investing Review features business intelligence, research and analysis from economists, financial planners, market analysts, research analysts, hedge fund managers, mutual fund managers, stock pickers, investment bankers, venture capitalists, real estate managers, and C-Level (CEO, CTO, CMO, CFO, Partner) executives from the world’s largest and most prestigious firms. Each quarterly issue focuses on the most pressing business issues, trends, and emerging opportunities in the marketplace that affect every investor in some way or another. Every quarter, Aspatore Investing Review focuses on topics that every investor needs to be aware of such as:

• Staying Ahead of Changing Markets • Hedging Risk • Diversification • Stocks to Watch • Emerging Market Opportunities • Economy Trends • Private Equity Opportunities • Real Estate Opportunities • Investment Banking Perspectives • Technology and the Internet • Sector Analysis • Goals & Planning

Aspatore Investing Review is the one journal every investor should read, and is the best way to maintain your edge and keep current with your business reading in the most time efficient manner possible.

Only $1,090 a Year for 4 Comprehensive Issues A Fraction of the Increase in Your Investment

Portfolio This Journal is Sure to Provide Fill Out the Order Form on the Other Side or Visit Us Online!

www.Aspatore.com

ASPATORE Investing Review ENABLING INVESTORS TO OUTPERFORM

Aspatore Investing ReviewTear Out This Page and Mail or Fax To:

Aspatore Books, PO Box 883, Bedford, MA 01730 Or Fax To (617) 249-1970

Name:

Email:

Shipping Address:

City: State: Zip:

Billing Address:

City: State: Zip:

Phone:

Lock in at the Current Rates Today-Rates Increase Every Year Please Check the Desired Length Subscription:

1 Year ($1,090) _____ 2 Years (Save 10%-$1,962) _____ 5 Years (Save 20%-$4,360) _____ 10 Years (Save 30%-$7,630) _____ Lifetime Subscription ($24,980) _____ (If mailing in a check you can skip this section but please read fine print below and sign below) Credit Card Type (Visa & Mastercard & Amex):

Credit Card Number:

Expiration Date:

Signature:

Would you like us to automatically bill your credit card at the end of your subscription so there is no discontinuity in service? (You can still cancel your subscription at any point before the renewal date.) Please circle: Yes No

*(Please note the billing address must match the address on file with your credit card company exactly)

Terms & Conditions We shall send a confirmation receipt to your email address. If ordering from Massachusetts, please add 5% sales tax on the order (not including shipping and handling). If ordering from outside of the US, an additional $51.95 per year will be charged for shipping and handling costs. All issues are paperback and will be shipped as soon as they become available. Sorry, no returns or refunds at any point unless automatic billing is selected, at which point you may cancel at any time before your subscription is renewed (no funds shall be returned however for the period currently subscribed to). Issues that are not already published will be shipped upon publication date. Publication dates are subject to delay-please allow 1-2 weeks for delivery of first issue. If a new issue is not coming out for another month, the issue from the previous quarter will be sent for the first issue. For the most up to date information on publication dates and availability please visit www.Aspatore.com.

Inside the Minds: Building A

$1,000,000 Nest Egg Financial Gurus Reveal the Simple, Proven Ways for Anyone to

Build a $1,000,000 Nest Egg on Their Own Terms

CONTENTS

Harry R. Tyler 11 THE GOLD IS IN YOUR GOALS

Christopher P. Parr 43 TIMELESS TIPS FOR BUILDING YOUR NEST EGG

Jerry Wade 87 IT’S NOT WHAT YOU MAKE – IT’S WHAT YOU KEEP THAT COUNTS

Marc Singer 119 ACCUMULATING YOUR MILLION- DOLLAR NEST EGG: THE EASY WAY OR THE HARD WAY!

Marilyn Bergen 137 FOLLOWING TIME-HONORED INVESTING PRINCIPLES

Clark M. Blackman, II 167 THE ART AND SCIENCE OF INVESTING

Laura Lee Wagner 199 WHO WANTS TO BECOME A MILLIONAIRE?

Gary Mandell 213 ALTERING STRATEGY FOR RETIREMENT AND NON-NEST-EGG GOALS

Building a $1,000,000 Nest Egg

11

THE GOLD IS

IN YOUR GOALS

HARRY R. TYLER

Tyler Wealth Counselors, Inc. President and Chief Executive Officer

Inside The Minds

12

It Starts With Goals

Building a $1,000,000 nest egg in and of itself is actually just one of the many actions required to satisfy a bigger and more motivating goal for personal financial security. When asked how they define personal financial security, most people say it’s having enough money to do whatever they want, whenever they want to. Others respond in relationship to their work by defining personal financial security as not having to work for pay, but because they like what they do. Still others relate their own security to their ability to help other family members become more secure financially.

Whatever your personal definition of financial security or financial independence is, it all starts with goals. The more specific you can be in defining your goals, the more likely you will be motivated to achieve them.

Make Your Goal Realistic

It is critically important that financial goals are both realistic and attainable. Although it is common for younger people to relate financial security to a particular amount of money or lump sum, most retirees relate their personal


13

financial security to a target income level. Since individuals are accustomed to spending income rather than principal, using a target income level is a better way to plan for true financial independence. Most advisors feel a good rule of thumb involves a target income of between 65 percent and 75 percent of your current gross earnings – assuming, of course, your current income or living standard is a desirable objective for long-term financial security. Another method is to use your current net (after tax, after deductions) paycheck amount as your retirement income and spendable income goal. This assumes you are not already saving or investing large amounts of money after-tax. If you are, you can reduce the target income goal accordingly. Other adjustments might involve excluding some large monthly or periodic expenditure, such as an installment loan payment, education expenses, or a mortgage payment on a loan that will be paid off before your desired retirement date.

Table 1 illustrates the annual savings required to accumulate $1,000,000 in nominal dollars (unadjusted for inflation) at various growth rates over different periods of time. For example, assuming a growth rate of 8 percent, an annual deposit of $8,827 is required to reach $1,000,000 in 30 years.

Inside The Minds

14

Think Long-term

The goal of true financial security and long-term financial independence is long-term for most people. One of the biggest mistakes individuals make when doing financial security planning is greatly underestimating the number of years they will need income. Take a look at how long your parents or grandparents lived, and then assume you will outlive them by at least five years. In our financial planning practice, we routinely assume males will live to age 90 and females survive to age 95. If your goal is to be totally financially independent at age 55, for example, and you are a male, you will probably spend more years living off the income from your accumulated wealth than you did accumulating that wealth. The last thing you want is to retire with adequate income but inadequate principal or

Table 1ACCUMULATION PERIOD

Required Annual Savings to Reach $1 Million (nominal dollars) *

Timeframe10 Yrs 15 Yrs 20 Yrs 25 Yrs 30 Yrs 35 Yrs 40 Yrs

TARGET 1,000,000$ 1,000,000$ 1,000,000$ 1,000,000$ 1,000,000$ 1,000,000$ 1,000,000$6% $75,868 $42,963 $27,185 $18,227 $12,649 $8,974 $6,462

7% $72,378 $39,795 $24,393 $15,811 $10,586 $7,234 $5,009

8% $69,029 $36,830 $21,852 $13,679 $8,827 $5,803 $3,860

9% $65,820 $34,059 $19,546 $11,806 $7,336 $4,636 $2,960

10% $62,745 $31,474 $17,460 $10,168 $6,079 $3,690 $2,259

11% $59,801 $29,065 $15,576 $8,740 $5,025 $2,927 $1,719

12% $56,984 $26,824 $13,879 $7,500 $4,144 $2,317 $1,304

* Annual contributions to investment account are made at the end of each year.


15

growth, because you might run out of money before you run out of breath.

Using Table 2, you can determine how much annual income you can expect your $1,000,000 fund to provide and how long it will last, based on various growth rates. For example, assuming a more conservative 6 percent growth rate during the distribution period and a 30-year distribution timeframe, your can expect to receive a constant annual payment (principal and interest) of $68,537. At the end of 30 years, your $1,000,000 fund will be exhausted.

Table 2DISTRIBUTION PERIOD

Constant Annual Distribution from $1 Million Dollar Account (nominal dollars) *

Timeframe10 Yrs 15 Yrs 20 Yrs 25 Yrs 30 Yrs 35 Yrs 40 Yrs

6% $128,177 $97,135 $82,250 $73,799 $68,537 $65,070 $62,700

7% $133,063 $102,612 $88,218 $80,197 $75,314 $72,181 $70,102

8% $137,990 $108,176 $94,308 $86,740 $82,248 $79,447 $77,648

9% $142,954 $113,815 $100,501 $93,400 $89,299 $86,822 $85,284

10% $147,950 $119,522 $106,781 $100,153 $96,436 $94,263 $92,963

11% $152,974 $125,284 $113,131 $106,973 $103,626 $101,736 $100,648

12% $158,022 $131,093 $119,535 $113,839 $110,843 $109,211 $108,307

* Annual distributions are made at the beginning of each year.

Inside The Minds

16

Do Not Ignore the Impact of Inflation

It is critical that you carefully consider the adverse impact of inflation on your income goal and factor this into your planning. Financial security planning that ignores longevity and the adverse impact of reduced purchasing power is guaranteed to ruin your retirement party; the only question is when. For example, assume you retire at age 60 with a pension from your former employer of $1,000 monthly for life. Assuming an average inflation rate of 4 percent, your pension will lose 50 percent of its purchasing power when you are 78 and probably have another 12 to 17 years of living to do. In this regard, it is extremely important that your investment portfolio, both before and after you retire, include adequate investment assets that have consistently demonstrated their ability to statistically out-perform inflation and maintain purchasing power over long periods of time. This would generally include common stocks, stock mutual funds, real estate, and real estate investment trusts, or REITs. Individuals who ignore this lesson and invest 100 percent of their retirement capital in “fixed” assets like bonds (taxable or tax-free), bond mutual funds, fixed annuity and insurance contracts, GNMAs, or certificates of deposit (CDs) will likely lose purchasing power in mid-retirement and discover too late they are “going broke safely.” Unfortunately, at that age it may be


17

impossible to repair the damage to their retirement security even if they could be shocked into a change of attitude. They will have discovered the hard way that to avoid the biggest risk to their long-term financial security, it is absolutely necessary to take a measured amount of manageable risk with a portion of their retirement capital.

For your annual income to maintain its purchasing power, it’s critical to adjust your target income objective (Table 2) for the loss of purchasing power caused by inflation during the accumulation timeframe.

Using Table 3, which assumes 4 percent inflation over a 20-year accumulation period, our 25-year income target, for example, gets reduced to $33,681, which is the purchasing power equivalent of $73,799 (Table 2 – 6 percent). The further away from retirement you are (accumulation timeframe), the lower your inflation-adjusted income will be, and the more money you’ll need to accumulate to reach your target income.

Inside The Minds

18

The Power of Compound Interest and Tax Deferral

We are told Albert Einstein called compound interest the “Eighth Wonder of the World.” What he was referring to was the incredible power of compound interest over long periods of time. An easy tool financial advisors and educators use to demonstrate this power is the so-called “Rule of 72.” For example, if you want to know how many years it takes for $100,000 to double at an average growth rate of 8 percent annually, simply divide the growth rate (8 percent) into the number 72 to get the answer, which of course is 9, or more accurately 9 years. If you are 33, expecting to retire at the age of 60 with $100,000 in your 401(k) plan earning 8 percent, you should have $800,000 in your account by age 60 with no additional contributions. We know this because 72 divided by 8 equals 9, giving you 27 years, or three “doubling” periods before age 60. In nine

Table 3DISTRIBUTION PERIOD

Constant Annual Distribution from $1 Million Account, 6% Growth Rate (Today's Dollars) *

Accumulation Distribution TimeframeTimeframe 10 Yrs 15 Yrs 20 Yrs 25 Yrs 30 Yrs 35 Yrs 40 Yrs

10 Yrs $86,592 $65,621 $55,565 $49,856 $46,301 $43,959 $42,35815 Yrs $71,172 $53,935 $45,670 $40,978 $38,056 $36,131 $34,81520 Yrs $58,498 $44,331 $37,538 $33,681 $31,279 $29,697 $28,61525 Yrs $48,081 $36,437 $30,853 $27,683 $25,709 $24,409 $23,52030 Yrs $39,519 $29,948 $25,359 $22,754 $21,131 $20,062 $19,33135 Yrs $32,482 $24,615 $20,843 $18,702 $17,368 $16,490 $15,88940 Yrs $26,698 $20,232 $17,132 $15,371 $14,275 $13,553 $13,060

* Annual distributions are made at the beginning of each year.


19

years, or at age 42, your $100,000 becomes $200,000, and at age 51, your account grows to $400,000, and in the final nine years, it increases to $800,000 at age 60.

Still another wealthy individual, J.D Rockefeller, is alleged to have said, “The best way to create real wealth is to never pay taxes on income you do not intend to spend.” If you are accumulating assets or wealth for long-term financial security or an early retirement, then in general you will want to avoid paying taxes on the earnings or growth on your account or assets until you are ready to turn your capital accumulation into an income source. In the meantime, you will achieve maximum or higher compound growth rates if you do not have to take out money for taxes every year.

For example if your account earns 9 percent annually, but it is 100 percent taxable in a 30 percent marginal tax bracket, you are actually compounding only at 6.5 percent annually, which increases that time required to double your invested capital from eight years (72 ÷9) to 11 years (72 ÷ 6.5). If you are age 33 with 27 years to accumulate your retirement nest egg, you will have fewer dollars to produce income from during your retirement years.

Inside The Minds

20

Simple Funding Strategies That Get BIG Results

If we can agree that tax-deferred growth produces greater and faster results than earnings or growth that is taxable, then let us explore some simple funding strategies that work. Unless you are already financially independent or retired, almost everyone has some amount of earned income and, therefore, is eligible for a government-subsidized retirement or savings account. This could be as modest as a $2,000 annual IRA or ROTH IRA contribution or as substantial as a $35,000 (or greater) annual contribution for a self-employed individual or owner of a closely held and profitable business enterprise. Assuming you are eligible to contribute $10,000 annually from your $150,000 salary to an employer-sponsored retirement plan, you will save at least $2,800 (28 percent marginal bracket) in taxes annually. Assuming your account value grows at an average rate of 8 percent, you will accumulate $908,448 toward your retirement nest egg in 27 years.

The whole idea is to “pay yourself first,” and tax-deductible and tax-deferred, employer-sponsored retirement savings plans are simply the easiest and best ways to start. If both spouses work for employers who sponsor tax-deferred plans, they should both attempt to “max out” the contribution amounts allowed by the plan or IRS rules. If


21

one spouse’s employer offers a more favorable plan, such as greater contribution limits or higher employer matching contributions, then that spouse should consider maxing out, and the couple could reduce their spending or depend more on the other spouse’s income for living expenses. Everyone’s situation is unique, but the goal is always the same.

Also, individual growth stocks held for long periods of time can be considered “tax deferred” growth assets until they are actually sold. Such stocks usually pay little if anything in annual dividends, so the annual tax liability during their holding period is generally minimal. Usually, this is not true for growth mutual funds, where the fund manager makes changes in the portfolio from time to time, creating a realized capital gains tax liability for the mutual fund shareholders – unless, of course, the mutual fund shares are held inside a tax-deferred account, which is ideal. Generally, my bias would be to always use mutual funds inside tax-deferred accounts and individual stocks, or a “managed” portfolio of individual stocks outside of tax-deferred accounts, to manage the tax liability.

One common mistake employees make is limiting their contribution level to the employer’s match level. If the plan otherwise allows you to contribute 15 percent, and you can

Inside The Minds

22

afford this, consider maxing out your tax-deferred and tax-deductible contribution, whether your employer matches zero or 100 percent of your contribution. Consider the employer’s matching contribution, if any, “icing on the cake,” but never the real long-term benefit to your participating at the highest level you can afford.

Use Modern Portfolio Theory to Improve Performance

In our investment advisory and portfolio management activities, we base asset allocation recommendations on the principles of modern portfolio theory as defined by Nobel Laureates Dr. Harry Markowitz and Dr. William Sharpe. The research of these two brilliant economists changed the standards for portfolio construction and has been the single most important influence on the practice of asset allocation in the past decade.

Quite simply, Modern Portfolio Theory holds that the whole is greater than the sum of its parts, and constructing portfolios using different classes or types of assets that historically demonstrate a negative correlation to each other produces portfolios with statistically higher total return potential and lower overall portfolio risk or volatility. Essentially, we’re looking for different asset classes that,


23

when combined in a portfolio, give us the desired return and risk potential and have “dissimilar price movement behavior,” or tend not to go up or down at the same time, which enhances long-term performance.

In addition to diversifying through large stocks and smaller stocks, it’s important to further diversify your large and small stock allocations between growth and value styles. Domestic mid-cap stocks and international stocks (both large and small value and growth) also need to be considered in the equity, or stock, portion of your allocation. It’s also vital to include an appropriate allocation to bonds or “fixed income” assets, depending on the income beneficiary or owner’s need for current income, as well as their risk tolerance and time horizon. Generally, the older you are, the greater your need for current income, and usually the lower your risk or volatility tolerance, which converts to a larger allocation to fixed-income asset classes. Historically, over long periods of time, stocks have greatly outperformed bonds; however, not all investors have the same amount of time available to them, which increases the role of bonds for older investors or those who just cannot tolerate great volatility or risk in their investment account. Modern portfolio theory devotees believe you should always invest for total return (current

Inside The Minds

24

yield plus portfolio growth), since this ultimately drives the long-term performance of a portfolio.

Totally ignoring stocks in a portfolio and investing for current dividend yield alone is a losing game that, over long periods of time, will dramatically reduce the real (inflation-adjusted) value of your portfolio and your ultimate financial security.

As the following chart illustrates, the types of stocks a portfolio manager focuses on (their style) can have a profound impact on performance during different economic periods. This reinforces the importance of making sure both styles are represented in your stock portfolio.

Source: Frank Russell Co.

During the past decade, Growth & Value Investing Styles have traded market leadership.

-30%-20%-10%

0%10%20%30%40%50%

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Growth Value


25

The Importance of the Investment Policy Statement

Each investor should have an Investment Policy Statement (IPS) as part of their overall financial plan, which should be updated at least annually. An IPS will allow an investor to follow a disciplined approach to investing and provide a paper trail that describes what steps were taken and why. The investor will be able to use the IPS as a road map to see where they have been and where they are going. The sections included in the IPS should address these key factors that work together to form the basis for investing:

Return Objective

To structure an appropriate saving and investing plan, investors need to consider what they want to accomplish with their money. For most people, retirement is the major goal, with college funding and charitable giving also high on the list. Once these goals and their respective amounts and timing are defined, and the expectations for inflation and the other portions of the IPS are decided upon, a realistic annual target rate of return can be determined. The emphasis must be on realism, for if the long-term return for the S&P 500 is 10.5 percent on an annualized basis, it would not be realistic to expect a long-term annual return of 15 percent for a portfolio. It’s nice when it happens, but

Inside The Minds

26

it should not be assumed to happen on an ongoing basis. Many financial planners work with overall portfolio expected returns closer to the 7 to 9 percent range.

Risk Tolerance

Everyone has a different level of risk tolerance. One of the most important things all investors need to have is a good understanding of the level of risk they are comfortable with, in both good times and bad, over the entire investment time horizon. In finance, risk is commonly defined as volatility of return. During the NASDAQ tech stock bubble of the late 1990s, many investors thought they liked risk (volatility), but they had only seen upside volatility. When the bubble broke, and they were exposed to downside risk, they learned that their risk tolerance – their ability to accept volatility in the returns from their portfolios – was not what they thought. Understanding their personal risk tolerance and having a portfolio built in concert with that level will allow an investor to sleep at night, and to follow their investing plan over the long term.

Time Horizon

Whether an investor needs the money in one year, five years, or 30 years will have an impact on the amount of risk


27

they can afford to accept, what return objectives are realistic, and how their portfolios should be constructed. Many investors fall into the trap of focusing on the short term and fail to realize that when it comes to retirement funding, they generally have a very long time horizon. Many financial planners assume life expectancies for their clients of ages 90 to 95. That means if an investor is currently age 50, they have an investment time horizon of 40 to 45 years and will need their funds to last them for that period. It also means they can generally accept a meaningful amount of risk in the pursuit of returns in line with their return objectives. Failing to recognize their true time horizon can put investors at risk of outliving their money.

Liquidity Needs

The amount and timing of withdrawals from the portfolio should be determined in advance, as those needs will affect the structure of the portfolio and types of investments to be considered for inclusion. The liquidity needs of a 30-year-old investor who is saving for retirement and still working are vastly different from a 70-year-old retired investor who relies on regular income from his portfolio for financial support.

Inside The Minds

28

Tax Consequences

Different investors, different investments, and different investment accounts all receive different tax treatment. An investor’s tax obligations can depend on the investor’s current income tax bracket, the state they live in, and the tax credits or deductions the investor may have. Some investments, when held for a sufficient length of time, receive favorable capital gains treatment, while others deliver ordinary income taxed at the investor’s marginal tax rate. Tax-deferred accounts, such as 401(k) accounts and traditional IRAs, allow investors to postpone taxes to some date in the future. Assets held in Roth IRAs can accumulate gains that are tax-free forever. Understanding the investor’s tax situation, in conjunction with all the other sections of the IPS, can help determine how an overall portfolio should be constructed and which investments should be held in which accounts.

Regulatory Issues

For most individual investors, the regulatory issue they will most likely face is insider-trading rules associated with ownership in shares of their employer’s firm. Other issues can arise when the assets belong to a trust or endowment fund.


29

Unique and Special Preferences

Some investors have unique preferences for how their money should be invested, and these should be incorporated into the portfolio construction. For instance, some investors prefer to avoid so-called “sin stocks,” such as tobacco or gaming industry issues. Others may have a preference for socially responsible firms that minimize their impact to the environment, while some investors may dislike paying taxes to the extent that they wish to focus predominantly on tax-free municipal bonds.

Portfolios to Maximize Growth and Minimize Risk

Many times investors focus only on return. The more important issue, however, is risk-adjusted return. For each unit of return the investor is expecting to receive, how many units of risk is the investor accepting?

In finance, risk is typically defined as volatility of return, and risky assets are those that exhibit volatility in their returns over time. In nearly efficient markets, long-term expected returns for assets are related to the risk levels of those assets. There is a trade-off between risk and reward, in that the more reward an investor wants to pursue, the

Inside The Minds

30

more risk the investor must be willing to accept. Unless an investor is extraordinarily lucky, it is impossible to achieve persistent high returns without accepting correspondingly high levels of risk. Sometimes the risk is not readily apparent to investors, but it is there, nonetheless.

The most efficient portfolios are those that can deliver the highest level of return for a given level of risk willing to be assumed. An efficient portfolio is also one that carries the lowest level of risk for a given level of expected return.

To create an efficient portfolio, risky assets from different asset classes are combined in appropriate amounts to achieve a portfolio that exhibits the desired level of return with less risk than the sum of its parts, a process referred to as diversification. While this may seem counterintuitive at first, there is good reason this effect occurs.

The range of potential asset classes for inclusion in a portfolio typically starts with stocks, bonds, real estate, and cash equivalents, such as money markets and Treasury bills, but can also include other classes, such as managed futures accounts and even precious metals. Each asset class has its own level of expected return and its own level of expected volatility of return (risk).


31

Each asset class also responds differently to the changing nature of the economy, interest rates, and the expectations for inflation, among other factors, meaning that some asset classes may be increasing in value at the same time others are decreasing in value. This feature allows a diversified combination of risky assets, to exhibit less risk (volatility of return) while having the same expected return as a portfolio that is not diversified.

To illustrate this effect, consider a single stock portfolio comprising Stock A only. The portfolio would have the expected return and expected volatility of return (risk) of only Stock A.

Now, suppose you create a second portfolio comprising 50 percent Stock A and 50 percent Stock B. Stock B has the same expected return as Stock A, but B is in a different industry sector from A, and so it will react differently to changes in the economy than Stock A will.

Because the two stocks in the portfolio will react differently to changes in the economy, they will not both go up by the same amount at the same time, and they will also not decline by the same amount at the same time. However, because both stocks have the same long-term expected return, the two-stock portfolio has the same expected return

Inside The Minds

32

as the one-stock portfolio, while having a lower volatility of return than the one-stock portfolio.

Studies have shown that to achieve the maximum level of risk reduction in a stock portfolio, the portfolio needs to include somewhere between 25 and 30 appropriately different stocks from different industry sectors.

Many investors who invest in individual stocks do not construct and rebalance their portfolios to retain this level of diversification, and therefore end up accepting higher levels of risk than need be for the expected levels of return of their portfolios. Moreover, because the market assumes that all investors are rational and risk-adverse, markets will price risky assets under the assumption that investors will always act to diversify away risk. Therefore, in a nearly efficient market, investors who do not use diversification techniques to reduce risk end up accepting risk for which they will not be compensated.

While many investors look at portfolio construction with consideration of expected return, it is really an approach to risk management on the way to achieving the desired expected returns.


33

The simple example above addressed diversification and the corresponding risk reduction benefit from only a two-stock portfolio. Much greater risk reduction can be achieved through investing in a portfolio with a well-diversified mix of stocks, plus a well-diversified mix of assets from different asset classes, such as bonds, real estate, and cash equivalents.

As described, different asset classes can have widely varying responses to changes in the economy, interest rates, expectations for inflation, and other factors. By adding the appropriate amount of bonds, real estate, and cash equivalents, portfolios can be constructed with the desired attributes of expected return and expected risk. In this manner, the investor’s return objectives and risk tolerance can be pursued as efficiently as possible.

The Role of Bonds in Asset Allocation

In constructing a portfolio, long-term risk (volatility of return) can be reduced through diversification by including risky assets from a range of asset classes. Bonds, also known as fixed-income investments, represent one of the asset classes that should be considered for inclusion in a diversified portfolio.

Inside The Minds

34

Within the fixed-income asset class, there is a wide range of choices, with different risk, return, and maturity characteristics. These include U.S. Treasuries, investment-grade corporate bonds, high-yield (junk) corporate bonds, mortgage-backed bonds (GNMAs, etc.), and asset-backed bonds. A range of foreign issues are also available that can bring currency risk into play unless that exposure is hedged.

