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Latticework Wealth Management, LLC

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The Top 5 Most Read Articles in my Investing Blog During 2015

29 Tuesday Dec 2015

Posted by wmosconi in asset allocation, bond market, bonds, Consumer Finance, Fed, Federal Reserve, finance, finance theory, financial advice, Financial Advisor, financial advisor fees, financial advisory fees, financial goals, financial markets, financial planning, financial services industry, Individual Investing, individual investors, interest rates, investing, investing advice, investing information, investing tips, investment advice, investment advisory fees, investments, passive investing, personal finance, portfolio, reasonable fees, reasonable fees for financial advisor, reasonable fees for investment advice, reasonable financial advisor fees, rebalancing, rebalancing investment portfolio, rising interest rate environment, rising interest rates, risk, risk tolerance, statistics, stock market, stock prices, stocks, Yellen

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asset allocation, bond market, bonds, Federal Reserve, finance, financial advisor fees, individual investors, interest rates, investing, investing advice, investing blogs, investing tips, investment costs, portfolio rebalancing, reasonable fees for financial advisor, reasonable fees for investing, rebalancing, rising interest rate environment, rising interest rates, stock market, stocks

The most popular articles read over the past year included some writings from a couple of years ago and were also on a myriad of topics. The listing of articles below represents the most frequent viewings working downward.

  1. Are Your Financial Advisor’s Fees Reasonable? Are You Actually Adding More Risk to Your Ability to Reach Your Long-Term Financial Goals? Here is a Unique Way to Look at What Clients Pay For.

 This article has consistently drawn the most attention from readers of my investing blog. Individual investors have learned from me and many others that one of the most important components of being successful long-term investors is by keeping investment costs as low as possible.  This particular writing examines investing costs from a different perspective.  In general, the higher the investment costs an individual investor incurs, the higher the allocation to riskier investments he/she must have to reach his/her financial goals.

Link to the complete article: https://latticeworkwealth.com/2013/10/26/are-your-financial-advisors-fees-reasonable-are-you-actually-adding-more-risk-to-your-ability-to-reach-your-long-term-financial-goals-here-is-a-unique-way-to-look-at-what-clients-pay-for/

2. Are Your Financial Advisor’s Fees Reasonable? Here is a Unique Way to Look at What Clients Pay For.

 This article is closely followed by the previous one in terms of popularity and forms the basis for that discussion actually. The general concept contained in this writing is that most asset managers now charge investors a fee for managing their investments based upon Assets under Management (AUM).  The fee is typically 1% but can be 2% or higher.  The investment costs to the individual investor per year are the total balance in his/her brokerage account multiplied by the fee which is commonly 1%.  However, the 1% grossly misrepresents the actual investment costs because the individual investor starts off with the total balance in his/her brokerage account.  The better way to express the fees charged per year is to divide the AUM percentage by the growth in the portfolio over the year.  That percentage answer will be quite a bit higher.

Link to the complete article: https://latticeworkwealth.com/2013/08/07/are-your-financial-advisors-fees-reasonable-here-is-a-unique-way-to-look-at-what-clients-pay-for/

3)  Rebalancing Your Investment Portfolio – Summary

 Earlier in the year, I compiled a three-part series that examined the concept of rebalancing one’s investment portfolio. Rebalancing is an excellent investing strategy to learn about and apply at the end of the year.  Rebalancing in its simplest definition is the periodic reallocation of the investment percentages in one’s investment portfolio back to an original model after a passage of time.  This summary of rebalancing provides a look at rebalancing that is helpful for novice individual investors through more advanced folks.

Link to the complete article: https://latticeworkwealth.com/2015/11/25/rebalancing-your-investment-portfolio-summary/

4)  How to Create an Investment Portfolio and Properly Measure your Performance: Part 2 of 2

 While this article is the second part of a discussion on the creation of an investment portfolio, it is arguably the more important of the two because it looks at a topic too often not relayed to individual investors. This writing talks about the importance of measuring the performance of your investment portfolio’s investment returns.  The financial media tends to focus solely on comparing your portfolio to the performance of the S&P 500 Index.  That comparison is “apples to oranges” the vast majority of the time because most individual investors have many different types of investments in their portfolios.  Therefore, I show you how institutional investors measure the performance of their investment portfolios.  The concept is broken down into smaller parts so it is very understandable and usable for individual investors.

