Buying Vanguard National Resources (VNR)

Last week, I bought a position in Vanguard Natural Resources LLC (VNR). VNR is a master-limited partnership. MLPs in the United States are involved in transporting and storing a limited set of commodities, particular petroleum and other natural resources like natural gas. Basically, MLPs build and run pipelines for critical energy products used across the country.

MLPs are required to pay out a high rate of its cash flows as dividends in order to avoid paying corporate income taxes at the federal and state level. There are some other benefits involving depreciation that I won’t go into here. They aren’t effective when bought inside tax deferred plans like Roth IRAs, which is why I bought it in my tax exposed account. Just be sure to check if your CPA knows how to properly handle this when filing your tax returns.

If you haven’t gleaned this yet, MLPs have a higher payout than typical stocks. Looking at Yahoo, VNR’s current dividend yield is 8.40% ($2.40/share per year). It has an attractive P/E ratio of 7.50. Combined with a purchase price of $27.49, it makes a nice and affordable equity. Add to it that most if not all dividend payouts will be tax free (until you finally sell the stock, which is hopefully never), and you got yourself a sweet investment in my book to eventually draw retirement income from years from now.

VNR has recently announced their plans to shift from quarterly dividend payouts to monthly payouts in a few months. There aren’t many stocks that pay out monthly dividends. Imagine the convenience of building up a nice position to draw dividends upon in retirement. For the record, I decided on picking VNR before this was announced, but was pleased to hear such an announcement.

The other criteria I employed before picking VNR was the fact that it has been increasing it’s dividend payouts for several years. It is nowhere near being a dividend aristocrat or dividend king yet. In fact, it has only engaged in increasing its dividends for five years. For some, this may be a critical factor with five years being too short. In this case, I decided to take a chance. If they shift their dividend payout strategy in the future, I can sell my position and shift it to another MLP. There are many to choose from.

By all means, feel free to read my analysis and use it to create your own investment criteria, but don’t just buy VNR because I did.

Disclosure: Long VNR

What is the purpose of building wealth?

The other day, I found myself reflecting on what exactly is the goal of wealth building. To answer that, we must dig deeper into the definition of wealth. Wealth includes:

  • the means to sustain ourselves, such as buying food, paying for shelter, and providing transportation and clothing
  • the money to buy other goods like cameras we can take pictures of our family or gasoline to travel and visit family
  • the ability to spend days visiting friends and family without worrying about work
Can you think of other key reasons you need to build up a storehouse of wealth in order to retire? If you haven’t, then you need to set aside some time and think about this. Why do you want to retire? Can you put it into words, or is it just some nebulous concept you are pursuing simply because everyone else is?
You see, wealth isn’t a means unto itself. There is an age old adage that says “family is more important than money.” But there is a twist, because it requires a certain amount of money to have the means to visit your family. My long term goal is to acquire enough wealth to comfortably enjoy retirement with my wife and be able to visit our family as often as possible. Now that last statement isn’t too complicated, but it provides an overall guidance on my plans to build wealth.
To accomplish my goal, I have already realized that putting money away in a 401K isn’t good enough. There is too much volatility. My own analysis of the last 60 years of market data shows that for any 20-year period of retirement, things swing too widely. It is possible to hit a big boom, but it is also possible to get passed up by inflation, which would halt any family time and instead force me to resume work. It really is a luck-of-the-draw on whether you hit a major downturn close to retirement or not. In fact, we are quite likely to hit a major downturn somewhere within five years before or after retiring. That is not good! Factor in things like taxes, and the returns of a 401K falls into dismal performance. 
My cash value life insurance policy will provide a nice chunk of tax free money. My dividend paying stock portfolio should also pay a nice chunk of money, partially tax free. Hopefully the rest will be at a better tax rate than my 401K could have produced. But, there is no way to tell. Tax laws are always the subject of election campaigning. But since I also plan to reduce my total tax exposure, I won’t be stressed about this when it’s time to retire. Instead of shouting at the TV set, I can instead be boating with my family on a pleasant day.
We have friends in Florida that we visit rather frequently when we travel to our town home in Florida. Just last week, they happened to be traveling up north, and stopped to stay with us for a couple days. It was fun! To fully enjoy it, I took off for a couple of days. My long term goal is to be able to enjoy those times without having to take any time off. When we travel to Florida, I work from my laptop, but in the long run, my plan is to retire so we can travel any time of the year and not worry about working.
That is what wealth building is all about. Building up enough wealth that you can go the places you wish without worrying whether you have enough vacation or holiday time. At least that is what it is for me. What is it for you? If you can’t say it in a couple of sentences, then try setting aside some time to  think about your long term plan. Don’t just drop some money into an account that you never think about. That isn’t a plan at all, and it can be the most expensive thing you never thought about! Remember, failing to plan is planning to fail.