One factor that will affect a bond value is whether the borrower (the issuer of the bond) will be able to repay the interest and principal in a timely manner. Another factor involves whether the issuer can retire, or “call,” the bond if interest rates decline and the issuer chooses to refinance the bonds with new lower interest-rate bonds. Investors need to be aware of the credit quality of the fixed-income investments they consider for their portfolios, as well as the interest rate sensitivity characteristic of the bonds, the measure of which is referred to as “duration.”

Bonds represent a stream of cash flows to be paid in the future, so the current value of a bond is determined by the present value of the stream of cash flows. The present-value calculation is based on an interest rate used to discount those future values back to the present so they can be expressed as a value today.


35

If the interest rate used to discount the future cash flows rises, the present value of those future cash flows declines, reducing the value of the bond. If the interest rate used to discount the future cash flows declines, the present value of the bond increases. This inverse response to interest rate changes has a profound affect on the value of bonds.

During different phases of the economic cycle, interest rates may increase, decrease, or remain stable. The expectation for future interest rates will affect the value of bonds, not only in the calculation of their present value, but also with regard to expectations concerning at what future interest rate the periodic interest payments from the bond will be able to be reinvested.

Generally, investments in bonds can deliver capital gains if non-callable bonds are purchased in advance of interest rate declines or favorable changes in credit quality expectations, or both. Bonds can generally be expected to maintain their value and provide a steady stream of income if interest rates are expected to remain stable and there are no changes in credit-quality expectations. Bonds can lose value if interest rates increase or the creditworthiness of the issuer comes into question.

Inside The Minds

36

The percentage of bonds to be held in a portfolio, as well as the quality and maturity ranges of the bonds, can all be tactically increased or decreased based on the expectations for interest rates or changes in credit quality.

In addition to providing risk reduction through diversification and the opportunity for capital gains, bonds provide a stream of predictable cash flows for a portfolio. They can also provide the ongoing liquidity that some investors need, particularly those in retirement. Having bonds provide the liquidity an investor requires helps the investor avoid having to liquidate other assets at inopportune times, or other assets that have high transaction costs or low marketability. Further, using tax-free bonds can be advantageous for investors who are in a high tax bracket but still desire current income and wish to avoid liquidating long-term capital assets.

Consider Non-Financial Assets to Hedge Risk

As practitioners of Modern Portfolio Theory (MPT), we occasionally make appropriate use of selected non-financial investments or assets in portfolio construction for our long-term investor clients. Non-financial assets include but aren’t necessarily limited to real estate, real estate


37

investment trusts, energy (oil and natural gas) programs, managed futures (both financial futures and commodities), hedge funds, direct participation, and private equity investments. Obviously, some of these investments have stringent net worth and “suitability” requirements and should be considered only by high net-worth, experienced investors and always in moderate amounts in relation to the client’s overall holdings. Used in moderation, these non-financial assets can increase a portfolio’s overall return without any corresponding increase in the portfolio’s total risk characteristics. Here again, we’re counting on their “negative correlation” or dissimilar price movement behavior, to carry the day and out-perform during periods when traditional financial assets (stocks and bonds) experience downward pressure.

The following chart illustrates the diversification and portfolio return potential created by using non-financial assets (equity REITs) in the overall allocation.

Inside The Minds

38

Diversify to Reduce Risk or Increase Return Stock & Bond Investors 1972-2000

with 20% REITs

T-Bills10%

Bonds30%

Stocks40%

REITs20%

w ith 10% REITs

T-Bills10%

Bonds35%

Stocks45%

REITs10%

Risk: 11.2% Risk: 10.9% Return: 11.8% Return: 12.0%

Risk: 10.8% Return: 12.2%

Source: NAREIT

Stocks & Bonds

T-Bills10%

Bonds40%

Stocks50%


39

Some of these non-financial investments may have limited or no market liquidity, while others will have daily liquidity like publicly traded stocks or mutual funds. Liquidity in and of itself should not be a deal-killer. In volatile markets, you can actually make a strong case for the benefits of having a portion of your investment portfolio that doesn’t go up and down like a yo-yo based on unrelated economic events or consumer sentiment surveys. In general, we believe liquidity is a portfolio issue and not necessarily a specific investment issue. Few long-term investors need to have 100 percent liquidity in their investments 100 percent of the time.

Achieving Goals Without Professional Advice?

In today’s world of the Internet, discount brokerage accounts and training classes for day traders, it’s awfully tempting for individual investors to think “going it alone” is better. This was especially true during the late 1990s, when anything related to growth or technology was going great guns and all you had to do was show up to be declared a winner. After the tech bubble burst in the spring of 2000, individual investors and a good many seasoned professionals learned that volatility isn’t nearly as much fun on the way down.

Inside The Minds

40

Our financial planning practice has been contacted by dozens of former “do-it-yourselfers” who now have serious concerns about their long-term financial security. They all want to know how you go about building an investment portfolio that will guarantee them an adequate and increasing income stream for their lifetime without exposing their income capital to substantial risk of principal loss. This is good because that is exactly what financial advisors are uniquely qualified to do!

The Internet has become an incredible source of accurate, timely, and comprehensive data on every financial topic or investment, which has helped both individual investors and professional investment advisors do a better job evaluating specific investments and investment strategies. Although there are an increasing number of Web-based research and analytical tools, including artificial intelligence, or “advisor-in-a-box” software programs, none of these great applications will ever provide or come close to replacing the judgment and wisdom of a trusted and experienced financial counselor.

Planning for financial independence today requires a skilled and experienced financial advisor who understands the financial markets; the client’s personal risk tolerance; income, estate and gift taxes; retirement plan distribution


41

rules; insurance and risk-management issues; wills; trusts; and estate-planning strategies. It requires an advisor who can draw out the client’s deepest concerns and goals and weave all of this diverse and complex information into a clear plan of action clients understand and willingly follow.

I believe that as long as humans – not robots – are the investors, human nature will prevail, and the age-old emotions of greed and fear will drive financial markets along with investor behavior. In my opinion, individual investors will always benefit from the coaching and judgment of experienced financial counselors who conscientiously try to understand the goals clients want to accomplish with their money and their lives and who then create clear and disciplined approaches for their achievement.

Harry R. Tyler, president of Tyler Wealth Counselors, Inc. (www.tylerwealth.com) has successfully combined solid professional credentials with a personal approach for over 30 years. Tyler Wealth Counselors, Inc., a Registered Investment Adviser, was created to provide comprehensive fee-based financial plans for individuals and business owners.

Inside The Minds

42

For the past four years, Mr. Tyler was named one of the top 250 financial advisers in America by the editors of Worth.

He was one of only five financial planners in the country retained by Forbes magazine (October 1998) to create a written, comprehensive financial plan from the same case study provided by Forbes. He is also a contributing author to 21st Century Wealth, published in 2000 by Quantum Press, LLC.

Mr. Tyler’s education includes studies in business administration at St. Joseph’s University and the designation of Chartered Life Underwriter (CLU), the Graduate Certificate of CLU Studies in Advanced Estate Planning, Chartered Financial Consultant (ChFC) from the American College, and Certified Financial Planner (CFP) from the College for Financial Planning. He is also a member of the Financial Planning Association (FPA) and the ICFP Registry of CFP Licensed Practitioners. Today, Harry Tyler is considered to be one of the Delaware Valley’s leading financial consultants, advisors, and instructors.


43

TIMELESS TIPS FOR BUILDING

YOUR NEST EGG

CHRISTOPHER P. PARR

Financial Advantage, Inc. Officer and Principal

Inside The Minds

44

Lessons from a Homeless Shelter

After attending a seminar entitled “Reengineering Your Finances for a Smooth Career Transition,” sponsored by a local nonprofit, career networking organization, a man named Stan Booker approached the guest speaker, a young financial advisor, and asked if the advisor would be willing to speak to his organization. The advisor routinely mentioned that he spoke regularly at career fairs and meetings of civic organizations and local investment clubs. When the advisor asked for the name of the organization, Mr. Booker replied, “The East Oakland Community Project.” The advisor agreed to make the presentation and asked for a date. Mr. Booker mentioned he was not the contact person for the organization, but he would put an officer from the organization in touch to schedule the presentation.

At that moment, the advisor suddenly realized that Mr. Booker’s organization was a homeless shelter in the heart of the Oakland, California, projects, one of the toughest neighborhoods in the country, and that he was asking the advisor to address a group of about 50 homeless residents. Furthermore, Mr. Booker identified himself as one of the shelter’s residents!


45

The advisor immediately wanted to know what good it could possibly do to talk to homeless people about their financial matters. The content of the advisor’s presentation covered the basic building blocks of sound financial management, including setting goals, budgeting, establishing adequate liquid emergency reserves, sound debt management strategies, and tracking household net-worth. Unfortunately, from the advisor’s perspective, a homeless audience, by definition, is not in a position to focus on any of these issues. Their needs were perceived to be at a much lower level of basic survival, according to the classic Maslow’s Hierarchy of Needs.

Mr. Booker offered these three financial rules to follow that he gathered from the presentation he had just attended. He correctly perceived that these rules could apply to all, regardless of current financial status:

Wealth is accumulated gradually over time.

To accumulate wealth, one must understand the concept of delayed gratification.

All people, poor and wealthy, need to practice sound money management principles.

Inside The Minds

46

The advisor agreed to do the presentation. It was certainly an experience outside the general comfort zone of the advisor and requiring the advisor to meet at 7:30 p.m. at the shelter in the heart of Oakland’s ghetto. There were Maslow’s Hierarchy issues of basic survival for the advisor, as well!

Although this lesson took place in the early 1990s, the essence of Mr. Booker’s words of wisdom recently appeared in the best-seller The Millionaire Next Door. The authors, Thomas J. Stanley and William D. Danko, studied a broad sample of the affluent market and reached this conclusion: “The key to building wealth is not luck, inheritance, advanced education, or intelligence. Wealth is accumulated by hard work, careful planning, self-discipline, consistency, and personal sacrifice.”

Mr. Stan Booker is to be commended for challenging the advisor, who happened to be me, to make the presentation at the East Oakland Community Project. I was able to broaden my perspective and dispel several incorrect assumptions I had about the homeless. Being able to make a positive difference in several lives also rewarded me. Creating a positive change in just one person was enough to make this endeavor worthwhile.


47

A Closer Look at the Rules

1. Wealth is accumulated gradually over time.

If you are able to start early, accumulate savings in a steady, consistent manner over a long period of time, and invest prudently, you will find that your nest egg gradually evolves toward the goal of $1 million. The following rather simplistic exhibit reinforces the concept of starting early and saving over a long time horizon. The annual deposit amount has been rounded to simplify the exhibit. The table does not take the impact of taxes into consideration. It assumes all savings take place inside tax-deferred retirement accounts.

Years of Annual Savings

Annual Deposit Required

Annual Rate of Return

Future Value

5% Annual Withdrawals

40 $5,000 7.00% $1 million

$50,000

30 $10,600 7.00% $1 million

$50,000

20 $25,000 7.00% $1 million

$50,000

Inside The Minds

48

10 $75,000 7.00% $1 million

$50,000

A nest egg of $1 million can be conservatively invested to earn an average long-term rate of return of 7 percent. This portfolio, if prudently constructed, should be able to generate an annual lifetime pre-tax income stream in retirement of $50,000 per year, or 5 percent of the portfolio value, do a reasonable job of keeping up with inflation, and also conceivably not be depleted during the owner’s lifetime.

There is, however, a pitfall to be aware of in the oversimplified model. For the average family, $50,000 pre-tax income equates to perhaps $35,000 of net after-tax or disposable income. The point to make here is that a nest egg of $1 million is not an adequate long-term savings goal for many families because of the impact of taxes and inflation.

I selected a conservative return of 7 percent in the table above for these reasons: Over a long period of time (more than 75 years), according to Ibbotsen, stocks have averaged annual returns of more than 10 percent. Over the same time period, bond returns averaged about half as much, or 5.5 percent annually. Returns on cash and short-term


49

investments such as money markets have averaged 3.5 percent to 4.0 percent, and inflation has averaged about 3 percent. These numbers are not precise but, in my opinion, represent reasonable long-term expected (but certainly not guaranteed) returns. Markets behave in cycles and can exhibit very different returns and steep losses in interim periods of 1, 3, 5, or even 10 years. Based on the weighted averages of these returns, a portfolio of 60 percent stocks, 30 percent bonds, and 10 percent cash could be forecast to provide a total return of about 8 percent before taxes. A 60 percent stock portfolio may not be suitable for many retirees because of the downside volatility. Less exposure to stocks will lower both the portfolio risk and the expected return. The bottom line is that the assumption of a 7 percent return is relatively conservative, can be expected to have a spread over the long-term average for inflation of about 4 percent, and is a realistic conservative goal for long-term planning purposes.

2. To accumulate wealth, one must understand the concept of delayed gratification.

The key to building a nest egg lies in foregoing immediate gratification in favor of greater future benefits. A household’s total annual income, or economic “pie,” is only

Inside The Minds

50

so large. Income is either consumed, absorbed by taxes, or deferred for longer-term goals.

There are essentially three ways to increase savings and thereby accumulate wealth. The first option is to increase the size of the economic pie by generating additional income. For many families, this is not a feasible solution. The second option is to increase the return on investments. Unfortunately, this strategy is certainly not guaranteed to be effective and comes at the cost of higher uncertainty and risk. In any event, this is a dangerous strategy, but one that is practiced by many. The third option is to reduce personal consumption and spending on nonessential material items and redirect those funds into long-term savings.

My brother always challenged this point vehemently but is starting to mellow and “see the light” as he gets older and has increasing family responsibilities. His point of view is well taken and represented by the cliché, “Live for today – you may not be here tomorrow.”

In my opinion, the optimal position is one of balance. Saving for the future must be respected and cannot be ignored, but life’s activities and experiences are priceless. For example, it is important for young retirees to experience their fair share of travel, if this is a personal


51

goal, while they are healthy. Personally, against my father’s wishes, I used my entire life’s savings ($1,000) during my third year of college to take a study tour of France. The opportunity and experience of living in Paris for a month were priceless.

3. All people, poor and wealthy, need to practice sound money management principles.

A personal goal of saving 10 percent to 15 percent of gross annual income toward building your nest egg can be applied whether your annual income is $30,000 or $300,000. It is the steady, consistent discipline that ultimately makes a difference. During my years as a financial advisor, I have seen millionaires who live on $30,000 of disposable income per year. I have also seen high-powered executives in their 50s making hundreds of thousands of dollars in income each year with nothing to show for it except material possessions and incredible annual income tax bills!

Comprehensive Financial Plan – An Indispensable Tool

To effectively build a nest-egg, it is also essential to protect your growing nest-egg from unanticipated financial

Inside The Minds

52

disasters by the use of proper planning. The development and implementation of a comprehensive financial plan for yourself or for your family can provide the framework for a flexible, dynamic plan of action that:

Maintains focus on immediate, intermediate, and long-term financial goals Can potentially cut income taxes, improve cash flow, and reduce debts Establishes a suitable investment policy consistent with goals to balance risk and return Minimizes or eliminates the risk of unanticipated financial disaster Provides clear instructions in the event of incapacity or death for family and loved ones Helps minimize the risk of prematurely depleting assets during golden years

As the baby-boomers evolve from their peak-earning years toward retirement, they are starting to realize that a sound financial plan can have a major impact on their financial well-being. A well-crafted comprehensive financial plan provides unquestionable value. The major sections addressed in a comprehensive financial plan are:

Goals and Financial Summary


53

Tax/Cash Flow/Debt Management Education Funding Analysis Risk Management (life insurance, employee benefits, property and casualty, medical, long-term disability, and long-term care insurance analysis) Estate Planning Retirement Planning Investment Portfolio Analysis

It is quite common for a comprehensive financial plan to contain 20, 30, or more specific recommendations or action items. A single-page implementation checklist serves as the first page of the plan, providing a bullet-point summary of the key recommendations. It also helps tie the plan together and encourage implementation.

It is important to prioritize the action items and implement them accordingly. A plan that sits on the shelf and is not implemented is worthless. Once a comprehensive financial plan has been prepared and implemented, it is not necessary to go through this complete exercise annually. A particular section or module of the plan can be updated as major changes occur. For instance, the addition of a new family member requires an estate plan, education plan, and risk management review. Other typical life events that call for an update to a plan are a change in marital status, an

Inside The Minds

54

employment change, a death in the family, or a special needs analysis such as the terminal illness of a family member.

Some people prefer to develop a financial plan one module at a time, ad hoc. This is better than not planning at all, but it has a couple of major disadvantages.

First, some sections of the plan may be overlooked and never addressed. For example, it is estimated that perhaps 75 percent of the public does not have an adequate estate plan in place. Every adult should have an estate plan, regardless of the size of the estate or potential estate taxes.

Also, the parts of a comprehensive financial plan are integrated. This means decisions made in some areas can have a significant impact on other areas. For example, the decision to buy life insurance can cause estate tax consequences that require additional planning considerations. For another example, investment decisions can lead to unanticipated income tax consequences.

It is for these reasons that a comprehensive financial plan is recommended for those who have never been through the process.


55

Now that I have explained the need to invest on a regular basis and a few core principles that are essential to building and protecting your wealth, let’s focus on the issue of how to invest.

Your Investment Portfolio: a Shoe Box?

Most people have a tendency to make ad hoc investment decisions. Ad hoc investment decisions are those made in a piecemeal fashion as encountered. Under this common scenario, the investor has surplus cash available to invest, and an idea comes to mind. It may be a hot tip from a friend or co-worker. It may be the “flavor of the month” from a commissioned broker who is compensated on a transaction basis. At this point, the investor reaches a decision on which specific investment (stock, mutual fund, etc.) to purchase and simply executes the transaction.

While the process just described appears to be logical and straightforward, this style of investment decision-making leads to a more complicated issue we can refer to as the “shoe box portfolio.” The shoe box portfolio is a collection of multiple types of investments and accounts that tend to accumulate gradually over a period of time. Many of the

Inside The Minds

56

individual investment holdings could even be different versions of essentially the same thing.

Three serious problems face the investor with a shoe box portfolio:

A potential tax reporting nightmare Lack of a clear investment strategy directly related to personal goals such as saving for retirement, the purchase of a new car, or investing for a child’s future education Inability to manage or assess the risk and the investment return of the total portfolio

A more effective approach to the investment decision process is do exactly the opposite, by making the specific investment selection (the least important decision) last. The first step in the investment decision process is to develop a customized investment policy statement. The statement can be summarized on a single page but should take into consideration at least the eight critical investment factors listed in the following exhibit.


57

Goals

Time horizon

Risk

Liquidity

Diversification

Marketability

Tax consequences

Inflation impact

Critical investment factors

It is quite common for most investors to have multiple goals covering different time horizons, requiring distinct investment strategies for each.

Once the investment policy is established, the next step in the investment decision process is to determine which broad asset classes will be used in the portfolio. The broadest and most common asset classes to consider are cash, bonds, and stocks. The third step is to determine the appropriate allocation of investments to each asset class; that is, how much of the portfolio may be invested in stocks, in bonds, and in cash or equivalent short-term, liquid investments.

Inside The Minds

58

The next decision to be made is which sub-asset classes to include in the investment portfolio. Within the asset class of U.S. stocks, the investor, for example, could consider the sub-asset classes of large or small and growth or value. Each decision could have very different implications for risk and return. Sub-asset classes for bonds include government or corporate, high-quality or high-yield (low quality junk bonds), taxable or tax-exempt, and short, intermediate, or long-term.

Only at this point, after taking the above factors and considerations into account, should the investor be adequately prepared to make the final decision on which specific investments to choose.

Investment Risk – The Impact of Individual Stocks

The fastest way to accumulate portfolio wealth is to buy the stock of the best company you can find, invest all of your available capital, and sit tight until you eventually need to draw on your capital. Most people do not follow this approach because they realize no one can predict the future with any degree of certainty, and they are uncomfortable with the inherent risk. This concentrated strategy can be the fastest way to lose all of your wealth if you place a bad bet.


59

It is possible to reduce overall portfolio risk and volatility by creating a diversified portfolio. From the chart below, total investment risk can be divided into unsystematic risk and systematic risk.

Sources of investment risk...

BusinessRisk

FinancialRisk

UnsystematicRisk

MarketRisk

Interest RateRisk

PurchasingPower Risk

Exchange RateRisk

SystematicRisk

TOTALRISK

A truly diversified portfolio eliminates unsystematic risk. The first component of unsystematic risk is business risk. Business risk is risk that is attributed to a particular industry, competitive threats, and regulatory constraints. The second component of unsystematic risk is financial risk. Financial risk is related to the financial health of the company itself, its level of debt, and its cash flow, earnings, and profits.

Inside The Minds

60

When you purchase the stock or bond of a single company, unsystematic risk is an additional risk you incur. The professional investment community generally agrees that a basket of at least 20 to 30 different stocks must be held to minimize or perhaps virtually eliminate unsystematic risk from a portfolio. Keep in mind, however, that risk and volatility are an investor’s friends in a rising bull market. Some investors are perfectly willing to take on higher risk with the hope of achieving higher returns. A diversified portfolio will generally not lead to the highest returns over time, but should offer more stable and consistent returns than a portfolio that is not adequately diversified.

The second major category for investment risk is systematic risk, of which there are four types.

Purchasing power risk is the risk of inflation. Stocks have proved the best long-term hedge against inflation. It is prudent, therefore, for most investors to have at least some portion of stocks or stock funds in their long-term portfolios.

Interest rate risk refers to changes in market interest rates. When interest rates rise, bonds lose market value, and stocks quite often perform poorly, as well.


61

Market risk is related to the behavior of the market in general. In the long run, the stock market is driven primarily by the growth of earnings. In the short run, the market can be driven by irrational and emotional factors. Many individual investors do not realize how much the performance of a company’s stock depends on the behavior of the general market. The statistical term for this is beta. The best way to diversify against market risk is to hold different asset classes in your portfolio that behave differently (are not highly correlated). This strategy involves using a combination of cash, bonds, and stocks, or even other asset classes. Within the major category of stocks, an investor can further diversify by choosing among small cap, large cap, growth, and value stocks.

The last type of systematic risk is exchange rate risk.Exchange rate risk results from adding international investments to a portfolio.

It is impossible to eliminate systematic risk completely from a portfolio, but it can be reduced. If your investment goal is to implement a strategy of lower volatility and reduce risk, then mutual funds provide an excellent way for most investors to accomplish this by achieving adequate diversification in their portfolios. This is especially true for pensions, IRAs, 401(k) plans, and other tax-deferred

Inside The Minds

62

retirement accounts. Tax considerations are an important investment consideration, but should rarely be the most important factor in an investment decision.

For investors with taxable accounts who prefer to invest in individual stocks primarily because of tax concerns, what is the appropriate size of the total investment portfolio needed to achieve adequate diversification? At a recent investment conference, a nationally acclaimed speaker addressing the topic of prudent investment policy alluded to a portfolio size of at least $1 million as a starting point to consider using individual stocks over mutual funds. This cut-off is a reasonable rule of thumb for most investors. Given electronic trading and much lower investment transaction costs, perhaps a diversified basket of individual stocks becomes feasible for experienced investors with total portfolios of somewhere between $500,000 and $1 million.

Diversification and Correlation to Manage Volatility

In the new millennium, investors are by now uncomfortably familiar with the fact that the stock market does not always go up, and that short-term stock market performance can be quite unnerving. I once heard portfolio manager Louis Navellier refer to the three items in the


63

exhibit below as “stock market killers.” It is not necessary to have all three factors present simultaneously to experience market turbulence.

Stock market killers

Global Uncertainty

High Interest Rates

Poor Earnings

In a difficult investment environment, an investment strategy practicing broad diversification can pay off with reduced downside volatility. One way to accomplish this is by carefully selecting different types of investments (technically referred to as “asset classes”) that have low correlation.

Inside The Minds

64

Correlation is a statistical measure of how different investments behave relative to each other. It can range from +1.00 to -1.00. A correlation of +1.00 indicates perfect correlation. For example, rain and umbrellas have a correlation close to +1.00. Rain and sun have a correlation closer to -1.00 (but not absolutely -1.00, as an analytical engineer would surely be quick to point out). The correlation between rain and a cow is perhaps 0.00, implying that these two items are uncorrelated and have nothing to do with each other.

According to data provided by Morningstar, the average monthly correlation between technology-heavy NASDAQ stocks and bonds over a recent five-year period is only about +0.10. Bonds generally are not expected to outperform stocks in the long run. However, under present economic conditions and a relatively stable interest rate environment, bonds arguably offer competitive risk-adjusted returns. Increasing your exposure to bonds can increase yield and lower portfolio risk. In addition, bonds currently provide relatively high “real” returns of about 3 percent (after inflation) compared to historically beating inflation by only about 2 percent. I generally recommend using a combination of high-quality, short-term and intermediate-term bonds and avoiding high-yield (junk) bonds.


65

When evaluating bonds, it is important to keep in mind the spread over inflation and the general outlook for the direction of interest rates. Bond values fluctuate inversely with changes in interest rates. When interest rates rise, bond prices fall. Another important use for bonds is to provide a more stable return than stocks to meet short-term needs.

Another type of asset that has a low correlation with stocks is real estate, as represented by REITs (publicly traded real estate investment trusts). The correlation between REITs and NASDAQ was less than bonds during the same recent five-year period at +0.03, indicating almost no correlation whatsoever. Even though some investments exhibit periods of high volatility, investors can reduce the fluctuation in their total portfolio by selecting a mix of assets with low correlations to each other.

The asset class “Cash,” as measured by three-month Treasury Bills, actually has a negative (opposite) correlation to most types of stocks, including large cap, small cap, international, and technology. This is why permanently keeping a small portion of your long-term investment portfolio in cash-equivalent investments can reduce risk and actually enhance long-term returns by helping stabilize the downside.

Inside The Minds

66

Adding international stocks to a portfolio can still provide some diversification benefits and reduce portfolio risk because the United States represents less than half of the stock market capitalization in the world. Historically, the correlation between international stocks and the U.S. stock market was perhaps +0.40. With the increasing globalization of our economy and the dominance of large multinational corporations, the diversification benefits are no longer as pronounced. Recent correlation measures between international stocks and the U.S. stock market have increased to perhaps +0.75.

During the tremendous bull market in the U.S. during the 1990s, the U.S. was never the leading country in a particular year in terms of stock market performance. Since 1975, the U.S. has ranked only 7th as a country. International investing can be complex and treacherous, as anyone who has invested in emerging markets in the past few years can attest. To add international investments to your portfolio for the first time, a recommendation would be to stick with high-quality, large-cap, blue-chip international mutual funds with low expense ratios. In addition, the funds should be broadly diversified by country and by industry or economic sector.


