How do financial planners add value to workers seeking to retire?

The November 2014 issue of the Journal of Financial Planning published an article by two professors, Terrance K. Martin Jr., Ph.D.; and Michael Finke, Ph.D., CFP® “A Comparison of Retirement Strategies and Financial Planner Value”

They conducted a study to determine if – and how – financial planners made a difference in how well people retired.

Financial literacy and planning is much more important today than ever before.  The last two decades has seen a dramatic shift in how people prepare for retirement. A generation ago, most employees worked for companies that provided pensions as an employee benefit. The company took care of investing for their employees’ retirement. The employee was guaranteed a pension income when they retired.

That’s no longer the case. The responsibility for funding retirement has shifted from employers to employees. The (defined benefit) pension is out, the (defined contribution) 401(k) is in. But that’s a problem.

“Only 38 percent of all private workers participate in employer sponsored defined contribution plans, and just 14 percent of Americans are confident in their ability to retire comfortably.”

“Greater employee responsibility for funding retirement means that individuals, rather than pension professionals, must estimate how much saving is needed to provide an adequate retirement income … A lack of financial knowledge and sophistication among many American workers may contribute to inefficient retirement savings … Most American households cannot maintain a constant level of consumption in retirement with their current retirement savings … and one-third of retirees obtain 90 percent of their income from Social Security, according to 2012 data from the Social Security Administration.

The study was intended to determine what value financial planners brought to workers saving for retirement.  There were three main benefits.

1. Professional financial planners can help households accurately estimate the amount of retirement income needed to fund household retirement goals.
   • Most people have heard the old adage that if you don’t know where you are going, any road will take you there. Without a specific goal most people save too little. Studies have shown that young households aged 35 to 45 save 9% to 19% less than they should. Another study estimated that the median household needs to save 20% more than they do.
2. A financial planner can provide a financial plan that provides the steps needed to meet a retirement goal, review progress regularly, and make appropriate adjustments.
   • Planning for retirement begins with an analysis of current assets, the mix of assets needed to achieve the retirement financial income, and the savings rate to meet the goal. The financial planner will use an investment strategy consistent with economic theory and “help reduce a client’s behavioral biases.” The professional financial adviser will help the client overcome the anxiety that comes from market volatility.
3. Working with a financial planner helps the worker become aware of the consequences of low savings and help overcome the biases that many people have against participation in the financial markets.
   • Financial literacy surveys show that most American workers don’t have the investment knowledge to make effective retirement savings decisions. The simple process of process of calculating retirement income makes people realize that they have not been saving enough for retirement. A major value of working with a financial planner is to be shown the difference between current and optimal retirement saving.

To understand the value of a financial planner it is important to distinguish between types of financial advisors. Many who hold themselves out as advisors are stockbrokers or investment managers. The ones who have the biggest impact on retirement savings behavior take a holistic approach, making the plan and the goal the center of the relationship. They take the time to explain the complex choices involved in creating the appropriate portfolios.  They are typically RIAs.

Here’s the bottom line:

Results indicate consistent evidence that a retirement planning strategy and the use of a financial planner can have a sizable impact on retirement savings. Those who had calculated retirement needs and used a financial planner (which likely captures those who used a comprehensive planner who follows a more thorough planning process that includes retirement needs assessment) generated more than 50 percent greater savings than those who estimated retirement needs on their own without the help of a planner.

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Family Business Financial Planning

A family business is one of the ways that individuals build something of value for themselves and their family. Suffolk is a great example of a community where family owned restaurants, hardware stores, gift shops, bike shops, jewelry, sporting goods, clothing and furniture stores line the streets. Suffolk has its national chains, but its most recognizable businesses – in the pork and peanut industry – began as family businesses.

These family shops often provide a comfortable living as well as job opportunities for family members of the founders. Whether they stay small and local or grow into large businesses, there are challenges that everyone running a business has to face.

