personal finance

I’ve been seeing a lot a recent press warning investors about Financial Advisors.

Most FAs aren’t your advisors. They are just salesmen of financial products. The titles on their business cards don’t mean anything. Financial Advisor, Wealth Manager, Private Wealth Manager, Your Personal CFO….they’re just made up titles with no minimum qualification. See this article in the New York Times cautioning you against advisors with fancy titles.

For the most part, they’re brokers (and thereby fully commissioned salespeople), whose main objective is to make as much money for their firm and for themselves. They do this by “selling” you a financial product like a mutual fund or insurance vehicle with an investment component.

Only they don’t call this “selling”. They call it “investing” your money.

But when someone puts my money in a vehicle with high up-front fees and ongoing expense ratios, I call that selling. Plain and simple.

One of my friends recently had an “advisor” put him in a bunch of mutual funds offered by Mass Mutual. These funds all came with a 5.75% front-end load (or fee) and an annual 1.75% expense ratio. All of the front-end load and part of the expense ratio was a commission back to his advisor.

One of the funds was a unit trust and even came with an expiration date. After a couple of years the fund automatically sells everything and you get the cash value of the stocks at that time. At that point your “advisor” is free to put you in another fund with an upfront fee and restart the whole process again. Read this excellent article about the mutual fund industry’s rating scam.

It’s not uncommon for unsuspecting victims, I mean customers, of such “advisors” to pay 6% in upfront fees and 2% a year in mutual funds fees. And then pay an additional 0.5% or 1% as the advisor fee!

But that doesn’t mean advisors don’t add value.  Here’s a great piece by the White Coat Investor on the benefits of using a Financial Advisor.

Before hiring a financial advisor, or planner, make sure you ask a few important questions.

Are they your fiduciaries?
That is, do they have a a legal obligation to put your interests first? Or does their firm come first?

How are they compensated?
Do they get commissions from any of the products they sell? If so, will it be disclosed upfront?

Ideally, you’d want to use a fee-only advisor – they only get compensated by the fees you pay them and don’t except any commission. This removes any conflict of interest.

What’s their investment methodology?
Do they just put you in a bunch of stocks or mutual funds? Or do they use Modern Portfolio Theory to put you in a well-diversified portfolio where they show you (and take the time to explain) the portfolio’s alpha, beta, standard deviation and sharpe ratio (see definititions at investopedia.com). If they use mainly low-cost ETFs instead of mutual funds, they might be able to pay for their services just by the reduction of fees alone. For example, if their portfolio of ETFs has an expense ratio of 0.4% and they charge 1%, that’s like you buying a mutual fund charging 1.4% on your own. But without the upfront load fees and mis-management that comes with it.

If you’re looking for financial planning advice then you want to make sure they have a background in finance, or a CFP to make up for it if not. Many ex-pharmaceutical sales reps (read pretty blonde women) make a career change and become financial advisors. Don’t just go for the cutest saleswoman. Make sure they understand investing and all the aspect personal finance like estate planning, and taxation.

When looking for a financial advisor, try looking for a Registered Investment Advisor Representative. People with this designation usually have a fiduciary duty and are more often than not fee-based instead of commission based. Go to Brokercheck.finra.org and put in the advisor’s name and you’ll find out whether he’s just a Broker or an Investment Advisor Rep. If he’s both, you definitely want clarification on how he is compensated.Investment Advisor Reps are required to provide prospective clients with a firm brochure called the ADV-2, which describes the services they provide, how they are compensated, their investment philosophy. Brokers are not required to provide this document. Make sure you ask for, and get this document from your advisor.

A trusted advisor can be a great resource. A salesperson can be disastrous to your financial future.

Do you have any advisor horror stories to share?

I just read an article about a reporter who had his finances critiqued by a group of multi-millionaires. The results were surprising.

Tiger 21 is an investment club, where members get together once a month to discuss money. They share investment ideas and personal finance tips. Membership at the club costs $30,000 a year, so it’s definitely not cheap. But guess what, rich people love talking about money. Maybe, that’s why they’re rich to begin with?

The reporter submitted his personal finances and agreed to have the members give him advice. He thought they’d tell him to stop spending so much on eating out. Otherwise, he thought he was in good shape.

But they didn’t care about how much he spent on eating out.

Instead they gave him some really good advice.

One, start saving more.

Saving just 10% of your income isn’t enough. He could easily bump it up to 15%.

