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10 Things to know when buying insurance

By Daniel Harris, RIA, Saturday May 28, 2016


1)  The insurance agent works for the insurance company and not for you.  The only smart way to buy insurance, in our opinion, is through your independent financial advisor who isn’t compensated based off what you buy.  They can shop agents in a way that you can’t and they can get you transparency in pricing that we believe you could never get on your own. 


2)  The insurance agent most likely has a contract requiring them to sell a certain amount of high margin but objectively bad insurance products for their customers.  If you are unlucky they may convince you to buy one of these products to meet their quota and keep their contract with the insurance company.  If you work with us hopefully they will sell those sub-par products to someone else and not to you.


3)  The exact same insurance policy can cost vastly different amounts depending on the agent you use.  We’ve seen difference as much as $7,000 in premiums from the same company, on the same industry leading low priced product, from different agents.  We think the reason must have to do with the general agents (brokers) insurance agents use because every agent we’ve seen has a different price than their peers on the exact same policy.


4)  If you make anything but a small claim the insurance company will likely act in a surprisingly adversarial manner towards you and they will try really hard not to pay your claim.  You’ll possibly or probably have to compel them in court to pay you – which is why an insurance contract is really a legal document with a company you expect to have a fight with so you should only deal with them through independent parties like us and your own lawyer (and in writing only).  They are most likely to do three surprising things to legally get out of paying your claims even if your claim is legitimate.


They will almost certainly 1) go through your application at the time of the claim with a fine tooth comb to prove you made a material misstatement of fact which relieves them of their obligation to pay you (a single material misstatement even if accidental is often sufficient grounds to not pay your claim) 2) They will likely conduct secret video surveillance on you for 3-4 days to see if they can get a 30 second video clip of you doing an action that allows them to not pay their claim (like walking 4 feet when you say you are disabled) and they will submit that video to the court as evidence why your claim is fraudulent even if they know your claim is not fraudulent 3) They will likely interview you on a monthly basis with a claims adjuster who is adversarial and trained to trick you (not the nice agent who sold you the policy).  In these interviews they will likely request you do things like get them a cup of water which would allow them to have evidence that you can move and they don’t have to pay your claim.  They will likely record or document their interview but they usually will not allow you to record them (which is why if you make a claim on a disability policy you should only deal with them in writing and through your lawyer to ensure your rights under the contract are upheld).


You should always assume your insurance company will act in bad faith and you’ll have to take them to court to get them to pay.  You aren’t buying the agent; you aren’t buying the insurance company, when you sign that contract you are buying a legally enforceable contract that they have to pay on if the conditions for payment in the contract are met. 


Based off our survey of customer claims experiences, you won’t be in good hands or treated like a good neighbor, but you should be paid if you approach them from an equally adversarial point of view.  With your insurance contract it is important to understand that you are just buying a contract, which is a total commodity, and all contracts that say the same words are identical.  Your agent cannot (and usually will not) help you when the insurance company is being adversarial because he works for the insurance company.  You are on your own and so you should approach the insurance buying process with this type of mindset.  It’s truly swimming with sharks in our opinion.


5)  Independent agents still work for insurance brokers or general agents.  To keep their contracts, I believe that general agents have to have the agents working under them sell a certain amount of crappy products to the customers each year. 


6)  There is almost no quality control from one agent to the next within the same company.  For example, I’ve met with agents from the same company who have tried to mislead me and I’ve met with other agents from that company who were totally honest with me.  I suspect this lack of accountability and risk of getting an agent who will mislead you is a constant in all companies.


7)  Not all agents are equally efficient.  Some agents will talk your ear off – some will get the job done quickly.  We always send our clients to those who agents who are a combination of 1) the cheapest premiums and 2) the most efficient.


8)  Your agent generally will not be able to get you a special deal despite what they say.  Agents will say “I’ll get you this or I’ll get you that” or “I have special relationships with underwriters who I know.”  I’ve talked to the underwriters and what they’ve told me is that unless they are the top salesman in the company they usually won’t get a deal from underwriting.  The underwriters make their decision based off risk and when the insurance agent says otherwise they are usually not being honest with you.


9)  Online sources our captive agents usually aren’t cheaper.  The more an insurance company advertises the more expensive their products tend to be.  Advertising usually does not recover enough costs in additional sales to do anything but raise the premiums of the policyholders.  For insurance to be cheap you need a company that doesn’t advertise and has an inexpensive distribution system.  Ohio National is the cheapest for term and for disability it depends on the applicant but usually Standard is the cheapest quality company for men and Principal is the cheapest quality company for women.  Neither Standard or Principal advertise very much and they use independent low cost agents.  This makes their commodity contract a little cheaper to the customer – but you still need to run it through us if you are a client because the example of the $7,000 price difference was on a Standard contract and Standard was the low price leader (it was $7k lower through the lowest priced independent agent as compared to an online agent who was the most expensive).


10)  Mutual companies are not better, in fact, they are usually a lot worse in our opinion.  They tout their mutual structure and investment portfolios as key advantages but the truth is that the two big mutual companies: Northwestern Mutual and Mass Mutual spend tons of money on advertising and this just runs up their costs.  I believe their target market is price insensitive customers who are willing to buy what I believe to be inferior and often watered down insurance contracts.  The companies that provide high value for your money, in my opinion, aren’t the mutual companies or the companies that sponsor a lot of events on TV – it’s those that you’ve never heard of. 


For example, Ohio National has grown their life insurance premiums for 26 years straight, which is the best record in the insurance industry.  Have you ever heard of Ohio National?  Neither had I until I asked a college friend of mine who was an actuary at Met Life who the Southwest Airlines of the insurance industry was?  Without hesitating he said Ohio National – they have great products and great pricing and I never see them advertise.


There are equivalent companies to Ohio National in other lines of insurance and if you work with us we’ll let you know who they are.

Expected Returns (and Risk)

By Daniel Harris, RIA, Thursday May 26, 2016


I often ask people what they expect to earn back from their investments and usually I get a blank stare back in return – they really have no idea.  They just bought this or did that because other people were doing it or it seemed like a good idea at the time.  But in truth, you’ll likely be much better off if you’re strategic about your investments and know what you’ll likely get in return in exchange for temporarily giving up the use of your money and possibly subjecting it to risk of loss.


The Role of Inflation in Expected Returns


Inflation varies widely over time.  Historically it has been about 3% a year.  But it’s prone in extremes in both directions.  It’s been as high as 18.2% and as low as -10.3% per year.


However, when analyzing investment returns it’s important to deduct the historical rate of inflation (2.9%) because until you’ve earned at least 3% on your money you usually aren’t any better off having invested your money.  Inflation isn’t profit – it’s just a hurdle that you have to clear before you start making money.  It’s only expected returns above the rate of inflation that actually are investment profits.


The Three Types of Assets and their expected returns


Generally speaking there are three types of assets you can invest in: growth assets, defensive assets and cash.


Growth Assets typically earn 4-6% above the rate of inflation.  $100,000 invested in growth assets will typically be worth between $710,000 and $1,800,000 in today’s money after 50 years assuming now taxes.  So growth assets can produce between $6 and $17 of profits per dollar invested over 50 years.


Defensive Assets typically earn 2% above the rate of inflation.  $100,000 invested in defensive assets will typically be worth $269,000 in today’s money after 50 years.  So defensive assets can produce a little less then $2 of profit per $1 invested if you keep them invested for 50 years.


Cash will typically earn 0.6% above the rate of inflation.  This is a little bit confusing because cash generally loses value in periods where there is any inflation.  But because cash generally can’t generate a negative return even in a deflationary environment it has produced a return that is slightly higher than the long-term rate of inflation.  $100,000 invested in cash will typically be worth $134,000 in today’s money after 50 years.  So cash can produce around $0.34 of profit per $1 invested if you keep it invested over 50 years.