Paul Graham discusses how to make wealth

I recently was pointed to a wonderful essay by technologist and start up founder Paul Graham. For those of you running in software circles, Paul Graham pursued LISP and even tried to build his own dialect of it, “Arc”. He has been involved in startup companies, which are a bit of a rage amongst software geeks, especially in the Bay Area.

In his essay, How To Make Wealth, Paul discusses some core points developers should understand before they dive into a startup company. While coming to grips with joining a technological startup, he sprinkles this essay with key elements of wealth building that stretch to any business. If you are reading this blog and are not a software developer, every word of this essay is still of high value for you to read.

Let’s visit some of the highlights.

Leverage

Paul discusses how a fresh, young software developer working for a big corporation could probably average $80,000/year in salary. If you worked at a startup, it is not unreasonable to assume your work would be better valued at around $3 million. This may sound ridiculous, but when you move into a startup environment, a lot of barriers are removed, empowering you to build a lot more wealth than you ever imagined was possible.

But the demands rise as well. As I mentioned before, when you trade up for higher performance, it’s possible to move a bigger load. That is the nature of leverage. And no lever is of any value if it’s not used. So don’t expect that you can join a startup and not be expected to carry much more than a typical corporate job. The other half of that coin that Paul points out is that no one expects you to work at that rate forever. The idea is to generate enough value and growth that your company is either acquired, goes IPO, or some other aspect where you ultimately get paid off and possibly catapulted into better prospects.

Money is not wealth

Moving beyond the subject of software startup companies, Paul makes several powerful points. One of the biggest is the fact that money is not wealth. Money is simply a medium we use to exchange with other people. Wealth is what you build. There are strong opinions on what is and isn’t wealth. If you dig deep into the arguments that are out there, many of these boil down to two opposing viewpoints: either there is a fixed amount of money/wealth in the world, or there is a variable amount.

Would you would like to be the richest person in the 1600s or a relatively poor person in today’s age? Most people quickly answer they would prefer what we have now. The reason is that we have more now than people have ever had before. This is the result of generations of people building new wealth, not simply moving existing wealth around between different people.

There is a great inertial force at work. Each person that is born will work a certain amount of time, generating a certain amount of wealth for society. One big criticism from fixed wealth believers is that a new invention, like the cotton gin, is invented, it puts existing laborers out of work, essentially rerouting the wealth they were generating. But these people don’t simply go home and stop working forever. Instead, they find new jobs, new pursuits, and redirect their existing energy into other places, continuing to create wealth in other places.

Work smarter, not harder

It’s really interesting that every now and then, I pick up some amazing insights from my daughter’s favorite cartoon: Duck Tales. In one episode, Scrooge McDuck is explaining to his nephews how he got wealthy. He repeats several times, “worker smarter, not harder.” There is no harm in working hard, but spinning your wheels and not creating much isn’t going to be effective in your wealth building plan. A critical factor in growing wealth is building something people actually want and working strategically to get that product into as many hands as will buy it with as much efficiency as possible. Your first instinct may be to double your hours of assembling your product, but it may be better leverage to automate some or all of the process. There is risk in that you may need a loan or entertain bringing on board an investor. But if you can succeed at building more without burning more hours, your time may better serve at visiting more stores to develop more sales.

Another type of leverage are the tools you use, and the means you employ to reach as far as possible. One of the reasons Facebook was so successful is because it a) provided something people wanted (socializing with current friend and finding past ones), b) it was free, c) ran on any computer with no effort, and d) sold ads to companies that wanted to get inserted into all this networking we as humans enjoyed. We already mentioned that more physical labor may not the best step to take. Technological leverage like developing a web site to market and sell your business is of undeniable benefit in today’s society.