Link to the complete article: https://latticeworkwealth.com/2013/07/19/how-to-create-an-investment-portfolio-and-properly-measure-your-performance-part-2-of-2/

5)  How Can Investors Survive in a Rising Interest Rate Environment? – Updated

 Although this particular article was first published a couple of years ago, the content is even more valuable today. The Federal Reserve increased the target range for the Federal Funds Rate by 0.25% on December 16, 2015 and has indicated that more interest rate increases are likely in the future.  Thus, we have entered a period in which interest rates are generally headed higher over the next several of years.  Most financial pundits will bemoan this type of environment because higher interest rates mean that the prices of most bonds go down.   It makes it harder to earn any investment returns from bonds.  However, there are a number of investments and investment strategies that benefit from an increasing interest rate environment.  This article examines six different things individual investors can do.

Link to the complete article: https://latticeworkwealth.com/2013/11/30/how-can-investors-survive-in-a-rising-interest-rate-environment-updated/

 

I hope you enjoy these popular articles from my investing blog. My goal is to keep on releasing more information in 2016 to assist individual investors in navigating the world of investing.  Thank you to all my readers in the United States and internationally!

A New Paradigm for Investing Available on Amazon.com – FREE for Thanksgiving Holiday

27 Wednesday Nov 2013

Posted by wmosconi in asset allocation, Bernanke, bonds, business, Charlie Munger, Consumer Finance, Education, Fed, Fed Taper, Fed Tapering, Federal Reserve, finance, financial advisor fees, financial planning, GIPS, GIPS2013, Individual Investing, interest rates, investing, investing, investments, stocks, bonds, asset allocation, portfolio, investment advisory fees, investments, math, Modern Portfolio Theory, MPT, personal finance, portfolio, risk, statistics, stock prices, stocks, Suitability, volatility, Warren Buffett, Yellen

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Greetings to all my loyal readers of this blog.  In keeping with the Thanksgiving spirit, I have decided to make my first two books absolutely FREE for the rest of the week.  These two books on Amazon.com are available for download onto a Kindle.  Additionally, there is a Kindle app for iPhones and Android devices which is free to download.  Please feel free to check out the titles below.  I have provided links to make it easier.   My email address is latticeworkwealth@gmail.com.

The books are as follows:

1)      A New Paradigm for Investing:  Can Your Financial Advisor Answer These Questions?:

http://www.amazon.com/New-Paradigm-Investing-Financial-ebook/dp/B00F3BDTHW/ref=sr_1_1?s=books&ie=UTF8&qid=1381107823&sr=1-1&keywords=A+New+Paradigm+for+Investing+by+William+Nelson

2)       Spend 20 Hours Learning About Investing to Prepare for 20+ Years in Retirement

http://www.amazon.com/Learning-Investments-Prepare-Retirement-ebook/dp/B00F3KW9T2/ref=sr_1_1?s=books&ie=UTF8&qid=1379183661&sr=1-1&keywords=William+Nelson+Spend+20+Hours

The first book listed is normally $9.99 but available for FREE until November 30th.  The other book is normally $2.99, but it is also FREE for the same time period.

I would like to thank my international viewers as well.  I also wanted to especially thank some selected followers of my @NelsonThought and @LatticeworkWlth Twitter accounts (each of whom I would recommend following for the content and insight):

Followers on @NelsonThought:

The Wealth Report @wsjexperts – #wsjexperts

The Royce Funds @RoyceFunds

Research Magazine @Research_Mag

Barron’s Online @BarronsOnline

Vanguard FA @Vanguard_FA

Cleveland Fed Research @ClevFedResearch

Pedro da Costa @pdacosta

Muriel Siebert & Co. @SiebertCo

Roger Wohlner, CFP® @rwohlner

Ed Moldaver @emoldaver

Sylvia Maxfield @sylviamaxfield

The Shut Up Show @theshutupshow

Berni Xiong (shUNG) @BerniXiong

Followers on @LatticeworkWlth:

Euro-banks @EuroBanks

Direxion Alts @DirexionAlts

Charlie Wells @charliewwells

AbsoluteVerification @GIPStips

Investment Advisor @InvestAdvMag

Gary Oneil @GaryONeil2

MJ Gottlieb @MJGottlieb

Bob Burg @BobBurg

Melody Campbell @SmBizGuru

TheMichaelBrown @TheMichaelBrown

Phil Gerbyshak @PhilGerbyshak

MuniCredit @MuniCredit

D.J. Rob-Ski @DJRobSki

Are Your Financial Advisor’s Fees Reasonable? Are You Actually Adding More Risk to Your Ability to Reach Your Long-Term Financial Goals? Here is a Unique Way to Look at What Clients Pay For

26 Saturday Oct 2013

Posted by wmosconi in asset allocation, bonds, business, Consumer Finance, finance, financial advisor fees, financial planning, Individual Investing, interest rates, investing, investments, math, Modern Portfolio Theory, personal finance, portfolio, reasonable financial advisor fees, statistics, stock prices, stocks, volatility

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asset allocation, bonds, conflict of interest, finance, financial advisor fees, Financial Advisors, financial planning, FINRA, gross fees, investing, investment advisory, investment advisory fees, investments, net fees, performance, portfolio, reasonable financial advisory fees, retirement, stocks, total returns

More and more financial professionals are charging clients based upon assets under management (AUM).  A common fee is 1%.  The fee for a $1 million portfolio would be $10,000 ($1,000,000 * 1%). Now you have heard me talk about the importance of keeping fees as low as possible.  Essentially you are trying to maximize your investment returns each year.  If you have quite a few needs, a Financial Advisor usually can provide a number of different services and advice.  For example, you also may need assistance with legal and tax advice.  Additionally, you may have more complex financial planning needs.  Financial professionals will assist you with portfolio allocation always.  Now I am going to look at AUM fees in a way that you may not be familiar with.  I can tell you already that the financial services industry will not be happy or agree with this presentation.  However, my goal is to help you and provide you with an argument that may finally give you the impetus to manage your own investments or think seriously about working with a financial planner that charges fees on an hourly basis.

I also encourage you to read the Wall Street Journal’s Weekend edition for October 26, 2013.  On the bottom of the Business & Finance section, Jason Zweig discusses the many conflicts of interest that Financial Advisors have.  FINRA (a Self-Regulatory Organization comprised of all brokerage firms) issued a 22,000-word report about fees, conflicts, and compensation of Financial Advisors.  Oddly enough, the words “advice” and “investing” showed up less than 10 times.  The financial services industry is concerned about this matter, so you should definitely take note and learn much more about what you are actually paying for.

Example for Retirees:

I will start out with an example for retirees because they tend to be working with financial professionals already.  If you are retired and not independently wealthy, you are in the wealth distribution phase of your life.  There are some retirees that are permanently in the wealth preservation phase.  Wealth preservation simply means that an investor has enough money to live comfortably, but he/she does not need to deplete his/her investment portfolio.  Furthermore, this investor does not really try to increase the value of his or her investment portfolio.  A retiree in the wealth distribution phase of life is the most common example.  This investor is gradual depleting his/her investment portfolio to pay for living expenses on an annual basis.  Due to the fact that this person is not working anymore and, thus has no income from work, and longevity keeps getting longer, he/she needs have an investment portfolio that is somewhat conservative in nature.  Therefore, it is not reasonable to expect to earn 8% per year.  A more common target return might be 5.5-6.0%.  If you are working with a financial professional who charges you 1.0%, you need to earn 6.5-7.0% on a gross basis in order to get to that target net return.  Now the long-term historical average of stocks is about 8.0%, so the higher your AUM fees are, the more weighting you will need to have in stocks and away from bonds and cash.  Well, we have already gone over that, and most individuals that present information will stop there.  I want to take this even further though.

Let’s say you are a current retiree with $1 million that you are living off of in additional to Social Security income.  You have a target return of 5.5% to fund your desired retirement lifestyle, and your Financial Advisor charges you a 1.0% AUM fee.  Thus, you will need to earn a 6.5% return gross to reach your bogey.  Now I would like to put in the twist, and I want to do a thought experiment with you.  Your Financial Advisor will sit down with you and assess your risk tolerance and ensure that the investment recommendations made are not too aggressive for you.  If you cannot take too much volatility (fluctuation in asset prices up and down over the short term), your financial professional will reduce your exposure to equities.  Well, I like to present information using economic principles as well.  If you just retired and are 65, you have one option right away.  You can simply invest all your retirement money in 10-year Treasury notes issued by the Department of the Treasury.  Treasury notes are free to buy.  All you need to do is to participate in one of the Treasury auctions and put an indirect bid in.  What is an indirect bid?  An indirect bid is simply saying that you would like to buy a set dollar amount of notes, and you are willing to accept whatever the market interest rate set by the auction is.  What is the yield on the 10-year Treasury right now?  The 10-year Treasury closed at 2.51% on October 25, 2013.  When you go to a financial professional, he/she is selecting investments in lieu of you simply purchasing the 10-year Treasury.  Keep in mind that US Treasuries are among the safest investments in the world.  They are backed by the full faith and credit of the US government.  Stocks, bonds, real estate, gold, and other investment options all have an added degree of risk.  With the additional risk, there is a possibility for higher returns though.  How does this relate to your 1.0% AUM fee?