Two, stay liquid.

The reporter had a vacation condo in Florida. It was a money sink. Everyone thought is was a bad idea and told him to dump it. Sell, even if you take a loss, was their advice. Rich people are always concerned about maintaining their liquidity. Money-sucking “investments” kill one’s liquidity.

Liquidity helps you take advantage of real opportunities to make money.

For example, when the stock market crashed in late-2008. I know rich people were jumping in to buy great stocks at ridiculously low prices. You can only do this if you are liquid.

Additionally, liquidity provides a safety net in bad times.

Speaking of bad times, the best advice they gave was about his lack of insurance.

Most people are incredibly under-insured.  The reporter was no different.

I remember when my dad died. I can’t believe how little insurance my dad carried. It was absurd.

He had a 30 year Term-life policy which he had paid for 26 years. Unfortunately, he had never increased the policy to keep up with his increasing salary, or inflation. The death-benefit amount my mom received was about 6 months of my dad’s gross income at the time. It was a joke.

Luckily, we were able to sell his medical practice which provided a sizable amount to take care of her. But as soon as my dad was out of the picture, it was worth 50% less. If he had sold it himself, we would’ve received double.

Tiger 21 members said if you’re not spending 1-3% of your annual income on insurance, you’re not spending enough.

In addition to life, you need disability insurance as well. If something were to prevent you from making a living, you’d be surprised how tiny the premiums would seem.

I know a family that made over $500,000 a year. The wife was a dentist who made $250,000. At the age of 35 she developed a problem with her hand and was unable to work. For a few thousand a year in disability premiums, she could have collected $70,000 in tax-free money. Now, she can’t work, and they have to pay someone to take care of the kids even though she stays at home.

Like most things in life, insurance is a thing you miss the most when you don’t have it.

Get insurance folks, its cheaper when you don’t need it!

And if you need a referral for a good insurance agent, let me know.

Some of the best advice is timeless. Here’re some nuggets of wisdom from the late Harry Browne.

  • Your career provides your wealth
  • Don’t assume you can replace your wealth
  • Recognise the difference between investing and speculating & speculate only with money you can afford to lose
  • No one can predict the future
  • No one can move you in and and of investments consistently with precise and profitable timing
  • No trading system will work as well in the future as it did in the past
  • Don’t use leverage
  • Don’t let anyone make your decisions
  • Don’t ever do anything you don’t understand
  • Don’t depend on any one investment, institution or person for your safety
  • Create a bulletproof portfolio for protection
  • Keep some assets outside the country in which you live
  • Beware of tax-avoidance schemes
  • When in doubt, err on the side of safety

These topics are covered in the timeless classic – Fail-safe Investing, probably the best $10 you’ll spend on personal finance and investing!

Regular readers know I’m currently pursuing an MBA. What they don’t know is that I’m currently taking 6 classes plus an Applied Management Research project which is almost twice the usual workload. I’m a third of the way through the quarter and I’m already feeling burnt out.

To help take my mind off things, I decided to look at vacation packages. Once my quarter gets over, I might travel for a week.  I’ve been dying to visit South America or the West Indies for quite a while. Several packages look pretty good. And by  good, I mean from the aspect of being good value for money. Yes, I like to travel cheap, or as I like to emphasize, I’m a price-conscious consumer. Some of the places that had good deals were Costa Rica, Puerto Rico, and Mazatlan. Argentina also looked enticing, but the flights were slightly more expensive. One of the things I noticed was that my Discover Card was offering 5% cashback on travel booking until the end March 2010.

I don’t usually use my Discover credit card very much. It has a strange (but useful) rotational rewards program. Usually, you get 1% cashback, but every month (or sometimes for a whole quarter) you’ll get 5% cashback on a specific category of purchases. Each month its a different category. For example, it might be on travel (plane, hotel, car rentals or cruises), only restaurants, gas or maybe just groceries. This quarter, it just happens to be travel. Pretty useful if I actually end up traveling somewhere.

I typically use my American Express True Earnings Card instead of Discover. The rewards are more predictable. You get the typical 1% cashback on regular purchases, but you always get 2% cashback at restaurants and 3% cashback on travel. I paid my MBA tuition fees with it and got over $500 on it! While I don’t condone spending $50,000 just to get $500 back, it still makes for a nice Christmas present! (I would’ve actually preferred the American Express Starwoods Card since the rewards are great for taking vacations and the points are redeemable for stuff on Amazon, but I was coldly rejected).