Wrapping it up

One of the most interesting things I found in Paul’s essay towards the end was comparing small businesses with big ones. Paul compares this to a big person chasing a small one. When you reach a decision on what to add to your business, consider it as a choice to either run downstairs (easier) or upstairs (harder). In all likelihood, the small guy can run faster than the big guy upstairs. This creates a bigger lead for the little guy, which can materialize as wealth your business creates that your big competitors can’t keep up with.

Yes, this essay may be long, but it is definitely worth a read if you are thinking about running your own business or joining a new, small startup. If you are working on your wealth building plan, consider this essay a valuable lesson plan as well. Perhaps it will inspire you start your own business.

Can your CPA protect you from the IRS?

In a previous post, I mentioned that we must guard ourselves from experts. Reading an article on Fidelity.com, this is shown yet again. It appears that the government is getting hungry for more funding.


Tell me something I don’t already know.

It appears the IRS is getting more stringent on cracking down on things like excess contributions to IRAs. This appears to be another case of where all the complex rules for accessing my own money bugs me. I like the idea of collecting dividends on dividend aristocrats tax free, but if I exceed the limits for making Roth IRA contributions, I will have to shift to other means.

Back to the article I just mentioned. In the middle, it shows a case of a husband and wife who for seven years made contributions to their IRA where they weren’t qualified due to their level of income. This wasn’t discovered until they changed accountants. The prior CPA was totally unaware he was making this mistake. This is another case where you can have someone with the right pedigree and the proper licensing where they must properly protect, but they flat out can’t handle it.

Do you think the IRS extends much leniency in these situations? Not. At. All. In fact, the whole atmosphere of this linked article is the fact that the IRS has let TOO MUCH slide by. They are apparently looking high and low for violations of the IRA regulations, demanding their “fair share” and even exerting penalties.

This is a key reason why picking your experts based on fees is the wrong approach. It is important to find a CPA sharp enough to protect you from these errors. It is equally important to find one that can help you have the most tax efficient wealth building possible. It may take some time to find such a person. Work hard to find this person and the cost will be worth it.

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

New study shows excessive 401(k) fees

A new study has come out titled “The Retirement Savings Drain: The Hidden & Excessive Costs Of 401(K)S” by Robert Hiltonsmith. The results are quite shocking. Or perhaps they SHOULD be shocking. I’ve already heard about this, and so I’m not surprised. But perhaps you haven’t? Some of the big ones:

  • 65% of 401(k) account holders aren’t even aware they are paying fees
  • 5 out of every 6 investors lack basic knowledge about the fees everyone with a 401(k) pays
  • fees are taken off the top, meaning reported rates-of-return are post-fee, hiding these costs
  • administering average pension funds costs 46% less than the cost of 401(k) plans
  • new regulatory tweaks that are coming, requiring better disclosure of fees, will have little effect on reducing the fees nor fix the issues associated with market risk and longevity risk
  • the individualized nature of the 401(k) doesn’t work and must be replaced with something else
Did you catch that last one? The author of the study has concluded that much of the issues that arise in 401(k)s is because of it’s individualized nature, and that tweaks and adjustments won’t fix it. The author figures that the new disclosure rules won’t fix 401(k)s, but instead expose them for the bad investment vehicle that they are.
I said shocking right? Well, I already learned this about six months ago. I have been working on my plan to leave my 401(k) behind. I have already stopped putting money into my corporate 401(k) and rerouted that money into an EIUL. In that article, you will find mention of the high fees embedded in 401(k)s. Combine that with the onerous rules that restrict your access to the money, and that pretty much sums up my disgust with them.

The study estimates that people will lose something like $155,000 on average over their working lives to excessive fees, enough to buy a house. What could you do with $155,000 of investment capital? Buy Berkshire Hathaway, or perhaps leverage it with investment property? Both of those options has a higher historical rate-of-return. Why don’t you hear about this from your financial advisor? Aren’t they supposed to be putting you first, according to the license they hold?