Think about it this way:  why are you paying your Financial Advisor?  You are paying him/her to select investments that can earn you more than simply buying a US Treasury bill, note, or bond.  As an investor, you do not want to just settle for that return in most cases.  With that being said though, you can just start out there and forget it.  You do not need to engage a Financial Advisor to simply buy a 10-year US Treasury note.  This means that you are paying the Financial Advisor to get you incremental returns.  In our example above for a retiree, your target investment return is 5.5%.  If you are able to earn 5.5% during the year, the incremental return is 2.99% (5.50%-2.51%).  Remember that you are paying the Financial Advisor 1.0% in an AUM fee.  Therefore, you are paying the Financial Advisor 1.0% of your assets in order to get you an extra 2.99% in investment returns.  Well, 1.0% is 33.4% of 2.99%.  Thus, you are essentially paying a fee of 33.4% in reality.  Now your financial professional would flip if the information was presented in this way.  He/she would say that it is flawed.  The mathematics cannot be argued with; however, I will admit that many folks in the financial services industry would disagree with this type of presentation.

Remember that you started out with $1 million.  You could have gone to the bank and gotten cash and hid it in a safe within your residence.  AUM fees are always presented by using your investment portfolio as the denominator.  In our example, your investment fee is 1.0% ($10,000 / $1,000,000).  I urge you to think about this though.  Does that really matter?  Of course, the fee you pay to your Financial Advisor will be calculated in this manner.  But what are you paying for in terms of incremental returns?  If you want to calculate what you are paying for (the value that your Financial Advisor provides), the reference to the starting balance in your brokerage account is really moot.  It is yours to begin with.  Therefore, it should be removed from the equation when trying to quantify the value your Financial Advisor provides in terms of investment returns on your portfolio.

Now remember that I said your target investment return was 5.5%.  The long-term historical average of stocks is approximately 8.0%.  If you choose to simply allocate only enough of your investment portfolio in stocks and the rest in cash to reach that 5.5% target, you will select an allocation of 68.8% stocks and 31.2% cash (5.5% = 68.8% * 8.0% + 31.2% * 0.0%).  Note that I am assuming that cash earns no interest at all and that you can select an ETF or index mutual fund to capture the long-term historical average for stocks.  Now your financial professional is working with you to select an investment portfolio that achieves the 5.5% target return, and their investment recommendations will be different than this hypothetical allocation.  With that being said, the hypothetical allocation achieves your target return with a simple choice of two assets (an ETF or index mutual fund and hard currency).  Keep in mind that you will normally have a portion of your portfolio allocated to fixed income.  The 10-Year US Treasury note is trading around 2.50% as of October 25, 2013.  If you allocate your portfolio to 60% stocks, 30% 10-Year, and 10% cash, your expected return would be 5.6%  (60% * 8.0% + 30% * 2.5% + 10% * 0.0%).

