personal finance

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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!

A UK-based chocolate manufacturer, Hotel Chocolat, has come up with a novel way to raise capital for expansion. Instead of borrowing money from banks or issuing regular corporate debt, it has decided to raise about $7.5 million USD by issuing “chocolate bonds“. Instead of a regular dividend payment (well technically it’s a coupon payment and not a dividend), these bonds will pay dividends in chocolates!

hotel-chocolat-box-of-chocolates

In order to be eligible, you need to be a member of their “Tasting Club”, which already has 100,000 members. For an investment of $2,890 USD or $5,760 USD, you can get a juicy annual dividend of 6.72% or 7.29% delivered to your doorstep every other month.

If you’ve ever been to high-end confectionery, you’ll know they charge a couple of dollars for each piece of candy.  So spending a few thousand quid might not be such a bad investment. Especially since bank yields aren’t very impressive right now. At least it guarantees you won’t have to spring for chocolate for three years, even if the rest of your portfolio tanks!

I wouldn’t be surprised a chain of British gyms are next in line to offer special “weight-loss bonds”, with special dividend rates for people who bought the chocolate bonds!

But the real question is whether Inland Revenue will be accepting their tax payment in chocolate too?

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!

Here’s a round up of some terrific articles I’ve read in the past week:

  • Why spend $1.7 million on lunch with Warren Buffett when you already know what he’s going to say? Well if you don’t then you better read the link.
  • Is Goldman Sachs the equivalent of a Wall Street Mafia? Read this great piece and you’ll be convinced and maybe flabbergasted as well.
  • Thinking of joining a startup firm? Guy Kawaski offers great career advice that I wish I had received 8 years ago!
  • The specter of the subprime is still lurking! (use firefox plugin “refspoof” to read the WSJ for free)
  • A little bit of personal finance with everyday luxuries you definitely can do without
  • And finally, a link to the Christian Science Monitor’s new economic blog who discusses whether or not you should buy real estate at this time. Of course, with a link back to my site, how could I not include them!

Enjoy!

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

    According to Reuters:

    A New York man who discovered that millions of dollars had mysteriously appeared in his bank account, and withdrew more than $2 million, has been arrested on charges of grand larceny, prosecutors said on Wednesday.

    Benjamin Lovell, 48, pleaded innocent on Tuesday to charges that he withdrew money from a Commerce Bank account that had been opened by someone with the same name, prosecutors said.

    Lovell had just $800 in his own Commerce Bank account when he went to make a deposit, but a teller, mistaking the Woodlawn account for Lovell’s personal account, told him that his account contained more than $5 million, prosecutors said.

    Lovell made multiple withdrawals even though he knew that the money was not his, prosecutors said. He used the money to buy jewelry for his girlfriend and to make several investments, they said.

    Lovell is being held on $3 million bail. He faces up to 25 years behind bars if convicted, prosecutors said.

    If a 48 year old guy only has $800 in his bank account, he’s obviously thinking this is a sign from God. If he’s not going to withdraw and spend it, what else is he going to do? (Apart from the honest thing of informing the bank manager that the money isn’t his?)

    But seriously, I think 25 years is too harsh a penalty for this. It’s obviously the bank’s error. He is definitely wrong for spending it, but if I had only $800 to my name and had the chance to make $5 million, I’m pretty sure I’d be tempted to do the wrong thing, even if I knew I might burn in hell for it. He had to have known that he was going to get caught. $5 million doesn’t just disappear without someone realizing its missing.

    What would you do if you were in Benjamin’s position? What is a good punishment for greed and stupidity?