Money Management Styles: Beyond Active vs. Index

Posted on March 22, 2012 by joconnell

Quite a bit in the financial press lately on the continued inability of active management to outperform their benchmarks over time. This is a classic debate in the investment community, and always an interesting read.

The latest S&P Index Versus Active (SPIVA) scorecard (Year End 2011) reveals that with few exceptions, active fund managers underperform their respective benchmarks the great majority of the time, and this is true across the majority of asset classes.  For most investors, paying higher fees for outperformance is usually a losing proposition.

Which leads us to Index funds (and the majority of ETFs as of this writing), hailed by many as low cost, asset class investing. But one of the drawbacks of index funds is the their need to replicate the index, so they often have to buy and sell when the index changes.

So how to improve on Index investing?  Asset Class investing – This is an efficient market approach that focuses on cost-effective asset class investing. Rather than chasing returns through stock picking and market timing, an asset class manager seeks to capture risk dimensions identified through academic research. Unlike a pure indexing approach, an asset class strategy allows a flexible portfolio composition and gives traders more freedom to pursue value in the transaction process. This can result in lower costs, more precise asset class exposure, and enhanced returns.

So next time you feel your portfolio needs some additional exposure to a particular asset class (for example, there’s a lack of emerging markets or TIPS), in place of seeking an index fund, seek out fund management that uses the asset class investing approach.

For more info on S&P study:

http://www.standardandpoors.com/indices/spiva/en/us

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Making Money in THIS Market

Posted on October 31, 2011 by joconnell

Visiting with friends the other day, the conversation turned to how difficult it is to make money in this market – that particular comment started me thinking again about this gap that sometimes occurs between how we think about our accounts vs. having an overall investment strategy for your portfolio. And also that the idea that we can’t predict the future is hard to accept.

I’ve talked to a few people over the past few months that will tell me about some of the defensive moves they have made in one of their accounts. I know this is a good feeling for them – at least for now. The not-so-great feeling comes when we project out their expenses with the impact of inflation, and their portfolio struggles to keep up.

To me, it highlights the importance of looking at ALL your investments accounts and labeling the purpose and timeframe of the account. If your investments accounts are for your retirement, then this is your retirement portfolio. And your retirement portfolio should have an asset allocation that makes sense for not only when you retire, but also for the time span of your retirement.

And once you have the proper asset allocation for your portfolio, it’s a matter of finding the appropriate investments to make up that allocation. So, despite whatever is going on in this market, your plan stays intact. For most time periods, we expect some assets will be up, some will be down. Overall, your retirement portfolio should be less volatile and experience growth in the long term – making money for your retirement as opposed to making money in this market!

This data is for informational purposes only; please consult with your advisor or tax professional for your individual situation. Diversification and asset allocation does not ensure a positive return or protect against a loss.

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Why Everyone Needs to Minimize Volatility

Posted on May 2, 2011 by joconnell

Clients say “I understand that I need to take on more risk to get the returns I need for my retirement…I have a long time horizon; I’m comfortable with the risk/return factor.” And I’m glad they understand that in order to achieve a higher expected return, they take on more risk – meaning the chance the value in their investment could go up and down. 

But even though many clients have thought through their comfort level with risk and return, and take the long-term perspective for their investments, most ignore the importance of reducing the level of volatility in their portfolio as a whole and why they want to do that…and overall volatility has a significant impact on wealth accumulation over time.

Let’s look at two hypothetical portfolios: Portfolio A (low volatility) and Portfolio B (high volatility) with a starting balance of $100,000.

The Impact of Volatility: Source - The Investment Answer, Dan Goldie and Gordon Murray

Both portfolios have an average annual return of 10%, but the low volatility portfolio ends up with more wealth accumulated than the high volatility portfolio. It is really the compound return that matters – when the high volatility portfolio dips down, it requires a greater recovery just to get back to its original value.  The greater the loss, the smaller the base on which your earnings can grow!

What should you do? Pay attention to how all the investments in your portfolio track with each other during up and down markets – in general, this is called correlation – you want a mix of assets that are not “highly correlated” with each other. This will help your investments, as a whole, not be as volatile and therefore help you grow your investments.

This data is for informational purposes only; please consult with your advisor or tax professional for your individual situation. Diversification does not ensure a positive return or protect against a loss.

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529 Plan vs. Financial Aid

Posted on April 6, 2011 by joconnell

“Is saving into a 529 Plan a good idea considering it may affect my child’s chance for financial aid?” This question came up the other day when discussing starting up an education savings program using a 529 Plan – I thought it might be useful to highlight some important considerations:

1. 529 Plans allow for education savings without regard to income limitations and provide tax-free growth if used for qualified educational expenses. Account maximums are set by each state – states have their own plans, but you do not have to use your state’s plan.