Whatever your Financial Advisor is charging you in terms of fees, you need to make that percentage more in your total return on a gross basis such that your net return equals your target return.  In our example above, the assumed AUM fee was 1.0%.  That investment fee means that you have to earn 6.5% on a gross basis because you need to pay your Financial Advisor 1.0% for his/her services.  After the fee is paid, the return on your portfolio would be 5.5% on a net basis.  If we keep the allocation at 30% 10-Year and 10% cash, how much weighting do stocks need to be in your portfolio to ensure that your overall returns is 5.5% after paying your AUM fee?  The answer is 72.7%.  Why?  The expected return of your portfolio is 6.5% (72.7% * 8.0% + 27.3% * 2.5% + 0.0% * 0.0%) before fees.  Given the average retiree’s risk tolerance at age 65 or older, most people do not desire to have a portfolio with 65% or larger allocated to stocks.  Plus, the historical, long-term average of stocks is just that.  It is an average and rarely is 8.0% in any given year.  For example the S&P 500 Index has not had a single down year since 2008.  The returns for 2009, 2010, 2011, and 2012 were 26.5%, 15.1%, 2.1%, and 16.0%, respectively.  The average return over that span was 14.9%.  As of September 30, 2013, the S&P 500 Index was up 19.8%.  Now I am by no means making a prediction for the remainder of 2013 or 2014 for that matter.  However, I wanted to drive home the fact that, if your Financial Advisor sets up your financial plan with the assumption that your stock allocation will earn 8.0% on average, any actual return lower than that estimate will cause you to not reach your target return.  What is the effect?  You will not be able to maintain the lifestyle you had planned on, even more so if there are negative returns experienced in stocks over the coming years.

Essential/Important Lesson:

Let’s look at the next five years starting in 2014.  A five-year period covers 2014-2018.  If you start out with $1,000,000 invested in stocks and plan on earning 8.0% per year, you are expecting to have $1,469,328 at the end of five years.  Let’s say that the return of stocks is actually only 4.0% per year over the next five years.  You will only have $1,216,653 as of December 31, 2018.  The difference is $252,675 less than you were expecting.  The analysis gets worse at this point though.  How can it get any worse?  Well, if you were planning on 8.0% returns from stocks per year, the next five-year period 2019-2023 needs an excess return to catch up.  Thus, if your starting point on January 1, 2014 is $1,000,000, your financial plan is set up to have $2,158,925 as of December 31, 2023.  If you are starting behind your estimate in 2019, the only way you can make up the difference is to have stocks earn 12.2% over that five-year period which is 4+% higher than the historical average.  As you can see underperformance can really hurt financial planning.  The extremely important point here is that a 1% AUM fee will cause you to be even further behind your goals.  Remember that the illustration above is gross returns.  You only care about net returns and what your terminal value is.  Terminal value is simply a fancy way to say how much money is actually in your brokerage account.

Example for Those Saving for Retirement:

For those of you that are saving for retirement, you should use a different bogey than the 10-year US Treasury.  If you are 35 years old, you can simply invest in the 30-year Treasury bond (the jargon on Wall Street is “the long bond”).  The closing yield on the 30-year Treasury on October 26, 2013 was 3.60%.  Thus, I would suggest that you use this benchmark to calculate your incremental return.  If your financial professional tells you that this analysis does not apply to you because you are 45 years old and your timeframe to retirement is 20 years, I would agree.  With that being said though, you can find the current yield on a US Treasury bond with 20 years to maturity.  Most people are familiar with the Treasury yields quoted in the financial media and on financial websites.  Those yields are calculated based upon on-the-run Treasuries.  On-the-run simply refers to the most recently Treasuries sold at auction.  Once the Department of the Treasury sells new bills, notes, or bonds, those last financial instruments are referred to as off-the-run.  Keep in mind that the off-the-run Treasuries still trade on the bond market.  You always can get a current yield for them.  It is harder to find, but it is available on the Internet.  You can find out more information directly on the Department of the Treasury’s website:  http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/yieldmethod.aspx if you wanted to learn about this concept in more detail.  I would never recommend using a bogey less than the 10-year Treasury note though even if you have fewer than 10 years to retirement.  The aforementioned analysis for the calculation of incremental returns and the value-added from your financial professional will apply as in the example for retirees.

I will admit that this is a novel way to look at fees on investment portfolios.  However, there are a number of financial professionals that are using this approach now.  Keep in mind that one of the hardest questions to answer is in regard to the measurement of how much value your Financial Advisor provides.  How do you know if he/she is doing a good job for you?  The more common approach is to look solely at investment returns and compare it to a standard index return(s).  This analysis is meant to supplement the discussion.  I am hoping that this presentation will give you added incentive to seriously consider managing your own investments.  Or at the very least maybe try to find a financial planner that charges an hourly fee or flat fee.  You can pay a financial planner an hourly fee to sit with you and decide if your life situation and the current state of the financial markets warrant a change to your portfolio allocation among asset classes.  That financial planner also can work with you on your emotional intelligence and the urge to sell all your stocks and/or bonds because of current negative news and events.

