NOTE:  This post is part of an ongoing education series.  This information is for educational purposes only.  This information does not constitute investment advice.  No rational person would make investment decisions based on a blog post.  Please consult with your financial advisor before taking any action.  If you wish to have specific advice for your situation please contact Polaris Financial Planning.

via CNN.

A few days ago, I told you that I may speak at TAM9.  I have been working on the PowerPoint presentation and the paper that goes with it.  The paper will be published on the JREF (James Randi Educational Foundation) blog.  Several people have already helped me and I think the paper is much better.  I am putting the current draft of the paper below.  Please take a minute and let me know what you think.  Is there anything that needs to be improved?  It could be a better expatiation of a term, a spelling error, or even the placement of a comma.  Put your suggestions below in the comments.  I need to submit this on June 4th, so  make suggestions soon.

Thanks!

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Skepticism and Investing – Guaranteed Mutual Funds

Psychics use cold reading and tell you what you want to hear.  Did you know that some of the same tricks that promote woo are employed by your investment advisor?  These people may not even know that they are hurting your long-term financial success.  Most investors know that the stock market tends to return about 10% per year (over long periods of time) but what if you don’t want the risk.  In this case a sales person can use that fear and try to make you feel safe and secure.  They want to take away the fear you have about investment risk and, most of all, they want you to invest with them.  The sales person tells you about a product that may pay a little less but it is Guaranteed.

Just to let you know I am not one of those people, let me give you a full disclosure.  Here are a few things that the fine people at the Illinois SEC strongly suggest I make clear.  I am an Investment Advisor Representative (IAR) with 15 years of experience and I am the president of Polaris Financial Planning LLC (Polaris).  Polaris is a “fee-only” Registered Investment Advisor (RIA) in the state of Illinois.  Registration with the state of Illinois does not reflect an endorsement by the state or Illinois. Finally, the material contained here is for educational purposes only and does not constitute investment advice or a solicitation.  Please consult with your financial advisor before taking any action.

Because they wish to avoid risk, some financial advisors and their customers find products like Guaranteed Mutual Funds very attractive.  These types of products may also be called “equity-indexed annuities”, “fixed-indexed insurance products” and “indexed annuities”.  These products make a lot of promises and by the time the sales person is done telling you about one, it may be hard to say no.  The description below is based on a real product that you can buy from an advisor or broker.  Let’s go over some of the good things that your friendly sales person may tell you:

- This is a new product that combines the best of bonds and stocks.

- Your principle investment is guaranteed; you can’t lose.

- Part of the money is invested in an index fund .

- The balance of the money is invested in Zero-coupon bonds (Zeros).

- Zeros are issued by the US Government  and they are AAA rated.

- You will make at least 40% in the next 10 years.

- The 40% return is guaranteed.

- You make about 4% each and every year.

- You have the potential to make more in the stock index funds.

We will now cover some of the details that the sales person “forgot” to tell you.  The odd thing with the investment world is that they don’t need to tell you these things verbally, because all of the details are in the prospectus.  Often the prospectus is 72 pages of 6 point font written in the best legalese.  You sign the last page of the prospectus that you never read, and now they can do almost anything with your money.

Now we need to get specific and do some math.  I know – MATH!  This is your life savings we are talking about so… be strong.  Let’s start with a $100 investment which you cannot lose; its guaranteed.  You will earn 40% in 10 years which is also guaranteed.  After ten years you should have $140.  We can be sure you will stay in for ten years because there is a 10% penalty for early withdrawal and the idea of losing 10% of your money scares you. That is why you bought this type of investment in the first place.  Another small technicality is that you don’t make 4% per year.  4% per year compounded over 10 years would make your investment worth around $148.  Your result is closer to 3.4% per year compounded; but hey, it’s only your long term retirement plan, right?

Here is how we will do the math; we will start with the $140 you expect to have at the end of 10 years and take out a few small expenses.  Did the salesperson tell you about the 8% load?  A load is a sales fee that is collected from you and paid to the company and/or sales person.  Eight percent is on the high side for mutual funds, but this is a really good investment, so it is a small fee to pay.  You invested $100 and the $8 fee comes off the top, so you actually start with an investment of $92. Subtract $8 from your expected total of $140.

Your 40% return adds $37 to your investment not the $40 you expected.  Remember, you only invested $92 ($100 – $8).  Subtract $3 from your expected total of $140.  As you were told in the prospectus, your money is invested in mutual funds and all mutual funds charge an annual fee.  This fee covers the cost to manage your funds – and they deserve it for getting you such a great product.  This fee is 1.8% per year.  It is above the industry average but, you’re worth it.  Total cost over ten years is just $18.  Subtract another $18 from your expected return.