So before making any major purchases, you should definitely go through your credit card rewards and see which one gives you more bang for your buck. If you don’t have a Discover card, make sure you sign up for it – the additional 5% might be worth it if you’re planning a big ticket purchase.

If you’re a student with limited credit history, you can sign up for the Discover Student credit card. It is a bit easier to get approved for it and it comes with the same set of rewards.

And if any of you have any vacation suggestions for the end of March, please let me know.

Detour Destinations - The Best Local Trips. Local Prices. No Hassles.

Suzie Orman is a famous financial planner who appears regularly on TV and is a prolific writer. I’m not a big fan, mostly because her ideas are too simplistic for me although they must appeal to a lot of people who have no knowledge of financial information.

But now and then she has a good nugget of information. Check out this short clip about paying off your home mortgage as soon as possible.

The only counter argument I can think of is inflation.

If you bought your house in 1980 for $50,000 and never paid off the mortgage (that wouldn’t be possible unless you refinanced the home loan along the way), the value of $50,000 today is a lot lower than it used to be 30 years ago.

But on the flip side, the mortgage interest tax deduction on $50,000 is rather small too. So maybe you should send in that extra $100 every month!

One resource I strongly recommend is How to Save Thousands of Dollars on Your Home Mortgage. You can buy the book used on Amazon for under $2.00 – possibly the best 2 bucks you’ll ever spend!

You must have read the recent post about the New York Times economics reporter who is facing foreclosure himself. Edmund Andrews covered the US economy and Alan Greenspan for over six years, but despite his financial accumen still got suckered into a loan he couldn’t really afford. He hasn’t made a mortgage payment in 8 months and is wondering when the bank is going to throw him out of his house. Instead of making his payments, he has been busy spending money on a beach rental, clothes, gifts and other necessary expenses. At some point, I think foreclosure is inevitable.

But could he have avoided foreclosure?

I think so. Let’s review some of the financial mistakes he made. The real ones, not the excessive spending that set in once he stopped making house payments!

1. He divorced his wife of 21 years

This is always grounds for economic disaster. No matter who you are, the longer you stay married, the more it’s going to hurt you financially.  If you are going to divorce, do it like Tom Cruise and get out before the magic 10 year mark or before you have kids.

2. He paid almost 2/3rds his net income in child support

Ouch! Paying $4,000 in alimony and child support when your net income is $6,777 is a lot. Effectively, his take home income is $33,000 per year or about $16/hour. I think most people on that wage move back home to their parents basements.

3. He bought a house he couldn’t afford

If there’s one major recipe for disaster, it’s buying a $500,000 house when you’re only taking home $16/hour.  He really should have known better. But then again, he outsourced the analysis of his finances to his mortgage broker instead of doing it himself.  He was set up to fail from the beginning. I’m sure his broker knew in the back of his mind there was a chance Ed would face foreclosure at some point. But Ed really should have bought a cheap house instead.

4. Not spending enough time understanding the most expensive purchase of your life

A home mortgage is the most complex financial transaction you’ll probably ever undertake. So it’s easy to blow it off or let some one else do the heavy lifting for you. However, the mortgage broker doesn’t necessarily have your best interest at heart. They get paid on commission for every loan they close and are directly incentivized to get you into the largest, most outrageously expensive home loan possible. There is a tremendous conflict of interest and you should not let them dictate what you should do. Many people claim that a home loan is just too difficult too understand. True, but only if you don’t take the time to understand it.

I strongly recommend Randy Johnson’s stellar book How to Save Thousands of Dollars on Your Home Mortgage. If you don’t know what Yield Spread Premium (YSP) or Paid Out of Closing (POC) means on a HUD-1 you definitely should read this book. If you own a home and don’t know a HUD-1 is then get your spouse to smack you and then go buy the book! I promise you’ll save thousands of dollars on your mortgage.

Just in case, you missed that last paragraph, BUY THAT $12 BOOK ABOUT SAVING THOUSANDS OF DOLLARS ON YOUR HOME MORTGAGE. You should buy it before you buy a house, before you even think of buying house, maybe before you even graduate from college. If you’ve already read it, you should buy a dozen copies of the book and gift it all your friends, co-workers, in-laws, cousins, nieces and nephews for Christmas. Unless you hate them.