But the tricky thing is what is a growth asset and what is a defensive asset isn’t constant, it keeps on switching based off the current pricing of assets and market conditions, and that is why you need to hire a financial advisor or be very aware of market conditions.


What is a growth asset or a defensive asset?


This is where things get difficult, because no asset is constantly a growth asset or a defensive asset.  Historically, growth assets have included virtually every asset class. 


Similarly, bonds and commodities have typically been defensive assets historically but that it isn’t always the case.  Almost all assets have been defensive assets at one point in their history.  By contrast if traditional defensive asset prices are low enough they actually act like growth assets and produce returns in the 4-6% and if their prices are too high they act like cash and produce barely any returns or even negative returns.


Finally cash is similar.  In some environments cash pays more than inflation, especially in deflationary environments.  But in other environments cash pays dramatically less than inflation.  So sometimes cash be a growth asset, sometimes it can be a defensive asset and sometimes it can be a negative returning asset.


I’ve heard that you have to take risks to get return is that true?


First of all, it’s important to understand that there is no universal definition of risk as it applies to all investors.  The reason is that everyone is a little different in terms of their stomach for negative price movements and their natural toughness.  The true risk in investing, in my view, is that you are going to sell at the bottom and that’s a highly individualized risk.  Some people can take losses of 70% without selling, some can take 30% others get sick and sell out at 10% losses.  One of our principal jobs as financial advisors is to try to assess which category you fall into.


In academic settings, a commonly used definition of risk is volatility or standard deviation of the returns relative to those of a similar asset.  The criticisms of this approach are that it defines like Google or Microsoft as risky because they grew more than the index did.  To get around this they sometimes switch to measuring semi-standard deviations or just historically drawdowns relative to those of a similar asset.  The most successful investors almost wholly reject this definition.


The second highly valid criticism of the academic definition is that volatility doesn’t actually mean risk of investment loss since often the most productive with the lowest long-term risk of investment losses are more volatile in the short term.  You can see why this is so confusing – with no standard definition accepted amongst all camps.


But let me take a second and walk through the two camps about risk in investing and how it relates to expected returns and finally give you our take.


The Warren Buffett/Objectively Successful Investor Camp


Warren Buffett is well known and is the second richest person in America.  He had about $100,000 in his mid 20’s (he went to college young) and he turned into around $60 billion by his mid 80’s.  He is pretty open about how he did that.  He did this by investing at a compound rate of return of around 17.5% a year after inflation.  Buffet’s philosophy is, roughly stated, is to hold cash for your immediate needs and invest the rest 100% in growth assets.  It’s also to focus on the parts of the market where there is the least competition until you eventually have too much money and grow out of those markets.  Realistically, you won’t compound your money at 17.5% for 50 years but there is still quite a bit to be learned from the objectively successful investor camp.


Most people on the Forbes 400 list of richest American near the top have taken this same probabilistic approach to risk vs. return.  Their optimism is actually rooted in probabilities.  The Buffet/Objectively Successful Investor camp recognizes the need for cash on hand or liquidity and is willing to sacrifice long term returns to maintain enough liquidity for their needs.  However, when they are investing for the long term, they go all in and invest exclusively in high growth assets.  What they invest in constantly changes based off market conditions but their view is that if you are invested for 10 or 20 or 30 years the growth asset will almost always be more productive than the defensive asset so it doesn’t make sense to invest in defensive assets if you don’t have or expect to have a pressing liquidity need.  From what I can tell, the vast majority of objectively successful investors are in the Warren Buffet/Successful Investor camp regardless of the asset class they invest in.


The Statistician Camp/University of Chicago Camp


The second school of thought on risk doesn’t really come from investors, per se, but rather academics.  The University of Chicago persuaded Merrill Lynch to pay for a research project that tracked the prices of all securities in the United States and allowed the statisticians to parse historical data and look for relationships or trends in what types of stocks did well. 


What they found in short was that the companies that are small, highly profitable, inexpensive and not capital intensive were the best performing stocks in the data set.  They published a series of these findings in the 1980’s, 1990’s and 2000’s – but in general their publications came long after the successful investors had been using similar strategies for years.  The successful investors didn’t publish their findings simply because they didn’t want to get copied and had no financial incentive to do so, but they were pretty open in talks with selective groups about what they were actually doing.


The statisticians’ view is that if you make more money you did so by taking more risk and that’s where the popular saying that stocks or real estate are more risky than bonds or cash became popularized.  And it’s certainly true that over short time horizons (one year, five years or even ten years) there is a much greater probability that your investment will lose value if it’s a stock as compared to a bond or cash.  The research clearly shows that.


But what the successful investors said was that even though a growth asset could often would fall beneath the growth rate of a defensive asset in a short period of time (10 years or less), in general after 10 years the growth it was never worth less than the defensive asset despite continued draw downs each recession.  The tremendous growth of the growth asset and the upward facing slope made it so you were less likely to lose money from stocks after 10 years than you are to lose money from bonds or cash.  So if you invested for 30-40 years it was actually riskier to own bonds and cash than it was to own stocks.


The response of the Chicago school (remember these are mostly academics and not actual investors) has been that they outsized returns of a few groups was not based on how they invested it was merely luck and would eventually end.  They said it was as if you flipped a coin and these guys were “lucky” for 50 years.  At the time you first started to hear these comments in 1984, Berkshire Hathaway’s share price was $1,300 a share.  Today it’s $216,300 a share.  Someone who bought 5 shares of Berkshire for $6,500 in the 80’s when the first 20 years of Berkshire were being called lucky would be a millionaire today on that investment alone.


This isn’t to take anything away from the academics.  But it’s important to understand that unlike in a lot of fields there is tremendous value in knowledge about securities and the most knowledgeable people get paid more this information on the private market than through an academic setting.  That is why in this field, where there isn’t enough to go around, the academics largely make their discoveries years after the practitioners have been successfully applying the same concepts.  Not surprisingly, the practitioners don’t bother to share this information with academics but by looking at past returns and statistics the statisticians do eventually discover most of it.



What is our take away on the role of risk in investing and the two camps of thought


We think the Chicago guys are pretty accurate about short term investing (a time horizon of 10 years or less until the money is spent).  In the short term, volatility, or price movements matter a lot.  In the ultra short term (1 year or less) price movements are almost completely random.  As a result, we tend to believe in using historically low volatility assets for investing for expenditures our clients plan to make soon (like buying a house or having a major cash outlay).


But the evidence is pretty clear in the longer term, that the volatility reduction that the statisticians suggest has tremendous long-term costs and is probably a riskier way to invest over a lifetime.  Growth assets give you a margin for error for things to go wrong whereas defensive assets, because they don’t grow as much, often don’t give the ability to grow out of your investing mistakes.  Even the statisticians own data shows this be objectively true. 


There is a strong correlation between IQ and percent of growth assets in people’s portfolio.  We think it is true for advisors too, a less good advisor in general will have a statistician type orientation for all assets, whereas a better advisor will be like the statisticians for short term investments but like the more successful investors for long term investments. 


Regardless of what school you come down in, the important thing is to be able to value assets because successful investors often never just bought from one asset class they bought things that were the best deal at the time and would jump across asset classes to lock in the highest returns.  In other words, they weren’t dogmatic and this openness increased their odds of financial success.  We believe the same will likely be true for you.

Should you fund a Roth IRA during your internship?