2. The account owner (typically a parent or grandparent) can change the beneficiary at any time – the money does not automatically transfer to the child at a certain time or age.

3. 529 Plans are considered a non-retirement asset of the parent for Financial Aid purposes – this is much better than being considered an asset of the student, as a higher portion of student assets are considered to be available to pay for college (for the purposes of the Financial Aid calculation).

4.  Based on the current rules, when calculating any need based “aid” a child will receive, there is an excludable amount of non retirement assets based on the older parents age – for older parent 52 the amount is $55,500 today. Amounts over that get multiplied by a factor of 5.45% and that amount gets subtracted from a student’s aid.

5. Keep in mind that the majority of need based aid takes the form of student loans.

With all that in mind, 529 plans still provide a significant advantage to not having these type of savings. Borrowing money is ultimately more costly than saving the money. In addition, taking distributions from any type of retirement account, including Roth-IRAs, will cause an increase in income on next year’s Financial Aid calcuation – a much more significant impact on potential aid than savings!

This information is provided for general information purposes only – please consult with your individual advisor and tax professional for advice regarding your situation.

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NAPFA Resources

Posted on February 24, 2011 by joconnell

Blue Water is a member of NAPFA (National Association of Personal Financial Advisors), and the other day we received an email of their latest newsletter designed for consumers that has some great information regarding investing and financial planning. Some of the topics covered: Paying off Mortgage Early, ETF vs. Mutual Fund, and a Guide for Selecting a Financial Advisor.

Access the link below, and sign up if you’re interested. They do a nice job of not flooding your inbox with these newsletters - they are usually available monthly.

http://www.napfa.org/UserFiles/File/Planning_Perspectives/Feb2011FINAL.pdf

NAPFA also sponsors free consumer webinars – Visit NAPFA.org to register or for additional information.

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Solo 401(k) vs SEP-IRA

Posted on February 7, 2011 by joconnell

A Solo 401(k) and a SEP-IRA are two popular retirement plan choices for the self-employed – so which is best for your situation?

Solo 401(k) Advantages:

  • Higher tax-deferred contributions due to both employer contributions and employee deferrels – employee deferrals not based on percentage of income
  • Additional catch-up contribution if over 50.
  • Loans are allowed if provided by plan administrator

SEP-IRA Advantages

  • Ease of setup and reduced potential administration
  • Can be rolled over into a 401(k)
  • Funds can be accessed (subject to tax and penalties)
  • Low cost – typically a custodial fee, similar to a traditional or ROTH IRA.

Because the Solo 401(k) allows for a significantly higher tax-deferred contribution (even more so if you are 50 or older), it’s the perfect choice for the self-employed business owner who is able to maximize their contributions. (Note – the Solo 401(k) must be started by December 31 of the tax year, so if you’re looking to maximize your retirement contributions for 2010, it’s too late to start one. Consider the SEP for 2010, startup a Solo 401(k) for 2011, and you can roll over the SEP once your plan is established.

However, a self-employed business owner who is not able to make that higher level of contribution, the SEP is a great choice due to the ease of administration and simplicity. To put it simply, if you won’t max out your SEP contribution, why not stick with the SEP until you are at the point where you want to contribute more but are hampered by the 20% max? At that point, you can startup your solo 401(k), and roll over your SEP. Note that one of the nice features of the Solo 401 (k) is the ability to take a loan, subject to plan administration and IRS limitations.

Note: This discussion assumes a self-employed individual without employees.  Both SEP and Solo 401(k) are subject to the maximum contribution of $49,000. Additional salary limitations and considerations apply. This information is provided for general information purposes only – please consult with your individual advisor and tax professional for advice regarding your situation.

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Considering a Solo 401(k)?

Posted on January 24, 2011 by joconnell

Saving for retirement can be challenging if you’re self-employed – you might be wondering what type of plan bests fits your business and stage in life.

Traditionally, many have used the SEP-IRA or the Simple IRA, but the Solo 401(k) plan is starting to generate interest because of its ability to allow you save more into your retirement plan.

The SEP allows you to defer 20% of net SE income (after SE tax deduction) up to a maximum of $49,000. A SEP is easy to set up, has minimum costs to establish and is flexible in that you are not required to make contributions every year. A Simple IRA is another option – it allows you to defer 100% of self-employed compensation up to a max of $11,500, with an additional employer contribution of 3% of self-employed compensation. Like the SEP, the Simple is easy to set up, and has minimal administrative requirements.