Since your money and the 40% return is guaranteed, it’s like insurance.  You pay for auto, life and home insurance – of course you have to pay a little something for this insurance.  This cost is just 1.5% per year.  Total over 10 years is about $15.  Subtract $15 from your $140.  Isn’t this a wonderful investment?

We need to talk about taxes.  The IRS does not want to wait and tax you on all the money you are going to make with the Zero Coupon Bonds.   So they created a thing called imputed interest. They collect tax on the money you are going to make.  This costs about $.80 year or $8 over the 10 years.  Don’t forget to subtract the $8 in taxes from your fabulous investment!

You started with $100 and expected to end up with $140!  After we took out a few “small” expenses and end up with $88 ($140 – $8 – $3 – $18 – $15 – $8).  Your principle and the 40% return were guaranteed but, so were the all of the fees you agreed to when you signed the last page of the prospectus.

I can’t tell you what you should do with your money but, I can give you 5 simple ideas that can help you with your future investments.

- KISS = Keep It Simple Silly.

- Only invest in what you understand.

- Use ultra low cost index funds.

- Use your critical thinking skills and learn what you are doing.

- If it sounds too good to be true; it probably is.

If you wish you can read more about this type of product at this FINRA (Financial Industry Regulatory Authority) investor alert page.  More information about investing can be found at http://polarisfinancialplanning.com/

NOTE:  This post is part of an ongoing education series.  This information is for educational purposes only.  This information does not constitute investment advice.  No rational person would make investment decisions based on a blog post.  Please consult with your financial advisor before taking any action.  If you think it is OK to make investment decisions based on a blog post, then for the love of the FSM – Stop reading this blog.

Money Monday

Diversification is one of the most important things you can do to reduce the risk in your portfolio.  If you have all of your money in one stock in could go up 100% or lose 100% .  If you owned Enron or Kmart you could have lost all of your money.  Risk can be measured mathematically and it is called volatility.  This is an image of a stock with high volatility.

Below is a picture of stock with low volatility.  In this example, the stock went down.  Volatility is not related to the direction of the stock price but to the rate of change (up and down) in the price.  More movement equals more volatility which is said to be more risk.

If you own only one stock you could get a big surprise if the company does not make its expected revenue numbers.  If you own more stocks, the effect of one stock becomes much smaller.  The idea is that while some stock go up – some go down but on average they go up with much less volatility. 

From Wikipedia…

In 1977 Elton and Gruber worked out an empirical example of the gains from diversification. Their approach was to consider a population of 3290 securities available for possible inclusion in a portfolio, and to consider the average risk over all possible randomly chosen n-asset portfolios with equal amounts held in each included asset, for various values of n. Their results are summarized in the following table. It can be seen that most of the gains from diversification come for n≤30.

Number of Stocks in Portfolio	Average Standard Deviation of Annual Portfolio Returns	Ratio of Portfolio Standard Deviation to Standard Deviation of a Single Stock
1	49.24%	1.00
2	37.36	0.76
4	29.69	0.60
6	26.64	0.54
8	24.98	0.51
10	23.93	0.49
20	21.68	0.44
30	20.87	0.42
40	20.46	0.42
50	20.20	0.41
400	19.29	0.39
500	19.27	0.39
1000	19.21	0.39

The Important thing to see is that 1 stock has a volatility of  100% and 30 stocks have a volatility of 42% (of one stock).  With more stocks you dramatically decrease the volatility / risk.

Most investors do not have the funds to buy stock in 30 different companies.  Just $5,000 per company would take $150,000 plus all of the fees involved to make the trades.  What you can do, is buy a diversified stock mutual fund or even better – an index fund.

NOTE:  This post is part of an ongoing education series.  This information is for educational purposes only.  This information does not constitute investment advice.  No rational person would make investment decisions based on a blog post.  Please consult with your financial advisor before taking any action.  If you think it is OK to make investment decisions based on a blog post, then for the love of the FSM – Stop reading my blog.

Money Monday

Today I will show you how great stock pickers are able to find the winners – every time.  Now when you get a tip via a call or an e-mail from a broker you will know how they do it.  Now you can do it too.  If you use this same method you can guarantee a correct prediction on a stock.  With this system you can win every time.

I found this video from Darren Brown.  He calls it the system and I will stick with that name.  He uses it on horses but, I will tell you how to do it with stocks.  It is even better with stock because they can only go up or down.  It is so easy – it will blow your mind.  The same secrets apply to stocks as it does for horses.  Watch this video to see how it works.  Don’t skip ahead… YOU NEED to see how well this works.

In part 2 you see how it works with a coin toss.  A coin has only heads or tails and a stock only has up and down.  Watch and learn.  When we are done you will be able to pick 10 winners in a row.  This system is guaranteed.  You will be able to win over and over again.

Here is part 2.

Part 3 gives another demonstration of the power of the system.  The system uses the power of statistics and probability to make amazing predictions.

By the end of part 3, our gambler has won 4 times in a row.  Proof that the system works.