By Daniel Harris, RIA, Tuesday May 24, 2016


One of the questions that I often get is whether it’s better to fund a Roth IRA during your internship or whether it is better to pay down your student debt? 


For those who aren’t aware of it, the Roth IRA is a retirement account you fund with after tax dollars.  You set it up directly at a brokerage firm (like Fidelity, TD Ameritrade, Etrade, Charles Schwab ect.) and it doesn’t have anything to do with your employer.  The rules are you can put $5,500 a year into your Roth IRA but you must fund it with earned income, which are basically your wages from your job. 


Our firm generally has two separate rules we use for whether to invest or pay down debt.  Our first rule is that clients of ours who have debt whose interest is less than 7.75% a year, should generally use their retirement options first before paying down debt.  This is because with our help, we believe there is a good probability that they can earn above a 7.75% return on their retirement accounts over their lifetime if they invest in a way we often recommend.  This means that we expect a positive spread between the return on their investments and the cost of their debt. 


Our second rule is that you have to have the liquidity to make a retirement account contribution.  We want our clients to have a little bit of an emergency fund or at least viable plan to build one up over time.  One of the bad things you can do financially is contribute to an IRA and then have to pull the money out and so we don’t like to see retirement account contributions if you don’t have at least a little bit of a cash cushion on the side.


Now if you don’t work with us, the answer to this question might be very different.  The evidence has shown that the average investor only earns about 0.25% above the rate of inflation on their investments over long periods of time. 


So we expect that a typical investor, working alone without a financial advisor to only earn 3.25% on their money.  If they have no debt it may still make sense for them to consider funding a Roth IRA.  But if their debt costs them more than 3.25% a year that investor would be better off paying off debt in our opinion than they would be funding an IRA.  So the threshold of investing versus paying off debt is generally higher for our clients than for the average investor because we teach them how to invest in a way that the average investor doesn’t utilize (and hence why the average investor has lower expected returns).


So what should I expect in return for my $5,500 Roth IRA Contribution?


Our expectation for our clients


Our expectation for our clients with a growth oriented retirement account: if they put in $5,500 and let if grow for 50 years that money should be worth $63,070 in today’s dollars.  In other words, for every $1 invested in this structure today we expect our clients to get $11.47 back in today’s dollars after 50 years.  That’s a fantastic return on investment that is only possible because of the tax shielding features of the Roth IRA.  This isn’t a guarantee, of course, but it is what we believe to be a reasonable expectation of their likely outcome.


Our expectation for people who invest without a financial advisor


For people who do it on their own and don’t use us, we expect that their $5,500 contribution to their Roth IRA, if left alone for 50 years, will be worth $6,231 in today’s dollars.  In other words, for every $1 a DIY investor puts in and invests on their own, we expect them to get $1.13 back in today’s dollars after 50 years.


Why such a big difference in expected outcomes?

With the right investment help, the Roth IRA may produce 78 times more profits ($57,550 vs. $731) in today’s dollars than the typical do it yourself investor gets.  This is the reason why financial advisors are widely employed by people who make it to upper ranks of financial security in our society. 


The research is pretty compelling on these issues and it indicates that amongst people with $100k or more in savings between 72% and 89% of people use financial advisors.  For each step up in net worth there are lower and lower percentages of people who don’t have a financial advisor.


There a number of ways to interpret that data, but our guess is that most of the people who do it on their own don’t make it to the next level compared to their peers who get help.  It’s worth noting that most people, even though they employ a financial advisor, make the ultimate decision about what to buy or what to sell themselves, which is what we’ve seen in our business as well.  It’s like using a lawyer – they give you guidance and help you understand the legal consequences of different lines of action – and now that you are well informed – you make the ultimate decision about what to do.


Switching back, the cause for difference in outcomes is that it is reasonable to expect that our growth-oriented clients can earn 5% above the rate of inflation in their retirement accounts if they invest in a particular way.  We also know the typical investor, over long periods of time only has earned 0.25% above the rate of inflation on their money. 


Our expectation is that our clients will double their retirement money after inflation every 15 years whereas the typical investor would double their retirement money after inflation every 304 years. 


We don’t try to beat the market, but we work to do things that gives our clients a high probability of making their money productive.  We can’t and don’t guarantee returns but we think taking a sophisticated approach to investing really should put you in a place of better financial security and we use evidenced based methods for making our recommendations.


The combination of the right vehicles (like the Roth IRA) and the right investments made at the right time can you put you on the road to financial security.  This is why we encourage you to invest in yourself and get an advisor as soon as you can to help teach you what you need to know about this stuff.

The Ridiculous Nature of One Size Fits All Investment Products and Services


By Daniel Harris, RIA, Monday May 23, 2016


The longer that I’ve worked as a financial advisor the more I’ve seen the same themes come up over and over again.  It’s like that old saying – the more things change the more they stay the same.


One of the themes that I always see is an attempt to get something for nothing in investing.  The demand for good outcomes with no effort or costs is insatiable and there is always a flavor of the week or month or year with these things.


The flavors of the week almost always involve a one size fits all investment product.  These are kind of pie in the sky products that when proving time comes around they often disappoint.  This in the past may have been a global allocation fund, then a target fund, then an index fund, than an automated investment service.  The siren song was if you just buy this one thing (and continue to pay them fees every year) you can get great results with no effort and minimal costs.  Of course, there is often some degree of truth in the statement but mostly people misunderstand what the product is actually capable of.


Anyone who has thought this through can immediately spot the problem with this argument.  Investing is a competition where everyone is bidding against each other constantly – there never can be enough of a good thing to go around for everyone.  Eventually you drive up the price of that formerly good thing and now it’s an expensive bad thing that hurts you and lets you down.  That is the nature of an auction market – in order to win at it you have to keep on changing what you do and innovating because people will copy those who succeeded in the past even if they don’t understand what they are doing.


Let me explain how this works: suppose it is the 1980’s and long term treasury bonds and U.S. stocks are cheap and so you buy those, but by the 1990’s U.S. stocks are expensive and if you buy them you won’t likely do well, so you switch to real estate and emerging market stocks and commodities.  Now it’s the 2000’s and U.S. stocks are cheap again, emerging market stocks, real estate and commodities are expensive.  You can play the game smart – but to do so you have to continually evolve to changing opportunities and market conditions. 


And this is the problem with target date funds.  They have a fixed annual allocation, largely set in advance, made without any knowledge of what market conditions will be.  They also keep large amounts of cash and bonds, which are too much for some and too little for others depending on their goals. 


Successful investors know that you can’t know the lay of the land until you get there.  That is why it is so hard to plan ahead in investing but absolutely critical to respond to the current environment.  Those who ignore the current environment usually do much worse over time in my experience.


Of course knowing the environment doesn’t guarantee that you will succeed.  Investing is an exercise in probabilities where if you do smart things for a long enough period of time you usually end up with a comfortable to nice amount of resources.  But at least part of the time the smart thing won’t yield the result you want, just because it’s a probability and not a guarantee.


When customers come to me with a target fund allocation, I always ask them why they picked it or the underlying holdings.  They almost always don’t know why.  They usually don’t know how the underlying parts work together or what they are designed to do.  They like that it does things, but they rightfully don’t have much confidence in it because they don’t really understand what it is designed to do or why it has the weightings that it has.  In practice, many clients feel so uncomfortable about these portfolios that the hedge around them, buying more cash or bonds or stock to supplement the portfolio just because they have so little confidence in it.


My take is that you should have very little confidence in these products as anything more than a very short-term solution.  There is a place for them and it isn’t because you want to retire in 2040 or 2050 – it’s because their allocation exactly matches current market conditions and this is your cheapest option for putting it together (which is something that rarely happens).  But most of the time, I believe you are better customizing your solution to your goals, your need to take withdrawals early, your ability to withstand downturns and your openness to consider various investment options.