Towards the end of the study is a list of bullet points for what appears to be core principles in some sort of universal retirement plan. I think either the author or the institute that funded him believe we should all receive a universal, i.e. government orchestrated pension fund. I have my doubts on how effectively the government can manage something like that, considering their track record with managing social security. I could never support something like that unless we had the freedom to opt out and choose our own path. Or, they may be saying we need something better than what the IRC affords us from section 401(k), and these are the key points that must be met to have a true success. I just don’t remember the government having a big rate of success when it comes to money.
So what is the solution to all this? Don’t be a passive investor. Take active management of your plan. And HAVE a plan. Don’t just throw money at your 401(k), pick a handful of their funds, and then assume it will all work out. At the Wealth Building Society we focus on learning how to read this information, how to understand risk, and how to understand the mechanics of investing, so you can formulate your plan. One of the top reasons so many people are failing at retirement planning is because we have been told it’s easy and we don’t need to really be active. And also that there are plenty of experts out there to handle it for us.

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

The good, the bad, and the ugly of leverage

Over the weekend, two significant things happened: the power outages in the West Virginia area caused one of Amazon’s regional data center to suffer an outage and a leap second was distributed to all computers and phones running NTP.

The cloud is good for us…

Companies have been discovering that by off loading major, critical operations to services like Amazon’s S3 and EC2 cloud support, they can leverage their development teams and more productively and efficiently. They are also able to enjoy better uptimes and longer mean-time-to-failures.

This means better profits, better products, and eventually lower prices for all of us. It is an economy of scale situation. Instead of every company paying for fully staffed sysadmins and devops team, they can delegate that to the cloud providers. This is leverage; one of the most powerful tools ever invented.

Remember your grade school science classes when they mentioned things like the pulley, the wheel, the wedge, and the lever? Archimedes is the one who said, “give me a lever long enough and a fulcrum on which to place it, and I shall move the world.”The lever works by trading force for distance. By requiring you to move a lever twice as far, you only need supply half the force.

…even if the news stories don’t support it

When 1% of the internet goes down due to Amazon’s cloud outage followed by a leap second bug 48 hours later, it makes big news headlines. Services like Netflix depend on the cloud, and people began to doubt whether the cloud really is the right solution to pursue. What makes this hard to judge is a form of journalistic bias. I’m not talking about left wing/right wing political bias, but instead what is/isn’t reported. When a single system goes down and impacts dozens of popular, online services, it’s easy for the reporters to flock to the central location and write their negative stories.

But when lots of small companies, running their own systems, suffer the same power outage, the problem isn’t as centralized. Reporters may still write about the power outage, but it doesn’t have the same amount of leverage and it’s not as noticeable to the consuming public. Moving further along the spectrum, the companies that were prepared for both of these situations by having backup generators, backup clouds, and prepped for the leap second, typically don’t show up in the news at all. When things work perfectly and no outage is involved, it doesn’t make for an exciting headline.

Good debt vs. bad debt

Leverage carries similar power in financial circles. When you borrow money from a bank to buy real estate, you need only supply a fraction of the capital, but you can gain extra “distance”, i.e. earnings when you either pour the rent money into paying it off or letting appreciate in value (or a combination of both).

But every investment includes risk. Your property may not have tentants, resulting in negative cash flow. Or it might fall in value, reducing your equity position. The thing to remember with leverage, is that it amplifies the outcome. If you suffer losses, leverage can cause you to lose big time.

That is the reason many people abhor debt. Consumer debt (credit cards/auto loans) should be viewed as bad, because it eat ups more capital for assets that produce no revenue. But debt used to purchase cash flowing assets (stocks and real estate) requires a different evaluation. It could be good for you, or bad.

As my buddy Jeff Brown says, buying swamp land is still real estate but would be stupid to buy. If you invest in good quality real estate (including good location AND quality property), you will attract good tenants and end up making money. No spreadsheet will provide the complete answer to this.

Leverage amplifies results

The key principle of leverage is that is AMPLIFIES the results. If you invest in a good cloud provider, or buy a good piece of real estate, the leverage will help you in the long run, BIG TIME, despite the occasional bump in the road or vacant tenant. You are also unlikely to make any news headlines. But if you invest in some cheap provider or buy the cheapest property you can find, and the leverage bankrupts you, then you stand a greater chance of ending up in the news and giving politicians something else to regulate to death.