67

TIPS – An Excellent Hedge Against Inflation

Long-term investors are well aware that traditional financial assets, such as stocks and bonds, perform poorly or even negatively during an extended period of high inflation. For example, according to research by the Vanguard Group, for the entire decade of the 1970s, inflation averaged 7.4 percent annually, while stocks (S&P 500) returned only 5.8 percent, and bond returns were around 6 percent to 6.5 percent, depending on the type of bond. A common problem for retirees is how to protect their financial resources. An aggressive portfolio of stocks may be expected to produce the highest long-term returns, but is also subjected to the most short-term downside risk. On the other hand, a portfolio that is too conservative may contain a high allocation of bank CDs and bonds that may not adequately protect against the risk of inflation.

Recognizing this dilemma, the U.S. Treasury introduced government-guaranteed Treasury Inflation-Protection Securities (TIPS) in 1997. TIPS are bonds whose return is indexed to inflation so that they guarantee a real rate of return. TIPS pay interest semi-annually, based on an inflation-adjusted principal value. When the bonds mature, they will pay the greater of their original principal value or the inflation-adjusted principal.

Inside The Minds

68

For example, an inflation-indexed Treasury Bond maturing in January 2008 has a current real yield of about 4 percent. This means the bond will effectively yield 4 percent plus the rate of inflation. Inflation currently ranges from about 2.5 percent to 3.0 percent. For comparison purposes, since 1926, inflation has averaged about 3 percent, and government bonds have had nominal returns of just over 5 percent. The historical real yield on government bonds has therefore been about 2 percent (5 percent minus 3 percent). TIPS are currently a bargain because inflation is currently not perceived as a major threat.

There are four primary advantages of TIPS. First, TIPS provide greater diversification than traditional stock and bond investments because they have low or even negative correlation to these assets. In other words, TIPS behave differently. The second advantage is that TIPS provide lower risk than traditional bonds with similar maturities. TIPS are less volatile. Third, TIPS provide a fixed U.S. dollar pre-tax return that will keep up with inflation. If actual inflation exceeds expected inflation, TIPS will pay a higher rate of return than traditional U.S. Treasury Bonds. Finally, for investors with most of their portfolios invested in traditional financial assets, adding TIPS to the portfolio can lower risk and increase returns of the entire portfolio across the risk-return spectrum (technically referred to as


69

the efficient frontier). Recent academic studies have gone as far as recommending that TIPS be considered a separate asset class because of their unique behavior relative to other asset classes. TIPS can handily outperform traditional bonds in a steadily rising interest rate environment.

There are several issues to be aware of before investing in TIPS. Because of the way TIPS are taxed, it is best to hold TIPS only in tax-deferred accounts, such as retirement plans and IRAs. Taxable accounts will receive a 1099 statement annually for the inflation-adjusted income and must pay tax on this income, even though it is not received in cash, but is added to the bond’s underlying value.

A second issue is that because these bonds are adjusted periodically for changes in inflation, semi-annual interest payments will vary, unlike traditional fixed income investments. In a period of disinflation or deflation, TIPS will underperform traditional bonds. If the inflation index falls, the principal value of TIPS will be adjusted downward, and interest payments will be reduced. However, if deflation reduces the principal below par, the investor will still receive par value at maturity.

Inside The Minds

70

To summarize, investors who seek a low-risk, inflation-protected strategy should strongly consider adding Treasury Inflation-Protected Securities to their portfolio.

Understanding Cost Components of Mutual Funds

The baby boom generation is starting to shift its focus from consumption and spending to savings and investment. The key driver of this change could be the threat of a life of poverty in retirement. On the other hand, perhaps major household expenditures, such as a home purchase and children’s education expenses, have been completed at this point, and more cash is available to build a long-term investment program.

In any event, it is certainly clear that more and more money is flowing into mutual funds regularly. It is important for all investors to have a general understanding of the potential cost components related to investing in mutual funds and to minimize these costs. Here is a brief summary:

Mutual fund expenses can be split into two major categories: transaction expenses and operating expenses. Transaction expenses are the fees charged to the account at the point where a transaction takes place. One type of


71

transaction expense is trading costs. Some mutual funds have a modest cost charged when a fund is bought or sold. This is a cost to process the order that is passed on by the fund to the account holder.

A second type of transaction expense is a “load.” The front-end load is a commission paid by the account holder at the time of purchase. A related charge is a deferred load (also referred to as back-end load). The deferred load is payable when the mutual fund is sold. Some deferred loads gradually decline over a period of a few years. A load (front or back) can typically be 5 percent of the value of the transaction. Another type of transaction expense is an exchange fee, which can be assessed when switching from one fund into another. The last type of transaction expense is a reinvestment expense. This fee can be assessed as dividends are earned by the fund, and then used to purchase additional shares of the fund.

Operating expenses are the second major category of mutual fund expenses. These charges are incurred annually and represent the typical costs of doing business for the fund. Operating expenses are not paid directly by the shareholder, but are paid by the fund. Thus they represent a hidden cost to the mutual fund shareholder. The primary operating expense component is the management fee,

Inside The Minds

72

which represents compensation to the fund’s investment advisor. Other operating expenses are administrative charges paid to custodians and transfer agents. The management fee and other operating expenses combined are commonly referred to as the mutual fund’s expense ratio.

Another operating expense is a 12b-1 fee. This fee has nothing to do with the quality of the mutual fund, but instead is assessed by some funds to support marketing and sales distribution functions. The 12b-1 fees are used to compensate brokers.

There are, of course, true no-load funds that do not charge loads or 12b-1 fees. Numerous studies have consistently shown that the load issue has nothing to do with the quality of the management of the fund. The important issue is an investor’s net return after all transaction costs, expenses, and loads have been paid.

It is also important to compare fees among similar kinds of funds. For instance, it is not reasonable to compare a large cap domestic fund with an international fund because the latter will have higher transaction and research costs. When considering adding a mutual fund to your portfolio, it is important to be aware of all its associated costs.


73

Tax-Deferred VAs – When Do They Make Sense?

Tax-deferred variable annuities are currently one of the fastest growing types of financial products. They must be issued by insurance companies, but can be sold by banks, insurance companies, credit unions, and brokerage firms.

These accounts are actually not investments, but insurance products that include an investment feature (like a mutual fund). If your goal is to find a suitable investment, why not just buy the investment directly and avoid paying for the added insurance expenses? It is appropriate to use insurance products prudently to insure against the possibility of catastrophic losses, or proactively to solve potential estate tax problems. But it is usually not a good idea to use insurance products as a substitute for a straight investment because of the added layer of expenses.

Tax-deferred annuities are sold by many “financial consultants” who earn substantial commissions from the sale. If a tax-deferred variable annuity makes sense for your situation, consider purchasing the annuity directly from a reputable no-load (no sales commissions) company.

Tax-deferred annuities generally make sense for investors if the following conditions can be met:

Inside The Minds

74

1. The investor is in a high marginal tax bracket. 2. The investment time horizon is ideally 15 years or

greater. 3. The funds are not needed before the age of 59. 4. The initial investment amount is at least $25,000 (to

minimize expenses). 5. Contributions to an employee retirement account have

been maximized. 6. Deductible or non-deductible IRA contributions have

been made for the current tax year.

Let’s weigh both sides of the issue. Some common justifications for favoring tax-deferred annuities are:

All earnings compound tax-deferred. An annuity can provide an income stream for life. Unlike traditional mutual funds, annuities may allow a tax-free exchange among different mutual fund options. Unlimited contributions can be made - unlike IRAs and retirement plans. Guaranteed principal (the amount you contributed) is returned at death.

And here are the disadvantages of tax-deferred variable annuities:


75

Annuities can be very expensive. In fact, the costs can exceed the tax benefits for many investors. Earnings are taxed as ordinary income at withdrawal instead of at more favorable capital gains rates. This becomes an even greater issue under the recent tax law changes that favor lower long-term capital gains tax rates. There is a 10 percent IRS penalty for withdrawals from tax-deferred annuities before the age of 59. Investors are unable to borrow against annuities or use them as collateral. Initial contributions are not tax-deductible.

Tax-deferred variable annuities can be expensive insurance products. As investments, they are not very liquid before age 59, because of IRS penalties and the potentially steep surrender charges. These accounts can appropriately be used as supplementary retirement accounts after all other alternatives have been maximized. Because of the high initial costs and the ongoing annual expenses, tax-deferred annuities should only be considered for long-term investments, ideally of 15 or more years.

Another very important consideration is the financial health of the issuing insurance company. This is especially

Inside The Minds

76

significant because of the long time horizon. Generally, only top-rated insurance companies should be considered.

On a final note, many people are being sold tax-deferred annuities for their tax-deferred IRA and 401(k) accounts. This is not an appropriate strategy, since these accounts are already tax-sheltered.

Surviving a Bear Market

It is impossible to make the call precisely when bear markets hit bottom and begin to turn around. We do know the stock market is a leading indicator of the direction of our economy, usually by about six to nine months. As such, stocks tend to reach the trough around the mid-point of an economic slowdown.

Here are five steps investors can take to weather stock market turbulence:

1. Distinguish financial resources required to meet short-term goals from long-term goals.

2. Understand your portfolio liquidity needs and cash-flow requirements.


77

3. Be aware of how volatile your investment portfolio becomes in percentage terms relative to the risk of the overall stock market.

4. Modify your investment plan by reducing exposure to stocks if your needs have changed, or if you are uncomfortable with the current volatility of your portfolio.

5. Stick to your long-term investment plan if you have sufficient financial resources to meet immediate needs and you can accept a higher degree of risk with funds targeted to fund long-term needs (of greater than three to five years).

The 10 Most Common Investment Mistakes

1. Swinging for the Fences

Many investors gravitate toward investments offering the highest potential returns while ignoring their associated risks. If your portfolio loses 50 percent of its value during a bear market, it will take a gain of 100 percent just to return to break-even status. As I demonstrated at the beginning of this chapter, a steady, consistent, conservative return will eventually lead to the accumulation of a $1 million nest

Inside The Minds

78

egg. It is just as important not to lose 20 percent, 30 percent, 50 percent, or more of your portfolio along the way. This strategy may lack excitement, but will allow you to eventually reach your goal while sleeping comfortably at night. The goal of a well-diversified, balanced portfolio is to reduce market risk while earning a reasonable return.

2. Using Stocks to Meet Short-term Cash Needs

Funds that are absolutely required to be on hand to meet a specific need in less than three years – or more prudently five years – should not be invested in stocks or stock mutual funds. Examples of needs could be car replacement, the down payment on the purchase of a home, or even plans for a major vacation. The logic behind this is simple. Stocks are quite capable of losing 30 percent or more of their value in a rather short length of time. When these periods of volatility occur, the odds are that you will not escape the carnage. Based on historical data, it often takes two to four years to recover from a major market setback. When your goal is short-term, it is more important to protect your resources than to reach for higher returns. Money market funds and short-term bond funds are two ideal places to park short-term cash.


79

3. Lack of Depth on the Bench

Diversification is the key to managing total portfolio risk and volatility. A portfolio containing primarily U.S. stocks will perform exceptionally well during bull market periods in the U.S., but will also carry significant exposure to downside U.S. market risk. Reallocating funds moderately between asset classes that have a low correlation to the U.S. stock market can potentially reduce portfolio volatility without significantly sacrificing long-term portfolio returns.

4. Keeping Most of Your Eggs in One Basket

A concentrated investment strategy is the quickest way to accumulate wealth, as long as you make the correct investment decisions. It is also the quickest way to lose wealth if you make a poor investment choice. A general guideline is to limit any individual stock to 5 percent or less of the stock portion of your portfolio to achieve adequate diversification. An allocation above 5 percent is justified if you have a sound understanding of the unsystematic risk of the specific investment, including company and industry factors, and are confident that this particular investment can outperform the broad market or other alternatives.

Inside The Minds

80

5. Failing to Think Globally

I previously mentioned the impact of the global economy and the diversification benefits of investing abroad. Academic studies consistently demonstrate that a 15 percent to 25 percent allocation to international funds in the stock portion of a portfolio (not of the total portfolio) can actually reduce portfolio risk and sometimes enhance returns.

6. Tying up Too Much Capital in Low-Return Assets

It is quite common for investors to gradually accumulate large sums of cash in low-return bank checking, savings, and money market accounts. Invest some of the excess cash or permanent cash portion of your portfolio in high-quality, short-term or low-duration bond funds with low expense ratios to enhance returns.

7. Avoiding Paying the Government At All Costs

Here are three common tax-related mistakes investors make:

Focusing on tax advantaged investments instead of after-tax returns. Investors often become obsessed with trying to


81

avoid paying taxes. A tax-exempt investment must be analyzed on a case-by-case basis to determine whether it makes sense in a particular situation. The best way to do this is convert all returns to after-tax dollars. For the average investor, it may be possible to net more after tax by investing in a comparable taxable investment, rather than the tax-exempt investment. You have to run the numbers to find out.

Making tax reduction or avoidance the most important investment factor. A real example can best summarize this problem. The prudent financial advisor carefully articulated the recommendation that a young high-tech client liquidate one third of a $1.5 million position in highly appreciated stock of a single technology company. The stock represented 85 percent of the client’s personal wealth. The client declined the advice on the grounds that the company was solid with a great future and that the sale of stock would trigger realizing a capital gains tax payment of 20 percent, or $100,000. Within six months and a major bear market, the $1.5 million had been reduced to $500,000. A million dollars in wealth evaporated virtually overnight! The only good news was, of course, that not a penny of it went to the government in the form of capital gains taxes. By the way, this particular story also supports the case for

Inside The Minds

82

not putting all of your eggs in one basket. Nudge-nudge, wink-wink, say no more!

Creating a tax-inefficient portfolio. A portfolio can be restructured to be more tax-efficient by holding the income-generating portion of the portfolio inside tax-deferred accounts, such as retirement plans. Also consider using a basket of individual stocks or tax-efficient mutual funds, such as index funds in taxable joint accounts. This will minimize the tax problem of year-end taxable mutual fund distributions.

8. Investing Based on Hot Tips and Rumors

Following this investment strategy is the quickest way to accumulate a shoe box portfolio. There are several problems with this approach, beginning with the reputation of the source of the advice. The second problem is that of placing individual security selection as the highest priority ahead of your personal goals, time horizon, tolerance for risk, and all the other critical investment factors that make up a personal investment policy statement. As mentioned earlier, individual security selection is actually the last issue to be addressed.


83

9. Stretching for High Yield at the Expense of Quality

Income-oriented investors are frequently attracted to the promise of high-yielding investments. It is important to mention that investment returns have two components. One is the income, or yield, that is generated in the form of interest or dividends. The second is capital appreciation or depreciation (loss). Total return, the sum of these two factors, is the bottom line and all that counts. If an investment advertises a yield that seems too good to be true, it probably is. Yield means nothing if your entire principal is lost.

10. Taking More Risk Than Needed to Meet Your Goals

Do not take more risk than you need to take to meet your goals. This is without a doubt the most important piece of investment advice I have ever heard. As wealth increases, it becomes more important to protect what you have while earning a reasonable return, rather than focusing on achieving the greatest absolute return and taking excessive risk. If you retain only one idea from this chapter, this should be it.

Inside The Minds

84

Seeking Financial Advice

I hope this chapter provides some insight to you from a different perspective, and that you gain a few valuable ideas you can implement.

Some readers may have more complex issues and may desire to seek the services of a financial advisor. If so, the National Association of Personal Financial Advisors (NAPFA) is a nonprofit organization dedicated to advancing the practice of fee-only financial planning. NAPFA’s brochure, “How to Choose A Financial Planner,” is an excellent starting point for evaluating potential advisors. The organization can be reached at 1-800-FEE-ONLY or www.napfa.org and can provide a list of financial advisors who meet its stringent membership requirements by state. All members must accept fiduciary responsibility to their clients and offer objective, unbiased financial advice, and are prohibited from earning commissions from the sale of financial products.

Christopher P. Parr holds an MBA degree in finance from Loyola College in Maryland, and earned his BA degree in economics from Western Maryland College. In 1993 he was awarded the Certified Financial Planner designation


85

(CFP) by the College for Financial Planning in Denver, Colorado. Mr. Parr has been recognized by Medical

Economics magazine as one of the nation’s “150 Best Financial Advisors for Doctors,” and was selected for the third consecutive year by Worth magazine as one of the nation’s “250 Best Financial Advisors.” For more information, he can be reached at www.FinancialAdvantageInc.com.

Mr. Parr started his career in commercial banking in 1980. His corporate career covered 11 years of financial services industry experience. His responsibilities included managing an $80 million budget, strategic planning, forecasting, information systems, mergers and acquisitions analysis, and operations reengineering.

Mr. Parr founded PARR Financial Solutions following relocation to the San Francisco Bay Area in January 1992. The firm provided fee-only comprehensive financial planning and investment advisory services. The firm also provided strategic planning and management information systems (MIS) consulting services to several major software firms in Silicon Valley.

In 1995 Mr. Parr returned to Maryland with his family, where he subsequently launched Maryland operations for

Inside The Minds

86

Parr Financial Solutions and experienced very rapid growth of demand for his professional services. In April

2001 Mr. Parr successfully merged Parr Financial Solutions into Financial Advantage, Inc. He is an officer and principal of the combined entity.

Mr. Parr is a member of the National Association for Personal Financial Advisors (NAPFA). He currently serves on NAPFA’s Ethics Committee and has made a number of presentations on financial planning topics to regional and national gatherings of professional advisors.

Having written articles for many national publications, Mr. Parr has been quoted by Accounting Today, The Baltimore Sun, Black Enterprise, Financial Planning Magazine, Investor’s Business Daily, Kiplinger’s Personal Finance Magazine, Medical Economics, Physicians Financial News, and The Daily Record. He serves as a volunteer on the Howard County Board of Directors for the American Red Cross, is past chairman of his church finance committee, and recently served as advisor to a nonprofit organization dedicated to helping the homeless become self-sufficient. Mr. Parr, his wife Diana, and their two children live in Clarksville, Maryland.


87

IT’S NOT WHAT YOU MAKE –

IT’S WHAT YOU KEEP

THAT COUNTS

JERRY WADE

Wade Financial Group President

Inside The Minds

88

Have Faith in the Future

Investors and the news media tend to over-complicate what it takes to become a successful investor and build a $1 million dollar nest egg. You don’t need to spend lots of hours, be a day trader, or become an investment expert yourself. The 10 most important rules are:

1. Have a positive long-term bullish attitude. 2. Establish a written game plan to achieve your goal. 3. Avoid mistakes. 4. Recognize that market timing does not work. 5. Don’t let your success be eroded by income taxes along

the way. 6. Position your portfolio for success, not failure. 7. Recognize that past performance isn’t enough. 8. Recognize that lots of people just want to sell you

something. 9. Identify the independent sources of personal advice that

can help educate you on your journey. 10. Slow and steady wins the race.

Each of the above steps is simple; yet collectively they are not easy to achieve. The keys I will share with you can help you build a $1 million dollar nest egg – and then keep it!


89

Why You Should Be Profoundly Bullish Long Term

Optimism will always yield better long-term results than pessimism. Progress is exponential. People assume progress is linear. Progress is always exponential. We too often underestimate human ingenuity and the future. It is too often assumed that problems are exponential and human ingenuity finite. It is not the earth, but people, that produce food. Since humankind’s first steps, we have dreamed of flying. We finally flew, and then within a short time were on the moon. Progress is exponential.

Progress is just getting started. Humans have been walking for about 100,000 years. Compress that into one 24-hour day and it goes something like this:

Midnight to 10 p.m. we are hunter-gatherers. 10 p.m. to 11:57 we are farmers and craftsmen. The industrial age, from the late 1700s, is about three minutes old! And the microprocessor, the single greatest human technological achievement, was invented 19 seconds ago in 1971!

Long-term bearishness is counterintuitive – it is the exact opposite of the trend of your entire life. When Russia and

Inside The Minds

90

China are switching to capitalism, then you have to think as a long-term bull.

Faith in the future is the essence of becoming and remaining an investor. Fear of the future is the essence of becoming and remaining a saver.

Think Big – Goal Setting

Accumulating a $1 million dollar nest egg is a big, yet achievable, goal for most Americans. It comes down to some basic ingredients with the following formula:

The number of years you have, times the amount you can invest annually, times your rate of return, less the taxes you have to pay, equals what you will end up with!

Let’s look at a couple of examples:

You are married, and your total gross annual income together is $70,000. With your and your employers’ 401(k) contributions, you put away 15 percent of your income pre-tax ($10,500) via your paychecks. On an after-tax basis you


91

then invest 10 percent of your gross income ($7,000). In 10 years you will have accomplished the following:

8 percent return: $253,000 10 percent return: $278,000 12 percent return: $307,000

You will note there is not a huge difference in the amounts at 10 years; the big factors above are time and annual contributions. Let’s see what happens when we extend the time to 20 years:

8 percent return: $800,834 10 percent return: $1,002,312 12 percent return: $1,260,947

By adding 10 years, we hit the goal in two of the above return scenarios. Also note the large impact of compound interest on the end accumulation amounts.

I could go on and on with countless examples, but the bottom line is this: Your life’s personal and investment destiny is in your hands. Starting as young as you can and investing as much as you can, combined with avoiding mistakes along the way, leads to the million-dollar pot of gold. Many great Web sites can assist you in calculations

Inside The Minds

92

for your personal situation. Good ones include quicken.com, retire-smart.com, and troweprice.com.

You know the clichés, such as “No pain, no gain.” Money isn’t going to fall off a turnip truck into your lap. You have to take the old-fashioned approach: Earn it first, and then stow it away.

My rule of thumb is if you are willing to save and invest 25 percent of your gross income, almost all of your financial goals can be achieved. If you are not willing to do that, then accept that in retirement you may end up living in a trailer park, clipping coupons for groceries, with a supply of $9-a-case beer in Little Rock, not in a condo on the golf course in Ft. Myers, sipping piña coladas!

Limit Mistakes

I have spent much of my career as an investment advisor helping investors undo past investment mistakes and avoid making new ones. That said, I also believe we learn from our mistakes. So the key for you is to not keep repeating the same investment mistakes. I often tell invertors at seminars, “If you wonder where the hole came from in your foot, you need look no further than the smoking gun in your


93

own hand!” Most investor mistakes are self-inflicted wounds often based on over-confidence and greed.

One mistake investors often make is getting too greedy, thinking the stock market can provide a 25 percent rate of return annually. While that may happen for a couple years, it’s not realistic. No greater than a 12 percent return should ever be assumed in running projections on your $1 million dollar nest egg goal. Another mistake is just the opposite – being too conservative, investing 40 percent of your portfolio in cash or bonds, but expecting your portfolio to perform in line with the stock market.

One of the biggest mistakes you as an investor can make is losing too much of your annual investment return to income taxes. Mutual funds are the most popular investment structure for most people to begin building their $1 million dollar nest eggs. According to Morningstar, a financial research firm, the typical stock mutual fund is only 85 percent tax efficient. That means for every 10 percent in annual return, 1.5 percent is lost to income taxes, reducing the return to 8.5 percent. Using our 20-year example and adjusting for taxes, the following happens:

Inside The Minds

94

8 percent return: $800,834 before tax; $602,260 after tax

10 percent return: $1,002,312 before tax; $846,597 after tax

12 percent return: $1,260,947 before tax; $1,061,039 after tax

Let’s do one more thing. We will assume that five years into the 20 year investment program, you get a bit greedy and take $50,000 of your portfolio and try to “hit a home run” with what you have concluded is a solid opportunity to really get ahead, maybe doubling your $50,000 in one or two years. My experience has been that most of the time, these “sure things” blow up on investors, and you end up asking yourself, “How could I have been so dumb?” The cumulative impact of taxes and making a greed-based mistake is illustrated below:

12 percent return: $1,260,947 before tax; $1,061,039 after tax; $898,180 after $50,000 mistake


95

Market Timing Does Not Work

During market corrections and the associated media hype, I always see an increase in the number of clients asking if we can move them out of stocks and move them back in when things look better. This is the old story that bears repeating. To achieve building your $1 million dollar nest egg, your goal is to buy low and sell high, not buy high and sell low. The bottom line from academic studies is that for market timing to be successful, the investor needs to be right 70 percent of the time to break even with a buy-and-hold strategy over a long period of time.

In baseball, a player gets into the Hall of Fame with a .350 batting average. In basketball it takes a 50 percent shooting average. In the money management business, it is hard enough to pick the right players (stocks), let alone predict the “short-term weather” in the stock market. I am always searching for managers who are good stock pickers. I spend no time looking for managers who claim to be able to time the market because there are none. In almost all instances when a client has chosen to modify their long-term account strategy, we can look back and see that what took place was the opposite of what they thought was going to happen.

Inside The Minds

96

There are countless newsletters and self-professed gurus who claim to have a system for telling you when to get in and out of the stock market. In some cases, they may have been correct with one, or even several, of their predictions. The problem is that since the beginning of the stock market, no one has been able to develop and sustain a system that in the future can work as well as it may have luckily worked in the past. You are much better off adopting a starting investment strategy based on being predominantly invested in the stock market and riding out the ups and downs.

A study by SEI Investments demonstrates the degree of difficulty required for market timing to prove successful. SEI’s study of stock and U.S. Treasury Bill returns from 1901 to 1990 indicates that you need 69 percent accuracy on timing between the two asset classes (stocks and cash) vs. a constant asset allocation strategy. This assumes that investors subscribing to the “I can help you time the stock market” newsletter instantly receive their newsletter from their “timing guru” and implement the suggestions instantly. In reality there is a lag between when the gurus forecast a move and when the investor actually implements. A one-month time lag is typical, which then requires a 91 percent accuracy rate to beat a buy-and-hold strategy. Don’t try to time the market. That is a loser’s game.


97

The Problem of Taxes

Einstein believed compound interest was the “Eighth Wonder of the World.” Avoiding taxes while compounding via tax deferral amplifies the benefit. Over the long term, investing in such a way that you avoid or defer taxes allows you to accumulate more money. That’s because you get to postpone current taxes until later and use Uncle Sam’s zero-interest loan to earn money for you.

A long-term investment strategy should include controlling the taxes you pay and taking full advantage of the tax reduction techniques legally available to you. These include employer 401(k) plans and tax efficient or tax controlled investment accounts.