This is the same thing that happens with the best stock pickers.  They give you a tip and you put a little money down and your stock goes up.  Next time you buy more and make more.  As you gain more confidence in your stock picker – you can invest (bet) more money.  Now you will see that you can do it all on your own.  Here is part 4.

Now you are starting to see how it works.  It is the same way with stocks.

Here is the part 5!

Someone had to win with each bet.  A stock picker can do the same thing.  They will call dozens, hundreds or even thousands of people.  They will tell half of the people that a given stock will go up and the other half will be told that the same stock will go down.  Those that lose never get called again.  The winners are called again and get a new stock tip.  So with just 16 people to start with a stock picker can get 4 in a row for one lucky person.  Now that person will do just about anything.  Even borrow money from friends.  They may or may not make money.  It does not matter to the broker.  Each time you buy or sell a stock, you make will make the broker money.

Now, when someone calls you with a hot stock tip, you will know what to do – RUN!

I have been asked to give a presentation to the St. Louis Skeptics.  It will be January 7th at 7PM.  We will meet at Jack Patrick’s on the corner of 10th and Olive, downtown St. Louis, MO 63101

If you are in the area stop in and join around 100 of the coolest skeptics you could ever meet.  The presentation will be “Skepticism and Investing”.  This presentation takes a critical look at investment strategies and some investment scams.

I hope to see you there!

NOTE:  This post is part of an ongoing education series.  This information is for educational purposes only.  This information does not constitute investment advice.  No rational person would make investment decisions based on a blog post.  Please consult with your financial advisor before taking any action.  If you think it is OK to make investment decisions based on a blog post, then for the love of the FSM – Stop reading my blog

From CNN.

Fidelity reported that, as of the second quarter, 2.2% of all 401(k) participants had made a hardship withdrawal at some point over the preceding 12 months. That’s up from 2% in the prior year, and was the highest level in 10 years.

There are many things that you can look at that can point to strength or weakness in the economy.  This is not a good one.  If more people take more money out of the market that puts downward pressure on the market. 

At the same time, the percentage of 401(k) participants that had an outstanding loan from their account rose to a record high of 22% in the second quarter. The average loan amount was $8,650 at the end of the quarter.

That shows that many people have taken money out of their retirement.  Again, not a good sign.  So, more people may have to work longer before they retire.  It also shows that people need money today to pay their bills.

The top reasons people took loans and made withdrawals were to prevent foreclosure or eviction, pay for college, or purchase a home, according to the firm.

Good and bad here.  If home values go up then they should be able to pay the money back.  However, some of them are probably out of work.  It sure looks like the two most important things for the economy in the short run is employment and home values.

NOTE:  This post is part of an ongoing education series.  This information is for educational purposes only.  This information does not constitute investment advice.  No rational person would make investment decisions based on a blog post.  Please consult with your financial advisor before taking any action.  If you think it is OK to make investment decisions based on a blog post, then for the love of the FSM – Stop reading my blog.

Today we are going to talk about life insurance.  There are many different types and it can get very confusing.  One of my basic investing philosophies is KISS (Keep It Simple Silly).  If you don’t understand what you are buying – YOU SHOULD NOT BUY IT!

Today I will talk about the difference between Whole and Term life insurance.  Term insurance lasts as long as you pay for it.  It is like car insurance, if you stop paying the bill, the insurance stops!  Term insurance is VERY cheap because your odds of dying are very small, at least while you are young and in good health.  However, Term insurance will adjust (and go up) each and every year.  When you get over 50-60 it gets quite expensive.  You can also get term that keeps the rate same for 10, 20 or even 30 years.  You start by paying more – but the payment will stay level. 

Whole insurance is a type of permanent insurance.  It will last until you die, if you pay the bill!  It starts at a much higher rate but, never goes up.  Generally, these policies will have an age at which they end, often 100.  It is very hard to buy straight whole life.  Usually, it is sold as insurance and investment combined.  They will give you projected returns which almost never come true.  This type of policy also costs much much more per year.

There are many other types of life insurance.  I will cover some of them in later posts.  With some rare exceptions, I generally think the more complicated an insurance policy it – the worse it is for you.  Remember KISS!  I also think that insurance is a poor investment.  I am a strong proponent of, “buy term and invest the rest.”

I will now go over a specific example of Term vs. Whole life.

Our sample person is a 30 year old male and has his first kid on the way.  He is in good health and does not smoke or engage in risky activity.  He wants to have life insurance long enough for this child and any others that may show up to make it thru college.  He thinks that $1,000,000 should do the trick so he starts to compare the two choices. 

The 30 year level pay term insurance will cost as little as $700 per year or less than $60 per month. He will have $1,000,000 of insurance from the age of 30 to 60.  After that time more insurance will be quite expensive.  The same coverage could be about $5,000 – $6,000 per year. 