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

Tell tale facts about mutual funds

Are you invested in mutual funds? The likely answer is yes. That’s because Wall Street has very successfully pitched mutual funds inside 401K wrappers as the primary means of retirement savings for at least 30 years. This is despite some astonishing information about mutual fund providers.

Did you know that there is over $12 trillion invested in mutual funds? That doesn’t indicate the success or failure of mutual funds, only the magnitude of the situation at hand. After all, there is a lot of money invested in cash value life insurance. Many top executives at large companies provide over funded life insurance policies to their executives as part of their compensation package. At the same time, some of the companies have their salespeople preaching “buy term and invest the difference.”

The average salary for a mutual fund manager is $240,000/year. I have no quarrel with someone making a good salary, since I applaud successful entrepreneurs being rewarded for their efforts and choices. But where this really starts to lose ground is the fact that 15% of these directors stay in the business for 20 years or more. They come back, year after year, and keep managing funds, whether or not they did well. You see, their measurement on how well they do isn’t 100% based on how well you or I do. A significant factor is whether or not they made good sales. Did they keep enough clients from the previous year, or in turn, gather enough new clients. Either way, if the fund itself takes a nose dive, it shouldn’t be an assumption that the fund manager gets fired. If that were true, the turnover would be huge.

61% of mutual funds have lagged the S&P 500 over the past five years. This is where Wall Street’s message of “find a financial investor” gets spelled out crystal clear. In one breath they say, “odds are against you picking a mutual fund that will succeed. You need an advisor.” And then the next thing they say is, “but we can pick a good mutual fund. The odds are NOT against us.” The odds cut both ways. If you are looking at hiring a financial advisor, ask for a listing of every client he or she has had for the past 10 years, and their overall performance.

Let me say that again: ask for their client’s performance. If your potential advisor tries to tell you the 10-year performance of the funds he or she suggested, don’t accept it. You aren’t evaluating whether the fund works. You are evaluating whether his clients succeeded using him.

Another tragic fact of mutual fund companies is that most of the oversight controls are in house. They may have a separate board in charge of oversight that doesn’t directly pick the funds, but this is still under one roof. Now we may look at people like Warren Buffett and Berkshire Hathaway and try to ask, “what is the difference?” After all, Warren Buffet and his board essentially decide what to buy and sell. They own either in part or entirety, over 70 companies.

What’s the difference? A huge one. Berkshire Hathaway has annual shareholder meetings and have votes. Shareholders can vote out board members, even Warren Buffett himself, if they aren’t doing their due diligence. Past members of the board have left due to various differences. This bodes for true accountability to the shareholder. Mutual funds don’t have shareholder meetings. There are not votes. The board put in place makes all the decisions, and the company board overseeing them don’t answer to you either. They are on the hook to answer to the SEC, but when is the last time that the SEC prevented a major fiscal disaster?

Another major difference between mutual funds and owning the same equity in Berkshire Hathaway is what happens when people want to dump their holdings. When you own a mutual fund, you don’t really own stock. Instead you own shares in a fish bowl of equity. When you ask for your piece, they must empty out the fish bowl. Due to their strategy of investing, they may be forced to sell lots of stuff, good and bad, to pay you out. When a lot of people dump their holdings due to a downturn, they have to cash out a lot and take bad losses. It is hard for them to simply sell the most profitable stuff and allow you to share in the good fortune. That’s because a huge portion of the equity of a mutual fund is kept in stocks and bonds (or whatever else they are investing in). Very little is kept in liquid cash.

When you sell a chunk of Berkshire Hathaway, you aren’t asking Warren Buffett to unload any stock. Instead, you are asking another investor to buy your shares at whatever the current trading price is. There is no middle man in this respect the way there is in a mutual fund. Maybe they picked up some bad stocks, maybe their good, but your panicky nature during a downturn doesn’t directly force Warren Buffett to unload good stocks just to meet your liquid needs.

Does any of this sound like the stuff you heard the last time you chatted with a professional mutual fund advisor? I didn’t think so.