Because investments are so productive when done right, I think it’s silly to take the short cut and do the one size fits all approach given the huge number of people (I would guess the vast majority of people in those funds) for whom I don’t think the one size fits all approach actually fits them. 


It may be okay to cut corners on things that don’t matter – but second to your job nothing will matter as much for your financial security as your savings rate and how well you set up your portfolio and how sophisticated and targeted you are in your approach.  As a result, I can’t recommend customization enough.  I believe if you don’t customize to your situation, you are really selling yourself short and that decision will likely cost you more in the long run than the cost of just getting a proper advisor who will customize things to you.

The Steps I Recommend you go through before you hire an Accountant, Attorney, or Financial Advisor


By Daniel Harris, RIA, Sunday May 22, 2016


1)  Check their legal record to see if they’ve ever been sued and why


I’ve found that dishonest people often can’t stay out of superior court.  Not only do they screw their clients, they screw their landlords, their lenders, their business partners and almost anyone else they come in touch with.  On average only about 2% of people get sued each year, so if your financial advisor, accountant, or lawyer shows up here as a defendant more than once you have cause for concern.


If it’s in San Diego County, just type in their last name on the online case search and you’ll see if they have a track record of not dealing fairly with people.


2)  Check out their field specific compliance record by looking up their individual license, which will show their disciplinary record




Investment Advisors

Investment Brokers


We estimate that about 12% of practicing accountants have had their license suspended at some point in their career according to the Board of Accountancy disciplinary data.


We estimate that about 12% of practicing attorneys have had their licenses suspended for a major disciplinary event at some point in their career based off our study of the California State Bar Annual Discipline Report.


We estimate that about 4% of financial advisors have had their licenses suspended at some point in their career according to FINRA’s disciplinary data. 


Now it’s important to understand that most financial advisor disclosure events are not from upset customers or customer complaints.  Most of these disclosures are administrative in nature or are for noncustomer facing activities.  For example, if you have a dispute with your contractor and they put a lien on your house that is a discloseable event according to FINRA.  Missing a $15 filing fee is a discloseable event according to FINRA.  Many regulators don’t require these disclosures (lawyers don’t have to publicly disclose their liens to my knowledge) but financial advisors are held to a higher standard than lawyers or accountants and so we have to disclose more.


Here are some facts on the topic.  In 2012, 0.44 out of every 100 financial advisors received a written customer complaint according to FINRA.  By contrast, 8.17 out of every 100 lawyers in California received a presumably written customer complaint according to the State Bar of California.  So customers are 18 times more likely to complain about their lawyers than they are to complain about their financial advisors.


If you see an attorney, accountant, or financial advisor who had been suspended be very cautious – that isn’t norm for any of our fields. 


3)  Look into their lives and ask yourself whether you would make the same decisions that they would


Whenever I hire and accountant or attorney one of the first things I do is look up where they live.  I ask myself, would I live in that school district or that house? 


I also look up their business revenue and their office and see whether the costs seem reasonable for their revenue.  I ask myself, if I had the revenue they did would I rent that office?


In general accountants, financial advisors and attorneys, who live and work in neighborhoods where they get high value for their money likely have good business and personal judgment and can give really good advice.  They can serve as a confidante but they are also savvy about what they are doing and can help you out significantly with their good judgment.


I love seeing an advisor who has easy to get to office space, a home that is reasonably priced in a neighborhood with exceptional schools per dollar of home value.  On the other hand, I run in the other direction when I see an advisor who lives in Carmel Valley and has a $10k a month office rental and a 8 or 9 high school to send their kids to.  Those high costs mean low profits for their business and lots of pressure on them to sell unnecessary services to their clients (or maybe even steal or cheat) to cover their expensive overhead. 


4)  I want to see an advisor with a good educational background because that has been correlated with better results


I don’t need my advisors to go to a top ten school or anything like that, but I want to make sure that they’ve gone somewhere with a good reputation and that they got value for the money.  Good private schools and good public schools are fine.  Studies have found that the higher quality school that an investment advisor attended the better the net returns to the customer.  I assume that may be true for attorneys and accountants as well – which is why I always like to see a good undergraduate or graduate school on their resume.


In a lot of fields, professional credentialing requires a checkbook and a warm body.  But schools are a true meritocracy – it’s hard to get into a place like MIT, Stanford, Yale, UC Berkeley, UCLA or UC San Diego and it’s hard to do well there.  A checkbook isn’t enough at those places and that is why I always look for a good educational background in my advisors.


5)  I want to know that they can do the tasks I’m asking them to do outside of the client setting


My goal in hiring an attorney is to keep me out of trouble.  I want to know that they don’t personally get sued all the time because if they can’t keep themselves out of trouble how can they keep me out of trouble?


My goal with an accountant is to have a good strategic thinker who has good business judgment and doesn’t take risks I wouldn’t take.  I don’t want to see them on the list of people who owe money to the IRS.  I don’t want to see an extravagant lifestyle.  I want to see the millionaire next door type because the optimal advisor to a millionaire or a future millionaire is someone who has done it or is doing it themselves. 


If I were hiring a financial advisor, I would want to know that they are productive with their money.  I would want them to be way ahead of their peers in terms of how much they have and how much they saved.  I’d want to know that they are savvy with money and I want them to have a lifestyle that matches their task of making money productive.  I’d also want to know that they did all the other stuff that goes into financial advising including having an estate plan for their own family that they can talk about, having structured things in a way that reduced taxes for themselves, and having structured their finances in a smart way.


6)  I want to like them personally and feel comfortable around them


Most people would put this as number 1 but for me it is number 6 and the reason is that I have much higher standards for my advisors.  I’m willing to be committed to my advisors and be a loyal client of theirs because I want the information they have and I want to receive good advice.  I’m more than willing to pay for good advice in these areas because it often pays you back several times over. 


But I also want to like them as a person and believe that they care about my wants and my goals.  I want them to treat me like I’m a member of their family and be proactive in addressing my needs.  I want them to actually care about me and not just treat me like a dollar sign. 


Most advisors will fail to pass the test on steps 1 through 5, but for those who get through and also have number 6 on their side – I’m committed to them for life and will do whatever it takes to continue to be their client.  I understand that advisors like that are rare and I’ll do what I can to have the opportunity to continue to learn from them, be looked out for by them, and improve my own life in the process.




What you should know about financial advisors


By Daniel Harris, RIA, Saturday May 21, 2016


It is hard to imagine writing a more self-serving article than this one but I’m going to use this as an opportunity to explain how the financial industry works and what your options are as a customer.  I’m also going to talk about what I would do if the roles were reversed and I were in your shoes.


I’m going to talk about 4 things in this article 1) different types of financial advisors, 2) what they do 3) their cost structure and 4) how to work with them.


1)  Different Types of Financial Advisors


Financial Advisors generally come in three camps: independent owners (the only type worth hiring), independent employees (not worth hiring) and brokers/insurance agents (you have to use them for transactions but I wouldn’t recommend relying on them for advice [they have no obligation to give you advice that benefits you more than it benefits them]).


An Independent Advisory Firm Owner or Partner: The independent owner is the only type of financial advisor/planner/investment advisor worth hiring.  The independent owner generally does not receive kickbacks for their advice nor are they restricted in any way in what they can recommend.  They are compensated generally by their clients alone.  Think of them like your family lawyer – they work for you and only for you.  Most of other financial advisors don’t necessarily work for the client. 


