Rick Kahler's Financial Awakenings

The current bewilderment and surprise over the “subprime” crisis that is shaking the financial and real estate markets would be funny if it weren’t so sad.

This meltdown in the U.S. credit markets was predictable. It can be traced back to a combination of unintended consequences from government policy and excessive risk-taking by lenders.

The price of real estate, like most investments, cycles according to the universal law of supply and demand. Raise demand and prices increase. Lower demand and prices drop. It would seem inevitable that a housing boom created by the easiest credit available in modern history would someday go flat.

“Subprime” loans were, in part, a policy decision of the U.S. Government in the late 90’s to increase home ownership from 64.2% to 67.5%, according to statistics cited in a recent article by Holman Jenkins, Jr., in The Wall Street Journal. Subprime loans are those made to borrowers who do not qualify for the lowest interest rates because of their deficient credit. By making mortgage money available to those who normally would not be able to qualify, demand for housing increased.

In addition to subprime loans, other offerings included zero-down payment first mortgages, home equity loans that even exceeded the value of the home, and interest-only loans made to credit-worthy buyers. All these contributed to the increase in buying power and demand for housing. Builders could hardly keep up. Prices rose as the surge in buyers bid up prices on an inelastic supply of housing.

Buyers who normally could not qualify for the larger loans “shot the moon,” gambling with no-interest loans and subsidized initial loan payments. The ensuing payments on these high loan amounts amounted to up to 50% of their take-home pay. Many rolled the dice, hoping that when the payments increased a few years in the future, they would have received significant pay raises to cover the increase.

The trouble with gambling is that sometimes you lose. Today, millions of borrowers who gambled and lost are being forced to sell their homes, all at the same time. When a glut of homes hits the market, at the same time that fewer buyers are available, prices fall. This sell-off should continue for the next few years as these loans all come due.

When the price of a home purchased with nothing down falls by even one percent, the seller must come up with cash at closing to fully pay off the loan. Since most of these buyers had nothing to put down in the first place, they don’t have that cash. Lenders are faced with losing the difference or foreclosing on the loans and taking the houses to sell themselves.

Again predictably, subprime borrowers and their elected officials are looking for someone to blame. Perhaps they don’t need to look far. A recent study cited by The Wall Street Journal, done by Carolina Katz Reid, suggests the fundamental cause may be a flawed government policy.

Reid’s study addressed the issue of whether low-income households actually benefited from subprime loans created with the intention of bringing them the American Dream of home ownership. Her study found that 53% of them returned to renting within five years after buying their home. She concluded that high housing payments left less money for education and necessities. Families were also geographically tied down and less likely to relocate for better jobs.

We’ve long had a stereotypical image of the evil, greedy banker saying “no” to the poor but honest mortgage applicant. Maybe those bankers aren’t so evil after all. Maybe the real villains are those who encourage people to incur mortgage debt they can’t afford.

How much can you withdraw from your portfolio and be relatively sure you won’t outlive your money? Jon Guyton, CFP, one of the leading authorities on portfolio withdrawal rates, suggests you can withdraw up to 5.5% of your retirement nest egg and have enough money for the rest of your life…..IF you follow three simple rules.

Join Jon and Rick for answers to the number one question asked financial planners and investment advisors: “How can I be sure I won’t outlive my money?” Click here to go to the KFG Client Only section of our website. If you are not a client and would like a one-time special authorization to hear this timely teleclass, please call Lindsay at 605-343-1400 for a temporary password. Continue Reading »

Last week I received an inquiry from a reporter who writes for a well-known national news magazine. It read, “I am trying to find individual investors from all walks of life (blue collar, immigrants, retirees, etc.) who are ANGRY and would be willing to talk about it. Who do they blame for this mess and why?”

My response was, “When you have found and interviewed those ANGRY investors, would you give them my contact information? Investment advisors doing their jobs properly have prepared their clients for times like these. I haven’t received ONE phone call from a client who is panicking or angry!”