The first is competition. For every business there is a better financed competitor. The supermarket doomed the family-run grocery store. Wal Mart is a feared competitor for anyone selling groceries, clothing, furniture, electronics, toys, eyeglasses; and now it’s even getting into banking.

The second challenge is a bad economy. Many communities have seen their downtowns shuttered when local industry left. The businesses depending on housing have still not fully recovered from the crash of 2008.

Finally, most small businesses are very dependent on one or a few key people. If the children don’t want to get into the business when the parents are ready to retire, the business often closes. There is no guarantee that a business can be sold when they owner is ready to retire. Unless the owner has prepared for this, the financial results can be devastating.

For all these reasons, the family business owner has to make sure that they have prepared themselves financially for life after the business. Succession planning is critically important and should be part of the business plan from the moment the business is started. If a business is a partnership, buy-sell agreements should be in place to avoid complications from the death of a partner. If a business is going to be passed along to children, the owners should be clear about the division of assets. Otherwise there is likely to be wrangling – or even lawsuits – over who is entitled to what.

Most people in business choose to convert from individual proprietorships to limited liability companies. This protects the business owners’ personal assets in case of a lawsuit against the business. Some convert to “Chapter C” corporations for tax purposes. If a company wants to grow even larger, it may want to raise cash by “going public” and selling shares to the general public.

One of the most common mistakes that business owners make is to invest too much of their money in the business. It’s a fact that a family business is a high-risk enterprise. Competition, the economy – even a change in traffic patterns – can bring a business to its knees. Building an investment portfolio should go hand-in-hand with building a business. When most of your money is tied up in your business you are making the same mistake as the investor who owns only one stock. Diversification reduces risk and provides a safety net. Factors that are out of your control could end up severely damaging your business value, thereby crippling your total savings and your future goals and ambitions.

In addition to the traditional savings and investment accounts, the tax code provides many ways for business owners to put money aside in a variety of tax-deferred accounts such as SEP-IRAs, 401(k) plans, and SIMPLE-IRA plans. As a business owner you can even set up a “Defined Benefit Plan” which works much like a traditional pension.

There are a great many things that running a business entails beyond offering customers a great product or service. People who start a business are usually focused on this aspect of the business. But to insure that the business – and the family – survives and thrives, business owners should seek the assistance and guidance of a team consisting of an attorney, an accountant and a financial planner. They may be in the background, but they are critical for the financial success of the family business.

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Companies Offering “Financial Wellness” Benefits.

Companies offer benefits to their employees to attract better employees. It’s also a way to encourage good employees to stay. The range of benefits has expanded to include financial wellness.

Financial wellness is becoming an important priority for many companies. Money troubles can distract employees from their jobs. Merideth, Inc., publisher of such magazines as Better Homes and Gardens and Ladies Home Journal, does more than offer employees a 401(k). It reimburses eligible employees for the services of a financial counselor.

A number of companies help their top executives as well as their over-50 employees with their financial planning. They realize that they don’t want these experienced, highly paid employees to spend their time studying investment guides or wondering how to invest their retirement plan. Employees who suffer from money worries get sick more often, do not perform as well, and are apt to be absent. By offering to pay the fees of a financial advisor, these companies – for a relatively modest investment – reward their employees and boost productivity.

The typical company offers workshops for their employees, being careful that these meetings do not turn into a sales pitch.  If an employee decides that they wish to work with a particular financial advisor, they sign a separate form stating that they are entering an agreement separately, not as part of a company sponsored solicitation.

The advisor is almost always fee-only and often an independent RIA (Registered Investment Advisor).

If your company wants to offer financial wellness benefits, contact us.

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Chinese guarantees and the illusion of safety

A “guarantee” is only as good as the guarantor. If you buy a car with a ten year parts and labor guarantee, you make the assumption that the company will be around for that long and able to make good on its promise.

That’s becoming a potential problem in China. The Wall Street Journal shows how a lot of Chinese loans are ‘guaranteed” by guarantors who may not be able to make good in case of trouble.