To sum things up, mutual funds have been very profitable for the companies. That is probably why the managers can keep their jobs. It should be a tell tale sign that when mutual fund companies keep the same people for decades, their lack of ability to police costs and serve your needs not of serious concern. Actively investing in your own strategies and seeking out products that meet your wealth building needs requires constant, active research on your end. Handing this off to someone tilted towards merely finding the “best” mutual fund for you won’t cut it.

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

Does your 401k company match have a dollar limit?

An interesting thing has happened today: my company sent out an update on it’s 401k policy. They have increased the dollar amount of the match they are willing to make. If you read the first part of portfolio rebalancing, you are aware that I’m no longer investing any money there. Since I made that choice, I see such enticements through a different lens. I appreciate the generosity my company has extended, but it’s important to realize companies aren’t successful because they are benevolent and generous. It is more likely a need to stay competitive with other companies and what they are offering. There are probably tax benefits as well to consider from their perspective. There is nothing sinister or wrong about this. It is simply business, and all active financial planning done on your part requires that you think like a businessman.

Did I mention active investing? When I joined my current company, I took a passive approach. I picked a handful of mutual funds from a list, and spread my contribution among them. There was no in depth analysis. Frankly, I didn’t think I needed anymore. Instead, I assumed (as I had in the past) that the mutual find manager would fo his jon and earn me s good retirement. I didn’t realize how passive and wrong I was at the time. Another dimension of passive investing was the fact that I wasn’t aware of the limit of the company match. While they will match a certain percentage, there is a hard limit in dollars of how much total match. Guess what? I exceeded the limit. Even with this new increase, I still can’t get the full percentage match. This all makes for a very manageable situation for my company. They can go to the shareholders and give a very concrete listing of the maximum liability they have in 401k funding.

This is very different than the old style of managing pensions. Instead of managing the complex and unpredictable risk of a pension fund, they can simply add up the number of employees and multiply it by the dollar limit for each year. The rest is, as they say, up to us. If you assume your 401k along with a passive investing strategy will carry you to a comfortable retirement, you’re in for a shock. I have been saving money in my 401k for 15 years. When I started back then, I maxed out to the tune of 15%. At one point they raised the limit, and I pushed it up to 18% (the IRS dollar limit). I did that for years. Then one day, I looked at what was there and realized what was there wasn’t growing fast enough to beat inflation AND fund a comfortable retirement for 20+ years. This is what allowed me to break away from the propaganda of Wall Street and it’s message of the stock market always rising.

I was listening to Dave Ramsey today while driving, and for the nth time heard bim throwing out the same “grow your mutual funds at 12%, withdraw at 8%” gibberish. Mutual funds average 7% with wide swings. In fact going back to 1951, the S&P 500 has swung from between 5.15% and 10.05% over any given 30-year period. Mutual funds  tend to underperform this index, so expecting 12% is ridiculous on its head.

Advisors have been telling people to withdraw no more than 4%. Factor in that this must be based on the roller coast value of your portfolio and NOT on some average (to avoid dipping into the principal), and you must realize your mutual funds are just too risky with their horrendous track record to be your primary venue of retirement. I don’t have anything against my company. It’s just important to understand that what is best for you, your company, and the IRS do not often coincide.

Cross posted from http://blog.greglturnquist.com/2012/06/does-your-401k-company-match-have.html.

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

Go anywhere funds that really go nowhere

I chuckled as I saw an article today posted on Fidelity.com titled “5 funds that ‘go anywhere’ for a smoother return.” It involves a new “type” of mutual fund. They are called ‘go anywhere’ funds, meaning the fund manager isn’t constrained to the usual set of restrictions, like only investing in certain types of asset classes, or adhering to a certain proportion of stocks vs. bonds. Some of the quotes are really quite telling.

“The so-called Lost Decade proved that we don’t need to rely on large equity allocations to seek meaningful returns,” says Rob Arnott, chairman and founder of Research Affiliates and manager of the PIMCO All Asset fund (PASDX), noting many investments, including high-yield bonds, emerging market debt and commodities, offer equity-like returns. Yet, because of the complexities of these assets, there’s value in having an expert calling the shots on when to move in and out of these alternatives.