They may say they work for the client but when you look at the contracts you sign their name will usually not be on it.  Moreover, there is a contract that their name is one – the one between them and the bank, brokerage firm, or insurance company.  Usually on that contract they’ve pledged to act in the bank, brokerage firm or insurance company’s best interest – but they never signed any contract pledging to act in your best interest. 


An Independent Advisory Firm Employee (not an owner or a partner): Most financial advisors are not actually owners of their firms but work as employees.  I don’t think you should ever work with someone other than an owner or a partner of an advisory firm.  The reason is that the employment contract between employer and owner can rewards all kinds of behaviors that hurt you and discourage all kinds of behaviors that help you.  In short the advisor often has to work against their own self-interest to be helpful to you.  Your money is important and from day one you can get an owner or partner to help you – you should never settle for an associate.


A Broker Dealer or Insurance Agent: The key distinction between an advisor and a broker dealer is that an advisor has a fiduciary duty to put their interest before your own.  This is because under the Investment Advisors Act of 1940, investment advisors must act in their client’s best interests and put their clients interests before their own (this is known as a fiduciary duty). 


But Congress acknowledges that not all financial transactions involve advice.  A lot of times you just want to buy something and you need to buy it from someone with a securities or insurance license.  In these instances people who sell you something can give you advice but are not required to put your interest before their own and are allowed to self deal in a way that in investment advisor is not allowed to do under the Investment Advisors Act of 1940.


Brokerage firm and insurance agents are allowed to self-deal.  They are allowed to push more expensive products even if less expensive products that do the same thing are available.  They are allowed to push products that are financially harmful to the customer because they aren’t actually required to work in your self-interest.


Often times brokers or insurance agents will straddle the line between investment advisor (who is required to act in your best interest) and broker/agent (who doesn’t have to act in their best interest).  When they are advising you on mutual funds they may be an investment advisor, but when they are pitching an annuity or whole life or universal policy they are not acting as an investment advisor.  This can be very confusing to the customer which is why you shouldn’t use them for advice at all because it’s highly unlikely you’ll be able to figure out when they are giving advice as an investment advisor and when they are giving advice as broker/dealer or agent.


I believe the confusion tactic (which is the most tactic I see used to sell crappy products to people) is done intentionally so if you really knew what was going on you 1) wouldn’t buy the product 2) wouldn’t use that advisor and 3) would be biased against using that firm ever again because they likely confused you so they could burn you, in our assessment.


To deal with this problem – my advice is to not use brokers and insurance agents for advice because you can’t be sure when they are acting in your best interest and when they aren’t.  It’s better to keep it simple and use an advisor that works solely for you and doesn’t get kickbacks or commissions on products because that it increases the chances that you will receive good, unbiased advice in our view.


One Size Fits All Products: One way that investment companies work to control costs is to give essentially identical recommendations/product structures to all clients regardless of their individual needs or circumstances.  These products often aren’t expensive at first – but they are so inefficient that they often leave thousands if not hundreds of thousands on the table by their lack of customization to the client.  I avoid these products because their lack of specification to the client makes them some of the most expensive products in terms of opportunity costs.


2)  What they do


Independent Owners can often do everything financial or money related – making them a one stop shop: As an owner in the firm (imagine something like a partner in a law firm or the CEO of a company) they have the authority to do basically whatever they want – which is why they are the best type of advisor.  They can guide you in your estate planning, they can help you purchase insurance, they can help you set up accounts, they can advise you on what to invest in, how to save on taxes, how to protect yourself from creditors ect.  While they specialize in investing its all the other things they do that make them so valuable to clients.  They basically become your “money guy” and help you handle all issues that touch on money.


Independent Employee are almost always restricted and often can only do one or a few tasks:   The firms these guys work for often don’t trust them to make decisions on behalf of the firm.  So they may have narrow authority to recommend say mutual funds or stocks from a preselected menu but they can’t fully exercise good judgment because their firms don’t trust them and don’t want to be liable for their actions.  And they usually can’t do the other stuff like estate planning, tax planning, creditor protection ect.  So basically you pay the same price for a greatly limited set or services, which is why I wouldn’t hire these guys if I were in your shoes.  Owners and partners in advisory firms would be the only option I would consider just because they cost about the same and they can do a lot more.


Broker Dealer and Insurance Agents are necessary to use on a transactional basis – but when they are advising you they often don’t have to act in your best interest because they are excluded from the Investment Advisors Act of 1940:  Even if you use an investment advisor partner or owner for your financial advice (which is our recommendation) you will still have a broker or insurance agent.  The reason is that you need a license to buy or sell securities or insurance.  The brokerage firm guarantees the other side that the shares/money will be delivered when you make a trade and that is their role.  The insurance agent guarantees that a minimum amount of diligence has been done on you in order to sell you an insurance product.  Both of these roles are transactional and if you want to own a security or an insurance contract you must go through these guys. 


However, the way we recommend thinking of them is like a bank teller.  You have to use them but most people ignore their advice or recommendations.  They are in a functionary role and when they decide to step out of that role and give you advice they usually are not obligated to act in your best interest because their advice is considered to be ancillary to carrying out a transaction as a broker and so it is not covered by the Investment Advisors Act of 1940. 


Sometimes they will try to straddle the lines and give investment advice as an investment advisor (they are dully registered as a broker and an investment advisor) but they difficulty of this situation is that it is really hard to know when they are giving you advice whether they are acting as an investment advisor with a duty to put your interests first or a broker dealer or agent where they can put their interest first.  It’s so confusing, we recommend only using insurance agents and dually registered brokers on a transactional basis and we recommend buying from the lowest cost place with relatively decent service.


One Size Fits All Products generally make your securities decisions for you without any tailoring to your unique situation.  They don’t do estate planning, tax planning, creditor protection of other essential functions of financial planning.  They often have no real knowledge of your true financial situation and are not required by law to be knowledgeable.  They generally offer a nonspecific, nontailored investment product at a low price initially but an extremely high price when you factor in the opportunity cost of not tailoring your investments to you exact situation.


3)  Their cost/fee structures


Independent Advisory Firm Owners and Partners:  Generally you will pay the individual or the firm, which are functionally the same people since the owners owns all the profits in the firm.  You’ll generally pay them directly either through a check or through a set withdrawal amount in your account.  It’s very similar to paying a lawyer.


But they differ from lawyers in one main way – investment advisors generally charge a flat fee or percentage of assets and this gets you an unlimited amount of their time.  Why not charge by the hour?  Hourly charges generally have no relationship to your financial success and they just incentivize the firms to be very inefficient with their time.  On flat fee bases of assets under management fee structures the advisors know that you’ll have to succeed to be happy and that they’ll need to make a meaningful contribution to your success and not just push papers around all day.  Where investment advisors will take both sides of the coin and often not charge in recessions you will find that those advisors are willing to eat their own cooking and not take advantage of you in recessions.  We are one of the only firms that we know that does this but if you choose to go with someone other than us we hope you negotiate this into your contract – because your advisor should absorb some of the risk as well as benefitting from their contribution in helping you achieve your financial goals.


Independent Advisory Firm Employees:  These guys work basically the same way as a owners and partners in independent advisory firms except there is a middleman in the transaction which can create big disincentives to acting in your best interest.  Whereas the owner/partner has or is likely going to be doing this for 40-50 years and considers the client’s best interest as the best thing they can do for themselves – the employee may only be there for a year or two or five.  The employee may have an incentive to do things that pay out quickly because they won’t be your advisor five years from now.  Your fees will be the same largely, but what you get back will probably be less in our view.