While the rest of the investment world had a frenzy over the stock market decline last week, investors with solid, diversified portfolios took the decline in stride….maybe with a yawn. We’ve “been there and done that.”

Indeed, the Dow’s decline from its all-time high on July 19th to August 20th was about 6.5%. However, a portfolio with good asset class diversification (in this case nine asset classes) was down around 4.8%. That is 26% less of a decline than the Dow. This decline is a little more than the decline a diversified portfolio experienced back in February, when the Dow was down about 4% in one week. The difference is that the decline of the past month is much broader than just the Dow Jones or the S&P 500. The current decline has hit almost every asset class, with only cash having a positive return. Of the remaining asset classes, the two that are down the least are bonds and market neutral funds. The balance of the asset classes are down 5% to 8%.

Readers of this column know I’ve written repeatedly that the markets of the past four years were doing far better than what my models show is sustainable over a long period of time. Savvy investors know that what goes up will not continue to go up forever. Indeed, my experience is that about every five years we experience a market where almost nothing in our portfolios increases. This is the nature of investing.

Personally, I think another 5% to 10% fall in the Dow would be a good thing, washing a lot of optimism out of the market and building a solid foundation for another advance. But it really doesn’t matter what I think, does it? The market will do what the market is going to do. We just need to have well-diversified portfolios and hang on for the long run.

Long-time readers also know that most investors know very little about asset class diversification. Heck, most advisors don’t practice it, either. Polls show that three-fourths of financial planners don’t practice asset class diversification with their clients.

What is asset class diversification? In addition to the usual asset classes of US and international stocks and bonds, a diversified portfolio will also include real estate, commodities and natural resources, market neutral funds, junk bonds, and Treasury Inflation Protected Securities (TIPS).

The key to investment success is having reasonable expectations. It is normal for a diversified portfolio to have annual returns anywhere between -10% and +25%. The last five years have seen diversified portfolios produce average returns of 12% to 18%, well above our expected long-term returns of around 7%. When you know that a -10% return one year is as normal as a 25% return the next year, you don’t panic. You don’t make “the big mistake,” which is selling low and buying high.

If a portfolio is well-diversified, about 50% of the roller-coaster volatility is eliminated. Investors don’t panic, because they have no reason to.

The cover story in the August 6, 2007, issue of U.S. News & World Report featured Warren Buffett, the second-wealthiest person in the United States and perhaps the world’s most famous investor. The headline read “How to Make Money the Buffett Way.”

A more appropriate headline might have been, “Don’t Try This at Home.”

According to the magazine, someone who had invested $1,000 with Buffett in 1956 would have $27 million today. That’s an annual return in excess of 22%, impressive by anybody’s standards. It’s certainly more than I or any other reputable financial advisor would lead our clients to expect over the next 51 years. Most prudent investment analysts are expecting total returns from a diversified portfolio of large company stocks in the range of 8% to 12%.

Does that mean we are all misleading our clients or missing some simple secret to building wealth? Not at all. Investing in individual companies rather than building a diversified portfolio through mutual funds is simply not a wise option for ordinary investors.

Suggesting you try to make money “the Buffett way” makes about as much sense as suggesting you try to play golf “the Tiger Woods way.” If playing golf is your dream, if you have that talent, and if you’re willing to take the risks and do the hard work it takes to succeed—then go for it. Of course, it might have helped if, like Woods, you had started learning the game when you were three or four.

Just as golf is Tiger Woods’s business, investing is Warren Buffett’s. He started his first investment company when he was in his 20s. Researching companies’ performance, management, and future possibilities is what he does. He understands economics and is skilled at evaluating balance sheets, weighing management competence, and assessing probable risks against probable gains. Investing is his talent. He’s obviously passionate about it as well as very good at it.