Both of these plans, especially the SEP, are popular choices for the self-employed business owner without any other employees. But they are definitely limited in the amount you defer every year. Solo business owners whose business are more established or can forecast more significant amounts to invest for retirement should consider the solo 401(k) plan, which allows for a much higher contribution rate.

The 401(k) allows for both an employee deferral of 100% of SE income up to a maximum of $16,500, plus an additional employer deferral of 20% of SE income, with the combined deferral subject to the maximum annual additions limit of $49,000. A self-employed owner over 50 can make an additional catch up contribution of $5,500 each year, bringing their maximum annual additions limit up to $54,500.

The Solo 401(k) is a defined contribution plan with a 401(k) provision and would involve a bit more administrative work and higher fees than the SEP or SIMPLE. But for the established solo business owner looking for a plan to maximize their retirement savings, it’s an appealing choice.

In an upcoming post, I’ll examine the best candidates for each type of plan and go through some examples for each.

Sources: Thomson Reuters QuickFinder Tax Handbook, 2010, Fidelity.com Small Business Plans, WSJ: 401(k) plans and the self-employed. This data is for informational purposes only; please consult with your advisor or tax professional for your individual situation.

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The Business of Predicting

Posted on January 14, 2011 by joconnell

As always, there are people making predictions for 2011.  As always, you should ignore them.  Here’s an example from late 2010. For Christmas 2009, a friend shared his copy of Fortune’s 2010 Investor Guide (December 21, 2009). Knowing how these consumer magazines like to make bold predictions, we knew its contents would make for some good material for later.  Sure enough, there was a feature article called “The Best Stocks in 2010.” The subtitle proclaimed “We’ve found 10 stocks that should prosper even if the markets don’t.”  Let’s see how their picks have turned out so far:

Only 3 of their picks outperformed the S&P 500.  The entire market was up at least double digits, yet they actually had 6 stocks lose money – that’s hard to do. We don’t spend a lot of time reading market predictions, but we thought it would make good material. Granted this is only 1 prediction from last year, but it’s not like it’s from some obscure blog – this is a national, well-read, and well-respected magazine.  They make these predictions to sell magazines.  A lot of people probably bought and were influenced by this issue, and then wonder why they never make money in the market.  Remember, market predictions are for entertainment purposes only.

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2010 Market Performance by Asset Class

Posted on January 14, 2011 by joconnell

Up, up, up. It’s pretty rare to see a year when stocks, bonds, and alternatives were all positive.  A strong 2nd half of the year erased the mid-year losses and led to some very good returns. US stocks for the most part outperformed international stocks. Gold was also a big winner.  The only asset class that lost money was Market Hedging, which typically moves opposite of the stock market, so that was expected. The chart below summarizes the various asset classes and 2010 performance.

Portfolio Performance by Asset Class

* Through 12/31/2010.  This data is for general purposes only and is not a guarantee of future performance.  Your performance in these asset classes may have differed due to your specific holdings and the timing of your contributions and/or distributions.

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Women and Retirement: What’s the Real Issue?

Posted on December 21, 2010 by joconnell

I run across articles about women and their attitudes toward financial matters, or articles geared toward advisors on how to work with female clients. The upshot is women, more than men, are feeling unprepared for retirement and, in general, not confident about their financial situation. Lately, it seems as though these articles are on the rise.  As a female advisor, it makes me want to dig deeper – what’s with this gender gap? Is it overstated, perhaps a bit patronizing? And what does it mean to my female clients, friends and family? I plan to explore this a bit further over the next few posts.

What’s the real issue?

In general, studies show the following (I’m taking liberties and summarizing):

On average, women live longer, make less, save less, invest more conservatively, work less over their lifetime (time off for children and care-giving), and feel less confident in their investing skills. The end result of this: they need more wealth accumulated to fund their retirement, and they need to save more to accumulate this wealth.

When it comes to feeling unprepared or feeling anxiety about investing and retirement, significant differences occur between men and women.  A 2010 Harris Poll for the MetLife Mature Market Institute found that 62% of career women earning $75,000 plus per year fear they may never have enough to retire.  A 2006 Harris Poll for Charles Schwab found 48% of women agreed with the statement “Investing is scary for me,” twice the rate as men. A female advisor who works with a variety of clients in the tech-rich SF bay area sums it up as follows – women don’t know their “number,” which is the amount of net worth needed to be permanently financially independent.  However, the majority of her male clients do know their number.

I think the real issue in the whole financial gender gap issue is this uncertainty and anxiety around retirement that many women feel compared to men.  Both sexes can have career situations where there is less income or more time out of the workforce and therefore more has to be saved, but in general women appear less certain and more anxious about their financial future.

So what will help? In the next few posts, we’ll talk about some retirement resources or strategies that can help anyone get a clearer picture of their financial future.

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