Paying less in taxes equals faster goal achievement. I believe the art of investing to be the philosophy of “It’s not what you make – it’s what you keep – that counts.” What good is achieving a 10 percent rate of return if you have to give away 2 percent annually in taxes? The more your annual return is eroded by taxes each year, the longer it will take to achieve your first million.

Many regular mutual funds are notorious for distributing short- and long-term capital gains and dividend income

Inside The Minds

98

annually with little attention given to the taxes that will have to be paid by shareholders. It is possible for you to lose 10 percent in value in a given stock mutual fund for the year and still pay taxes because you held the fund. This doesn’t seem fair, but that is the case for many stock mutual funds in down market years. This is the result of managers selling stocks at a gain during the year, that they bought many years ago – before you bought into the fund. These gains are passed on to the shareholders of the mutual fund. You should evaluate the distribution estimates from mutual funds held in your portfolio each year and consider selling those in which a large distribution is expected. You can then use the proceeds to purchase a similar mutual fund whose distributions are expected to be much smaller, resulting in a smaller tax bite on April 15.

The odds of the average “active” large cap money managers beating the S&P 500 on an after-tax basis are poor for the following reasons:

There is no research advantage now that we have the Internet. Research that used to cost tens of thousands of dollars per year is now available at Yahooforkids.com for free. Management expenses place the manager 1 percent to 2 percent behind the competitive index.


99

Less than 50 percent of large company (blue chip) managers are able to match or exceed the performance of their index benchmark on a before-tax basis.Less than 20 percent of large company (blue chip) managers are able to match or exceed the performance of their index benchmark on an after-tax basis.

Controlling Taxes

So how do you reduce the tax burden of investing in mutual funds? The answer is to construct a tax efficient or tax controlled portfolio strategy, with the largest position in the account being a large cap index manager or a tax managed large cap manager that tracks the S&P 500 index very closely. Doing this will beat most mutual funds that you will ever consider, as they are destined to underperform the after-tax performance of the broad U.S. stock market, as measured by the S&P 500 index.

Tax efficient accounts should be constructed as follows:

Choose an index or tax managed large cap U.S. equity manager as the primary large cap stock allocation in your account. This type of manager minimizes dividend income and taxable capital gain distributions, but does

Inside The Minds

100

not sacrifice performance. This results in better net performance, after taxes are considered. Choose a municipal bond fund for the bond portion of your account. This allows you to avoid federal income tax consequences on this portion of the account. While indexing the large cap portion of your stock portfolio will give you a tremendous advantage, there is still a research advantage in other market sectors, such as small stocks, foreign stocks, and emerging markets. The remainder of your account should be diversified via actively managed taxable bond funds and small cap U.S. equity and foreign equity funds, where appropriate, to provide additional return potential.

Wade Financial Group, Inc.’s research indicates that on a long-term basis, a properly designed tax efficient account has the potential to improve net after-tax returns by approximately 0.5 percent to 1 percent annually. As discussed earlier, every 0.5 percent will help you in your quest to accumulate your $1 million nest egg.

While tax efficient strategies are great, tax controlled strategies can take portfolio tax management to the ultimate level. Depending on an investor’s tax bracket, overall investment portfolio, and market environment, tax controlled accounts can eliminate the 1 percent to 2 percent


101

most investors lose to taxes annually and may potentially add a hypothetical 1 percent to 2 percent per year to an investor’s annual average net return over a long time period.

Tax controlled accounts offer taxable investors access to an experienced tax controlled manager that can construct a personalized portfolio (I like to call this your own private mutual fund) of U.S. stocks for the large cap U.S. stock allocation of an account. This manager, in addition to minimizing net gains passed through annually, can also pass through net realized losses, which mutual funds can’t. Tax controlled investing represents a unique opportunity for investors.

Building Your Portfolio

Along most of the way to building your $1 million dollar nest egg, mutual funds should be your primary investment vehicle. They offer the widest choice, controllable expenses, diversification, and professional management. This can be supplemented by professionally managed stocks (not managed by you), once you get above $250,000. Avoid the temptation to pick your own stocks. Let professional money managers determine which sectors

Inside The Minds

102

and stocks should be picked. Your time should be spent hiring a fee-only investment advisor to assist you with picking the fund managers for your portfolio.

Think of this as if you were the owner of a professional sports team. Would you feel qualified, as the owner, to pick the players and coach them? If you attempted this, your season would probably be a disaster. Why then do investors think that with over 10,000 mutual fund choices, they are qualified to figure out which 10 funds are the best for them? Your job as team owner is to interview and hire the right coach for your investment team and allow them to hire and coach the players for each position on the investment team – and then let them do their jobs. Some years certain players will have better seasons than others. Your goal is to have a winning record. Your job is not to think you are talented enough to coach the team and play all the positions on it.

While some investors seem convinced that they need to spend hours each week working on their investment portfolio, many studies have shown that more time and frequency of trading actually decrease your rate of return over a 10-year period. Again, your job is to hire the professional investment advisor and managers, monitor their performance on an annual basis, and expect that they


103

are performing in line with the agreed upon benchmarks for your portfolio.

Many investors believe that popular investment magazines are a great way to stay abreast of financial matters and can help with picking investments. Recognize that these magazines are in the business of selling advertising and magazines. Their “top ten stocks or mutual funds to buy now” covers have proved time and time again to offer performance that strays behind that of the chimpanzees used in the Wall Street Journal to pick stocks.

Don’t spend too much time trying to figure out where the market is headed. All the historical evidence shows that on a 10-year-plus basis, the trend of the stock market is up, and in almost all decades over the past 150 years, stocks have beaten bonds, and bonds have beaten cash. The key is to have a diversified portfolio, tilted toward stocks if you want to have any chance of achieving a $1 million nest egg. Ignore the doom and gloom preached by the hysterical financial media.

The information that follows contains what I believe to be the primary asset classes you should include in a properly diversified portfolio to increase your odds of achieving your $1 million nest egg quickly. I have also included

Inside The Minds

104

several funds in each category that I believe to be outstanding choices to consider.

Cash/Money Market

Depending on the interest rate environment, money market funds typically yield from 2 percent to 7 percent in most economic cycles. The beauty here is safety of principal. The negative is the low long-term return, coupled with these funds being fully taxable for non-IRA investors. Funds to consider: Schwab, Strong and Olde.

Fixed Income/Bonds

You can find bond mutual funds in all shapes and flavors. We recommend that taxable investors choose intermediate-term, high-quality municipal bond funds. For IRA investors, look for a “Core” bond fund that is of high quality with a low expense ratio and a good track record. Funds to consider: Municipal: Sit Tax Free, SEI Intermediate, and Eaton Vance; Core: Pimco, SEI, and Strong.


105

Multi-Asset/Hybrid

This category is where you generally find funds that claim to have some method of timing the market and/or they move assets between categories to attempt to achieve superior results. My research has led me to the conclusion that most of these funds are a complete bomb. In almost all cases, you will be much better off keeping your stocks in your stock funds and your bonds in your bond funds. Exceptions to this rule are the following funds to consider: Leuthold Core Investment Fund, Dodge and Cox Balanced, and Alger Balanced.

Large U.S. Stocks

Actively managed large capitalization “growth,” “blend,” and “value” stock funds have extreme difficulty beating the S&P 500 index on an after-tax basis. This is a result of expenses, cash held in the fund, lack of a research advantage on large stocks, and manager mistakes. For most investors (especially taxable), a low cost index fund or tax managed fund should be the core choice in this category. For investors with $250,000 or more, consideration should be given to a customized “tax controlled” account using individual stocks that replicate a given index. Funds to consider: Index Funds: Vanguard S & P 500 index, Schwab

Inside The Minds

106

1,000; Tax Managed: Eaton Vance Tax Managed Growth and SEI Tax Managed Large Cap; Active: TCW Galileo Select Equity, Harbor Capital Appreciation, and Oakmark; Tax Controlled: Parametric Portfolio Associates.

Small U.S. Stocks

This category allows for a greater research advantage for active vs. passive managers. Funds to consider: Managers Special Equity and SEI Tax Managed Small Cap.

Foreign Stocks

Foreign stock funds have historically provided a way for investors to lower their overall risk, because the markets of different countries often move up and down at different times. However, in recent years, the benefit of global diversification has been diminished with the electronic globalization of the world economy. Funds to consider: Masters Select International Equity and SEI International.

Emerging Markets/Regions/Countries

Emerging market funds are the “turbulent teenagers” of the investment world. They offer huge upside potential, just like a teenager, but are prone to get into occasional trouble


107

on the route to adulthood. Funds to consider: Sit Developing Countries, SEI Emerging Markets.

Below is a table that can help guide you as an investor on how much of your portfolio to place in the various asset class categories. Keep in mind that to achieve a $1 million dollar nest egg, you probably need to be invested at least 80 percent toward stocks. Cash/

Money Market

Fixed/ Bonds

Multi-Asset/ Hybrid

U.S. Stocks

Internat-ional

Emerging Markets

Conservati-ve Growth & Income 25

1% 59% 25% 15% 0% 0%

Moderate Growth & Income 40

1% 51% 18% 21% 6% 3%

Growth & Income 60

1% 34% 15% 36% 11% 3%

Capital Growth 80

1% 15% 13% 51% 14% 6%

Equity 100 1% 0% 13% 61% 16% 9%

Inside The Minds

108

Past Performance Isn’t Everything!

Track record is one-dimensional. Past track record is a known factor. Future track record is a guess. Using single dimensions (such as star ratings/expenses/track record) will always set the investor up for disappointment. Track record totally ignores the issue of risk. Track record suggests that investing is a one-variable equation. There is no such thing as a single-variable equation. Many big track records are built on some very large sector bets that paid off by the manager in the past. These bets can go the other direction.

On taxable accounts, be sensitive to turnover. Be interested in total return after taxes, not before. Many of today’s track records are potentially non-repeatable.

Don’t buy a great manager when their track record is a beacon to the masses. Buy them when they are temporarily in the doghouse. Professional advice is more critical than the “rear-view mirror” approach of looking at past track record in today’s mutual fund advertisements. Track record alone sets you up to fail.

If past performance isn’t the best criterion, what is the right criterion? A study by SEI Investments indicates that past performance alone as the primary criterion is of little or no


109

predictive value looking forward. The SEI study suggests instead that you look at the law of cause and effect. Below is the list of causes (determinants) that SEI believes cause the effect of future performance:

Manager’s decision-making process and philosophy The work environment of the manager or fund company Consistency of the manager’s process over time Continuity and tenure of the investment team

These qualitative factors are the cause that drives the quantitative effect of future performance. Examining these factors helps separate past “luck” from firms that possess skills that can lead to repeatable results. SEI’s study also indicates that mutual fund rankings that have become so popular in recent years are of little or no future predictive value.

They All Want to Sell You Something

If my ideas are so great, you may be wondering why you have not heard these concepts before from your broker, insurance agent, financial planner, or banker. We suspect there is one main reason most advisors have been reluctant to adopt our philosophy: greed. Traditional stockbrokers

Inside The Minds

110

and transaction-based advisors are strongly influenced by the need to generate commissions – not necessarily to decrease your taxes or save your money. Do these large Wall Street firms and big insurance companies want a well-informed public that knows their advice is often biased and that their expenses are high? If these companies showed you how to efficiently diversify across numerous funds and families and away from their proprietary products, it could cripple their profits.

If Wall Street and insurance companies won’t educate you, then surely the financial media want you to know the truth, right? Aren’t these magazines and money-oriented TV shows in business to help you make the best possible decisions? Essentially, no. They are in business to sell advertising. The media thrive on risk and uncertainty because this sells. If all investors had in place a long-term, low transaction-oriented investment program, or worked with a professional fee-only advisor, these publications would go out of business.

Considered the most trusted advisor to consumers for 100 years, many CPAs have now chucked their history of unbiased advice and are now offering investments and insurance to their tax clients. Keep your advisors separate. Don’t let your investment advisor do your taxes, and don’t


111

have your CPA sell you investments. Wall Street, big insurance companies, banks, the media, and now many CPAs all have major conflicts of interest with you when it comes to being unbiased and helping you make money.

Why Use a Professional, Fee-Only Advisor?

We discussed earlier the value of your positioning yourself as the owner of your investment team. How would you like it if the coach you hire gets paid partially by you and partially by the players he hires? Would that be the best solution toward winning your $1 million dollar nest egg investment championship? Is there a chance that some players would get hired and playing time get dictated by not only their talent, but also by the money they pay the coach?

To attain financial independence, you need the help of a trusted advisor who is an expert in helping you achieve your financial goals. This can best be achieved with a fee-only advisor who does not have the conflicts of interest that come with working with stockbrokers, insurance agents, or other transaction-based advisors.

Inside The Minds

112

We all know of someone who happened to “get lucky” and pick the right investment at the right time. For most people, however, there is not such a lucky short cut to reaching your $1 million dollar nest egg goal. If you want your money to work harder, you must invest smarter. This means taking a careful look at your finances, your goals, and your attitudes about money and risk, and then sorting through investments from among thousands of choices to find those that can best meet your needs. Most people take the short cut of the latest “top 10” list and forget that in most cases these investments will fall to the middle or bottom in a short time. The correct process is time consuming and – unless you are a financial wizard – very confusing. Using an independent fee-only advisor is usually the best way to address this dilemma.

One of the greatest benefits of working with a professional advisor is helping you avoid making the common mistake of buying high and selling low. Before the technology bubble finally burst in 2000/2001, my company had an increasing number of retired clients invested 50/50 in stocks and bonds, wondering where their 30 percent returns were. These are clients who originally stated they would be happy with returns in the 8 percent to 12 percent range! My company does not manage portfolios on a “home run” basis; that is, we don’t put all of an investor’s eggs in one


113

basket. This works very well over time, especially when we have normal market declines during which investors can potentially experience the benefits of a lower risk approach. During the mature stage of the greatest bull market in U.S. history, it was only human to have greed kick in, short-term. Unfortunately, the media focused investors’ brains on short-term performance, and, with the NASDAQ at 5,000, investors were constantly bombarded with how “this time it was different,” and Goldilocks is real!

Goldilocks is not real, and stock markets do suffer sustained declines. One of the benefits you receive from seeking professional investment advice is counseling to help you stick with a long-term investment strategy. At market tops, human emotions will lead you to be more aggressive. During market corrections, human emotions will lead you to want to become more conservative.

When you feel the urge to be more aggressive and potentially abandon a well-diversified, long-term strategy, remind yourself of the following:

After three years of 15 percent returns, if in year four you experience a 15 percent decline, your average four-year return drops to 6.6 percent.

Inside The Minds

114

After experiencing the 15 percent decline, in year five, to climb back to an average return of 15 percent, you

need a return of 56 percent.The chances that the U.S. market will return 56 percent in a given year in the future are minimal. The chances that we may experience a 10 percent to 20 percent decline in the U.S. stock market are very real, as experienced in 2000 and 2001.

Slow and Steady Wins the Race

Since the days of Aesop in ancient Greece, wise men and women have realized that “slow and steady wins the race.” Yet even today, countless intelligent men and women continue to follow the example of the hare. They emphasize speed over common sense. They want to get rich quickly. Granted, it can be exciting to invest in a hot tip or new scheme, but what you are really doing is betting, and the odds are against you – severely so. The truth is you don’t need to take big chances to grow wealthy. You need common sense, patience, determination, and a good advisor.

The time to become more aggressive as an investor is when you find it the most difficult emotionally. Numerous


115

growth stocks often drop 50 percent or more in price. If you like Motorola at $100 and feel it will be much higher in price five years from now, then why wouldn’t you want to buy more at a current price of $50? Use market declines as an opportunity to buy great stocks via mutual funds at “on sale” prices. My experience has been that stocks are the only things in America that consumers don’t like to buy when they are “on sale.”

The greatest investment skills you can have are humility, patience, and the ability to ignore media hype and the ups and downs of the market.

Know your objectives and your risk level. In short, know yourself. Set reasonable expectations. Be disciplined. Don’t give in to panic or to euphoria. Volatility is a short-term concern. Inflation is a long-term problem. A penny saved is a penny earned. What you don’t pay in taxes today can add to your value tomorrow.

Take a tortoise approach to your long-term investment plan, and remember, there is no such thing as a free lunch.

Jerry B. Wade, CFP, CFS, is president of Wade Financial Group, Inc. A native of New Castle, Indiana, Mr. Wade is a

Inside The Minds

116

1981 graduate of Ball State University in Muncie, Indiana, with a Bachelor of Science degree in communications.

While at BSU, Mr. Wade was a collegiate swimmer, was president of the Student Advisory Council, and worked in radio.

Mr. Wade began his career in finance at American Express Financial Advisors in 1984 as a financial planner. During his tenure with American Express, Wade functioned as a financial planner, trainer, and strategic consultant to American Express senior management. He was one of only two (of 7,000) advisors chosen to become a consultant to senior management in what is considered by many to be one of the most significant Total Quality Management projects ever undertaken by a U.S. corporation.

In 1994 Mr. Wade founded Wade Financial Group, Inc., an independent, fee-only financial advisory group in Minneapolis. His firm provides comprehensive financial planning, tax planning, investment management, and estate planning for high-net families located across the U.S. His firm has been a pioneer in the area of tax-efficient and tax-controlled investment strategies.

Mr. Wade has been chosen by Worth magazine as one of the 250 best advisors in the U.S. for 1998, 1999, and 2001.


117

He is a Certified Financial Planner (CFP) and a Certified Fund Specialist (CFS). He is one of only a handful of

financial advisors in the U.S. who have gained membership in NAPFA (National Association of Personal Financial Advisors), which advances fee-only planning

Mr. Wade has been quoted in, has contributed to, or has been featured in the Wall Street Journal, Mutual Fund magazine, Boston Globe, Bloomberg Financial, Mature Outlook, Black Enterprise, the Robb Report, Business Week, Mutual Fund News, Financial Planning Magazine, Dow Jones Investment Advisor, and the Journal of Financial Planning.

He is a member of Rotary International and founded the non-profit organization, Remember Our Heroes, which strives to connect veterans to the students in America’s classrooms.


119

ACCUMULATING YOUR

MILLION-DOLLAR NEST EGG:

THE EASY WAY OR

THE HARD WAY!

MARC SINGER

Singer Xenos Wealth Management Founding Principal

Inside The Minds

120

Simple Investment Equation: Time, Money, Interest

There is the old story about one of the Rockefellers being asked how he became so wealthy. He recounted that as a child on the way to school, he would buy an apple for 5 cents. Once he arrived at school, he resold the apple for 10 cents. The next day, he bought two apples for 10 cents and resold them for 20 cents. This went on for many years until he slowly accumulated a small nest egg. After many years of saving and saving, his grandfather died and left him $100 million.

There is a lot of traditional thinking about becoming a millionaire, and there is also some outside-the-box thinking. The traditional approach is that you need to work very hard to earn a lot of money, or take excessive business risk in hopes of striking it rich. Of course, neither of these strategies works very well. From my experience as a financial advisor who has worked with hundreds of clients, the best route is the slow but sure way – remember the tortoise and hare story? In real life I have seen the tortoise win almost every time. So in this case “outside the box” might mean taking the slow but sure route. If you can reach your goal with 100 percent certainty, it doesn’t make sense to take excessive risk by trying to get there a little faster.


121

How can $100 per month really turn into a million dollars? About 15 years ago I met with a potential client. The gentleman was a schoolteacher in the public school system. He had never earned more than $30,000 per year during his career. By saving about $100 per month since he was 25 years old, he had accumulated slightly more than $1 million, which today would be the equivalent of more than $2 million. He had invested this monthly amount in mutual funds only. Because of wise decisions, he never incurred any losses.

Actually, it is quite easy to develop your first million dollars. All you need are three key ingredients:

Some extra money every week or month: About $25 per week will do. Time: About 40 years would be best – much less time if you can save more than $25 weekly. A simple and steady investment vehicle: I believe a mutual fund will almost always end up being the best choice.

When you mix all these ingredients together, you get the time value of money, also known as the compounding effect. Time values are very hard to estimate in your head; even professionals need a financial calculator. The trick

Inside The Minds

122

here is to understand which of the three ingredients is the most important. Below is a chart showing how much money will accumulate over time if you save only $100 per month. Looking at the three variables of time, savings amount, and rate of return (interest rate), can you tell which is the most important?

Monthly Savings Amount = $ 100

Rate of Return (Interest Rate)

Yrs. 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 10.0% 11.0% 12.0%

10 14,725 15,528 16,388 17,308 18,295 19,351 20,484 21,700 23,004

15 24,609 26,729 29,082 31,696 34,604 37,841 41,447 45,469 49,958

20 36,677 41,103 46,204 52,093 58,902 66,789 75,937 86,564 98,926

25 51,413 59,551 69,299 81,007 95,103 112,112 132,683 157,613 187,885

30 69,405 83,226 100,452 121,997 149,036 183,074 226,049 280,452 349,496

35 91,373 113,609 142,471 180,105 229,388 294,178 379,664 492,830 643,096

40 118,196 152,602 199,149 262,481 349,101 468,132 632,408 860,013 1,176,477

45 150,947 202,644 275,599 379,259 527,454 740,488 1,048,250 1,494,841 2,145,469

50 190,936 266,865 378,719 544,807 793,173 1,166,910 1,732,439 2,592,406 3,905,834

As you can see, the rate of return is the most important factor by far. In the above chart, over 40 years, the difference between a typical CD interest rate of 4 percent and a rate of 12 percent is the difference between $118,000 and $1,176,000. In other words, 3 times the interest rate equals 10 times more money. This is a simple application


123

of the concept of compounding. So to become a millionaire in 4 percent CDs over 40 years, you would have to save $846 per month. At 12 percent interest, you would only need to save $85 per month. This is probably the most salient concept in investing. It will heavily influence some of my later comments on investment choices.

Another table that might be useful shows how much you would need to save monthly to become a millionaire.

Monthly Savings Required to Reach $1,000,000

Rate of Return (Interest Rate)

Yrs. 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 10.0% 11.0% 12.0%

10 6,791 6,440 6,102 5,778 5,466 5,168 4,882 4,608 4,347

15 4,064 3,741 3,439 3,155 2,890 2,643 2,413 2,199 2,002

20 2,726 2,433 2,164 1,920 1,698 1,497 1,317 1,155 1,011

25 1,945 1,679 1,443 1,234 1,051 892 754 634 532

30 1,441 1,202 996 820 671 546 442 357 286

35 1,094 880 702 555 436 340 263 203 155

40 846 655 502 381 286 214 158 116 85

45 662 493 363 264 190 135 95 67 47

50 524 375 264 184 126 86 58 39 26

If you think about these numbers over your lifetime, it is much easier to earn more on your investments than to save more money.

Inside The Minds

124

What are the best investment vehicles to achieve your goal? As I mentioned earlier, I have a very strong bias toward mutual funds. The rationale is very straightforward. Mutual funds are ideal for the investment strategy that involves adding a little money at a time. Much of the emotional decision-making involved in stock-picking is avoided. Introducing emotion into the art of investing is like smoking in a fireworks factory. It tends to blow up on you.

Types of Funds You Should Invest In

Initially, the first $50,000 of your accumulation portfolio could be invested in an S&P 500 index fund. This should work just fine, especially if you are truly adding money monthly. Index funds have low expenses and are readily available for your personal savings, IRA, or 401(k) plan.

After you exceed $50,000 of investments, you will need to change your strategy. Don’t fall into the trap of thinking that the index fund is the best all-around investment. It is not; it is just a good starting point. The difficulty in using an index fund as your single investment is that even though it may look good on paper, the concept of accumulating all your money in a single investment doesn’t work in the real world.


125

Let’s prove this through an example. You have $20,000 in an index fund, and we experience a market correction of 40 percent. Your portfolio goes down $8,000. Do you panic or sell everything to cash? No. This dollar amount loss can be tolerated for a year or two, while reason and logic tell you it will be regained. Now fast forward to the tail end of your 40-year plan. You have $1 million; you are age 60; and your savings just went down $400,000. What are the chances you will stick with it and not sell out to cash at or near the bottom of the market? What will your quality of life be, watching your lifetime savings plummet? The point is that the psychological risk of investing is directly related to the dollar amount invested. When that amount is too great, the stress simply cannot be tolerated.

Should you use a different strategy for personal investments rather than retirement plan assets? Many people think they should invest their retirement plan assets, such as IRA or 401(k) plans, more conservatively than personal assets. I do not agree. Ultimately all your money is your nest egg, period. A dollar lost, or a hundred thousand dollars lost, sets back your financial goals. The only difference is potential tax strategies that might influence certain buy or sell decisions.

Inside The Minds

126

Some people separate a part of their portfolio as a “play account,” perhaps to buy highly speculative stocks, hoping for the big hit. Others simply take that money to the casino and call it “gambling.” There is nothing wrong with either of these actions for entertainment value, but they should never be confused with a legitimate lifetime investment strategy. I recommend keeping the amount of this money modest.

Setting Goals and Following Market Trends

Goal setting is crucial to reaching any type of financial independence, unless you take the Rockefeller strategy. My favorite analogy is a quote from Lewis Carroll’s Alice in Wonderland:

“Would you tell me, please, which way I ought to go from here?”

“That depends a good deal on where you want to get to,” said the Cat.

“I don't much care where,” said Alice.

“Then it doesn't matter which way you go,” said the Cat.


127

“— so long as I get somewhere,” Alice added as an explanation.

“Oh, you're sure to do that,” said the Cat, “if you only walk long enough.”

In truth, without a clear financial goal, you may never get there, or it just may take 10 or 20 years longer.

There are two approaches to reacting to market trends. One I call the speedboat approach, and the other is the cruise-ship approach. In fair weather, everyone does well, and there is very little concern for risk and loss of capital. The speedboat investor can move quickly forward, a lot faster than the large ship. However, the speedboat needs to outrun bad weather, and in a true storm it needs to go into port and out of the water. If the speedboat is unlucky and gets caught in the storm, it can sink. The large ship can batten down the hatches and survive most storms, even if the ride is a little bumpy.

The problem is that no one has a very accurate weather radar system to predict market trends. For the investor on the 40-year journey, it would make sense to take the large-ship approach, which will survive all the market storms. Many investors learned from very painful experience over

Inside The Minds

128

the 2000-2001 correction. In fact, many of the most aggressive investors lost over 60 percent of their capital from their pre-correction peaks. Using a steadier investment strategy, they could have significantly reduced their losses to around 10 percent. In the long run they will sleep better at night, and also have a lot less ground to make up in the future.