Since 2007, the central government has instructed banks to lend more to small firms run by entrepreneurs, the most efficient part of the economy but one that banks have traditionally eschewed. Banks prefer to lend to large and state-owned firms that have sufficient collateral – typically land – to cover their loans.
The banks’ solution has been to insist that in the absence of collateral, someone else guarantee the loan – absolving banks of the need to look too closely at borrowers’ ability to pay, while giving loans the veneer of being safe. In some cases, the guarantee will come from another small firm – maybe a neighboring factory, and a company run by a close friend.

This would not be a problem for the industrialized world if China had not become the world’s largest economy. Major firms throughout the world are making big bets on the Chinese economy. The Chinese are known for their “creative” accounting.   The next big “Black Swan” event could come at us out of the Orient.

Living on a fixed income has gotten a lot harder

At one time, living on a fixed income meant you were retired, received a pension and social security, and got some extra income from your savings. For our parents and grandparents, certificates of deposit, otherwise known as “CDs” were a guaranteed source of no-risk income. Back in 1981 you could put your savings in the bank and get nearly 18%. That was a period of high inflation when prices were also going up. But CDs and bonds paid investors high enough rates so that retirees were comfortable with putting their money into CDs or bonds.

But interest rates have been on a downward path since then. CD rates have dropped from about 11% in 1984 to 1% or less today.

 

Today, CDs and bonds, once the go-to choice of the thrifty retiree, pay a small fraction of what they once did, and provide very little income to supplement their other retirement income sources.
The Federal Reserve has been keeping rates close to zero for years to try to jump-start the economy, with limited success. But while it’s been good for businesses and home buyers who have have been able to borrow money at rates that we have not seen since the 1950s, the traditional saver has seen their income dry up, collateral damage of Federal Reserve policy.

Charles Schwab, in an article published in the Wall Street Journal states that:

U.S. households lost billions in interest income during the Fed’s near-zero interest rate experiment. Because they are often reliant on income from savings, seniors were hit the hardest. Households headed by seniors 65-74 years old lost on average $1,900 in annual income over the past six years, according to a November 2013 McKinsey Global Institute report. For households headed by seniors 75 and older, the loss was $2,700 annually.
With a median income for senior households in the U.S. of roughly $25,000, these are significant losses. In total, according to my company’s calculations, approximately $58 billion in annual income has been lost by America’s seniors since 2008.
Retirees depend on income from their savings for basic living expenses. Without that income, many seniors have taken on greater risk to increase the potential yield on their savings, or simply spent down their nest eggs. After decades of playing by the rules, putting off spending and socking away money, seniors have taken it on the chin. This strikes a blow at the core American principles of self-reliance, individual responsibility and fairness.

What’s a retiree to do? Let’s look at some of the alternatives that people on fixed incomes are being offered and what to watch out for. All of them involve risk that may not be readily apparent. There are traps for the unwary.

What does it cost you to delay putting money away for retirement?

According to the Washington, D.C. based Insured Retirement Institute the cost of delay is staggering.  Yet many Gen X and Y (Generation NOW) people are delaying the most vital financial decision they will ever make: when to begin.

Postponing saving for retirement by five to 10 years could reduce retirement income by nearly a quarter, according to a new study.

A worker contributing 10 percent of his income annually to a retirement plan beginning at age 35—rather than age 30—will receive 11 percent less in annual retirement income ..

…If saving for retirement is postponed to age 40, income will be reduced by 23 percent, totaling $127,000 over a 25-year retirement…

 

Here’s the problem, compound interest is time dependent.  You can’t go back in time and begin saving ten years ago and time is your most valuable resource in building wealth.

A worker starting to save at age 40 would need to put aside more than 26 percent of income annually to achieve the same level of retirement income at age 65 as the person who started saving 10 percent at age 30.

That’s a huge penalty to pay for procrastination.  Start now!

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What if Brokers Had to Call Themselves Brokers?