Studying the masters is certainly one way we can increase our understanding of the activities that are important to us. A recreational golfer might enjoy and learn from a book or video about how Tiger Woods plays the game. An average investor might learn a few things from a book about Warren Buffett’s investing strategies. This doesn’t mean they should quit their day jobs. A weekend golfer isn’t going to become another Tiger Woods. Neither is a part-time investor going to become the next Warren Buffett.

In my 25 years of managing money, I’ve had a number of clients insist on placing a portion of their portfolios in individual stocks. After warning them of the risks, I typically set aside 5% to 10% of their portfolio and let them trade to their heart’s content. The experiment typically lasts about two years, by which time they figure out the mutual fund portion of their portfolio has garnered higher returns with far less volatility.

There is, however, one thing average investors could learn from Buffett. The U.S. News article quotes him as saying you need “the temperament to control the urges that get other people into trouble in investing.” It mentions his patience and his ability to buy when other investors are selling.

In other words, you need the ability to make your investment decisions consciously. You are likely to be a more successful investor if you understand the unconscious beliefs you have developed about money and realize how those beliefs guide your financial choices. Identifying and learning how to change your money scripts can help you avoid the “panic and sell” mistakes that so many novice investors make.

It can also help you avoid the mistake of thinking you’re Warren Buffet.

Here’s a riddle for you. What is something that you can’t afford to have, you can’t afford to be without, and you hope you never have to use?

The answer, of course, is “health insurance.” Actually, the whole topic of health insurance is a riddle, so complex and tangled that no one seems to have an answer for it. The problem of how to pay for health care has so many facets and so many causes that we don’t even know where to start talking about it, much less trying to solve it.

Out of this tangled riddle, one thing is increasingly clear. It’s more important than it has ever been for each of us to be active consumers of health care services and health insurance. The concept of low-premium, low-deductible health insurance plans routinely provided by employers belongs to the “good old days.” It’s becoming harder and harder for businesses, especially small companies, to find health plans that they and their employees can afford.

As a result, it’s increasingly up to individuals to find their own health insurance. One option—sometimes the only realistic option—is a plan that has a high deductible. Some of these plans may also pay part of the cost of doctor visits and prescriptions, though others do not.

Another choice to explore is a Health Savings Account. This is a combination of a high-deductible insurance plan and a personal savings account that is similar to an IRA. You pay the insurance premium, and you make regular contributions to the Health Savings Account. Then you can withdraw money from the account as you need it for medical expenses.

My research has found there isn’t much difference in premium costs between a Health Savings Account plan and a simple high-deductible health plan. So why not just get the health insurance and set up your own savings account?

The main reason is that money you put into a Health Savings Account is tax-free. When an HSA plan is offered through an employer, the employee contributions are taken out before payroll taxes are computed. For individual HSA plans, you get a tax deduction for the amounts you contribute, up to the amount of the insurance plan’s deductible.

Money you withdraw from the HSA is not taxed, either, as long as you use it to pay qualified medical expenses. These include expenses that normally are not covered by health insurance, such as dental and eye care, counseling, non-prescription medications, alternative treatments, preventive care, and medical aids such as wheelchairs.

If you don’t use all the funds in the account, they remain there as savings toward your retirement. Generally, you don’t have much control over how the funds are invested. You do pay taxes on any amounts you withdraw for non-medical expenses. In addition, there is a 10 percent tax penalty on any non-medical withdrawals you make before the age of 65.

A Health Savings Account plan may be one of the better options currently available for individual health insurance. Before you go this route, however, it’s important to do some research. This means far more than getting one quote from one insurance company. Ask questions. Compare plans. Make phone calls to several companies. For the computer literate, the internet is a great way to find out more.

The riddle of affordable health care and health insurance is one that has no clear right answers. For now, we have to settle for guesses that are close enough. It’s up to each of us to make the most educated guesses we can in order to find plans we can live with.

For KFG clients only, I’ve added an investment update to the KFG Client Only section of the website. The update covers each asset class we use in our investment portfolios. The update includes a downloadable Morningstar Report of the managers we use, plus a video on the managers I am following and my surmisings on the performance of each. I also include my current thinking on a number of ETFs I am following.