Diversification is Key!

The concept of riding out the storm is often quoted but not psychologically easy to do. The best way to handle market volatility is to have prepared for it long before it happens.

There are two major ways to reduce the risk on your portfolio. First is by using bonds. Typically, you should always have 10 percent to 40 percent in bonds. These provide a significant buffer to market corrections. They also provide psychological peace of mind.

The other way to protect against volatility is by diversification. After your portfolio exceeds the $50,000 (earlier is OK also), you need to diversify in what are known as different asset classes. A misconception about diversification is that if you buy several stocks or funds,


129

you are diversified. If you buy Microsoft, Cisco, Intel, and JDS, you still have all your money in Tech. If you buy five very diversified Tech funds, you still have all your money in Tech, just very well-diversified Tech.

You should remember that the volatility of a single sector is simply too great. This concept is known as asset allocation, or Modern Portfolio Theory. By diversifying between multiple asset classes, you can actually lower the overall risk of a portfolio without reducing the long-term rate of return.

True diversification means many asset classes. Here is just a partial list of equity assets classes:

Large Cap Value Large Cap Growth Mid Cap Value Mid Cap Growth Small Cap Value Small Cap Growth International – six sectors similar to above Real Estate Emerging Markets Others – many sub-categories beyond the above

Inside The Minds

130

The reason multiple asset classes can achieve full market returns with greatly reduced volatility and risk is that all the different segments of the market move in different cycles. While some are going down, others are going up or remaining flat. This tends to smooth out, or buffer, the volatility. Having a truly well-diversified portfolio makes it much easier to ride out the storm.

Another important virtue an investor can have is patience. Returning to our first table, an investor can be virtually guaranteed to save a million dollars in 30 to 40 years if they are consistent in their saving habits. Becoming impatient, getting bored, or losing focus can only serve to derail that plan.

Investors should be cognizant of their portfolio holdings. They don’t need to be experts, but they should not be ignorant, either. There is tremendous media overload, with several cable TV stations reporting full-time on the minute-to-minute changes in the market. This can be very harmful to the average investor. The media provide information as a form of content to sell advertising. They have virtually no vested interest in how their viewers’ finances are affected if they act on advice and ideas presented.


131

The most important thing to keep track of is whether you are losing more money than the market. If so, there is a problem. Notice I said losing money not gaining. If you are up 12 percent, and the market is up 25 percent, there may be nothing wrong with that situation. Sometimes, certain sectors of the market do exceedingly well for periods of time. The rule, “What goes up must come down,” very often applies to these short- to mid-term cycles in the market.

Advice for Managing Your Portfolio

It should actually take very little time to manage your portfolio. As discussed before, at least for the first five to 10 years, saving a monthly amount for an S&P 500 index fund is sufficient. After an investor accumulates $100,000 to $200,000, she or he needs to become more sophisticated or retain the services of a competent financial planner or investment advisor. The reason for this is the need for diversification.

As with anything else, in portfolio management, stick to what you know. As an investment advisor, I stick to investing in the markets, in particular, mutual funds. This

Inside The Minds

132

philosophy has been successful for my clients for over a decade in business.

For managing my clients’ portfolios in down markets, my advice is, “We planned for this, and you will be able to meet your long-term goals.” In good markets, my advice is, “Don’t spend the difference.” As financial planners, we understand that markets do not always go up; unfortunately, clients tend to forget this principle. In bad times, clients want to be assured. In our projections, we take negative years into consideration. We also embrace the concept of becoming more defensive in bad markets. In booming economic times, my advice was quite different. I didn’t need to remind clients about meeting their objectives, but about not escalating their spending.

To determine the appropriate level of risk for my clients, I look at how much risk they have to take and how much I think they can handle. In the majority of cases, clients do not need to take as much risk as they think. The driving factor of the portfolio return will be the cash, bond, and stock allocation. These factors will contribute directly to the ultimate portfolio rate of return.

My underlying philosophy is that my job is to help clients sleep well at night while earning them consistent


133

conservative returns. It is ironic that over the past two years “risk” has become a topic of conversation. I have received phone call after phone call from prospective clients who were taught a painful lesson about what it means to not take risk into consideration in portfolio construction.

The rules for building your $1,000,000 nest egg are simple but critically important:

1. Do not invest more than you can afford. 2. Have a plan. 3. Stick to the plan. 4. Don’t ever think you’re smarter than the market. 5. Never forget that compounding is the eighth wonder of

the world.

A sixth rule might be to avoid making mistakes. The biggest mistake you can make is greed. This is followed by greed, with third place being greed again. The one thing I have tried to emphasize is how easy it is to accumulate $1 million or more. Just follow your monthly savings plan. What could be easier?

In my career, I have seen hundreds make mistakes by looking for “easy money” because they felt a mere 8 percent to 12 percent return was not enough. Whether they

Inside The Minds

134

were invested in real estate limited partnerships, oil wells, cattle breeding, thoroughbred horses, restaurants, or Internet businesses, they all lost money. Most of the time the illusion was that it was an “affordable” loss.

Let’s define the expression “affordable loss.” Say you put $20,000 in a risky investment. That may seem affordable; in the short term that might be true. Now think about how much that would have been worth in 40 years. At a 10 percent return, this lost amount would have grown to $905,000. That doesn’t seem so “affordable.”

The Future of Investing

Over the next five years, building a $1,000,000 nest egg will become harder. Expected returns for all markets will be lower. The go-go years of 1991-1999 are behind us, and it will be harder to realize significant growth in many sectors. The days of dartboard investing (picking any stock with .com behind it and making a killing) are over. The people, investors and advisors alike, who looked brilliant from 1994-1999 don’t look so smart now.

The main factors involved in reaching your goal will be your dedication and persistence in staying with a long-term


135

investment philosophy. People will have to be much more disciplined, as well as frugal. Remember that not so long ago the financial press was talking about a “new era” or “new economy” – one that showed long-term performance was going to be dominated by growth-oriented investing. I try to remind people that there are no new eras. The market tends to bring investors back to reality.

Investing and accumulating your nest egg does not need to be a mysterious process. Sticking to a long-term plan should allow you to reach you goals with a very high degree of certainty. Remember time and compounding are your best friends in investing, and greed is your worst enemy.

Marc Singer is a founding principal of Singer Xenos Wealth Management. Their philosophy of going beyond the expected has placed them among the largest independent investment management firms in the Southeast, with more than $300 million in managed assets and 17 years of experience.

Mr. Singer has lectured extensively on financial and investment planning, as well as creditor protection for physicians. He has been interviewed by CNN, The Wall

Inside The Minds

136

Street Journal, Medical Economics, and Money Magazine. He has been a regular guest on the Network Financial

News daily financial program. In October 2001 he was named by Worth magazine as one of the top 250 advisors nationally.

Mr. Singer founded and heads the Advisor Forum organization. This group consists of 14 advisory firms nationally managing over $4 billion. They meet regularly to discuss ideas and resources.

Mr. Singer holds an MBA degree and is a Certified Financial Planner.


137

FOLLOWING TIME-HONORED

INVESTMENT PRINCIPLES

MARILYN BERGEN

CMC Advisers, LLC Co-President

Inside The Minds

138

Investment Style

My investment style follows several time-honored investment principles. These principles include the importance of diversification, the power of compounding, the effect of taxes, the effect of inflation, and the tradeoff between risk and return. Although it is certainly possible to build a nest egg and ignore one or more of these principles, I believe the ultimate consequence may be unfavorable to the investor.

For example, as an investor, you might become extremely wealthy by not diversifying. But the tradeoff is that you may also lose it all or lose so much of it that it’s not feasible to recoup your losses by the time you need the money.

Following those five basic principles means that an investor needs to have a clear understanding of their time horizon for when the money is needed, their personal tolerance for risk, and their goals and objectives for the money. Sometimes investors make the mistake of not clarifying their goals and risk tolerance before starting their investing.

Typically I recommend that investors use mutual funds until their portfolio is worth somewhere between $800,000


139

and a million dollars. At that value, it may make sense to consider individual stocks. For less than $800,000, I don’t think investors can achieve proper diversification by buying individual stocks. The diversification mistake that investors make when buying individual stocks is that although, indeed, they may be adequately diversified within large-company U.S. stocks, what does the rest of their portfolio look like?

The diversification aspect of my investment style means that investors need to look at two aspects of their portfolio. They should diversify the entire portfolio by using multiple asset classes. They also need to diversify within asset classes by using either mutual funds or a wide variety of stocks or bonds. If fixed-income assets are to be used in a portfolio, I usually recommend three to four asset categories. Generally, these categories include cash equivalents, short-term U.S. bonds, intermediate-term U.S. bonds, and international bonds. On the equity side of the portfolio, I normally recommend large and small U.S. stocks, large and small international stocks, and possibly real estate.

Once the decision is made about the asset categories to be used, the next step is to determine the percentage of the portfolio to put in each asset category. Within each asset

Inside The Minds

140

class are sub-styles that should be considered. Within equity categories, I further diversify by including a portion of both growth and value positions. Growth and value styles outperform each other during different parts of their cycles. I have never found evidence to suggest there is any one person or firm that can consistently time the market or choose the asset category or sub-style that will outperform all others for any specified period of time. Therefore, investors need to develop their investment plan ahead of time and stick to the plan.

Because of the need for adequate diversification, it will be too expensive for an individual to buy stocks with a small portfolio. The expense will involve both cash outlay and the time needed to analyze, buy, monitor, and sell at appropriate times. An investor will need to either spend the time to make all of these decisions on their own or hire professional help to do so. Even with a professional’s help, I think the appropriate value of a portfolio needs to be somewhere between $800,000 and a million dollars before individual securities should be considered.


141

Strategy for Building a Nest Egg

Having a plan is critical to the strategy of building a nest egg. Investors need to know their end objective. Ask yourself the following questions:

What is my goal? For example, your goal might be to retire when you are 63 years old. How much money do I need to achieve my goal? What is a reasonable rate of return I can obtain, given my tolerance for risk and long-term market returns? How much money do I need to save annually or monthly to achieve the goal? Am I able and willing to save that much money? What factors might come along to deter me from my savings goal? What can I do ahead of time to make sure those factors don’t blindside me and distract me from building my nest egg?

Investors should complete three “worksheets” as part of their strategy. These include a cash flow analysis, a goals and timeframe worksheet, and a written investment plan.

Many investors do not have a clear understanding of their personal family cash flow needs. Most people make the

Inside The Minds

142

mistake of not having a clue about how they spend money. One of things an investor needs is to have a budget and examine it. How much money comes in every month, and where does it go? If an individual doesn’t understand that, they may not be able to come up with the kind of money they need to be setting aside. Building a nest egg will require some sacrifice of current spending patterns.

In addition to a cash flow analysis, an investor needs to make a very clear list of their goals. Be very specific. Define each goal by when you need the money, the time horizon, and the dollar amount needed to meet each goal. Part of this process will determine the types of investments that are appropriate for each goal. For example, if you need $15,000 in exactly 12 months to pay for the upcoming wedding of your daughter, you will not want to invest that money in the stock market. You need the short-term safety of principal of an investment, such as a bank savings account, CDs, or Treasury Bills. On the other hand, if you are investing for retirement, and that time horizon is 10-plus years, you will probably need to have most of that money invested in the stock market, where you have a better chance of achieving higher returns. In addition, you have time on your side. If the stock market drops in value, you can ride it out and not be forced to sell when your funds are down.


143

The third thing to do is to have a written investment plan. This will help you stay the course when things get tough. Life and investing can throw all kinds of surprises your way. I tell clients that one of my jobs is to save them from their own emotional guesswork and mistakes. It is critical to take the emotional guesswork out of investing. You need a disciplined process to help you stick to building your nest egg. Your written investment plan needs to state the asset categories you will use, the percentages you will invest in each category, and the types of investments you will use. As part of your written plan, you need to include how often you will rebalance your portfolio (more on rebalancing will follow).

Completing these three worksheets puts the underlying strategy in place to help you build your nest egg. Sometimes the initial savings amount may look staggering. This is where the cash flow analysis is important. The investor can then go back to their analysis and say, “What am I willing to give up to make this work?” The goal setting, with dollar amounts, is critical because that drives the savings amount. The written investment plan is an important part of the strategy, because it will bring discipline to the process and remove some of the emotions of fear and greed that can harm your long-term wealth building. These three components of the strategy interplay

Inside The Minds

144

with each other. They each have importance. They should each be completed before you begin investing.

Budgets: Making Tough Choices Easier

If your savings goal seems overwhelming to you, examine your spending habits. One of the hardest pieces for investors is to know where money is going. Most people look at their checkbook and at the Visa statement and try to figure out where most of the money goes. They forget about cash spending. That’s the black hole for investors.

First of all, you have to be really clear about where you’re spending money. I recommend that people take between two and four months to actually track all of their expenses. This will help to have a clear idea of where the “black-hole money” is going. Once it is written down, you know where everything is going. This will enable you to make choices. If you wait until the end of the month to see what’s left over to save, it probably won’t happen. But if you are very clear about why you would really like to have a certain nest egg, at a certain point in your life, it’s easier for investors to make those tough tradeoffs in spending habits. Perhaps you are spending more than you need to on eating out or new clothes or expensive vacations. If you know where you are


145

spending money, then you can be in control of making changes to help you build your nest egg.

Once you make the decision about how much you will save, then it should be set up to happen automatically. There should not be a monthly choice. There are a variety of ways to achieve this. You can do it through a retirement plan at work, such as a 401(k) plan, where the money is taken out of your paycheck before you even see it. You can set up some sort of monthly bank draft out of your checking account – if you are investing after-tax dollars – so that it just gets invested automatically every month.

Once you set something up on an automatic basis, the painful period lasts between two and four months. You may experience an initial shock of seeing less money in your paycheck or in your checking account. But you will probably find that after a period of time, you simply adjust to the lower spending level, and then you may not even think about it. This automatic piece is part of the budget process of creating your nest egg. You can do much of the work up front in terms of goal setting. Then set it up to happen so you aren’t thinking about it all the time. As a result, you won’t debate about whether your nest egg gets the money or you will spend it.

Inside The Minds

146

The consumer society we live in is one of the biggest obstacles to saving. If you watch TV more than an hour a week, you are bombarded with constant “stuff” you have to have. Maybe you see your neighbors driving new vehicles, and you wonder how they can afford it, because you are sure they don’t make any more money than you do. Perhaps friends just put a new pool in the backyard, and you’d like to have one, too. We’re constantly being exposed to things that we “have” to spend our money on. In many ways, we feel we deserve to have them because everybody else we know has them. “Everybody else” may just be the people we see on TV or in newspaper and magazine advertisements.

As a society we are constantly exposed to consumer spending campaigns. I think it’s a real struggle for most Americans to avoid getting sucked into that spending trap. That’s why I recommend that people have written goals that include the timeframe of when they need the money and the dollar amount they need down the road. Then investors can back it up to say, “To get there, this is what I need to be saving monthly or annually to achieve that.” If that’s really important to you, it’s easier to say, “I guess I don’t need a new leather coat this month even though I’d really like to have one. I’d much rather keep working on building my nest egg.” The consumer-spending trap is very


147

difficult for people in our society. If you are consciously aware of it, you can achieve your savings goal by making smart choices and being in control of your money.

Investing to Build Your Million-Dollar Nest Egg

If you are a beginning investor and just starting to build a million dollar nest egg, you will need the long-term growth associated with equities (stocks and real estate). You will need to have the majority of the investments in your nest egg accumulation portfolio invested in mutual funds that are buying some kind of stocks. The use of mutual funds goes back to my strong belief in diversification.

If you are investing in equity mutual funds, you will need some education related to the long history of the stock market. Long-term historical returns suggest that you may average 10 percent to 11 percent annualized by investing in large-company U.S. stocks. However, the market has been very volatile. You may have years in which you lose five percent, 10 percent, or more. Are you willing to stomach that kind of downside volatility? It’s important to understand the volatility of the market before investing.

Inside The Minds

148

Experience suggests that people are heavily influenced by their emotional responses to market volatility. Investors must have a plan and stick to it. Even as a beginning investor, it’s important to have a plan. Your plan may start out as simple as the following: “I will invest $400 per month in a U.S. total stock market index fund until I have accumulated $25,000. At that time, I will review my situation and may add another mutual fund to my portfolio.” If you abandon your plan during a market downturn, you may do irreparable financial harm to your long-term goals. There is no such thing as a perfect investment. But having a plan and using a diversified fund is a great starting point.

As you build a larger and larger nest egg, diversification becomes even more critical. In the example above, you may have started with a U.S. total stock market index fund. This would provide exposure to two different asset categories with just one mutual fund. You would have both large and small U.S. stocks in one fund. As you increase the size of your nest egg, you can add an international stock fund to the mix. You may want to consider investing 20 percent to 25 percent of the equity portion of your portfolio in international stocks. Then you may want to add a real estate fund to the portfolio, in a smaller percentage. This is assuming you are willing to handle the downside volatility


149

associated with a 100 percent equity portfolio. If you have set aside money for emergency or opportunity events, and your time horizon for needing the portfolio is at least five years, then a 100 percent equity portfolio may be appropriate for you.

There are many advantages to having fixed income investments (cash and bonds) in a portfolio. As your portfolio increases in size, even if you have an emergency fund, you should consider some fixed income in your portfolio. It will help smooth out the downside of stock market volatility. It will provide more asset categories for diversification and rebalancing your portfolio. When stocks go down, the fixed income side of the portfolio may provide funds to buy stocks when they are “on sale.” Instead of worrying about a 20 percent loss in the equity side of the portfolio, you can take advantage of the buying opportunity by taking money out of the more stable fixed income side of the portfolio and buying stocks at bargain rates.

If your portfolio is very small, you probably won’t worry about rebalancing as you are aggressively adding to your portfolio. As you increase the size of your portfolio, your portfolio plan design needs to become more sophisticated.

Inside The Minds

150

Then rebalancing becomes a critical step in keeping the risk in line with your chosen risk tolerance.

Rebalancing the Portfolio for the Right Mix

Rebalancing your portfolio involves the investment principle of risk and return. Once you have determined your savings objective and established a written investment plan, you will need to rebalance your portfolio to keep your acceptable risk in line. If you don’t rebalance regularly, you will end up with either more market risk than you desire or possibly a lower than expected return.

Don’t allow your portfolio to swing dramatically to different percentages in asset categories through either market movement or your own guesses about where the market is going in the short term. Market timing doesn’t work. People who believe in market timing tweak portfolios and say, “I think small-company stocks are the place to be in the next six to 12 months. Therefore, I am going to put 100 percent of my portfolio in small-company stocks.” To me that makes no sense. No one can call market timing correctly enough of the time to make it work on an after-tax, after-transaction-fee basis.


151

My recommendation for rebalancing is that investors need to start spending more time on a portfolio plan design and rebalancing with a portfolio value somewhere between $50,000 and $80,000. Until then, I think it’s probably safe to just buy U.S. stock mutual funds, maybe with a little bit of international stock mutual funds, and not worry about it so much. Simply keep adding to the portfolio monthly.

At the level of about $50,00 to $80,000, even if it’s somewhat unsophisticated, there needs to be a portfolio plan design that states what percentage will be in each of the chosen asset categories. For example, your plan may state that you will have 50 percent in large-company U.S. stocks, 10 percent in small U.S. stocks, 20 percent in international stocks, and 20 percent in intermediate-term U.S. bonds. Once you choose a portfolio plan design, you should avoid the temptation to constantly tinker with the percentages on a short-term basis. You should look at your portfolio quarterly, examining the percentages. If the percentages today don’t match what your plan says, then you need to rebalance. Based on the sample portfolio plan listed above, if you currently have 25 percent in intermediate-term U.S. bonds and only 45 percent in large-company U.S. stocks, then you should rebalance. You need to sell the excess 5 percent out of the bond fund and use

Inside The Minds

152

that money to bring the large-company U.S. stock category up to the chosen 50 percent.

Unfortunately it’s never quite that simple. There may be other factors to consider. If it’s taxable money, then you have to look at the tradeoff between the need to rebalance the portfolio and the timing of the sale or buy. One example of this is that most mutual funds make taxable distributions in the fourth quarter of the year. If you buy a mutual fund right before it makes a distribution, then you will pay capital gains tax on the distribution, even though you may have owned the fund for only a few weeks during the year. In this example, it may make sense to wait until after the distribution to buy the fund for rebalancing purposes.

In general, however, the key is that you, as an investor, have a plan; you stick to it; and you are not swayed by the current hot news of the day, the disasters of yesterday’s market, or whatever else moves people emotionally. The emotional guesswork is where investors usually shoot themselves in the foot.


153

Tending Your Nest Egg

When your portfolio is between $100,000 and $200,000, you can’t afford to ignore it, especially as you reach the $200,000 level. Either you have to be monitoring it at least quarterly, or you need to hire somebody to do that for you. Tending to the nest egg necessitates having a written plan, as well as the discipline to rebalance the portfolio systematically. As you review your portfolio quarterly, you’re reevaluating two things:

1. Do I need to rebalance now? Am I enough out of my portfolio plan design that I need to rebalance?

2. Are my mutual funds still appropriate investments?

There are several questions to ask about your funds. Is the manager the same one who was there when you picked the fund in the first place? Are the performance returns for each fund still in line with performance for its asset category? Is the risk still in line with your original criteria for risk? Have the internal expenses or the objectives of the fund changed?

There is a two-step process that I think has to happen quarterly as you tend your nest egg. You need to monitor the investments and rebalance the portfolio as needed. The

Inside The Minds

154

rebalancing and the monitoring of the individual investments can take as little as an hour, or it might end up being five to 10 hours a quarter, depending on how many different investments you have in your portfolio. The more investments you have, the longer the monitoring will take. Therefore, as your portfolio grows and necessitates adding asset categories and style-specific investments, you will need to devote more time to your portfolio.

Guidelines for Getting Started

It may be helpful to have some savings benchmarks for guidance. If an investor is 25 years old, plans to retire at 65 years old, and wants to build a nest egg of $1 million, what does she need to save? Assuming a 9 percent rate of return, she will need to save about $2,959 a year, or about $246 a month. Averaging 8 percent, she would need to save $3,860 per year. To achieve an 8 percent return, a portfolio would probably resemble what has traditionally been labeled a “balanced” portfolio, with about 50 percent to 60 percent in equities and the rest of the portfolio invested in fixed income.

Many people start getting serious about creating a nest egg in their early 40s. For a 40-year-old investor who wants to


155

retire in 25 years, with an assumed portfolio average of 8 percent, they’d need to save about $13,678 per year. If they averaged 9 percent, they would need to save about $11,806 per year. These numbers start to look much more serious. This is where the investment principle of the power of compounding comes in to play. If you wait until you are 50 years old and want to retire in 15 years, the savings goal starts to look daunting. At a 9 percent average annual return, the 50-year-old will need to save about $34,058 every year. Many people don’t even make that much money. Unless you are making substantially more than that, you aren’t going to be able to save that.

Obviously, the key here is if you wait too long, it probably isn’t going to happen. No matter what your age, if you are just starting out as an investor, you can still follow the basic principles and begin to build a nest egg. You may not get to $1,000,000, but anything you have at retirement will look better than nothing.

Save All You Can and Consider Alternatives

Encouraging people to save and invest can involve many factors. If we ran numbers for a client and told him he needs to be saving $400 a month, he might respond by

Inside The Minds

156

saying, “That’s outrageous. There’s no way we can afford to save that much now.” One solution is to move from the fantasy amount to a more realistic one. Questions should be asked: How close can you get to that? Can you do $300? Can you do $250? Are there months when you could stretch it to a $400? Are there expenses you have now that you could eliminate down the road? An example might be car payments. Perhaps after the car is paid off, the client can save all of the former car payment in his portfolio. You start out with perhaps a fantasy amount of savings. Then you go back to making choices about spending patterns. You need to make decisions about what you are willing to “give up” to start saving more aggressively.

Depending on the goal, there may be alternatives. If you want your children to go to a private college, but you can’t afford to put enough money aside for that purpose, you reevaluate your goals. Perhaps your child will need to go to the local junior college for two years and then transfer to a private college. Or perhaps they will need to go to a state university where the fees may be lower. Life is full of choices, and it’s great to feel you have control over things that happen. If you can save enough for a private college, that is a worthy goal. If you can’t, don’t give up. Look at the alternatives and save as much as you can to achieve the new goal.


157

Sometimes I recommend investors look at short-term options. I might recommend an investor consider the option of taking a part-time job for a year or so and save everything they earn on the part-time job. Another alternative might be to set a timeframe where you save everything you would normally have spent on some item. For example, you might decide that for one year, you will not take your normal vacation, and you’ll save all of the money you might have spent. It is much easier to live with changes in a normal routine if the time frame is short. Then you may not feel as though you have to deprive yourself for the rest of your life.

Alternative investments may come in the form of sweat equity. Some investors buy a “fixer-upper” rental house. This obviously will not work if you don’t have “fixer-upper” skills. If there is some sweat equity you can use to build up your nest egg, this may work well.

Some investors choose to be very aggressive with their investments as a way of building their nest egg. They ignore the principle of diversification and buy a high-flyer stock or two and hope it works out. This strategy did work for many investors in the late 1990s. Unfortunately for many of them, it was pure luck. It wasn’t because they were brilliant investors. They just happened to be in the

Inside The Minds

158

right place at the right time. But the problem with that strategy is that you are really taking a huge amount of risk. Investors need to understand the extent of the risk they are taking. Many of the investors who made “quick” money watched as their profits eroded when the market turned down.

Overall, there aren’t any short cuts. I think the biggest thing for most investors is to figure out what their ideal savings would be, then get as close to the ideal as possible, even if you’re 90 percent of the way from it. If you need to save $500, and all you can save right now is $50, then save $50, because the time value of money is amazing. Albert Einstein called compound interest the eighth wonder of the world. It truly is an amazing factor.

Learn the Care and Feeding of Your Nest Egg

I oversee the management of our clients’ portfolios. Many of them defer decisions to us exclusively and just simply look at the quarterly reports and monthly statements they get. Some clients like to come in. We prefer to meet with our clients at least once a year to discuss their portfolios to make sure they understand what’s going on. We do have


159

clients who like to have quarterly meetings, either by phone or in person, to discuss changes we are making.