Broker/Dealers and Insurance Agents and Brokers: The lines are blurred here, but when giving investment advice under an advisory relationship they are likely similar to an advisory firm employee (not an owner) and they may receive different payouts or kickbacks from the brokerage firm or fund companies for the advice they give.  When selling investment products or insurance products they may be wearing their broker/dealer or insurance agent hat in which case they’ll get a huge check up front and not be required to act in your best interest.


For example, a broker selling a mutual fund may receive up to 5% of your investment up front or an insurance agent will likely receive 85% of your first year’s premium as their commission.  If it is a crappy product and it hurts you they still get paid and there really is no recovery for you.  You’re just kind of screwed because they were wearing their broker/insurance agent hat when they sold it to you (even if they sometimes wore the investment advisor hat with other products).  As you can see this is very confusing and is a trap for clients in our view.


One Size Fits All Investment Products: These guys generally charge a percentage of assets fee and they take it out of your investment fund value every year.  This can range from maybe 0.15% all the way up to 1-2%. It seems cheap at first, but you actually lose a ton on the one size fits all nature of the investments.  One thing that is easy to prove but most people are not aware of is that the variance of returns of underlying assets depending on when you buy them can be as much as 10% per year over a decade or two (a huge amount of money) but the variance of fees amongst your options is often only a fraction of a percent.  You never want to give up that 10% to save 0.25% because doing so makes you -9.75% worse off per year.  So, it’s important not to skimp on your investment advice and be penny wise and pound foolish.  It’s okay to be cheap with commodities (like which S&P 500 fund to buy or which Total Stock Market Fund to buy) because they are substantially identical but investment advice varies tremendously.  You’ll want to get the best investment advisor you can find because they are worth their weight in gold for someone with lots of time.  When you are in your 70’s or 80’s your lawyer is more important than your investment advisor but until then your investment advisor is the most valuable advisor you have because the gains from investing are likely to be much more than what a lawyer can save from creditors or an accountant can save from the government (unless you are a business owner in which case an accountant is probably more valuable than you investment advisor)


4) How to work with them


The Independent Advisory Firm Owner or Partner:  Just call them up or e-mail then.  Some of these guys have high minimums like $1 million or $500,000 or $250,000 and others do not.  We generally start at $50,000 even though most of our clients are far richer than that and our average client is a multimillionaire.  You might wonder why our firm would have such low minimums.  The answer is that everyone starts at the bottom and we like working with people early in their career because we believe we can have a positive lifetime impact on making them very financially comfortable.  As a result, we don’t set an insurmountably high boundary for clients to become members of our firm.  But as we get busier we may raise our minimum over time – so if you are on the fence you should contact us now.


Independent Advisory Firm Employee: We generally don’t recommend working with these guys.  Investment advisors can take on lots of clients and so it doesn’t make sense to use a nonowner or partner in an investment advisory firm.  We recommend only agreeing to work with an owner or partner if you want to be financially comfortable.


Broker Dealer and Insurance Agent: When you buy brokerage services or insurance products we recommend not going direct but going through us or your independent investment advisory firm partner or owner.  The reason is that the independent advisor generally gets information like a wholesale customer and can easily comparison shop since they have something all the brokers and insurance agents need – the ability to influence where clients do these transactions.  As such we get better treatment than you and you can get much better treatment and pricing, in our view, if you go through us and buy like a wholesale buyer not retail buyer.  By analogy I would compare this to the prices you get at a farmers market (retail) versus the prices you get a Costco (wholesale and a lot easier to buy).


One Size Fits All Products: You can simply buy these products through your brokerage firm or occasionally go direct but we don’t recommend it.  You should fully understand what you are doing when you buy these products and what the consequences are of buying them in terms of opportunity costs.  An independent advisory firm owner or partner can walk you through what you are giving up when you buy one of these products.





By Daniel Harris, RIA, Friday May 20, 2016


Can you hear the drum roar? 


Over the last few weeks and months, the major publications of the world have all been freaking out about China’s massive bad loan problem. 


Here is a sample of the headlines:


“China must manage debt bubble to avoid new crisis” CNBC


“China’s Subprime Crisis is Here” Bloomberg


“China’s Debt Explosion Threatens Financial Stability, Fitch Warns” The Telegraph


“How China Could Trigger a Global Crisis” The Washington Post



…and finally, the Financial Times maintains a whole section on what is going wrong with China right now called “China Tremors


Are you scared yet?  Do you want to go out and sell your Chinese stocks (if you have any)?  Do you want to tuck back into the comfort of U.S. Treasury Bills?


What all of this means for you?


First of all, we have to understand that everyone in the system has an incentive.  My incentive is to help you grow your money because if you do that you probably won’t fire me and I’ll get the joy of watching you succeed and feeling like my efforts played some contributing role in your success (which I believe they will).  My job is to keep you calm and to always help you focus on the long game.


But the long game often makes you fall asleep and maybe not pay close attention every single day and perhaps not hang on every word someone from the IMF or from the Federal Reserve or even a famous investor might say.  The long game says we’re going to try to own good assets and try to buy them right and sell them if they are massively overpriced.  The long game doesn’t worry too much about China’s debt situation because in the long game China will have lots of crises along the way, just as we have had in the United States.


However, The Financial Times, The Wall Street Journal, CNBC, Bloomberg, The Telegraph and The Washington Post have completely opposite incentives of you and I.  Their job is to get you scared so that you read their paper or watch their network and so they can sell your eyeballs to some advertiser.  They need to create activity or action even where none exists because if you don’t think it’s important and you don’t pay attention to them they can’t sell your eyeballs to advertisers. 


But is it good for us to be scared?  Does anyone make really good decisions when they are scared?  The long game is about being calm and having a steady hand and commitment – it isn’t about the latest fad or whatever thing is whipping up excitement at the current time.


The short answer on China is that yes they have a debt problem and it could impact their economy and their stocks.  It might even impact our economy and our stocks - but likely only in a temporary sense.  Debt bubbles grow and debt bubbles pop and in the long run they don’t have the same type of lasting impacts that other factors have. 


This isn’t to say it isn’t fun to discuss these issues.  I love talking to my clients about what is happening with the Federal Reserve, or with China, or with the Eurozone or in politics.  All of that information is fascinating to discuss and hear different takes on but for the most part it isn’t very actionable. 


The reason is if information is widely known it gets priced in pretty quickly and it’s hard to make much money with it.  The true gains in the market come from a change in the structural elements where for a while people aren’t even looking at certain types of investments and then at some other time they can’t get enough of them.  This requires the ability to be watching constantly for these sectors and to be knowledgeable about what people usually pay for things.  This stuff never makes the news until after the fact because people (wrongly) assume that sectors are permanently dead and the story is boring and has lost that sensationalistic element that used to capture our attention.  But when the story is no longer being talked about is often the time where there are serious profits to be had.




The Tax Savings Powers of the Health Savings Account


By Daniel Harris, RIA, Tuesday May 17, 2016


The Health Savings Account (HSA) provide a way for people to pay more than they like in income taxes to reduce their taxes and get a potentially triple tax advantaged account (no tax on contributions, no capital gains tax on the growth, and no tax on the distribution provided it’s used for a health care expense).  It is best used to pay for health care expenses in retirement but it can also be used like an IRA for a retirement account.  There are no penalties on distributions after the age of 65 even if you don’t use it for health care.


Can anyone qualify for an HSA?


The qualifications for having an HSA are:


1) You have a high deductible health plan (requires an annual deductible of at least $1,300 for a single person and $2,600 for a family, and out of pocket expenses other than premiums for the plan cannot exceed $6,550 for a single person or $13,100 for a family).


2) You are not covered by another health plan (including your spouses Flex Spending Account (FSA) or non high deductible family health insurance from your spouse)


3) You are not enrolled in Medicare


4) You are not claimed as a dependent on someone else’s tax return


How much can I put into an HSA each year?