Of course, I will not dissuade you from seeing a Financial Advisor.  On the other hand, I encourage you to have them walk through the value that they provide for you.  What can he/she do for you that you cannot do for yourself by buying an index mutual fund and US Treasury notes absolutely free?  You can use this analysis as a template for your discussion.  Most financial services firms essentially bundle financial advice.  Even if you do not need legal, tax, and complicated financial planning advice, you are still paying for it.  Now it is nice to have it available to you at any given time, but, if you do not use it or never use it, do you really want to pay for it?  It is very difficult to find financial services firms that can separate out those higher level services and provide advice on portfolio allocation and distribution of income to supplement retirement income only.  The vast majority of investors do not need complex advice though.  For example, the current exemption for estate taxes is $5.25 million.  Thus, if you do not have a net worth more than this, estate planning will not be a major concern.  Furthermore, if you are not planning on setting up a charitable trust for giving, legal advice is not necessary either.  In terms of tax advice, most investors simply have to record capital gains and dividends.  There are some techniques to “harvest” capital losses to reduce capital gains, but that is pretty simple to do on your own.  In terms of sophisticated financial planning, most investors do not have life situations that necessitate the advice (e.g. providing for the long-term needs of a special needs child, concentrated wealth in a family-owned business, significant stock options, etc.).  If your financial services firm offers that advice and you do not use it, you cannot just tell your financial services firm that you do not want to pay for it.  There really is not an ala carte option.  You will pay your 1.0% (or whatever it may be) AUM fee.  The ironic thing is that, if you have a large enough investment portfolio where this advice comes into play, your AUM fee will almost certainly be significantly less than 1.0%.  Doesn’t this make you want to learn more about investments and if you can take more of an active role?  I sure hope so.

I welcome comments/feedback and constructive criticism.  If there are Financial Advisors that totally disagree with my logic and presentation, I would love to hear from you.  I can be contacted at latticeworkwealth@gmail.com.  As I mentioned in a previous post, I wanted to hear from you.  I appreciate the topics selected.  In my next few posts, I will devote some time to discussing the issues that were suggested by you.  I will get back to my normal selections in a week or so.

Are Your Financial Advisor’s Fees Reasonable? Here is a Unique Way to Look at What Clients Pay For

07 Wednesday Aug 2013

Posted by wmosconi in asset allocation, bonds, business, finance, financial advice, financial advisory fees, investing, investment advice, investments, reasonable fees for financial advisor, reasonable financial advisor fees, stocks

≈ 12 Comments

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bonds, business, finance, financial advisor fees, financial markets, investing, investment advice, investment advisory, investment advisory fees, investment fees, investments, reasonable fees for financial advisor, reasonable financial advisor fees, retirement, stocks

More and more financial professionals are charging clients based upon assets under management (AUM). A common fee is 1%. The fee for a $1 million portfolio would be $10,000 ($1,000,000 * 1%). In practice though, the fee is normally charged on a quarterly basis. Thus, you will pay 0.25% in fees based upon your AUM at the end of every quarter: March 31, June 30, September 30, and December 31. Now you have heard me talk about the importance of keeping fees as low as possible. Essentially you are trying to maximize your investment returns each year. If you have quite a few needs, a financial advisor usually can provide a number of different services and advice. For example, you also may need assistance with legal and tax advice. Additionally, you may have more complex financial planning needs. Financial professionals will assist you with portfolio allocation always. Now I am going to look at AUM fees in a way that you may not be familiar with. I can tell you already that the financial services industry will not be happy or agree with this presentation. However, my goal is to help you and provide you with an argument that may finally give you the impetus to manage your own investments or think seriously about working with a financial planner that charges fees on an hourly basis.

I will start out with an example for retirees because they tend to be working with financial professionals already. If you are retired and not independently wealthy, you are in the wealth distribution phase of your life. There are some retirees that are permanently in the wealth preservation phase. Wealth preservation simply means that an investor has enough money to live comfortably, but he/she does not need to deplete his/her investment portfolio. Furthermore, this investor does not really try to increase his or her investment portfolio. A retiree in the wealth distribution phase of life is the most common example. This investor is gradual depleting his/her investment portfolio to pay for living expenses on an annual basis. Due to the fact that this person is not working anymore and, thus has no income from work, and longevity keeps getting longer, he/she needs to have an investment portfolio that is somewhat conservative in nature. Therefore, it is not reasonable to expect to earn 8% per year. A more common target return might be 5.5-6.0%. If you are working with a financial professional who charges you 1.0%, you need to earn 6.5-7.0% on a gross basis in order to get to that target net return. Now the long-term historical average of stocks is between 7.0-8.0%, so the higher your AUM fees are, the more weighting you will need to have in stocks and away from bonds and cash. Well, we have already gone over that, and most individuals that present information will stop there. I want to take this one step further though.