From “Financial Advisor IQ”

Brokers have run away from their long-held designations and now call themselves “financial advisors” or given impressive sounding titles such as “Vice President – Investments” by the Big Box stores.  But most of them are salesmen for their firm’s products who sell on commission.

There is a difference between sales people and fiduciaries, a difference the few people who use brokers or financial advisors understand.  And there’s a reason.

He [Bob Veres] characterizes the debate over the fiduciary standard as a single skirmish in “a long war between professionals and sales agents.” The latter — Veres’ term for brokers who work at wirehouses and big broker-dealers — won’t rest until they “emasculate” the legal framework that currently separates them from fiduciaries. “Tossing millions of dollars into congressional campaign coffers,” the brokerage industry wants regulators to dilute the fiduciary standard until it looks just like the suitability standard, he says.

I have lots of friends in the investment community, many who work for the big big names on Wall Street.  Many are good people who try to do their best for their clients.  But they are not fiduciaries; that is, people who are legally obligated to put their clients’ interests ahead of their own.  And that makes a big difference.

If you want to know more about the difference between brokers and fiduciaries, please contact us.

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The five stages of grief

Elisabeth Kubler-Ross, the late and eminent Swiss psychiatrist authored “On Death and Dying,” which was written to help women facing new lives as widows.The five stages are:

• Denial: it can’t be true.
• Anger: why did you leave me?
• Bargaining: a reaction to a feeling of helplessness … making a deal with God.
• Depression: associated with mourning. A feeling of sadness and regret.
• Acceptance: marked by withdrawal and calm.

As long as there is life, there is hope. As long as there is hope, there is life.

We found that money worries were one of the major issues that kept people up at night.  This is especially true of those who lost a spouse. We were unable to find a book that would help people prepare for this, so we wrote our own book “BEFORE I GO” and an accompanying workbook. Designed to help couples prepare, we have gotten great response. For an autographed copy, contact us.

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Four ways elite advisors select mutual funds

How do professionals select the people who will manage their money? That is the fundamental question that top-rated Registered Investment Advisors (RIAs) have to answer as they select the mutual funds that go into their portfolios.

What are the traits that are crucial for selecting a fund? At Korving & Company we believe that the number one consideration is clarity and consistency of investment philosophy. The fund should know what its role is and stick to it. If a fund begins to change – a term known as “style drift” – it loses our favor.

Following closely behind is risk-adjusted return. This is a fairly complex calculation. One observer defines it as

… a measure of the return on an investment relative to the risk of that investment, over a specific period.

A third criterion is the distinctiveness of strategy or expertise in the strategy. We create diversified portfolios. We choose funds that are distinctive and that are managed by individuals or teams that have exhibited extraordinary expertise in their particular investment strategy.

Fees are another consideration. Most funds offer several classes of the same fund, differing only in the expenses they charge. We have the ability to choose the least expensive version of the fund we wish to use.

By using the services of a professional RIA, all of these factors go into creating your portfolio. Call us for our guidance in choosing the best people to manage your money.

 

 

Benchmarking Inverts the Basics of Investing

The problem with “benchmarking”  – that is measuring your investment performance against market indexes (known as “benchmarks”) – is that it often leads to buying into asset bubbles.

During the tech boom of the last 20th century, billions of dollars went into internet stocks whose values became wildly inflated.  People who participated in this as a way of reaching for high rates of return, found that no one rang a bell when the party was over.  Many lost their retirement savings and saw their 401(k)s devastated.

Certain stocks become wildly popular, industries become wildly popular and investing styles become wildly popular, all of which leads to wildly inflated values.  This almost inevitably leads to financial pain.

But this does not only happen in the stock market.  In the first decade of the 21st century, real estate seemed to be a way of making outsized profits.  Of course, when the housing bubble collapsed, many not only lost money, but their homes.

The focus of serious investors is to align your portfolio with your personal objectives.  The focus should be on long-term – multi-year – performance.  The only benchmark that should concern you is the one you set for yourself.

At Korving & Company we keep our clients grounded and work with them to meet their personal benchmarks.  Contact us to do the same for you.