An individual can put $3,350 into an HSA each year and a family can put up to $6,750 into an HSA total.  People between the age of 55 and 65 you may be able to put an additional $1,000 a year into an HSA as a “catch up” contribution.


Where do I set up an HSA?


You set up the HSA at a number of banks and credit unions.  The HSA should be invested in low cost mutual/index funds.  These funds can grow in value without being exposed to Federal taxes.  Unfortunately, California is one of three states that does not recognize HSAs and so their earnings would be taxed in California and the contributions would not be tax deductible under California income tax.


How does it work?


Assuming you qualify for an HSA and set one up it works as follows.  You put in your $3,350 a year and this is pretax money that is deducted from your taxes.  There is no income cap on this deduction.  You can spend it on health care expenses immediately and pay no federal taxes on it.  Or you can let it grow.  If you invest it well, with the help of an advisor, every dollar you put in can be worth $3 or $4 dollars by retirement age.  At retirement age, you can spend these $3 or $4 dollars on health care expenses (which you will have) and the money you take out of the HSA will not be taxed at all.  Alternatively, if you are past the age of 65 you can just live off the money and that money will be taxed as income (but won’t have a penalty on it).


If you take money out of your HSA for something other than a health care expense prior to age 65 you will pay income tax on the distribution and you will pay a 20% penalty as well.  So you don’t want to do that.


Where does an HSA fit in my life?


If you want to reduce your taxes and you’ve already fully funded all the retirement options available, and HSA is another tool to reduce your exposure to taxes.  The benefit is you get a tax write off at the time of the contribution and if the laws stay the same you should be able to take out the appreciated gains and pay for health expenses in retirement without ever having paid any tax on the money.


So if you’d like to legally avoid taxes and don’t mind a high deductible health plan, the HSA is something that is worth considering.  If you have any questions about HSAs are the other ways to legally avoid taxes feel free to contact our firm, we’d be happy to help.





What to do about those student loans?


By Daniel Harris, RIA, Monday May 16, 2016


Student loans are the first big financial decision we all face coming out of school.  How to handle them can be a little complicated so let us help you demystify them a little bit.


The important role of inflation, the spread, and the opportunity cost of paying back student loans quickly


When you have debt the most important thing to think about is the opportunity cost of paying off that debt.  So long as you have a positive spread between what you earn on your investments and what the interest on the loan costs you, there is every incentive to pay off your loans slowly.  If you have a negative spread, it is important to pay off your loans quickly.


Retirement Accounts are extremely valuable from a tax point of view and are a use it or lose it option


It’s fairly hard to justify stretching out loans to build up savings in a taxable account because gains in a taxable account are often taxed at 25% or higher.  However, retirement accounts have a use it or lose it option – you must fund them in the year you earned the money or you’ll never be able to go back and put the money in for that year.  Money put in a retirement account creates tax benefits that last 30-100 years and so it’s a big deal to pass on this tax write off.


With that said, you have to be able to generate a positive spread in your retirement account to make it worth not paying off your debt early


We believe that the majority of customers working with us should be better off investing the money if their interest rate on their debt is less than 7.75% a year and they are putting their money in a retirement account.  However, if those same customers invest on their own and get the results investors typically get when they are do it yourselfers they should pay off all debt with an interest rate above 2.5% a year.  So you need an advisor from day one to make your money productive.


We often recommend making extended fixed payments under the Federal Direct Loan System and finding a fixed payment you can handle today on a private refinancing of your loans


On most private lenders you pay a penalty for extending your loan.  For example, at Darien Rowayton Bank, one of the more popular student loan lenders these are the rates for fixed payments:


5 Years – 5.75%

7 Years – 6.25%

10 Years – 6.5%

15 Years – 6.75%

20 Years – 7%


In general, you’ll want the lowest interest rate on your debt, provided that you can make the monthly payments after putting 11-16% of your gross (before tax) income into retirement accounts.  Since the highest payment is 7%, and most of our clients are better off investing in retirement accounts so long as the interest on their debt is less than 7.75%, all of these options would work fine for our typical client.  So the question would be what is a monthly payment they could reasonably afford today.  If you can afford your payment today, it’s likely you’ll be able to afford it forever, because inflation whittles down the payment over time.  For example if your payment is $388 a month, this is how the payment will feel over time due to inflation whittling away its cost


Today: $388 a month

5 years from now: $336 a month

10 years from now: $299 a month

15 years from now: $252 a month

20 years from now: $219 a month


Now the fixed dollar value of the payment stays the same (it’s still $388 20 years from now) dollars lose their value over time and so it feels like less money.  By the end of the term if will feel like your payments are 43% less assuming 2.9% inflation.


Fixed or Variable Rate Loans?


You should know that historically interest rates have only been this low about 6% of the time.  So 94% of the time interest rates are higher than they are today. 


  What that usually means is that it’s a good idea to lock in fixed rates for most people unless you can easily pay off your loan in the next 5 years and then it may not be so crazy to take the variable rate risk. 


  The important thing to realize is that we are in an unusually low rate environment and in general when you have a chance to borrow cheap you’ll want to borrow long term and as inexpensively as possible.  Going with variable rates doesn’t impact the term but can make your loans a lot more expensive over time and you should never count on being able to refinance them if rates go up because that is not a guaranteed thing.  The variable rate risk is best assumed by people who can pay off their loans in five years or less, everyone else should probably consider fixed rate loans in our view.


Income Based Repayment/PLSF


If you are working for the government and know that is what you want to do for your career, the IBR/PLSF is a sweet deal.  You simply make discounted loan payments for 10 years and then your loans get forgiven and there is no tax consequence to the forgiven debt.


But Income Based Repayment is not such a sweet deal for everyone else.  The reason is that is twofold. 


First, the forgiveness of the remaining balance on your loan is treated as taxable income (even though it is phantom income that you never receive).  You’ll probably have to come up with 30% of the loan balance in taxes at the end so that isn’t so great.


 Second, most people can’t stay on the income based repayement programs forever and so they’ll want to refinance later but the rates could go up.  As a result, we really prefer locking in a low rate from a private lender if you don’t plan to go PLSF.


If you are married and have a working spouse without a lot of debt themselves, IBR is often better than REPAYE because you can file separately under IBR and PAYE and not have your spouse’s income count against you.  Under REPAYE your spouses income is combined with yours for determining discretionary income regardless of how you file your taxes.


The Takeaway


What really matters in student loans is the opportunity cost in your retirement accounts.  If the rates are low enough due to refinancing with a private lender or extending them under the government plan, you may be much better off investing the money.  You should consider picking a fixed payment plan you can handle today as over time the payments will feel like less and less due to the impact of inflation.  And of course, you need a financial advisor to help ensure that you are invested in a way that you earn a positive spread on the difference between your investment returns and the interest costs on your debt.




Graduation is around the corner, what to do next?


By Daniel Harris, RIA, Sunday May 15, 2016


One of the hardest things in personal finance is when you have to make a whole bunch of decisions without a lot knowledge.  This is a problem that impacts graduates every July as they leave the world of being in training and enter the full time work world with all of its rules and nuances.  To make it easier for you, I’ve put together a quick guide about what to consider doing and if you have any questions feel free to contact our firm. 


Student Loan Consolidation


If you haven’t already looked into consolidating your student loans now is the time.  Every lender is a little different in terms of how fast they work and what type of loans they want to refinance for you.  Its important to look at the long term value of refinancing and how it will fit in with your lifetime goals.