Now, all that being said, I am not sure the format I used will really be interesting, useful, or of assistance to you…….so if you choose to view any of the videos or listen to the audio (in mp3 format) drop me an email as to what you think. I will not be offended if you concur that watching me “hem and haw” over investments is akin to watching sausage being made!

To view the updates, go to the KFG Client Only section of the website by clicking here and entering your user ID and password, and then click on “Workshops, Teleclasses, and Events.”

KFG is proud to sponsor a workshop that is designed for anyone who would like to learn more about facilitating change in others. Dr. Ted Klontz is one of the nation’s leading researchers and authorities on why people change. He will address the familiar situation of those who resist another person’s best efforts to help them help themselves. As anyone knows, a significant number of people fail to consistently follow through on even the best of strategies others suggest to change their life for the better.

Research tells us that resistance and ambivalence are the absolute norm for those who express a desire to do something different. The most successful “change agents” understand this and possess skills and tools to help others change. It is our experience that there are a number of tools anyone can use to help others change their self-defeating behavior.

This workshop is designed to give you the opportunity to learn and practice these state of the art, research-supported communication skills and tools. This “change technology” is a valuable aid to help others who are stuck begin to deal with the issues they can’t resolve. It has been demonstrated to increase the effectiveness of behavior change interventions, regardless of the topic, up to 400%. Participants in this residency will have the opportunity to:

• Learn and practice new and effective tools that you can use immediately
• Learn and practice the stages of the change process
• Learn how to uncover the hidden beliefs that keep people stuck
• Learn experiential tools to help you communicate with others more effectively
• Obtain gratifying wisdom that will transform your life, your practice and your profession

The workshop is August 31, 2007, at the Howard Johnson’s Executive Room from 9 AM to 4 PM. The cost is $95. The session is approved by the NBCC, NAADAC, and ASET for 6 hours of continuing education for mental health professionals. To register call 605-343-1400, or click here to register online.

How much can you withdraw from your portfolio and be relatively sure you won’t outlive your money? Is Rick’s rule of thumb of 3% too conservative? Can you withdraw up to 5% and be sure to have enough money. Jon Guyton, CFP, one of the leading authorities on portfolio withdrawal rates, suggests you may be able to if you follow a very specific formula. Jon will join Rick for a timely and intriguing discussion on safe withdrawal rates. To register click here.

Rick will be a guest on Courtney Bedard’s Talk Radio program, WHJJ 920, in Providence, Rhode Island on Saturday, August 18th. The program is from 3:00PM to 4:00PM, MDT. Courtney will have a money coach on the first half of the show, followed up by Rick on the second half. Rick’s interview will focus on his work with the psychology of money and how integrated financial planning can move people exponentially faster toward accomplishing their financial goals. You can listen to the interview on the Internet at www.920whjj.com.

A former Irish partner of mine was fond of calling life’s various adventures, “an experience in living.” Well, I had a new experience in living this weekend. An approaching thunderstorm was said to have quarter-sized hail. I quickly moved our vehicles into the garage and told the kids to pick up any toys they didn’t want damaged. My wife declined my offer to move her potted flower plants inside saying, “Oh, they’ll be fine.” That turned out to be a mistake.

The quarter-sized hail turned out to be of the baseball to softball variety. It was actually a bit scary hearing the thuds against the roof and wondering if the skylights were going to withstand the onslaught of ice. Of course, the kids thought the experience was awesome. The hail continued for about 10 minutes or so, accompanied by about 4″ of rain! We needed the rain, but could have done without the hail.

My house suffered some damage, how much I don’t really know. After calling my insurance agent, I was reminded that whatever damage I have better be a lot as my hail deductable is $3,600! I sense I’ll be paying more attention to my homeowner’s insurance policy in the future. As I have said many times in the past, all of a writer’s experiences in living are simply column fodder.