The best way to prevent foreclosure from happening to you is to buy a house you can afford with a mortgage that is the cheapest over the life of the loan. That may mean paying extra points to buy down your interest rate, which means the cheapest loan is not necessarily the loan with the lowest closing costs. Learning about your finances, and how mortgages actually work is probably the best way to save money in the long run.

Yesterday I got a call from American Express.  I was curtly informed that my True Earnings American Express Cash Rebate Credit Card limit was reduced 90%.  It isn’t a really big deal because I don’t need that sort of limit. I’ve never used more than 40% of the limit anyway. But I was still pissed. It’s very useful when traveling and I enjoy the cash rebate I get with the card.  I’ve been putting my tuition on it and then paying the balance off, which allows me to get some free cash.  Some of the benefits include:

  • 3% cash back for gasoline purchases
  • 3% cash back for restaurant purchases/dining out
  • 2% cash back for travel
  • 1% cash back for everything else, including Costco purchases
  • I guess Amex decided they weren’t making any money on my account so they basically told me my credit limit was now $2,500.  Since my revolving balance is close to that amount every month,  my ratio of available credit to debt ratio will look like its over 80% which will hurt my credit score.

    Apparently this isn’t an isolated incident. Smart money just had an article about credit card companies reducing credit limits on numerous borrowers, sometimes with the current balance exceeding the new limit.

    While the fees, frozen accounts and default interest rates resulting from credit-line cuts can sting your finances, they can do some serious long-term damage to your credit score. Your credit utilization ratio — the total amount of debt you owe in relation to the amount of credit available to you — accounts for roughly 30% of your score. A credit line cut has the potential to decrease your score by 50 points or more if you don’t have much other available credit, says Craig Watts, spokesman for FICO, the company that calculates and issues the credit score that most lenders use.

    One of my friends just graduated from USC’s Marshall School of Business. Last year he told me that a visiting professor announced in class that consumer lending was going to dry up and people would no longer be able to get credit.  His advice was to get it while they still could!

    Seems like that day has now arrived. Regardless of your credit, skittish credit card companies are reducing credit limits. How do they expect to make any money if they’re not lending money?

    But more importantly, what good is your credit if you can’t borrow any money?  Do you think this might drive people to max out their credit cards while they still have available balances and then default on them?

     

    Get $25 cashback on credit card signup

    Online retailers have been fairing better than their brick-and-mortar counterparts. One school of thought is that affluent buyers make up a bigger portion of online buyers and they fare better during recessions, which means online retailers are likely to do better.

    Another line of reasoning suggests that there is a perception among buyers that there are better deals online than in stores. So its the bargain hunting, not the higher incomes that is driving people to shop online. I think there’s some truth to this.

    Last week, I needed to replace the battery on my motorola KRZR cellphone. The battery was no longer holding charge and had developed a slight bulge in the middle as well. I went to the Verizon store and they told me I was out of luck, and would have to buy a new battery for $40 plus tax.

    Instead, I bought a cellphone battery online for only $6.41 delivered! I had to wait 2 days, but I got a whopping 85% discount!!!

    For some reasons, retailers think that replacement batteries should cost 40-50% of the cost of a new electronic item. If you’re willing to spend a few minutes doing the research and wait 2-3 days, then you can usually save at least 60% of the cost. Now whether your time is worth that 60% in savings is another question.

    Incidentally, that battery link goes to a niche store I built initially to buy cheap iPod batteries, which cost a ridiculous $79 plus tax at the local Apple store. I bought my battery replacement kit for $20 online instead!

    But getting back to my main point, I think that with inflation eroding the purchasing power of the average American, more people will turn to online shopping. And with gas prices being so high, people are more likely to limit they’re driving to the mall.

    So there are two lessons to learn here.

    1. If you own stocks of retail stores, ditch them and buy online retailers instead.

    2. Look online for bargains.

    Maybe it’s time to look at Amazon’s stock (AMZN)?

    The meeting started off with a humorous cartoon video of Charlie Munger running for US president. There was also a short video of Warren Buffett playing a role on tv-soap “Days of our lives” and Susan Lucci actually appeared live at the meeting.

    Rather than a boring annual meeting discussing the various aspects of BRK’s business, Warren Buffett instead started fielding questions from the audience, which went on for several hours. Except for which stocks BRK was buying, no question was taboo.