Let’s say you are a current retiree with $1 million that you are living off of in additional to Social Security income. You have a target return of 5.5%, and your Financial Advisor charges you a 1.0% AUM fee. Thus, you will need to earn a 6.5% return gross to reach your bogey. Now I would like to put in the twist, and I want to do a thought experiment with you. Your Financial Advisor will sit down with you and assess your risk tolerance and ensure that the investment recommendations made are not too aggressive for you. If you cannot take too much volatility (fluctuation in asset prices up and down over the short term), your financial professional will reduce your exposure to equities. Well, I like to present information using economic principles as well. If you just retired and are 65, you have one option right away. You can simply invest all your retirement money in 10-year Treasury notes issued by the Department of the Treasury. Treasury notes are free to buy. All you need to do is to participate in one of the Treasury auctions and put an indirect bid in. What is an indirect bid? An indirect bid is simply saying that you would like to buy a set dollar amount of notes, and you are willing to accept whatever the market interest rate set by the auction is. What is the yield on the 10-year Treasury right now? The 10-year Treasury closed at 2.67% on August 6, 2013. When you go to a financial professional, he/she is selecting investments in lieu of you simply purchasing the 10-year Treasury. Keep in mind that US Treasuries are among the safest investments in the world. They are backed by the full faith and credit of the US government. Stocks, bonds, real estate, gold, and other investment options all have an added degree of risk. With the additional risk, there is a possibility for higher returns though. How does this relate to your 1.0% AUM fee?

Think about it this way: why are you paying your Financial Advisor? You are paying him/her to select investments that can earn you more than simply buying a US Treasury bill, note, or bond. As an investor, you do not want to just settle for that return in most cases. With that being said though, you can just start out there and forget it. You do not need to engage a Financial Advisor to simply buy a 10-year US Treasury note. This means that you are paying the Financial Advisor to get you incremental returns. In our example above for a retiree, your target investment return is 5.5%. If you are able to earn 5.5% during the year, the incremental return is 2.83% (5.50%-2.67%). Remember that you are paying the Financial Advisor 1.0% in an AUM fee. Therefore, you are paying the Financial Advisor 1.0% of your assets in order to get you an extra 2.83% in investment returns. Well, 1.0% is 35.3% of 2.83%. Thus, you are essentially paying a fee of 35.3% in reality. Now your financial professional would flip if the information was presented in this way. He/she would say that it is flawed. The mathematics cannot be argued with; however, I will admit that many folks in the financial services industry would disagree with this type of presentation. Remember that you started out with $1 million. You could have gone to the bank and gotten cash and hid it in a safe within your residence. AUM fees are always presented by using your investment portfolio as the denominator. In our example, your investment fee is 1.0% ($10,000 / $1,000,000). I urge you to think about this though. Does that really matter? Of course, the fee you pay to your Financial Advisor will be calculated in this manner. But what are you paying for in terms of incremental returns? If you want to calculate what you are paying for (the value that your Financial Advisor provides), the reference to the starting balance in your brokerage account is really moot. It is yours to begin with. Therefore, it should be removed from the equation when trying to quantify the value your Financial Advisor provides in terms of investment returns on your portfolio.

Remember that I said your target investment return was 5.5%. The long-term historical average of stocks is 7.0-8.0%. (I use a range for the long-term historical average because the average will change based upon the universe of stocks you include and your chosen timeframe. In other words, you will see different people tell you that the long-term historical average is various figures). Let’s pick the midpoint of 7.5%. If you choose to simply allocate only enough of your investment portfolio in stocks and the rest in cash to reach that 5.5% target, you will select an allocation of 73.3% stocks and 26.7% cash (5.5% = 73.3% * 7.5% + 26.7% * 0.0%). Note that I am assuming that cash earns no interest at all and that you can select an ETF or index mutual fund to capture the long-term historical average for stocks. Now your financial professional is working with you to select an investment portfolio that achieves the 5.5% target return, and their investment recommendations will be different than this hypothetical allocation. With that being said, the hypothetical allocation achieves your target return with a simple choice of two assets (an ETF or index mutual fund and hard currency).