If you are going to work with anybody – a stockbroker, a financial planner, an investment advisor, or anybody who is overseeing your money – you need to be involved to some extent. You need to have a basic understanding of the goals and objectives. You need to know what the service is costing you. Nothing should be hidden. There should be no surprises. Investors need to understand the internal fees on investment products and the sales commissions, if any. You should know exactly how your advisor is being compensated and what the person is making from the service that is being provided to you. Even if you don’t understand every nuance of every investment, you need to have some basic ideas of what’s normal for different asset classes. What is a reasonable rate of return to expect over an extended period of time? What kind of volatility do you have to live with on a short-term basis for each of the categories you are using? If your advisor recommends investments you don’t understand, ask many questions until you understand the positive and negative possibilities before you give approval.

Inside The Minds

160

Make Saving a Way of Life

The best piece of advice I ever received came from my mother, who said I should save 10 percent of everything I make. My mother did not understand stocks, bonds, and mutual funds. Her advice was a very simple savings strategy. She basically said you should save something all the time. You should always be saving something, and start as soon as you can.

My mother spent lots of time sharing her budget with me – what she made and where the money went – and it was very clear to me that you had to understand that whole process of making choices with your money, even if the money is limited. You’re always making choices. Things don’t just happen. You don’t just get into a situation of spending more than you make without making a conscience choice. As a teenager, when she reviewed her budget numbers with me, I thought it was boring. In hindsight, I realize her review process had a very large impact on me and has influenced my savings and spending habits over the years.

With respect to building a nest egg, the best piece of advice I would give is to save early and save often. I think it goes back to a basic concept of having a very clear


161

understanding of your goals, time horizon, and risk tolerance. Those factors all have to be intermingled to allow you to make conscious decisions about how much to save and where it should be saved.

The discussion I have with many clients – whether they are building a nest egg or have already built it – covers the whole emotional piece of investing and how important it is to have a plan and stick to it. Even if you are just starting to build a nest egg, having an investment plan and the discipline to stick to it is probably the conversation I have the most with people. If you let your emotions rule the investment decision-making process, you are probably doomed to failure.

On the other hand, a successful investor feels excitement in trying to reach a goal and the willingness to sacrifice, trading off other things in their financial spending life to make the goal happen. Be very focused and clear. “Here is my goal. This is what I know needs to happen to get there, and I am willing to trade off something today to make this goal happen.” It’s a focus, a discipline, and also cause for excitement to say it’s OK that I can’t go out with my friends for pizza on Friday night. I am going to invite friends over to my house, and we are going to make pizza

Inside The Minds

162

instead. It is that ability to see that wealth building can be a fun process, not just drudgery.

Handling Risk

A critical factor for minimizing risk is understanding the time horizon for when the money is needed. If it’s a long time horizon, I think it’s my job to help people understand the short-term volatility they have to live with. Investors need to understand that even though it may look really bad in the short term, if we look at statistics on a long-term basis it’s OK to take that short-term volatility. The willingness to live with volatility will maximize their return for long-term growth.

Most investors define risk as the potential loss of principal. “If I have $100,000 now, will I still have $100,000 next year? Or will it be less than $100,000?” Sometimes they lose sight of the inflation-risk possibility, which even at very low inflation rates does make a difference down the road. Investors need to understand the various risk factors – not just inflation or risk to principal, but factors such as interest-rate risk on bonds, the various types of financial risk, market risk, and undiversified risk. If you understand risk factors before you start investing, you can make


163

smarter decisions. Understanding risk factors will also help you live through the emotional volatility of short-term events.

Three Golden Rules for Building Your Nest Egg

One of the golden rules for building a million-dollar nest egg is having an understandable goal that you are committed to. Having an understandable goal means you’re able to answer the following questions: When is the money needed? How much must I save each month to achieve the goal? What rate of return is required to achieve the goal? Am I willing to live with the volatility associated with that rate of return? You need to understand basic investment principles and the mechanics of making the goal happen.

The second golden rule is to have a plan. Your written investment plan should consider the five investment principles I covered at the opening of the chapter. The plan should look at both historical expectations for the risk and return of various asset classes, as well as your personal tolerance for risk. If your plan is thoughtfully established ahead of time, it will help you weather the emotional turmoil that can occur in investing.

Inside The Minds

164

The third golden rule is commitment to the plan and the process. Stick to both the investment plan and the savings strategy. Understand that building a nest egg is a long-term process. If you are married, you both need to be committed to building the nest egg. You both must make a commitment to build wealth because it means sacrificing a portion of current spending.

Part of the planning and commitment is examining factors that could be obstacles to your success. These might be emotional, and they might be financial. Do you have an emergency fund built in there for yourself? Do you have medical coverage? Do you have auto and homeowner’s insurance if you drive a car and own a home? Do you have disability coverage that would kick in if you could not work for an extended period of time? Do you have life insurance for a spouse or children if you die prematurely?

The three golden rules are significant. However, if you haven’t planned ahead of time for emergencies and unexpected events, you may find yourself starting all over again.


165

The Future of Investing

I don’t think we are going to see the same kind of market returns in the near future that we saw in the 1990s. During the 1990s we had market returns that were almost double the long-term averages. Historically, if you had 100 percent of your money in large-company U.S. stocks, you might have been able to average 11 percent. In the 1990s the average was closer to 18 percent. Now, if we are back to average, we will be back to 11 percent. But we may be in a period where, to revert to the mean, we may average lower than 11 percent in large-company U.S. stocks.

Investors may have to save more money in the future because they won’t have the kind of returns that we have become accustomed to. The next five years may mean investors have to return to those basic, fundamental principles of saving and investing money.

Marilyn Bergen has been successfully serving clients in the financial services industry since 1982. She has been a leader among her peers in striving for a standard of excellence. As a fee-only Certified Financial Planner, she brings this commitment of excellence to her own investment management and financial planning clients.

Inside The Minds

166

Worth magazine has listed Ms. Bergen as one of the nation’s top financial advisors since 1996. The July 1998

and November 1999 issues of Medical Economics named Ms. Bergen as one of “The 120 best financial advisors for doctors.” She is past president of the Oregon Society of the Institute of Certified Financial Planners. She has served on the Pass Score Committee for the CFP Board of Standards.

Other memberships and affiliations of Ms. Bergen include the Estate Planning Council of Portland and the Financial Planning Association.


167

THE ART AND SCIENCE

OF INVESTING

CLARK M. BLACKMAN, II Post Oak Capital Advisors, L.P.

Chief Investment Officer and Managing Director

Inside The Minds

168

Texas Chili and The Art of Investing

You can equate the art of investing to the art of cooking. Any chemist will tell you cooking is a science. A gourmet will tell you cooking is an art. The chef who cooks for thousands of people a week recognizes the reality that combining the chemist’s science with the gourmet’s art is how he can make a living satisfying his customers.

A chef takes ingredients that are known to interact in predictable ways, mixes them together, and in the end comes up with a creation that is mysteriously unique to that individual’s skills and talents. Investing is similar in many respects. There are basic ingredients to investing that virtually everyone can agree on – cash, stocks, bonds, risk factors, and return expectations. However, a whole lot of other “ingredients” are required to make an investment strategy work for a particular person.

Let’s look at Texas chili. Texans can all agree on some basic ingredients – meat, onions, chili powder, cumin, and peppers. But that’s about where the agreement ends and the arguments begin. These arguments can revolve around the use of tomatoes, tomato sauce, jalapeños, habeñeros, cayenne, garlic, pork chunks, ground beef versus chopped beef – the list can go on for some time. Heaven forbid you


169

might add beans, which I do because I like them. So I depart from the purist convention that a bean should never get closer to a bowl of real Texas chili than the length of a longhorn steer’s horns. In the investing world, this departure can be compared to adding hedge funds, options, leverage, or some other strategy to spice up a portfolio. Even when you agree on the ingredients that should go into the portfolio, like chili, personal taste dictates the amount to add. What will be too hot for one connoisseur is guaranteed to be too mild for another.

Like the science of cooking, the science of investing should be the basis upon which an investor makes fundamental decisions. Using proven principles, which are based on historic data and research, an investor can create a portfolio with somewhat predictable risk and return characteristics (it is investing after all, so there can never be absolutes in predicting outcomes). But there’s a very personal element to creating an appropriate investment strategy that is necessary if you are to be happy with your long-term investment decisions. The need to sleep at night requires that the skillful blending of the right ingredients not be overlooked. That is the art of investing.

Inside The Minds

170

Start Building Your Million-Dollar Nest Egg

Much of what we do at Post Oak Capital Advisors really focuses on the preservation of wealth, as opposed to the creation of wealth. With either, we certainly know what it takes to get from square one to financial independence.

To build a million-dollar nest egg, you need discipline and patience. You have to treat your personal income and expenses like a business. Typically, this involves having a plan, which incorporates short-, mid-, and long-term goals for putting money aside, so you actually have something to invest. Like cooking, you need basic ingredients; money to invest is as basic as it gets. Although that may seem pretty obvious, it is one of the biggest hurdles the average individual has to overcome in creating a million-dollar nest egg: They don’t get their spending in line with their income.

Goals need to be realistic, measurable, and attainable. Ultimately, you have to make sure the plan, or recipe for success, will work for you as an individual. This means incorporating reasonable expectations for returns over time, as well as your own ability to accept a given level of risk in your investment strategy.


171

When it comes to establishing goals, you must first think about what you can accomplish in the short term, and something you can start immediately. Set a small goal this year to systematically put a few dollars a week into that savings plan at work or your savings account at the bank. It’s an easy trap to set grandiose goals, then procrastinate about getting started. A “good old boy” from west Texas once said, as he set out on foot to survey his property, “The journey of a thousand miles begins with the first step” (my apologies to Confucius).

Again, your first goal has to be to ensure that you have some money set aside, some reasonable amount that is going to allow you to build your nest egg. Ultimately, you should look at your current age and determine the future point when you want to be financially independent.

After deciding upon those parameters, you can do calculations that will direct you in determining how much you need to set aside to invest at a specific rate of return to accomplish your objective. Along with some discipline, it means sitting down and determining what you’re spending your money on and how much you’re spending relative to how much you have coming in. Yes, I’m referring to that most feared, most heinous of evils – budgeting. We

Inside The Minds

172

Americans hate to put ourselves on budgets. But every successful business has one, and you should, too.

It’s easy enough to sit down with a handheld present-value calculator and very quickly do some math to figure out how much you need to set aside each year. Folks who read Money magazine, Smart Money, or similar publications have certainly come across the various tables that show if you put away less than $2,000 a year starting at age 20, or about $4,000 starting at age 30, you can achieve a million-dollar nest egg at age 65. All it takes is consistently putting money into savings at relatively reasonable rates of return – about 9 percent annually for these examples.

The magic of compounding can turn relatively small amounts of money into surprisingly large sums over time. But that requires the discipline to put the money aside and the knowledge of how to achieve the returns necessary to accomplish your goal. Also, keep in mind that $1 million 45 years from now will buy far less than it buys today, so some consideration for inflation must be factored into your calculations.

You can use a simple formula to adjust your required rate of return for inflation. If you assume the 3.1 percent historical rate of inflation, the 9 percent growth rate used in


173

the above examples would be 5.72 percent after inflation. Here’s the formula: Take 9 percent; subtract the inflation rate of 3.1 percent to get 5.9 percent. Divide 5.9 percent by 1 plus the inflation rate of 0.031 (3.1 percent). That gives you 5.9/1.031, for an adjusted rate of 5.72 percent. If you put away $2,000 a year starting at age 20 earning 9 percent, you would have over $1 million at age 65, but it would be worth only $415,000 in today’s dollars if inflation averages 3.1 percent. You would need to save $4,822 a year to have $1 million in today’s dollars.

(You really need a “present value” calculator to do these computations. Inexpensive ones – the only kind I recommend – cost less than $50. I particularly like the Texas Instruments BAII Plus for ease of use and price, if you can find it (I’ve had trouble in this regard when replacing lost ones).

The next step is not so much goal setting, but selecting the strategies you will employ to invest your hard-earned savings. These strategies should provide some reasonable assurance that your savings will grow at a rate that will get you where you want to be, with the least amount of risk.

Overall, the approach to building your nest egg should be process-driven. You should document the process you will

Inside The Minds

174

follow in a written investment policy statement. Your policy statement should be geared toward the long term, with specific parameters set for these factors:

1. What you will invest in 2. The criteria used for evaluating money managers (or

mutual funds) 3. Return expectations 4. The level of risk deemed acceptable to you.

Once you have established a plan (or recipe) for your nest egg, you need to keep an eye on it. Not only does that mean carefully deciding who’s going to play what roles in the management of the various asset classes and styles you decide to invest in, but also monitoring and watching them carefully over time. For example, if you use money managers (either mutual fund or separate account) instead of buying your own stocks and bonds, you must evaluate the managers’ performance and other aspects of their operations on an ongoing basis.

If you buy stocks and bonds yourself, you need to be continually aware of what is going on at the companies that have issued the securities in your portfolio. It is important not only that you understand the investments you decide


175

upon, but also that you also have the time and ability to monitor them.

If you haven’t yet seen the movie classic Lost in America, I highly recommend you check this video out as part of your education on how not to treat your nest egg.

Risk Business

Let’s take a moment to define “risk” as it is used by investment consultants when discussing long-term portfolio construction. An appropriately diversified portfolio will have significantly eliminated the type of risk associated with investing in one company when that company fails to meet expectations, or even goes bankrupt. Although that certainly may happen in a diversified portfolio, if appropriately diversified and managed by an expert, the probability that a company’s failure would materially affect your returns will be small. Over time, the effect of a truly horrible stock pick (Enron, for instance) should be overcome by the long-term positive trend of the market. We recommend that any one money manager have a minimum of 40 stocks and keep their exposure to any one stock to no more than 6 or 7 percent of the total portfolio. As a long-term investor, you should understand that “risk”

Inside The Minds

176

in your portfolio is the volatility, or ups and downs of the portfolio, which is driven primarily by market forces.

So “risk” and “market volatility” become synonymous for the long-term investor. This is not to say that the risk of notachieving your ultimate goal is unimportant. But that risk is what drives the decision to accept or not accept volatility in the first place.

The driving force in developing investment strategy is an individual’s need to take risk and their willingness to accept risk. The amount of time available for the portfolio to grow is also a critical factor. Individuals with the same risk profile will need to have a more conservatively designed portfolio as the time horizon is shortened. For example, take someone who is 30 who has a risk tolerance similar to someone who is 50, with the same goal to retire at 60. They should have markedly different portfolios in terms of risk, or volatility, because of the amount of time available to overcome down turns in the market. Unfortunately, the 50-year-old may have to take more risk to achieve the goal because of a later start.

If you are a long-term investor saving for a goal such as retirement or financial independence, you should be doing so using a diversified portfolio of securities, typically


177

stocks and bonds. Older folks might be forced to take on a lot more risk than a diversified portfolio has, in hopes of hitting some homeruns, but they have to do so knowing they may very well end up with little or nothing to show for it.

I wouldn’t recommend that strategy for most individuals. In fact, at our firm, we wouldn’t work with an individual who wanted to take a non-diversified approach to their long-term portfolio. Someone who wants to do that is beginning to go down the road of speculating, as opposed to investing for the long term. The risk built into a long-term investor’s portfolio is a function of the percentage being allocated to equity-type investments (such as U.S. and foreign stocks), versus fixed-income investments (bonds and cash equivalents).

Equities and Building the Million-Dollar Nest Egg

In regard to the role of equities in building the nest egg, a well known rule of thumb is to take a person’s age, subtract it from 100 and what’s left is the percentage of your portfolio in stocks. As you get older, you’ll reduce your commitment to stocks and increase your commitment to

Inside The Minds

178

bonds. Your age is essentially your percentage committed to bonds.

However, the problem with a “rule of thumb” is that everyone’s thumb is different! Again, this rule gives no consideration whatsoever to an individual’s willingness to take risk or their need to take risk to achieve a specified goal. A more knowledgeable individual may be willing to take on more volatility in their portfolio because they understand the volatility and can live through the downturns more easily than a less sophisticated investor, who might panic and sell out at the worst possible time.

Almost two weeks after September 11, 2001, I met with a potential client who, the day before, had decided to take all his money out of the stock market. That day was the Friday of the week the market had reopened after the terrorist attacks. On that day the Dow Jones Industrial Average was down more than 14 percent from its pre-attack close. The NASDAQ was down 16 percent, and the S&P 500 was down almost 12 percent. That was also the lowest point the market had fallen to in more than two years. By selling he had “realized” the losses of the market and put everything into a money market fund, earning money market rates that were at their lowest point in well over 30 years.


179

By Christmas of 2001 the Dow Jones Industrial Average had climbed more than 21 percent; the NASDAQ rose more than 36 percent; and the S&P 500 was up more than 18 percent. Ironically, this person indicated on his risk tolerance questionnaire that he would rather be in the market when it went down, than out of the market when it went up. This is a real-life, tragic example of the results of not having a well-thought-out plan you can stay committed to. Sadly, he became so anxious to get back into the market that he had no patience to create a well-thought-out plan before reinvesting again and went elsewhere. I can only wonder how long he will stay put this time.

Strategies in a Turbulent Market

The volatility of the market is not temporary. To change your strategy because the market has become more volatile means you didn’t have a good strategy you could be committed to in the first place. For most investors, a long-term strategy requires a long-term time horizon and should avoid speculating on what the market is going to do in the short term. Short-term speculating is not something anyone can do with any significant degree of long-term consistency; therefore, speculating becomes a very dangerous thing. Moreover, it’s costly to move in and out

Inside The Minds

180

of markets. Rather, one should be diligent and watch the pot closely so it doesn’t boil over. When it comes to monitoring the performance of stocks – just like monitoring the performance of money managers – if you’re not watching closely, things can get away from you very quickly.

Above all, people shouldn’t stop investing. Again, volatility is not going to go away. Fundamental changes in technology and the way people are trading in the market have made it more volatile. Increased volatility means you have to watch what’s going on in your portfolio more closely. This is the role both a consultant and a money manager play; staying on top of what a money manager is doing in any given portfolio has become more important than ever.

Dealing with Unknowns and Uncertainties

The strategy for building a nest egg and investing for other goals can be different. I wouldn’t say it must be different, but it can be different. It’s all a function of your time horizon. If your goal is to accumulate a certain amount of money in two or three years, your strategy should be different from your strategy for investing for a retirement


181

that’s 15 to 20 years off. In the former case you have a two- to three-year time horizon for your goal, and you shouldn’t be in stocks at all. In the short run investing in stocks is speculative; you are counting on short-term events for your returns.

At any given point in time, you can’t say with any degree of confidence that in the next year or two you will have more money than you started with in the market. If you extend that time horizon, the degree of certainty increases dramatically. Even an aggressively diversified portfolio of stocks, bonds, and cash has only a very small chance of being less than its beginning value after five years (based on historical data).

For a long-term, non-market timing type of approach, it is not important to analyze where the market is going to be in six months, 12 months, or two years. The cost of moving money, and more important, the cost of being wrong, is too great to overcome. Many studies show that being out of the market on a handful of days, over extended periods of time, can cost you up to half or more of the market returns for that period. You need to be careful not to fall into the trap of believing that you can know today where the market’s going to be in six months. There are too many unknowns. Even if you take everything that is known today, you will

Inside The Minds

182

find qualified experts (whether economists, financial analysts, or television/mass media gurus) who will have completely opposite points of view about where things will be in six months. What does that tell you?

No point of view can take into account the unknowns that can potentially take place. I don’t believe it’s a productive use of your time trying to figure out where the market is going to go in the short run. Obviously, if you are concerned that the economy will collapse over the long haul, then you have to change your strategy dramatically. I recommend you move to a farm in Iowa and learn to milk cows if that is where your view of the economy falls. Also, you can stop reading now, and save some time – which is the only truly irreplaceable asset you have.

Following September 11, the way our firm dealt with the increase in uncertainty had more to do with a client’s attitude about the risk involved than any increase in expected volatility or uncertainty. It’s not so much about changing investing styles, but being more aware of the existing uncertainties. For example, we didn’t go to clients saying, “The increase in terrorism is an added risk that needs to be factored into your investment strategy and your asset allocation, so you need to have a greater commitment to bonds.” We don’t believe that’s an appropriate response.


183

Certainly anyone who did that immediately after September 11 would have found they were doing their portfolio a disservice, as I showed in the real-life example of the potential client I mentioned earlier. If you’ll recall, once the market opened, after it had been closed for a week, it fell for five days, closing with its worst week in 61 years. Following that Friday the market certainly had its ups and downs, but it had a lot more ups than downs and before year-end had recaptured all of that week’s loses and then some.

For the individual who has become increasingly nervous about investing because of September 11, this feeling needs to be taken into consideration because of the whole personal aspect of investing. There is no right answer for everybody. Everyone has a different taste for the heat of their chili, and if their taste buds change, that has to be taken into account. We have had very few instances of people wanting to do that and expressing a fundamental shift in their willingness to take risk. There has not been a significant change in investment strategies within our client base.

Inside The Minds

184

Leave It to the Professionals!

Most individual investors probably have no business playing money manager with their portfolios. They may watch CNBC everyday, listen to the pundits, and make their buy and sell decisions based on what they read in a daily, weekly, or monthly publication. However, the art and science of buying and selling stocks and bonds should be handled by a full-time professional who does it five days a week and every minute of the day the market is open.

From the perspective of a professional investor and consultant, the appropriate approach is to watch your managers, not watch your stocks or the markets. To do that requires certain tools. You can be your own consultant – there’s no question about that. But you do need to have the knowledge of how to evaluate your money manager (or fund) beyond just looking at performance, which is one of the biggest mistakes individual investors make.

A study done by DALBAR provides some interesting data on how individual investors performed relative to the market from 1984 through 2000. Stock mutual fund investors received an estimated return of 5.3 percent, on average, during this period. This conclusion is based upon evaluating the flow of cash into and out of stock mutual


185

funds. The return on the overall stock market during this period was 15.2 percent (Wilshire 5000 index); the return on the bond market was 9.1 percent (Lehman Brothers Intermediate Bond index); and the return on cash was 5.8 percent (Treasury bills).

The reason stock mutual fund investors did so poorly was primarily that many investors were buying and selling their mutual funds based strictly on short-term past performance. They were “chasing the hot dot.” Just as a manager went through his period of overperformance due to market conditions, money would flood in just in time for the market to change, causing performance to fall. Investors were clearly buying high and selling low. These investors would have been better off investing in T-bills (a virtually no-risk alternative). Note that in reality the dot chasers actually did much worse than the 5.3 percent results. This return includes the investors who knew better and stayed put, realizing the returns of the market or better.

Let me give another real-life example of setting realistic expectations for your managers and not chasing short-term performance. The hottest top-10 technology funds for the year ending December 31, 1999, had returns ranging from a high of 493.73 percent (Nicholas Applegate Global Technology I), down to 108.01 percent (Matthews Korea).

Inside The Minds

186

On average, these funds were up about 250 percent for the year, and the dollars poured into them. In 2000 Nicholas was down 36.37 percent, and several of these funds were down by almost two thirds of their per-share value from the start of the year. In the first quarter of 2001 six funds had lost another 40 percent of their value, and for the 12 months ending March 2001 six funds lost more than 65 percent of their value (and two were no longer in existence). Enough said.

Beyond simply looking at performance, you need to stay on top of what’s happening in the manager’s shop. If your money manager (or mutual fund) loses a star stock-picker or financial analyst, you may want to move your money out of that fund immediately, even though until that time they were doing a tremendous job. Appropriate monitoring is vitally important.

Another trap to avoid is putting all your eggs in one basket …and watching that basket real closely. Sorry, but you can’t watch any basket closely enough to know when a market turn is going to smash your basket.


187

Look for Deals Chasing Money

In 1984 I had been at a financial planning firm in Denver for about a year. There was a “planner” in town who was gathering a lot of assets, bringing in a lot of new clients, and he had a secret. He did a lot of seminars, had a video, and would advertise his seminars with the hook that he was going to give people “the secret to accumulating great wealth without risk.” I finally got my hands on one of his videos to see what he was selling. At the end of watching his two-hour spiel, I discovered that the secret was, literally, “Buy low and sell high.”

The truth is, if you can do that consistently, you can become a very wealthy person – no doubt about it. What that “planner” was selling was precious metals futures – gold, silver, platinum, etc. He was also promoting the idea that since these metals were low relative to the recent past, they must surely be the way to easy riches. What he forgot to tell his investors is that it is far less important to know where the price is relative to the past and far more important to know where the price is relative to the future.The prices of gold and most other precious metals have floundered for almost two decades since then, while the stock market has risen to unimaginable levels at an unprecedented rate, even considering a dismal 2001.

Inside The Minds

188

In all seriousness, the best advice I have ever received I got at about that same time. It ties into the current craze for hedge funds and how wildly promoted they are and how everybody is so anxious today to invest in them. Back in the early 1980s tax shelters were being sold like crazy; everybody wanted to be in a 3-to-1, 4-to-1, or even higher, tax shelter. It was back then that I got the following advice: “Always be cautious when money is chasing deals, instead of deals chasing money.” Unfortunately, investment opportunities will crawl out from under the rocks when money is flowing indiscriminately into the next deal that comes along. It’s much healthier when the deals are out scrounging for money, because the bad deals will tend to disappear.

By the mid 1980s these tax shelter partnerships became a disaster. Willy Nelson was suing Price Waterhouse, and the IRS was suing Willy; and it was only through his good fortune he didn’t go to jail.

I suggest we had a similar scenario in the late 1990s with tech company IPOs and the funds that were created to hold all the rapidly growing tech stocks and the whole e-business craze. In the late 1990s all you had to do to raise millions of dollars was put a dot-com behind the company’s name. That is an example of more money


189

chasing opportunities than there are good opportunities chasing money. That’s not a healthy economic environment or a healthy investment situation.

I believe that was great advice, advice people should heed, whether they’re going to invest in hedge funds, tulip bulbs, or anything else for that matter. In 1990 there were about 200 to 300 hedge funds managing about $20 billion. By 2001 there were more than 3,000 funds managing $400 billion. That means an awful lot of people with very little experience started hedge funds, and these things are opening and closing overnight because there is so much money rushing into them. That’s a prescription for trouble for anyone who doesn’t truly understand how to identify and avoid the bad ones.