Is it just me, or is this manager now telling us that asset allocation doesn’t work? Not wanting to put words in his mouth, let’s see what another manager quoted in that article says:

Because the funds potentially can go anywhere, they may throw a wrench in your overall asset allocation but “that’s not always the worst thing,” says Waddell, explaining there are times when it pays to have a good manager making big-picture calls on your behalf. Still, it’s not a bad idea to see how such a fund will mesh with your other holdings by taking a look at the manager’s track record and current holdings.

It seems both Arnott and Waddell are telling us that it wouldn’t be the worst thing if the fund manager was able to go out and simply pick what is best and had the best deal. From 10,000 feet, it sounds like the same approach taken by Warren Buffet. He seeks out companies that are different sectors, ranging from insurance to jewelry stores, to shoe makers, to brick manufacturers, to carpet makers (and that ain’t the half of it!) But people none-the-less keep throwing stones at Warren Buffet even though he consistently beats the S&P 500.

Looking towards the bottom of the article, I notice a matrix showing the performance of five such funds. Strangely, they didn’t list all the ones actually mentioned in the article. I guess it is only the “go anywhere” funds that are sold by Fidelity. Though they mentioned 10-year returns in the article, I only see 1, 3, and 5-year annualized returns in this matrix. Why is that? Is the 10-year performance not too hot? Well the best one only sports an 8.23% 5-year return. With a 0.76% expense ratio, it would appear that my total gain (before taxes) would be 7.47%! Subtract 30% in taxes (5.23%) followed by by 4% inflation, and all you get is 1.23% gain. Not too good for long term wealth building in my opinion! Not to rub salt into your wound, but the article touts that these funds are doing better than 85-95% of the other mutual funds. Yikes!

And why are they coming up with these new strategies? Because the other ones crashed and burned over the last decade! People jump ship when mutual funds nose dive, so the Wall Street salesforce needs to offer something “new and exciting” that people are willing to buy, causing a reaffirmation of our human nature to sell to stop losses, i.e. sell low, and then buy on the upswing, hitting the high point, and killing our overal wealth building performance.

Bottom line: if 1.23% gain is what I have to look forward to, then you can count me out of trying use mutual funds to build my retirement wealth. But let’s at least adhere to the tail end of the second quote: “it’s not a bad idea to see how such a fund will mesh with your holdings by taking a look at the manager’s track record and current holdings.” Indeed, let’s check what the managers track record looks like over a 20 year period. Because that is the traditional time window we really have.

Cross posted from http://blog.greglturnquist.com/2012/05/go-anywhere-funds-that-really-go.html.

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

Guarding yourself from experts

Ever heard the joke about what you call someone who graduates last from medical school? The answer is “doctor”. It means that no matter how good or bad someone was in medical school, they are still a fully fledged doctor.

It’s an interesting fact that groups tend to click together, and groups of experts are no exception. They also tend to eschew anyone giving anything remotely close to advice in their area of expertise. Of course there is a reason that these people are experts: they went to certain classes, studied key material, and passed some sort of test to earn their certification, degree, or designation.

Do you think this is enough qualification to totally hand over all your decision making to one of these people? It’s not. Amidst certified financial planners, lawyers, real estate advisors, and others are good, honest people as well as snake oil salesmen. Sadly, it is up to us to sift through all these people and find the best person for our needs.

The law doesn’t protect you from incompetent advisors

I often read discussion forums and usually at some point, someone makes an appeal of authority that a financial advisor with a series 6x or series 7 license will put you first because it’s the law. Sorry, but you see, you don’t know what you don’t know, and that expert you’re consulting doesn’t know what he or she doesn’t know. A double blind spot! It is a tough situation to deal with, because after all, that is the reason you are seeking an expert! This person may be constrained by his education (or lack thereof) and whatever training materials he has. He may also not analyze every vehicle or have certain prejudices towards or against particular products for various reasons. He or she may be putting you first, but that doesn’t guarantee your advisor knows what they are doing.