For those of you that are saving for retirement, you should use a different bogey than the 10-year US Treasury. If you are 35 years old, you can simply invest in the 30-year Treasury bond (the jargon on Wall Street is “the long bond”). The closing yield on the 30-year Treasury on August 6, 2013 was 3.73%. Thus, I would suggest that you use this benchmark to calculate your incremental return. If your financial professional tells you that this analysis does not apply to you because you are 45 years old and your timeframe to retirement is 20 years, I would agree. With that being said though, you can find the current yield on a US Treasury bond with 20 years to maturity. Most people are familiar with the Treasury yields quoted in the financial media and on financial websites. Those yields are calculated based upon on-the-run Treasuries. On-the-run simply refers to the most recently Treasuries sold at auction. Once the Department of the Treasury sells new bills, notes, or bonds, those last financial instruments are referred to as off-the-run. Keep in mind that the off-the-run Treasuries still trade on the bond market. You always can get a current yield for them. It is harder to find, but it is available on the Internet. You can find out more information directly on the Department of the Treasury’s website: http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/yieldmethod.aspx if you wanted to learn about this concept in more detail. I would never recommend using a bogey less than the 10-year Treasury note though even if you have fewer than 10 years to retirement. The aforementioned analysis for the calculation of incremental returns and the value-added from your financial professional will apply as in the example for retirees.

I will admit that this is a novel way to look at fees on investment portfolios. There are a number of financial professionals that are using this approach now. Keep in mind that one of the hardest questions to answer is in regard to the measurement of how much value your Financial Advisor provides. How do you know if he/she is doing a good job for you? The more common approach is to look solely at investment returns and compare it to a standard index return(s). This analysis is meant to supplement the discussion. I am hoping that this presentation will give you added incentive to seriously consider managing your own investments. Or at least maybe try to find a financial planner that charges an hourly fee. You can pay a financial planner an hourly fee to sit with you and decide if your life situation and the current state of the financial markets warrant a change to your portfolio allocation among asset classes. That financial planner also can work with you on your emotional intelligence and the urge to sell all your stocks and/or bonds because of current news and events. I will not dissuade you from seeing a Financial Advisor. On the other hand, I encourage you to have them walk through the value that they provide for you. You can use this analysis as a template for your discussion. Most financial services firms essentially bundle financial advice. Even if you do not need legal, tax, and complicated financial planning advice, you are still paying for it. Now it is nice to have it available to you at any given time, but, if you do not use it or never use it, do you really want to pay for it? It is very difficult to find financial services firms that can separate out those higher level services and provide advice on portfolio allocation and distribution of income to supplement retirement income only. The vast majority of investors do not need complex advice though. For example, the current exemption for estate taxes is $5.12 million. Thus, if you do not have a net worth more than this, estate planning will not be a major concern. Furthermore, if you are not planning on setting on a charitable trust for giving, legal advice is not necessary either. In terms of tax advice, most investors simply have to record capital gains and dividends. There are some techniques to “harvest” capital losses to reduce capital gains, but that is pretty simple to do on your own. In terms of sophisticated financial planning, most investors do not have life situations that necessitate the advice (e.g. providing for the long-term needs of a special needs child, concentrated wealth in a family-owned business, significant stock options, etc.). If your financial services firm offers that advice and you do not use it, you cannot just tell your Financial Services firm that you do not want to pay for it. There really is not an ala carte option. You will simply pay your 1.0% (or whatever it may be) AUM fee. The ironic thing is that, if you have a large enough investment portfolio where this advice comes into play, your AUM fee will usually be significantly less than 1.0%. Does this make you want to learn more about investments and if you can take more of an active role? I sure hope so.

I welcome comments/feedback and constructive criticism. If there are Financial Advisors that totally disagree with my logic and presentation, I would love to hear from you. I can be contacted at latticeworkwealth@gmail.com. As I mentioned in a previous post, I wanted to hear from you. I appreciate the topics selected. In my next few posts, I will devote some time to discussing the issues that were suggested by you. I will get back to my normal selections in a week or so.

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