Whole life will cost this same person about $9,600 per year.  You not only have the insurance but you can build cash value.  If needed, you can loan yourself money.  However, it often takes several years for the cash value to start to build and the extra funds from the first few years pay all of the expenses and you may have a cash value of $0 for several years.  After that the money may grow at 2-4% per year.  A sales person may show you a projection with 6 or 7% return as an estimate.  Your return is determined by the insurance company.

Now some fancy math…. 

If you buy the Whole life you will have $1,000,000 in life insurance for the rest of your life.  If you make it to 100 years old – They give you the $1,000,000.  If you want any money out your insurance before then you have to take a loan against your insurance and those you care about may get less than you expected.

If you buy 30 year level pay term and invest the extra $8,900 in the stock market and make an annual return of 10% per year your investment will have a value over $1,000,000 in just 26 years.  You won’t need to borrow money – you have money.  After 30 years you let the term policy expire.  The kids are grown, out of college and you now have $1,600,000 – who needs insurance?

After the 30 years are over you can retire and spend your money or if you don’t need it, let it keep growing.  Let’s say you die at the age of 80.  What would you prefer to leave to your wife and kids….$1,000,000 or around $10,000,000?

NOTE:  This post is part of an ongoing education series.  This information is for educational purposes only.  This information does not constitute investment advice.  No rational person would make investment decisions based on a blog post.  Please consult with your financial advisor before taking any action.  If you think it is OK to make investment decisions based on a blog post, then for the love of the FSM – Stop reading my blog.

Historically the US market is around 70% large cap, 20% mid cap and 10% small cap.  The market can also be divided as 50% Growth and 50% Value.  Mid and Small caps tend to provide slightly higher returns over long periods of time. (As always, past performance is no guarantee of future results).  However, they also tend to have volatility that is even higher.  Investments in Mid Cap and Small cap segments above market norms should be reserved for investors with higher than average risk / volatility tolerance. 

Below is the historical performance 6 US market segments.  I divide the US market this way to try and decide where to invest money.

Data as of 3/31/10

This is only one source of information I generally think of it as a contrarian indicator.  That is to say, the better one of the segments has done and the longer it has exceeded the long term mean the less desirous it is.  As can be seen above all six US segments are UP (way up) over the past 12 months.  This could be a small cause for concern.  However, if you look at the 3 year average, they are all negative so the market has not been running hot for years in a row.  The 12 month return only looks so good because the previous 2 years were so bad.  Over 3 and 5 year time frames the performance of each segment is about the same. (within a few percent of each other). 

The 10 year returns do seem to indicate under performance from growth investments with a stronger effect on Large cap vs. small cap and may indicate an opportunity.  On the other hand this could be a result of the dramatic losses suffered by these segments around 9 – 10 years ago after several years of dramatic and unsustainable growth.  This same long term situation existed 6 months ago.  So if you would have put all of your money in growth then you would have missed some of the returns that have occurred in the value segment.

tip to One good move.

There is a growing set of funds called “Faith based mutual funds”

These funds usually choose things to avoid.   Let me give you a few examples.

The Timothy Plan (Investing with Biblical Principles)

The Timothy Plan® family of funds employs specific moral screening criteria designed to avoid investing shareholders’ money in any company that has a pattern of contributing to the cultural degradation of our society. As a result, the Timothy Plan’s screens prohibit investing in companies involved in abortion and/or pörnography, non-married lifestyles, as well as companies involved in the production of alcohol, tobacco or gambling.

Who decides which biblical priciples?  Is it ok to invest with slave traders?

However, you may purchase male or female slaves from among the foreigners who live among you.  You may also purchase the children of such resident foreigners, including those who have been born in your land.  You may treat them as your property, passing them on to your children as a permanent inheritance.  You may treat your slaves like this, but the people of Israel, your relatives, must never be treated this way.  (Leviticus 25:44-46 NLT)

Here are some of the types of companies they wont invest in Alcohol, I guess they wont invest in companies that provide wine for churches.  Whoa… that will blow your mind.  And no Tobacco, Gambling or  Pornography companies.

They promote a long list of virtues but I think my favorite is “Piety”.

Piety gives us a sense of duty to uphold the moral standards upon which our great nation was founded.

It appears that sucking up your money is a christian value.  The “A” class of shares start off by taking 5.5% of your money as a front end load.  That is followed up with above market expense ratios.  The Timothy Plan Large/Mid Cap Growtha “A” fund has an annual expense ratio of  1.56% and the average growth fund is about 1.39% and a nice no load index fund is about ) 0.20%.   This fund has a total five year return of about -5% while large cap funds have returned 10% and Mid-Cap funds have returned 17%.  So you have a net performance of -27% when compared to the average mid cap fund and -40% when compared to the Vanguard Mid-Cap Index fund – Ouch!