Disability Insurance at Work and as an Individual


When you finish your training you mainly have a lot of debt and perhaps a small bank account.  You tend to think you don’t have much in assets.  But you are dead wrong about that – you are full of potential and the whole reason why you got an education was to take advantage of that potential.  Over the course of your career you will probably earn $1,938,300 after taxes.  That’s a ton of money – imagine having that much in your bank account today – you’d be rich!


But here is the thing; if you get sick or hurt tomorrow you are likely to make no more than $650,000 after taxes (the payments on the social security disability system plus perhaps and perhaps 2-3 years worth of payments from your work long term disability policy).  That means you’d have to find a way to live on about $15,000 a year and deal with a 66% cut in your standard of living.  Based off our research we believe this happens to about 8% of men and 9% of women.  It probably won’t happen to you, but if it does, it’s going to be very uncomfortable and if you aren’t preemptive there is going to be nothing you can do to fix once you are in it.


To be preemptive you can buy disability income insurance as soon as you begin working to shift the risk from you to the insurance company.  These policies put a floor on how bad things can be and guarantee a minimum amount of income if you become disabled according to their definition.



You might have a policy at work, but usually these policies only pay 2-3 years of benefits.  Most work policies will only pay until age 67, if you can’t do any gainful occupation (like work as a telemarketer or take tickets at a movie theater).  If you are a client of our firm, we can help you understand the meaning of the insurance language in your policy.


Often the smartest thing you can do is supplement your work insurance with your own insurance to guarantee that you don’t have a huge drop in your standard of living if you get hurt.  Disability insurance generally costs 3-6% of the amount the insurance company will pay you in benefits and its best to get it right when you start in the work force.  Think of it as a form of retirement savings.  The benefits are generally tax free if you paid the premiums for the policy.  Buying it is a bit of a pain, but if you are a client of our firm, we will help through the process and try to make it easier for you.


How much to save for retirement


In general you’ll want to consider saving at least 11% of your gross (pretax) income an optimally 16% of your gross (pretax) income for your retirement.  You can split this between an IRA and your 401(k) and we often recommend funding the IRA first due to lower investment costs and greater flexibility.


How do you arrive at that number?


To see what you need to save today, you need to see where you need to end up and walk it back to how much you’ll need to put in.  The average household in San Diego spends around $63,000 a year and so that is what you probably need to live here.  Social Security will likely pay around $29,000 in benefits for a typical household.  That means that we have to find a way to produce $34,000 a year after taxes to maintain a normal standard of living (and more if you live on more). 


It takes around $25 of investments to produce $1 of income so you’ll need to have at least $850,000 saved up preferably in your retirement accounts by age 60.  If you just saved it in cash you’d need to save around $18,888 per year, but if you invest it in bonds, real estate or stocks you have to save substantially less to get to the same place.  How you invest the money is very important as it will have a big impact on how much you can spend later in life.


Roth IRA or Traditional IRA and Investment Options


When you start making real money you have the option of putting up to $5,500 a year away in a Roth IRA or a Traditional IRA.  These accounts generally cost nothing to own and only cost about $10 every time you buy or sell a holding.  You can buy stocks, bonds, real estate investment trusts, commodities or almost any security in these accounts.  Most people work with an investment advisor and you should to when you first get started.  We are happy to help you or help you find someone that will help you.


401(k) Investment Options


Your 401(k) has two components the part you put in (the elective deferral) which vests immediately and you can take with you when you leave your employer and the part your employer puts in (the profit share or match) which vests over time and if you leave to quickly you will lose it.  401(k)s can be Roth (after tax) or Traditional (pretax).  In most cases its better to save in after tax dollars but it depends on your individual situation.


401(k)s have sort of generic investment options like the 2055 fund which shifts its exposure over time, stock funds, bond funds, money market (cash) options, and usually a brokerage window.  It’s tempting to do the 2055 fund and set it and forget it but we highly discourage that to our clients.  The reason is the fund has built in inefficiencies like high holdings of bonds and has a strong U.S. bias regardless of market conditions.  Over time, you’ll learn that the U.S. market generally is only a good place to invest when our assets are cheap and any bias in a fund that doesn’t match your exact personal goals makes it usually not worthwhile to invest.  It’s better to build your portfolio in a way that is exactly customized to your needs, as this should give you the most money over time. 


The best way to do this is often through the brokerage window which is a program where you pay a little bit of money extra in order to basically invest in anything the brokerage fund sales.  This allows you to target asset classes more closely, which should mean a more comfortable retirement for you down the road.  Independent investment advisors can give you advice on your 401(k) whereas brokerage firm investment advisors usually cannot give you advice on your 401(k).


Should I get a financial advisor, lawyer, accountant etc?


You should definitely have a financial advisor from day one.  Not everyone will finish their life with a financial advisor but almost everyone should start with one.  The reason is that time is a critical element in growing money and the earlier you can start with the right moves the more money you should have.  The research has shown that people who use financial advisors end up having more assets per dollar of earnings than people who do not.  In the way that your education was a good investment, a loyal financial advisor to educate you pays huge dividends over a lifetime.  Other than you job, a financial advisor is your best investment right out of school.


A lawyer is appropriate if you expect to have a conflict with someone or have a tricky family issue.  Lawyers are most valuable to business owners and older people but they can be valuable to young people as well in certain situations.


An accountant is most valuable for people who own businesses because the tax code gives lots of leeway to business owners but not as much to employees.  They are also good for people who aren’t terribly detail oriented.


I don’t have much or any money who will take me on as a client?


At one point none of us had any money or not much to speak of.  Everyone starts at the bottom. 


However, if you are a client that is committed to saving for your future, you work well with an advisor and you are flexible you can usually find an advisor who will take you own with no assets for a flat fee.  You should seriously consider this since in order to make the most money over your lifetime, you probably need professional financial advice at least at the start.  Skimping on this advice is like skimping on your education – in the long run it costs more not to have it.


What should I look for in an advisor?


You’ll want an advisor that fits with your personality and that you feel comfortable with.  You’ll want your advisor to be independent, which disqualifies basically every advisor who works directly for a brokerage firm and you don’t want to use an insurance agent as an advisor (their advice is often really bad). 


The richest people in society use independent advisors who are loyal solely to them and who own or are partners in their own advisory firms and that is what we recommend for you.  One of the reasons why lawyers are so trusted is that they make their money slowly and they own the company you are paying and so they act with the long term in mind, and you should expect the same from your financial advisor.  You don’t want to take advice from a publicly traded entity because their shareholders’ interests can be treated as more important than your own. 


When do I start?


The best time to hire an advisor is right before you start work or soon afterwards.  Time is very valuable in investing and the earlier you start the better your chances for success are. 


What does a financial advisor cost?


Initially, a financial advisor may cost the same as going to eat with your friends once or twice a month.  At the beginning a financial advisor probably costs around $40 a month but because they work in such a productive area it is usually very easy for them to produce more benefits for you than they cost in fees. 


People who use financial advisors have been found to save at higher rates, rebalance more frequently, not have as much waste in their portfolio, and be more diligent in pursuing their goals. 


A good advisor, should help you replace your salary by your 60’s on a perpetual basis, meaning that their advice may generate up to $60,000 a year in benefits and only cost a small fraction of that over your lifetime. 


By contrast, the typical investor is only able to generate around $8,800 in income in retirement on their own from their investments, so while they save a little on fees, they may net out $51,200 less per year to live on which makes the decision to forego professional financial advice a penny wise and pound foolish decision.  The typical investor may be up to 5 times worse off for trying to do it on their own or if they don’t invest in themselves by hiring a good advisor.  The research shows that those who have advisors can produce more investment income per dollar of earnings than their peers who skimp on financial advice.

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