    Here’s some interesting points from meeting:

    1. Most of what you learn about Business school is crap.

    You only need 2 courses, how to value a business and how to think about stock market fluctuations. Unfortunately most professors end up teaching what they know, which consists of complex formulas and other useless stuff.

    I kind of knew this, even though I am going to start B-school in the fall.

    2. Develop good communication skills.

    That’ll be useful in life regardless of what you do.

    3. Non-professional investors should diversify their investments, both in terms of stocks and also in terms of time.

    Buffett also recommended buying a low-cost index fund.

    4. Be frugal, spend less than you earn, and invest a portion of your income.

    5. The best investments are simple ones.

    If an investment is overly complex it is usually never a good one. Buffett invested millions in PetroChina (PTR) after only reading the annual report. He realized the business was worth several times more than its current stock value and that there was sufficient margin of safety to invest.

    6. Always be ethical and honest in your business deals.

    All of the managers of the individual business owned by bRK are upright and ethical. As a result, Buffett doesn’t feel the need to micro-manage them and lets them do whatever they want. This fits in well with BRK’s philosophy. Whenever Buffett and Munger agree to buy a business, its set in stone. Whether there is “a nuclear explosion in New York, a flu epidemmic or Federal Chairmain Ben Bernanke runs off with Paris Hilton to South America“, the deal will go through. Yes, he actually said that.

    7. Invest in yourself.

    A person’s potential always greatly exceeds his realized performance. Invest in yourself and try to maximize your performance.

    8. Read good books.

    Two of the books Munger recommends are Yes and Influence. I strongly recommend Poor Charlie’s Almanack: The Wit and Wisdom of Charles T Munger, which is a beautiful hardcover book filled with Munger’s wit & wisdom. It also makes a great gift. One of my friends even called it one of the “all time best finance books“.

    9. America is a rich country and may not need to save as much as other countries.

    Maybe saving money isn’t necessary for the US, although it does look like we’re exporting ownership in US assets which is not good.

    10. Financial innovation for risk diversification should be banned.

    The current credit crisis and meltdown in the banking sector was caused by innovative financial products that were designed to make money for the financial institutions. Munger said that the online grocery delivery company, WebVan was a pretty asinine idea, but compared to the current bankers, those execs looked like geniuses!

    11. The US Dollar is likely to weaken over the next decade.

    A lot of BRK’s businesses have global sales, so a weakening dollar will result in improved profits. For example, BRK owns 200 million shares of Coke, of which 80% of its income comes from global sales.

    12. We’re likely to see very high inflation over the next several years.

    Inflation is bad, but BRK will profit more, than if there was no inflation.

    13. Don’t buy BRK stock.

    If you have time to go through the universe of stocks and pick winners, then do that instead of investing in BRK. BRK can only buy huge companies because buying a small company barely puts a dent in the annual revenue. You might be able to get better returns on your own.

    Of course, there were several hours of Q & A so this is just a small tidbit. If you’d like to read the whole script you can do so at The Investment Advice of Warren Buffett.

    I’d like to announce that I’m part of the new of The Wealth, Money & Life Network (WML-Net), a new personal finance network.

    The WML-Net is made up of a diverse group of individuals. The ages span across the 20s, 30s and into the 40s. They’re located in geographically diverse parts of America; ranging from the east coast to the west coast, from the midwest to the southwest to the deep-south. Their backgrounds are as varied as their careers, education, income streams and lifestyles. Some have debt, while others do not. There are those who are married, with and without children, while others are single. Some have a college degree and there are those who do not.

    Considering that that no one situation is alike, the group’s diversity should provide different insights based on everyone’s own personal financial experiences.

    Periodically a topic will be presented and we’ll approach it based on our own unique experiences. This month, we are going to discuss Emergency Funds. I certainly look forward to hearing about each member’s approach to the topic of having an emergency fund. If you would like to share your posts about having an emergency fund, feel free to contact any of us to add it to the network post at The Wealth, Money & Life Network site.

    Be sure to pay a visit the other The Wealth, Money & Life Network member sites and subscribe to their feed, and my feed, if you haven’t done so already. The links below will get you there quickly!

    Dividends4Life
    Dollar Frugal
    Her Every Cent Counts
    How I Save Money
    Living Off Dividends & Passive Income
    Saving For A Home
    The LocoMono Website

    Also, be sure to visit The Wealth, Money & Life Network site.