Whether or not a hedge fund should be part of your strategy to build a million-dollar nest egg depends on your willingness to take the time to become familiar with this type of investment. There are about 11 different types of hedge funds out there. It can be difficult to know what any one hedge fund manager is doing, or will do, on an ongoing basis. This makes monitoring them difficult at best. Unlike a mutual fund or a separate account manager who is investing in long positions in the stock market, what a

Inside The Minds

190

hedge fund manager does is not always predictable or easy to determine ahead of time.

Balancing the Risk/Reward Ratio

Harry Markowitz won the Nobel Peace Prize in the early 1990s for his work on Modern Portfolio Theory (MPT) that began in the 1950s. MPT introduced a concept known as the “efficient frontier.” The efficient frontier is the exact mix of diversified assets that maximizes your return potential at a given level of risk. To calculate this you need specialized software, and there is a variety of different alternatives available to consultants. Individuals can buy them too, although they’re typically thousands of dollars and require an ongoing commitment to keeping them updated. But there are tools available to help you identify an optimal portfolio for the level of volatility that you’re willing to accept.

There are a lot of ways to measure your risk tolerance and a lot of facts to consider. One of the most important is to determine how much your portfolio can go down over a 12-month period without losing sleep at night. If you can define that, you can create a portfolio of diversified investments that, based on historical data, optimizes the


191

return to the level of risk that you’re willing to accept. That’s the science part of investing. As with anything else, though, you have to understand that ultimately we’re talking about the future, and there’s an element of uncertainty to the future that will never go away.

I recommend two books today to anyone really interested in learning about the science of investing. The first is Wealth Management by Harold Evensky. The second (and not by order of importance) is Roger Gibson’s book, Asset Allocation. When I was national director of investment advisory development at Deloitte & Touche Investment Advisors in the late 1990s, I used to recommend these books to our financial planners as part of their “boot camp” training to become investment advisors. They are both great primers on the application of Modern Portfolio Theory to the everyday reality of investing.

Golden Rules for Building a Million-Dollar Nest Egg

The first golden rule for building a million-dollar nest egg is to have a plan you believe in. In the business of investment consulting, we call this plan an investment policy statement. The plan starts with identifying the money you have to work with – including the future cash

Inside The Minds

192

flow potential you’ll add to the portfolio. Next, you need to identify the types of investments you’re willing to invest in – and the amount of risk or volatility you are willing to take. The plan is critical to achieving any kind of long-term success. More than anything else, a plan can keep you from making knee-jerk reaction mistakes when things such as September 11 happen. You adopt your plan based on well-thought-out rules that are based on historical data and reasonable assumptions. Then you stick to that plan unless there are very compelling reasons (usually life-altering events) to change it.

Another golden rule is to know and understand what you’re investing in and to be comfortable with that knowledge. For example, most people investing in those tax partnerships in the 1980s did not really know what they were getting themselves into. To a large extent, I think the over-commitment to technology in the late 1990s was being made by individuals (some of whom were money managers) who really didn’t have a clue about what they doing; some of the companies they were buying had no earnings, no revenues, and, in some cases, few or no real prospects. The “greater fool theory” was hard at work then. (It doesn’t matter what you pay for it; a greater fool will come along and pay even more when you’re ready to sell.)


193

Diversification is absolutely essential. People today do not get compensated for the non-diversified risk inherent in a concentrated exposure to one stock. It is important to be diversified not only among major asset classes, but within those asset classes, as well. Making sure you have diversified away the majority of “single security” risk (also known as “specific issue” risk) is critical. Ask the folks who used to work for Enron. Living in Houston, the very real pain of too much exposure in one company’s stock is way too apparent. As an advisor, I continually have to tell clients to divest themselves of company stock if they can. That exposure should be no more than 5 percent to 10 percent of their total commitment to U.S equities.

The fourth golden rule has to be to have realisticexpectations. Having unrealistic expectations leads to making bad decisions. In 2001 a study done by Scudder Kemper Investments boggled the minds of those who know the actual historical returns that various asset classes have achieved on a diversified basis. The return expectations of investors in the 18-23 age group averaged 26.5 percent. This was the most aggressive of all of the age groups surveyed. It was also the youngest, so it was no surprise. Each successively older age group responded with a more conservative expectation. The most conservative response

Inside The Minds

194

was given by the 68+ age group, with an annual return expectation of 16 percent a year!

These people are setting themselves up for tremendous heartache because none of these expectations is achievable over the long run with a diversified portfolio. Because we tend to make our decisions and judgments based on our own personal recent experiences, it becomes necessary to step back and become educated enough to know what’s truly reasonable. You don’t want to constantly chase after the elusive pot of gold at the end of the rainbow that doesn’t exist.

Unreasonable expectations are very costly to one’s portfolio and have led to significant underperformance of the average investor’s portfolio over the past 15 years. The DALBAR study referred to earlier is an example of what people without reasonable expectations are capable of doing as they constantly chase the next hot thing. Moreover, they’re always doing it based on what a manager did last month, last quarter, or last year and comparing this to their current manager; and they’ll always find somebody doing better. These are important statistics for people to get their hands around and understand, so that they don’t make the same mistakes.


195

Of Bulls, Bears, Pigs, and Chickens

Investing does not need to be the gut wrenching ride many investors make it out to be. If you feel you are being cast about like a small boat on a stormy sea, do take heart. The way to bring some semblance of calm to the waters is to follow the path blazed by investment consultants over the past 30 years. Establish a well-thought-out plan and follow it. Become knowledgeable enough to allow your rational self to win the argument with your emotional self. Balance “greed” with “fear”; and let neither totally overrule the other. This means you have to get – and stay – diversified. An old saying on Wall Street has never been truer: “Bulls make money. Bears make money. But Pigs (and Chickens) get slaughtered.”

One final bit of advice I’ll pass along came from the world’s first historian, a Greek named Herodotus. It is particularly valuable for investors to heed, in that we can always look back and second-guess our investment decisions. There is inevitably some action that could have netted greater returns – in hindsight. Take the advice of this wise old Greek and sleep at night in the comfort of knowing that you made the best decisions you could, with the information available to you at the time:

Inside The Minds

196

There is nothing more profitable for a man than to take good counsel with himself; for even if the event turns out contrary to one’s hope, still one’s decision was right, even though fortune has made it of no effect; Whereas if a man acts contrary to good counsel, although by luck he gets what he had no right to expect, his decision was not any less foolish. Herodotus (c. 485-425 BC)

Clark M. Blackman II, CPA/PFS, CFA, CIMA, CFP/AAMS, was born in Kansas City, Missouri, and raised in Bettendorf, Iowa. He obtained his undergraduate degree in finance in 1979 and his Master’s degree in accounting from the University of Iowa in 1980. He has been employed in the financial services industry since 1980 and in Houston since 1995. He is a member of the Association of Investment Management and Research, the American Institute of CPAs, the Investment Management Consultants Association, and the Financial Planning Association.

Mr. Blackman is one of eight experts serving on the national “Resource Panel” for the AICPA’s Center for

Investment Advisory Services. He serves on the Education


197

Committee of the Houston Chapter of the Financial Planning Association and the Financial Planning

Committee of the Houston Chapter of the Texas Society of CPAs. He has also been a member of the Houston Business and Estate Planning Council since 1996. Mr. Blackman has been a featured speaker at national conferences of the AICPA, the Institute of Certified Financial Planners, the National Association of Personal Financial Advisors, and the American Association of Individual Investors. He has written or co-authored more than 40 published articles on financial planning topics over the past 15 years.

Mr. Blackman has been recognized by Worth magazine as one of the “Best Financial Advisors in America” six years in a row as of 2001. Candidates are nominated by national professional organizations that consider their nominees to be leaders in the field of financial and investment planning. In 1997 the editors touted their winners as “…advisors we would send our parents to.”

Mr. Blackman is executive vice president, chief investment officer, and managing director of Post Oak Capital Advisors, L.P. Post Oak Capital Advisors, L.P. is a Registered Investment Advisory firm formed in June 2000, providing an effective and disciplined approach to wealth management and preservation. This includes advice on

Inside The Minds

198

investing, estate and gift planning, tax planning, and retirement. These services are provided to high net worth

individuals, as well as the fiduciaries and trustees of pension plans, trusts, estates, corporations, and other business entities. Mr. Blackman has also been managing director and a registered principal of Post Oak Capital Advisors, Inc., a registered broker/dealer and member NASD/ SIPC firm, since 1999.

Before joining Post Oak Capital Advisors in 1999, Mr. Blackman was a national and regional director with Deloitte & Touche, LLP in the investment consulting services area. He served on Deloitte & Touche Investment Advisors’ advisory board and was one of 12 members of the firm’s Private Client Advisors Creative Services committee, charged with identifying and developing wealth management strategies for the firm’s national estate planning, income tax, and investment consulting practices. Before joining Deloitte & Touche, he was a director with Price Waterhouse, LLP where, in 1992, he brought in the first individual investment consulting client to that firm and was instrumental in helping develop the investment consulting practice at that firm. His clients have included chairmen, CEOs, and senior executives of such companies as NCR, Allied Signal, Shell Oil, Kelsey Hayes, Kmart, and Detroit Edison.


199

WHO WANTS TO BECOME A

MILLIONAIRE?

LAURA LEE WAGNER

American Express Senior Advisor

Inside The Minds

200

$1,000,000 Wrong Goal

So, who wants to become a millionaire? From TV shows, it seems to strike a cord in America that $1,000,000 is a magic number. Contestants from across the nation try to “win” it. Women vied to “marry” it on a two-hour show. Others try to inherit it and fight over it. Many try the lottery; most lose. The truth is most millionaires earn it, the old fashioned way, by saving over time.

Your beliefs about money, your intent about money, and your habits with money are the most significant factors in determining your financial outcome. If you believe money is “bad” or you don’t “deserve” to have it, you will consciously or unconsciously get in your own way and won’t have it. Mary, a 40-year-old veterinarian, believed money was bad and that people with money used it selfishly or were in positions of power over others. She tied money and emotions together. She had problems in her back (the support structure of the body), lived frugally, and did not want to be viewed negatively if she had money. She grew up in a household where her parents were tight with money, her father using money as a reward system and treating his employees abusively.


201

Lesson #1: Understand where your views of money come from. Make financial decisions financially, and emotional decisions emotionally, with intellect.

What is your intent to become a millionaire? Everyone has a core value of money. To find yours, ask yourself:

What’s the most important thing about money to me? If I had (fill in your answer), would there be anything else more important to me about money?

I have found with my clients a few core answers: Security.Money means, “I don’t ever have to be a bag lady”; “I can provide for my family”; “I don’t have to be a burden on my children.” Freedom and Independence. “I want to be able to live the lifestyle of my choice.”

Once you know your core, now you know what the purpose of money is for you. Remember, “The love of money is the root of all evil.” If you love money, for the sake of money or power, you will have challenges in your life. David, a 60-year-old professional, worked 12- to 14-hour days and spent very little time with his family. His desire was wealth. He worked to make money. David is a divorced millionaire estranged from his children. Money can buy

Inside The Minds

202

things like cars, homes, and vacations, but not happiness. What do you want money to do for you?

Lesson #2: When you make investments, understand your core value of what you want the investment to provide. You aren’t really looking to make 20 percent in one year. The real goal is for the investments to meet your financial goals, on time.

There are three kinds of money people: Super Spenders, Spenders, and Savers. Most people spend first and, if there is anything left over, save it. They live pay check to pay check. Some spend to fill emotional needs and have “stuff” that really doesn’t satisfy them. Joe, an engineer, earned $80,000, and Jenny, his teacher wife, earned $30,000. They had the maximum mortgage on their $200,000 home, and $30,000 in credit card debt. After seeing them for four years, preparing a realistic budget, analyzing their credit card rates and payments, and then watching their credit card debt grow to $70,000, I let them go as clients. Joe and Jenny were Super Spenders. They spent more than their combined $110,000 annual income. They “needed” a new shirt at the department store, or new furniture. They lived beyond their means and had no desire to change. They had no discipline.


203

Harriet, 57, a customer service rep at the same company as Joe, earns $18,000. She has investments of a quarter of a million dollars. She has the millionaire habit of saving first. She began saving with her first job and continued. She just bought her very first home, on her income alone, with a substantial down payment, and has comfortable biweekly mortgage payments taken out of her paycheck. She maximizes contributions to her employer’s 401(k) plan and diversifies her investments.

Lesson #3: It’s not how much you make that determines whether you will become a millionaire. It’s how much, and how soon, you save.

How much is $1,000,000? I’ll tell you the truth. A million dollars is the wrong goal to strive for. Why? Because it’s irrelevant. What is important is what you want and when you want it. You may need $2,243,000 to meet your goal to retire at age 60. Or you may need $579,000. The first step is to find out where you are now.

Determine your net worth: Add up all assets (investments/property you own) and subtract all liabilities (everyone you owe money to).

Inside The Minds

204

Assets LiabilitiesHome $150,000 Mortgage: $ 100,000 Auto $ 25,000 Auto Loan $ 10,000 Personal prop. $ 25,000 Credit Cards $ 5,000 401(k)/IRAs $100,000 School Loan $ 5,000 Stock/Mut.Fnd $ 25,000 Total $ 120,000 Chkng/Svng $ 10,000 CDs/SvngBnd $ 5,000 Total $340,000 Net Worth: $220,000

Can you live off your house, auto, and furnishings? So is your goal $1 million in assets, net worth, or only investments you can obtain monthly income from? If you own a home, an auto, and furnishings of $200,000 total, do you then want $1.2 million net worth? Or do you really want enough assets to generate monthly income to live on in retirement to support your desired lifestyle until life expectancy age?

Would $1 million be enough in money in your future with inflation? If you’re 35 now, and your goal is $1 million in today’s dollars, you need $ 3,243,397 by the time you’re 65 to buy what $1 million can buy today at 4 percent inflation rate. If your goal at current age 35 is $1 million at 65, that’s really only worth $308,319 today. That’s why $1 million is the wrong goal for most people.


205

Age now $1million at AGE 65 Inflation Equivalent 25 $4,801,020 $208,289 30 $3,946,089 $253,415 35 $3,243,397 $308,319 40 $2,665,836 $375,117 45 $2,192,123 $456,387 50 $1,800,943 $555,264 55 $1,480,244 $675,564 60 $1,216,653 $821,927

Now that you know where you stand, what age are you viewing your financial future from? Your current age and the targeted age of your retirement or financial independence determine the number of years you have to save and how much you need to save.

Amount needed to save monthly to have $1 million at age 65 at various interest rates:

Age 6% 8% 10% 25 $502 $286 $158 35 $995 $671 $442 45 $2164 $1698 $1317 55 $6102 $5466 $4882

Inside The Minds

206

15 Steps to Take Now

1. Prepare a cash flow/budget to determine where all your money goes each year.

2. Save first. Target a percentage of your gross income to save, and live on the rest of your income.

3. Establish specific quantifiable goals. Know the details and all assumptions for each objective. For example: I want to retire at age 62, on $60,000 per year in today’s money, with 3 percent inflation annually. I will be in a 25 percent tax bracket. I will take Social Security at age 62. My investments will average 9 percent pre-retirement and 8 percent post-retirement. I have no pension plan. My employer will match 3 percent of my pay per year in my retirement plan. My mortgage will be paid off at age 62, and I will live in a similarly valued home. I will have no other debt. I will replace my auto every seven years at a cost of $25,000 in today’s dollars. I have earmarked my 401(k)s/IRAs, mutual funds, and stocks toward this goal and will continue to save 10 percent of my gross income annually. My parents and children will/will not need my financial assistance. I will plan for a life expectancy of age 82.


207

4. Determine your risk tolerance and diversify investments over both class and style.

5. Determine whether you want to “do it yourself” or hire a professional advisor to work with over time. Prepare or hire someone to prepare a written financial analysis reflecting inflation to determine exactly what you need to save to achieve your goals.

6. Maximize participation in employer tax-qualified plans such as 401(k), 403(b) (TSA), or simple IRAs. Year 2002 maximum is $11,000. (See next tip.)

7. Keep abreast of tax laws. Legislation in 2001 encourages savings. If you are age 50+, you can save an additional $1,000 more in 401(k), 403(b), and Sar-Seps.

8. Maximize Roth IRAs. If your income as a single is under $95,000, or married under $150,000, you can contribute $3,000 in a 2002 Roth IRA, and if you’re 50+, you can add $500. These amounts are per person.

9. Participate in employer stock purchase plans (typically buying at a 15 percent discount).

10. Assess risk exposure. Are you over- or under-insured in the event of an auto accident, home damage, disability, premature death, long-term care need, medical insurance?

Inside The Minds

208

11. Check all liabilities rates to determine whether refinancing your home or paying off credit cards makes sense.

12. Prepare a net worth statement annually to track and monitor your progress.

13. Monitor investments quarterly or semiannually and compare to like kind. For example: Your CD rate to the average rate in your area; your large cap blend mutual fund to the average large cap blend mutual fund or S&P 500 index. Look for investments in the top half of investment performance.

14. Consult your tax advisor or financial advisor for each year’s retirement plan contribution limits and review tax reform acts to ensure you know all you can act on.

15. Get all your ducks in a row. Check beneficiaries on all assets, including life insurance and company plans. Review wills, trusts, powers of attorney, medical powers of attorney, living wills.

Ten Costly Mistakes

1. Carrying a balance on a credit card. (Live within your means.)


209

2. Listening to “hot stock tips” from everyone you know. (Don’t buy last year’s #1 performing stock or mutual fund.)

3. Forgetting to have an emergency fund of two to six months’ expenses. (This fund keeps you from having to sell equity assets in a down market when an unexpected money need occurs.)

4. Putting all your eggs in one basket or in employer stock. (Monitor and limit exposure of any single security to no more than 10 percent.)

5. Assuming you’ll earn more than 10 percent return per year on average. (Use 6 percent to 10 percent, depending on your risk tolerance.)

6. Taking a loan from your retirement plan. (You are robbing your future. You pay yourself back with after-tax dollars and end up paying double tax on the interest you “pay yourself” when you withdraw money. The second pitfall is you lose the compounding of the asset growth.)

7. Trying to time the market. (Evidence points to staying invested, even during bear markets. No one can know consistently when to both buy and sell over time. And don’t day-trade – it doesn’t work over time.)

Inside The Minds

210

8. Assuming that once you’re retired, all your money needs to be in “safe” investments. (Your money may need to last 20 to 30 years into retirement.)

9. Taking more than 5 percent of your assets per year as income, once you’re retired.

10. Buying lottery tickets or investing in anything “guaranteed to earn over 10 percent per year” when inflation is 7 percent or lower.

Final Millionaire Thoughts

Brian and Cindy lived beyond their means all their lives. Brian made over $200,000 a year, saving just $2,000 per year in an IRA, and had $20,000+ in credit card bills constantly. Brian became part-owner of a company, worked hard for four years, and sold his shares in the business for $2,000,000 after tax at the age of 48. In their first 14 months of retirement, Brian and Cindy spent $300,000. Cindy shops for expensive clothes and loves expensive hobbies. Still living beyond their means, they continue to buy what they want when they want it and are draining their principal. They bought more expensive homes every five years and now live in a million-dollar home with a


211

$500,000 mortgage. With their current spending habits, they will run out of money in six to seven years.

Michael and Mary, in their early 50s, live in a $175,000 home, own a vacation home, and have a net worth of $2.5 million. They started saving at the age of 21, maximizing retirement plans, and were self-employed, working hard to build their nest egg. They regularly give monies to charities, serve as volunteers, and tithe to their church. They focus on relationships, growing, helping friends and family members, and traveling the world to learn.

So, if you want to be a millionaire, what kind do you want to be?

Laura Lee Wagner is a senior advisor with American Express in Phoenix for 14 years. She is a Certified Financial Planner with a Master’s degree in financial services with an emphasis on retirement planning. Ms. Wagner has been quoted often in the Business section of the Arizona Republic, in Money magazine, and in The New York Times. She has written a series of articles for the Mesa Tribune and has appeared as a guest speaker on KFNN and KFYI radio and KPHO and Fox TV.

Inside The Minds

212

Ms. Wagner was listed in Worth magazine as one of the top 250 financial advisors in the United States. Her community

service includes volunteering for the Charge against Hunger, Special Olympics, and St. Mary’s Food Bank, and she serves as vice chairman of finance for Florence Crittendon-Girls in Crisis. She is a former Junior Olympics swimmer, plays tennis, and enjoys hiking, chess, and her three cats.


213

ALTERING STRATEGY FOR

RETIREMENT AND

NON-NEST-EGG GOALS

GARY MANDELL

The Mandell Group President

Inside The Minds

214

Timing Is Everything

Generally, I am pretty much a buy-and-hold investor. I have a strong belief that you must first do a financial plan to determine what you want your investment portfolio to do. Then the objective is to build a strategy based on that plan and stick to it. It might mean monthly, semi-monthly, or annual contributions to an investment program. Obviously, an investor needs to continue to monitor his or her investments and make sure nothing has changed in the financial plan that might require a change in the way their portfolio is structured.

To alter the investment strategy to include non-nest egg goals, such as a car or a boat, has to do with timing. If a 25-year-old couple talks about investing for retirement, I know generally we have 30 to 40 years to work with. If a 25-year-old couple says they plan to buy a house in four or five years and start a family, a portion of money that I know is going for the house will be invested on the conservative side of the portfolio – that’s true of college education monies, as well. If a couple has a newborn baby, we might start off with the money designated for that child’s college education invested 100 percent in the stock market. As the child turns 12 or 14 years old, we are going to reduce the stock market exposure because we can’t


215

afford a bad year or two right before we need the money for college. Basically, the amount of time before one of these cash needs comes up is a big determining factor in how that money is invested.

Risk Tolerance

Clearly, risk tolerance depends on the investor, and may or may not correlate with their age. Younger people can afford to be more aggressive because they have more time to make up for possible downturns in the market. If you’re 64 years old and planning to retire next year, there isn’t a lot of room to make up for a 20 percent down year in the stock market; as a result, it’s going to affect the percentages allocated to stocks and bonds. An investor’s risk tolerance might also affect whether they invest internationally (stocks and/or bonds), in small companies versus large caps, blue chip or emerging companies, and junk bonds or triple-A rated U.S. government bonds.

The first component of risk tolerance is what I call the sleep factor. If the market has gone down 5 percent every quarter for a year or two, and an investor is having trouble sleeping because of it, then the individual needs to have a lower exposure to the stock market and more exposure to

Inside The Minds

216

more conservative securities, such as high-quality bonds, regardless of the rate of return necessary to meet a goal. In a case like that, perhaps the goal needs to be adjusted.

The second factor is determining when you need the money. Generally, the younger you are, the greater percentage you should have in the stock market. Over the long term the stock market provides the greatest growth rate on an annual basis. On the other hand, if you’re 20 years old and married, and in three years you will need a large portion of your net worth to buy or put a down payment on a house, then that portion will be very conservatively invested. As you get older, and most of the large living expenses are out of the way, you should look at what kind of risk you can take based on how many years are left until your retirement.

My general philosophy is to take the least amount of risk necessary to meet financial goals. For a 25-year-old couple, I might recommend 100 percent investment in stocks, and for a 55-year-old couple, I might go as low as 30 percent or 40 percent in stocks. You can make a mathematical calculation to determine the rate of return you need to meet a goal, and then build the portfolio around that. The general idea is that over time, stocks should grow at a higher annual rate than other traditional investments. The greater


217

component you can put into stocks over the long term, the greater your average annual rate of return will be.

A Balancing Act

Building a nest egg through investing is a long-term program to meet specific goals. It is not an in-and-out, market-timing, or day-trading activity. In building a nest egg, the first thing to do before investing is to prepare an overall financial plan, which will help determine what the investment portfolio is trying to accomplish. Among other things, the financial plan will look at cash flow needs, tax brackets, and risk tolerance.

Some of the determining factors we look at when structuring a client’s portfolio include: Is there a retirement plan at work that they may or may not have investment control over? Are they expecting inheritances? Will they need money for short-term goals, such as the purchase of a home? Will they need money in 40 years for retirement? Do they have kids they want to put through school in a couple of years? Those are all going to be determinants in how the portfolio is structured, including what percentage should be in stocks and bonds.

Inside The Minds

218

Then we take a look at where they are now. How much money do they have in their portfolio now? What rate of return can we reasonably expect, given the kinds of investments they should be going into? With that knowledge, we can calculate how much money they will need to put away annually, monthly, or however they will be investing. It doesn’t matter if the goal is a $1 million or $10 million; the process is still the same. Only the investment strategy may change.

As for characteristics of a good stock, I don’t actually pick individual stocks; I pick the pickers (managers). Certain characteristics make for good stock managers. If the stock manager has a 500 percent turnover in their portfolio – which means they trade the entire portfolio five times in a year – that’s generally not the kind of person that I am looking for because they are very short-term market timers, almost a day-trading kind of manager. I am not looking for high turnover in their portfolio. Most of my clients are in income brackets where taxes matter. So we are trying to manage the portfolio on a tax-efficient basis. The more trading you do, generally the more taxable income is being generated.

In addition, your age is a factor to consider. Obviously, the older you get, the less risk you can afford, as far as


219

downside return in the stock market is concerned, so you will buy more conservative stocks. Most of my clients do have exposure to some international markets, and they also have exposure to some small-caps stocks, as well, but those percentages vary, depending on how old the clients are and what they can afford to risk. If someone needs a million-dollar portfolio only to live on, and they already have $5 million, then they can afford to take very little risk, regardless of what their age is.

When building the million-dollar nest egg, the right balance of stocks and bonds depends on your age and how much risk you’re willing to take. As for what kinds of investments you would have outside the stock market, there are a lot of choices in the bond market, as well, such as government bonds and emerging market debt. It really depends on the amount of risk you can take. Some of my clients are ultra conservative, and even a CD is too risky for them if the bank isn’t right across the street. In general I look at the bond portfolio as I do the stock portfolio: It needs to be diversified; an investor needs to have a lot of different issues there. It should be professionally managed. A wide variety of fixed-income investments can go into the portfolio: fixed annuities, government bonds, municipal bonds, junk bonds, and international bonds. The mix

Inside The Minds

220

depends on the individual, their age, their income needs and tax bracket, and how much risk they can afford.

Make No Mistake: Stay the Course

I don’t like market timing, nor do I like sector picking (autos, financials, drugs, etc.) on an all-or-nothing basis, because over the long run it’s a losing proposition. If an investor is easily making the return percentages, it doesn’t make sense to switch strategies suddenly and say, “I have all these hot stocks my brother-in-law told me about,” or “I really think this is a great time to be in the market, so I’m going to sell out my bonds and put everything into stocks,” or “I really think the auto industry is going to do great for the next three months, so let’s sell every other stock and put it all into auto stocks.” I don’t like those kinds of massive movements. As long as we stay diversified and close to the target ranges, there’s a lot of room for latitude.