One thing I’m aware of is that academics, you know, the people with the PhD’s, don’t like something that carries the weight of academic research coming from someone who doesn’t have a PhD. My dad told me this, and he was a college professor who retired as the department head of Biosciences Engineering at a well respected university. This is why when people write popular books that are filled with a lot of valid information, littered with evidentiary footnotes, like “Killing Lincoln”, they will be looked down upon because the author wasn’t an academic. Why is that? Is it because the book was faulty? Or is it because too many people that are non-PhDs might make the academic community to appear to be not as expert as they claim to be? Again, this is where just because someone has a PhD it doesn’t mean they are the expert you need. In fact, the most valuable advisor you can find needs to be able to say, “I don’t know” in certain areas. You will find that really good advisors tend to network with people OUTSIDE their zone of knowledge. These are people that have a much better sense of what they DON’T know.

One expert who lived on evidence

For another historical example, look at the famous Albert Einstein. We’ve all heard of him. So what was his story? He was an evidence based physicist. For 400 years, people had made assumptions about the laws of motion. This went back to Newton, who was well established in academic circles as the father of the laws of motion as well as gravity. One of the biggest theories that had existed for centuries was referred to as the Galilean transformations. It was used to convert coordinates of motion between two frames of reference, such as a girl bouncing a ball on a train, as observed by a man on the platform while the train passed. Buried in the middle of it was the assumption that time passed at the same rate for both the girl bouncing the ball and the man standing on the platform.

Einstein essentially said that he couldn’t accept such an assumption without any evidentiary way to prove it. Seeing none, he threw the Galilean transformations out, and started to form his own theory. This allowed him to derive the Special Theory of Relativity, which demonstrated that time in fact moved at different rates relative to the motion between two bodies. While he had a PhD, he wasn’t able to get a teaching post and instead worked in the Swiss patent office until after he had published these ground breaking papers. In fact, in one year he published four papers (1905), including the one on Special Relativity.

Even then, he wasn’t immediately accepted by the academic community. After all, the core of his conclusions said that Newton was wrong! His papers on photoelectric effect had managed to earn him a position as a lecturer at a university in 1908. In 1911, he became a full professor and also predicted a very different outcome than Newton’s laws when observing stars near the sun during a solar eclipse. But his career hung on a thread. Only when that could be observed, would the academic community finally believe his papers on Relativity. It wasn’t until 1919 that such an observation was made, and it catapulted Einstein to amazing fame.

Einstein worked from an evidence based approach. He didn’t accept assumptions. His willingness to be a gadfly and put centuries old traditional theories on the shelf and formulate whole new ways to look at problems led to amazing breakthroughs that still impact us today. (Did you know GPS devices must account for relativity to get the accuracy they achieve?)

Guarding yourself from experts

There is a way to guard yourself when seeking the right expert. Ask for the evidence and evaluate it before making a decision. Learn how to read the research so you can cross check what they are saying. When a financial advisor recommends a mutual fund to you, don’t ask “how has this fund performed over the past 10 years?” Instead, ask them, “how have investors done over the past 20 years in mutual funds?” After all, isn’t that what you are trying to do? Your advisor may stumble at that request, or hem and haw. The truth is, that answer has been published year after for some time now. The Dalbar Report indicates that investors, on average over the past 20 years, get less than 4% average annual returns when they invest in mutual funds.

Does the person giving you advice have some actual performance history proving their own investment advice has worked, and longer than a 10 year period? Have they accumulated wealth, and did they do it by buying what they are telling you to buy? For example, look at what happened in 2008 when the market went negative. Most of the mutual fund management companies increased their fees. You see, they tell you to stay in, but they don’t share the risk with you. Instead, when people pull out of mutual funds, they take their own share out of the pot!

Are the people making big money on investment books making their money on the advice in the book, or the fact that they can sell millions of copies? Did you know one of the best ways to get a book published is to already have published one? That is because fans of existing works are much more likely to buy other books from the same author. That is why you hear about famous authors writing many books, and the publishers know this!

What about those that have TV and radio shows? There is nothing wrong with having a show. But think about it: would you make more money using their advice or managing to get your own TV show? (HINT2: Research shows that one of the best money makers is running your own business. Maybe you CAN start a radio show and make a killing! But there are other places to build your business.) So try and figure out exactly what your expert is selling, and figure out if his advice is golden. If it is, then it probably doesn’t matter what fees he is charging. He is probably worth his weight in gold!

Cross posted from http://blog.greglturnquist.com/2012/05/guarding-yourself-from-experts.html.

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.