Investment strategies shouldn’t change due to short-term turbulence in the market. In general, markets trend in an upward direction. Since 1926 there is still an almost double-digit annual return on large cap stocks. Even though this average has dropped since the late 1990s, it’s still the best long-term investment out there. I don’t usually


221

recommend that anyone make any moves on short-term volatility.

If you really want to get specific, look at market performance since the destruction of the World Trade Center as a perfect example. While the market dropped precipitously immediately after that event (the S&P 500 dropped 11.6 percent on the first post-attack trading day), by the end of that year the market was up almost 20 percent from its post-event lows and had even gained about 6 percent since the day before the attack.

Historically, those kinds of events are very short-term in nature as far as their effect on the stock market is concerned. Better yet, look at the statistics on how many one-year downturns there have been versus how many five-year downturns there have been versus 10-year versus 15-year downturns. Since 1931, with one exception (1960-1974), there has never been a 15-year period where the stock market didn’t earn at least 5 percent a year. Of course, there is volatility, but over the long term, it’s still the best place to be. To be put it more simply, staying the course is generally the best way to invest.

Inside The Minds

222

Set Goals; Rebalance; Update

You should examine your portfolio systematically. I recommend quarterly, looking at your asset allocation targets. Let’s assume you want a total of 60 percent of your investments in the stock market, with 40 percent going to large caps and 20 percent going to small and mid caps. Every quarter, you should look at where you are in small versus large cap stocks position, as well as your stocks versus bonds position. If you’re more than a couple of percentage points away from your targets, adjust your positions to get back in line with them.

This really is a great way to invest. If the market goes way up, you’re selling some stocks at a relatively high price. If the market goes way down, you are buying stocks on sale because you know they are always going to come back to the average.

I usually will not take a client who won’t complete a goal-oriented financial plan before investing. To do so would be like building a house without a blueprint: If you don’t have a blueprint to tell the people how to build it, you can’t measure your progress along the way, and it won’t come together the way you want it. A financial plan also takes a lot of the nervousness out of an investor’s mind. If you


223

have a plan that states your goal and explains how you are trying to accomplish that goal and how many years you have to accomplish it, a short-term blip in the market won’t affect the long-term outcome. That should help you remain calm.

The plan should be updated any time a major event occurs that might affect the goals or your ability to meet them, whether it’s a job change, the birth of a child, or a child you were planning on not going to college turns out to be a genius and wants to go to Yale. Goals change as our lives change. Moreover, the plan is only as good as the information we use to create it.

Your plan should be reviewed every couple of years and no less frequently than every three years. A simple review may go as follows: As part of the initial financial plan, it may be recommended that you have X number of dollars in the bank, and Y number of dollars in your stock portfolio. When you update the plan, we’ll look at where you actually are, and we’ll try to explain the differences. Maybe you’re spending more money than you thought you would; maybe you’re earning more money than you thought you would. Maybe the investment return isn’t what we expected. The financial plan is a great tool, but it is a snapshot of one

Inside The Minds

224

particular moment in time. So you need to look at it on an ongoing basis to make sure that you are on track.

Characteristics of a Strong Investor

The first thing to figure out is how interested you are in picking the investments. Some people who are not professional investors still take a great interest in investing, and this is what they do in their spare time. They feel comfortable picking stocks. So the first thing you need to determine is how capable are you to do this yourself. You may be capable of picking individual stocks, and start to research individual issues. Or, more likely, you may be capable of determining how much is appropriate to have invested in the stock market. Many personal finance software programs can help you make some of those decisions.

You may want to start looking at mutual funds or private money managers – depending on the size of your portfolio – and do research on those money managers. It is good to ask if they buy the stocks you would be comfortable owning, and whether their investment philosophy similar to yours. You can do that kind of background checking on your own.


225

But picking individual stocks is a full-time job. It’s not expensive to hire a professional to do this for you. In fact, in the long run, I think it ends up being a lot less expensive.

The most important characteristic of a good investor is patience. The only thing we have to go on is historical data. The history of a particular stock shows the kind of returns we can reasonably expect. Remember, you’re not investing for the short term; this is a long-term goal. It really doesn’t matter what happens over the next four months; it matters what happens over the next 40 years (or whatever your retirement time horizon may be). So patience and the ability to stick to a plan are important.

I have several clients who, after a particularly good year, when they’re flush with cash, all of sudden change their lifestyle. They’re not putting their money into new investments; they’re buying new cars and new houses and taking more expensive vacations. Basically, they change the goal to fund current living expenses instead of putting money away for investment.

There needs to be balance. It’s a struggle for us all everyday, living for now versus the future. Since September 11, a lot of people are really thinking about that question: “What’s so great about putting money away for

Inside The Minds

226

40 years if I won’t be around tomorrow?” It’s a question we all must answer for ourselves and strike the proper balance. You have to realize the market evolves and gyrates, and you can’t have a knee-jerk reaction to those changes; you can’t get euphoric when the market goes up 25 percent in a year or depressed when it goes down 15 percent or 20 percent for two years in a row. It’s about having a strategy and sticking to it. I can say it a hundred different ways, but that’s really what it is.

The whole philosophy of Peter Lynch, who is one of the most famous and successful investors of our time, is to invest in things you know and stick to your plan. You know you can manipulate that statement a hundred ways, but it all comes down to the same thing: Have a plan; figure out what you’re going to do; and do it. Don’t let the short-term emotional swings sway you in another direction.

Learning About Investing

You have to want to learn about investing and investments. Some people just don’t want to, and you can’t force them to do that. That’s fine – I don’t want to learn how to become a brain surgeon. Between magazines and cable television there is certainly more than enough – in fact, probably too


227

much – information available on basic investing if you’re interested. I am not a big fan of certain media – television or magazines – that tout the best stocks or the best mutual funds to buy for the next three months. Investing is not a three-month process. It’s a lifelong process.

If you are interested in learning, there are a million places you can go for education. I used to teach adult education classes on basic investing and basic financial planning at a community college. With books like this one coming out all the time, you can do a lot of reading and a lot of television watching. Again, just don’t focus on whatever someone calls the next cool short-term thing.

Keep the Long Haul in Mind

The best piece of business advice I ever received was to not try to chase the markets. Don’t get too high with the highs, and don’t get too low with the lows. Some years will be better, and some will be worse, but if you stick to the plan, you should be fine. What happens tomorrow really doesn’t matter. What matters is what happens from today until 10 years from now. Stretch out your horizon to the furthest point – when you’ll need the money – and focus on that point on time rather than any of the intermediary points.

Inside The Minds

228

That doesn’t mean that you shouldn’t check your progress along the way, but realize that the market will move up and down, but as long as it trends upward at the average rate you are looking for, you should be fine.

Sometimes this information age can be a bad thing because people are on the Internet checking their stocks six, seven times a day. The reality is that they shouldn’t be trading that often. They should be thinking about things on a much longer-term scale. Look at the goal of investing as a long-term gain and not a short-term, quick, money-making scheme.

I never use the word gambling with investing except for day-trading. Day-trading is really people trying to make money by the minute, make every eighth of a point. That’s not to say you can’t do it, but after transaction costs, it’s pretty tough for the average investor to make money that way. And all of those garage owners that made $10 million in the market in six months buying Internet stocks in the late 1990s – they’ve lost not only their profits, but their garages, as well. The basic tenets of investing haven’t changed. It’s a long-term game. It’s a marathon, not a sprint.


229

Part of the financial process prevalent in the profession today is client education. One of the big things we talk about is managing client expectations. If the clients understand the investment process and how it works, they don’t feel they have to make panicked phone calls, like the ones some made after September 11, saying the world is coming to the end and it’s time to sell everything. As I spoke to every client after that terrible day, I was struck by how calm they all were.

Interestingly enough, some people refuse to sell an investment if they have to sell it at a loss. If they buy ABC stock at 100, and it’s down to 60, and there’s no reason to own it, psychologically they still can’t sell it. In doing so, they would have to convert a “loss on paper” to a real loss, and that’s an admission of failure. They think they can never make that money back. But once you buy that stock, what you pay for it is irrelevant (with the exception of tax considerations). All that matters is that it’s at 60 today, and what you think it will be worth next year or two years from now. If it won’t grow at a rate we can get on some other investment, then you ought to consider selling it. But the psychology of having to admit you made a mistake and sell something at a loss is something a lot of people can’t overcome.

Inside The Minds

230

Golden Rules of Investing

Mathematically, there are three variables in investing: time, dollars being invested, and rate of return. If you tell me two of them, I can tell you the third. For example, “When can I retire if I can afford to invest $10,000 a year and reasonably think we can get 8 percent a year?” Or, “ I know I want to retire at age 65, and I know I can put away $10,000 a year. What kind of return do I need to get, and how should my portfolio be structured to meet that return target?”

So having the plan and knowing what the goal is, taking a look at your current situation and how much you can afford to put away, and reasonably assessing your own risk tolerance – if you can do those things, then you should be able to successfully design an investment portfolio. You must be realistic, as well. If you need to earn an average of 20 percent a year over the long term to meet a goal, then the goal is unrealistic, as unfortunate as that might be. It might be that you can’t retire at 55 – you might actually have to work to age 63 – but that’s the reality of it. And if you try to stretch to reach that goal by taking more risk, you may end up never reaching it. So make your plan, and stick to it. If you need to put away $500 a month to invest, pay yourself first. Have money automatically withdrawn


231

from your bank account so it is separate from the rest of your budget.

The Future of Investing and Changes for the Better

It’s possible that we will have higher inflation, meaning higher actual expenses, when we retire. Where we once thought we might need a million dollars to retire, that goal may now be a $1.5 million. There will certainly also be a lot more investment information available and a lot more ability to do things on your own, so you’ll have to decide whether you want to do that.

I believe it will become even less expensive to hire a professional. It used to be when I first started that when someone sold you a mutual fund, they earned a 9 percent commission. I am not involved in commission sales anymore, but commissions have gone down to 4 percent on the high end now. When one of the major brokerage firms first started offering wrap accounts – where you pay the firm a fee to manage the portfolio for you with no additional commission – those fees started at 3 percent. Fees are a third of that now and still falling. Financial services will become more of a commodity, so it will be less expensive to hire professional management. It will also

Inside The Minds

232

be easier to do things yourself, though you need to make sure you’re interested enough to do so consistently and that you are educated enough to do it – that is, that you access the right information and pay attention to it. When my client says they may be interested in investing themselves, I advise them to take 10 percent of the amount we have allocated for the stock market, and invest it on their own. If they are successful at it, they may want to do more, or even all of it, themselves.

One change I hope for is that more employees take advantage of their companies’ 401(k) plan. In many 401(k)s, for example, an employee can put away up to 15 percent of their paycheck on a pre-tax basis, which means your taxable income is reduced by that amount. A typical plan may say that if an employee can put away 6 percent, the employer will match the first 3 percent. Sadly, though, a lot of employees aren’t even putting away that first 6 percent to take advantage of the employer match. They want as much current cash as they can get. It’s a balance between putting away money for the future and living for now. Everybody has to choose his or her own balance.

Gary Mandell founded The Mandell Group, an independent, full-service financial planning and portfolio


233

management firm serving nationwide clientele, in 1984 after spending two years with another firm in Chicago and

two years with public accounting firms in Cleveland, Ohio, where he was born and raised.

Mr. Mandell’s professional credentials include being a Certified Financial Planner, a Registered Investment Advisor, a Certified Public Accountant, a Chartered Life Underwriter, and a Chartered Financial Consultant. He is licensed with the NASD as a General Securities Principal and holds a Life and Health Insurance Broker license. In January 1985 he became one of the first in the nation to be admitted to the exclusive Registry of Financial Planning Practitioners and is listed in Who’s Who in Finance and Industry.

An active member of several professional organizations, Mr. Mandell served as a director of the Institute of Certified Financial Planners (now part of the Financial Planning Association). He is a Qualifying Member of the Million Dollar Round Table and served on the American Arbitration Association’s Panel of Arbitrators.

Mr. Mandell has been named by Worth magazine (for five consecutive years), as well as Money magazine, as one of the top financial advisors in the country, and he has been

Inside The Minds

234

profiled in many national publications, including The Wall Street Journal. He is often quoted in, and has authored

numerous articles for, national publications and is a frequent lecturer on various financial planning topics. He appears regularly on both local and national television and radio programs, advising listeners on personal financial matters.

A graduate of The Wharton School of Commerce and Finance of the University of Pennsylvania, where he graduated cum laude with a degree in accounting, Mr. Mandell earned his MBA with a specialization in finance from the Graduate School of Business of the University of Chicago.

AVAILABLE FOR THE FIRST TIME EVER ON A NON-INVITATION BASIS

The Most Subscribed to Investment Journal By C-Level Executives From the World’s

500 Largest CompaniesAspatore Investing Review brings you the most important, condensed investing intelligence from industry insiders on the most profitable investment opportunities such as stocks, mutual funds, hedge funds, fixed income opportunities, private equity investments and real estate opportunities-expanding your breadth of investment opportunities, providing you with information previously only available to the world’s biggest investors, and enabling you to outperform.

Aspatore Investing Review is the only way for investors to keep their edge and stay on top of the most pressing investment trends and opportunities. Each Aspatore Investing Review features business intelligence, research and analysis from economists, financial planners, market analysts, research analysts, hedge fund managers, mutual fund managers, stock pickers, investment bankers, venture capitalists, real estate managers, and C-Level (CEO, CTO, CMO, CFO, Partner) executives from the world’s largest and most prestigious firms. Each quarterly issue focuses on the most pressing business issues, trends, and emerging opportunities in the marketplace that affect every investor in some way or another. Every quarter, Aspatore Investing Review focuses on topics that every investor needs to be aware of such as:

• Staying Ahead of Changing Markets • Hedging Risk • Diversification • Stocks to Watch • Emerging Market Opportunities • Economy Trends • Private Equity Opportunities • Real Estate Opportunities • Investment Banking Perspectives • Technology and the Internet • Sector Analysis • Goals & Planning

Aspatore Investing Review is the one journal every investor should read, and is the best way to maintain your edge and keep current with your business reading in the most time efficient manner possible.

Only $1,090 a Year for 4 Comprehensive Issues A Fraction of the Increase in Your Investment

Portfolio This Journal is Sure to Provide Fill Out the Order Form on the Other Side or Visit Us Online!

www.Aspatore.com

ASPATORE Investing Review ENABLING INVESTORS TO OUTPERFORM

Aspatore Investing ReviewTear Out This Page and Mail or Fax To:

Aspatore Books, PO Box 883, Bedford, MA 01730 Or Fax To (617) 249-1970

Name:

Email:

Shipping Address:

City: State: Zip:

Billing Address:

City: State: Zip:

Phone:

Lock in at the Current Rates Today-Rates Increase Every Year Please Check the Desired Length Subscription:

1 Year ($1,090) _____ 2 Years (Save 10%-$1,962) _____ 5 Years (Save 20%-$4,360) _____ 10 Years (Save 30%-$7,630) _____ Lifetime Subscription ($24,980) _____ (If mailing in a check you can skip this section but please read fine print below and sign below) Credit Card Type (Visa & Mastercard & Amex):

Credit Card Number:

Expiration Date:

Signature:

Would you like us to automatically bill your credit card at the end of your subscription so there is no discontinuity in service? (You can still cancel your subscription at any point before the renewal date.) Please circle: Yes No

*(Please note the billing address must match the address on file with your credit card company exactly)

Terms & Conditions We shall send a confirmation receipt to your email address. If ordering from Massachusetts, please add 5% sales tax on the order (not including shipping and handling). If ordering from outside of the US, an additional $51.95 per year will be charged for shipping and handling costs. All issues are paperback and will be shipped as soon as they become available. Sorry, no returns or refunds at any point unless automatic billing is selected, at which point you may cancel at any time before your subscription is renewed (no funds shall be returned however for the period currently subscribed to). Issues that are not already published will be shipped upon publication date. Publication dates are subject to delay-please allow 1-2 weeks for delivery of first issue. If a new issue is not coming out for another month, the issue from the previous quarter will be sent for the first issue. For the most up to date information on publication dates and availability please visit www.Aspatore.com.

ORDER THESE OTHER GREAT BOOKS TODAY! Great for Yourself or Your Entire Team

Visit Your Local Bookseller Today! Visit www.InsideTheMinds.com For a Complete List of Titles

Inside the Minds: Leading Wall St. Investors (ISBN: 1587621142) Financial Gurus Reveal the Secrets to Making Profits in a Turbulent Market Inside the Minds: Leading Wall St. Investors features leading investment managers from some of the biggest financial companies in the world. These proven portfolio managers, hedge fund managers and stock pickers reveal the secrets to buying and selling stocks, how to trade in turbulent markets, trading IPOs, researching stocks, and fundamentals to help you develop a successful and profitable trading strategy. An unprecedented look inside the minds of the world's best investors makes for exciting and highly interesting reading for every investor, financial professional, and anyone interested in the trading strategies of the world's best investors.

Inside the Minds: The Wireless Industry (ISBN: 1587620200) Industry Leaders Discuss the Future of the Wireless Revolution - Inside the Minds: The Wireless Industry features leading CEOs from companies such as AT & T Wireless, Omnisky, Wildblue, AirPrime, Digital Wireless, Aperto Networks, Air2Web, LGC Wireless, Arraycomm, Informio and Extenta. Items discussed include the future of the wireless industry, wireless devices, killer-apps in the wireless industry, the international landscape, government issues and more.

Inside the Minds: Leading Women (ISBN: 1587620197) What it Takes for Women to Succeed and Have it All in the 21st Century - Inside the Minds: Leading Women features CEOs and executives from companies such as Prudential, Women’s Financial Network, SiliconSalley.com, Barclays Global Investors, RealEco.com, AgentArts, Kovair, MsMoney.com, LevelEdge and AudioBasket. These highly acclaimed women explain how to balance personal and professional lives, set goals, network, start a new company, learn the right skills for career advancement and more.

Inside the Minds: Venture Capitalists (ISBN: 1587620014) Inside the High Stakes and Fast Paced World of Venture Capital - Inside the Minds: Venture Capitalists features leading partners from Softbank, ICG, Sequoia Capital, CMGI, New Enterprise Associates, Bertelsmann Ventures, TA Associates, Kestrel Venture Management, Blue Rock Capital, Novak Biddle Venture Partners, Mid-Atlantic Venture Funds, Safeguard Scientific, Divine interVentures, and Boston Capital Ventures. Learn how some of the best minds behind the Internet revolution value companies, assess business models, and identify opportunities in the marketplace.

Inside the Minds: Leading Consultants (ISBN: 1587620596) Industry Leaders Share Their Knowledge on the Future of the Consulting Profession and Industry - Inside the Minds: Leading Consultants features leading CEOs/Managing Partners from some of the world’s largest consulting companies. These industry leaders share their knowledge on the future of the consulting industry, being an effective team player, the everlasting effects of the Internet and technology,

compensation, managing client relationships, motivating others, teamwork, the future of the consulting profession and other important topics.

Inside the Minds: Leading CEOs (ISBN: 1587620553) Industry Leaders Share Their Knowledge on Management, Motivating Others, and Profiting in Any Economy - Inside the Minds: Leading CEOs features some of the biggest name, proven CEOs in the world. These highly acclaimed CEOs share their knowledge on management, the Internet and technology, client relationships, compensation, motivating others, building and sustaining a profitable business in any economy and making a difference at any level within an organization.

Inside the Minds: Internet Bigwigs (ISBN: 1587620103) Industry Experts Forecast the Future of the Internet Economy (After the Shakedown) - Inside the Minds: Internet Bigwigs features a handful of the leading minds of the Internet and technology revolution. These individuals include executives from Excite (Founder), Beenz.com (CEO), Organic (CEO), Agency.com (Founder), Egghead (CEO), Credite Suisse First Boston (Internet Analyst), CIBC (Internet Analyst) and Sandbox.com. Items discussed include killer-apps for the 21st century, the stock market, emerging industries, international opportunities, and a plethora of other issues affecting anyone with a “vested interest” in the Internet and technology revolution.

Bigwig Briefs: Management & Leadership (ISBN: 1587620146) Industry Experts Reveal the Secrets How to Get There, Stay There, and Empower Others That Work For You Bigwig Briefs: Management & Leadership includes knowledge excerpts from some of the leading executives in the business world. These highly acclaimed executives explain how to break into higher ranks of management, how to become invaluable to your company, and how to empower your team to perform to their utmost potential.

Bigwig Briefs: The Golden Rules of the Internet Economy (After the Shakedown) (ISBN: 1587620138) Industry Experts Reveal the Most Important Concepts From the First Phase of the Internet Economy Bigwig Briefs: The Golden Rules of the Internet Economy includes knowledge excerpts from some of the leading business executives in the Internet and Technology industries. These highly acclaimed executives explain where the future of the Internet economy is heading, mistakes to avoid for companies of all sizes, and the keys to long term success.

Bigwig Briefs: Start-ups Keys to Success (ISBN: 1587620170) Industry Experts Reveal the Secrets to Launching a Successful New Venture Bigwig Briefs: Start-ups Keys to Success includes knowledge excerpts from some of the leading VCs, CEOs CFOs, CTOs and business executives in every industry. These highly acclaimed executives explain the secrets behind the financial, marketing, business development, legal, and technical aspects of starting a new venture.

Bigwig Briefs: Become a VP of Marketing (ISBN 1587620707) Leading Marketing VPs Reveal What it Takes to Get There, Stay There, and Empower Others That Work With You - Bigwig Briefs: Become a VP of Marketingincludes knowledge excerpts from VPs of Marketing from companies such as Ford, Home Depot, GE, Coke and more. These highly acclaimed VPs of Marketing explain the secrets behind keeping your marketing skills sharp, working with a team, empowering

positive change within an organization, working with your boss, utilizing your “special” marketing talents, getting noticed, motivating others and other important topics.

Inside the Minds: Leading Advertisers (ISBN: 1587620545) Industry Leaders Share Their Knowledge on the Future of Building Brands Through Advertising – Inside the Minds: Leading Advertisers features CEOs/Presidents from agencies such as Young & Rubicam, Leo Burnett, Ogilvy, Saatchi & Saatchi, Interpublic Group, Valassis, Grey Global Group and FCB Worldwide. These leading advertisers share their knowledge on the future of the advertising industry, the everlasting effects of the Internet and technology, client relationships, compensation, building and sustaining brands, and other important topics.

Inside the Minds: Internet Marketing (ISBN: 1587620022) Industry Experts Reveal the Secrets to Marketing, Advertising, and Building a Successful Brand on the Internet - Inside the Minds: Internet Marketing features leading marketing VPs from some of the top Internet companies in the world including Buy.com, 24/7 Media, DoubleClick, Guerrilla Marketing, Viant, MicroStrategy, MyPoints.com, WineShopper.com, Advertising.com and eWanted.com. Their experiences, advice, and stories provide an unprecedented look at the various online and offline strategies involved with building a successful brand on the Internet for companies in every industry. Also examined is calculating return on investment, taking an offline brand online, taking an online brand offline, where the future of Internet marketing is heading, and numerous other issues.

Bigwig Briefs: Guerrilla Marketing (ISBN 1587620677) The Best of Guerrilla Marketing Best selling author Jay Levinson shares the now world famous principles behind guerrilla marketing, in the first ever “brief” written on the subject. Items discussed include the Principles Behind Guerrilla Marketing, What Makes a Guerrilla, Attacking the Market, Everyone Is a Marketer, Media Matters, Technology and the Guerrilla Marketer, and Dollars and Sense. A must have for any big time marketing executive, small business owner, entrepreneur, marketer, advertiser, or any one interested in the amazing, proven power of guerrilla marketing.

Bigwig Briefs: The Art of Deal Making (ISBN: 1587621002) Leading Deal Makers Reveal the Secrets to Negotiating, Leveraging Your Position and Inking Deals - Bigwig Briefs: The Art of Deal Making includes knowledge excerpts from some of the biggest name CEOs, Lawyers, VPs of BizDev and Investment Bankers in the world on ways to master the art of deal making. These highly acclaimed deal makers from companies such as Prudential, Credite Suisse First Boston, Barclays, Hogan & Hartson, Proskaur Rose, AT&T and others explain the secrets behind keeping your deal skills sharp, negotiations, working with your team, meetings schedules and environment, deal parameters and other important topics. A must have for every financial professional, lawyer, business development professional, CEO, entrepreneur and individual involved in deal making in any environment and at every level.

Other Best Selling Business Books Include: Inside the Minds: Leading Accountants

Inside the Minds: Leading CTOs Inside the Minds: Leading Deal Makers

Inside the Minds: Leading Investment Bankers Inside the Minds: Internet BizDev Inside the Minds: Internet CFOs

Inside the Minds: Internet Lawyers Inside the Minds: The New Health Care Industry Inside the Minds: The Financial Services Industry

Inside the Minds: The Media Industry Inside the Minds: The Real Estate Industry Inside the Minds: The Automotive Industry

Inside the Minds: The Telecommunications Industry Inside the Minds: The Semiconductor Industry

Bigwig Briefs: Term Sheets & Valuations Bigwig Briefs: HR & Building a Winning Team

Bigwig Briefs: Venture Capital Bigwig Briefs: Become a CEO Bigwig Briefs: Become a CTO

Bigwig Briefs: Become a VP of BizDev Bigwig Briefs: Become a CFO

Bigwig Briefs: Small Business Internet Advisor Bigwig Briefs: Human Resources & Building a Winning Team

Bigwig Briefs: Career Options for Law School Students Bigwig Briefs: Career Options for MBAs

Bigwig Briefs: Online Advertising OneHourWiz: Becoming a Techie

OneHourWiz: Stock Options OneHourWiz: Public Speaking

OneHourWiz: Making Your First Million OneHourWiz: Internet Freelancing

OneHourWiz: Personal PR & Making a Name For Yourself OneHourWiz: Landing Your First Job

OneHourWiz: Internet & Technology Careers (After the Shakedown)

Go to www.Aspatore.com for a Complete List of Titles!

Documents

Building a $1,000,000 Nest Egg: Leading Financial Minds Reveal the Simple, Proven Ways for Anyone to Build a $1,000,000 Nest Egg On Your Own Terms