Investment Advice for Fun and Profit 
[Theirs, not Yours!]

Richard. A. Lawhern, Ph.D.
Last Update: November 2006

Table of Contents

An Offer by My Insurance Company

A Lesson Learned:  Disadvantages of Consumer Credit

Recommendations for Re-balancing Investments (Wups?)

Long-Term Return on Investment

Problems with Advice Based on 77 Years of Market Data

What the Senior Adviser Said

My Retirement Future

Other Lessons Learned

Finding Somebody to Help You

An Offer by my Insurance Company

In December 2004, I received a flier in my snail mail (US Postal Service). It described retirement planning services offered by an insurance company with which I have done business for over 30 years.  I believe this outfit to be reputable and solid, despite their having resisted a couple of my storm damage claims rather obnoxiously.  Their rates see pretty reasonable.  They try to pay attention to their policy holders' concerns.  And I'd been thinking for some time about sitting down with a professional financial planner to sort out my retirement income plan.

However, based on the experience I  had at the time, I concluded that these won't be the people who advise me on my retirement planning -- and nobody who operates in a similar way should be your adviser, either.   I won't name the company, because such characters have a bad habit of suing people like me who see through the truck-sized gaps in their sales pitch. I don't intend to spend the rest of my life fighting lawyers.  However, I hope that readers of this article may find  a few ideas here that might save you money and get you better financial advice than I did on my first attempt.  

Let me explain...

I'm like a lot of other middle-aged Americans.  I've worked hard 40+ years and achieved modest success.  I earn a decent living as an engineering professional, though I'm by no stretch of anybody's imagination,  "rich."  My wife retired a couple of years early, due to problems with a chronic pain condition in her face.  I am old enough to need to think about retirement sometime in the next few years.  My problem is that I don't know if I can afford to retire, or where, or in what style we should expect to live if I ever do.  

So, like a lot of other people in my position, I've been thinking about talking with a professional financial planner, to sort out such questions. When I got the flier from my insurance company, it seemed like a good place to start.  For a little less than a thousand dollars paid in monthly installments over a year, a Certified Financial Planner would walk me through a list of questions about our family finances, prepare a financial plan, and offer guidance for realigning my assets and investments to meet my personal objectives.   I'd been hearing a lot about the high fees that some financial planners charge -- so $1000 dollars didn't sound unreasonable.  I figured, "what the heck?"  It couldn't hurt to look into this.

I quickly learned that I could answer the financial questionnaire through the website of my insurance company.  That's certainly helpful.  It took about 90 minutes to survey my income and property tax records, check my insurance policies, and make a list of our income and expenses.  I was also guided through a series of questions to learn what kind of investors my wife and I are -- what our tolerance is for risk and the up-and-down movement of stocks, bonds and other investments. After I entered my data, a financial planning technician  contacted me by phone, to go over my entries and clarify a few details.  

So far, so good. 

I was then provided a copy of  my proposed financial analysis and planning guidance on-line, and an appointment for a phone review of the plan with a Certified Financial Planner, where I could ask questions.  I made the appointment for a 45-minute initial telephone session.  Meantime, I studied the plan.  

One Lesson Learned:  Disadvantages of Consumer Credit and Advantages of 401K Plans

When I talked with the CFP, I immediately learned that in at least two areas of our financial life, my wife and I have been doing something right.  (1) We carry  very little consumer credit from month to month, and (2) I have maxed out my contribution to my employer's 401K retirement plan.   

Consumer credit can eat your future alive when you indulge yourself in large doses. Credit card interest rates are much higher than mortgage loan interest. Allowing this kind of debt balance to mount up might mean that you're paying only the minimum payment each month -- and watching your total debts increase from month to month.  You can end up paying more than double the amount of your debt over time, if you use credit cards to finance a life style that your earnings won't cover. If you do that long enough, you're headed for bankruptcy, along with about 4% of other Americans.  Really dumb idea!

On the plus side, employer 401K plans give you a chance to save money that isn't taxed first (and therefore reduced).  Many employers also partly match your contributions.  It's like getting a tax-free salary increase. This means your retirement savings can grow faster, in whatever investments you've placed in your plan.  There are even "catch-up" provisions that let you contribute more than the usual tax-free limit, if you are over 50 years old and haven't contributed as much in the past as you are permitted.   Just about all of the retirement planning information that I've seen in the past few months suggests that saving this way is a very good idea.  

However, to keeping your 401K plan growing, you need to be sure that your investments are going into the right categories. Thus, when I talked with the Insurance folks' CFP, our discussion focused on two subjects: 

       (1)  The advice offered in my financial plan for re-balancing my assets between investment categories, and 

      (2) The planning model and other tools that the CFP used to arrive at his recommendations.  

Recommendations for Re-Balancing My Investments - Wups?

The advice I received concerning the asset allocations in my investment portfolio can be summarized in the following table:

Table 1:  Investment Mix

This table tells me to invest all of my present money market funds  in income-producing securities, and to add some different categories of securities.   The recommended mixture of assets is supposed to represent a "moderate" portfolio --  that is, a mixture appropriate for someone who has moderate tolerance for risk and who wants to be sure that their assets don't get eroded by inflation.  The table was also accompanied by a summary of long-term historical rates of  return from the old and new mixtures of assets, shown below:

Table 2:  Long-Term Rates of Return on Investment

Table 2 might seem rather intimidating if we take it all in one bite.  But the picture isn't as complicated if we look at one row at a time.  

The first row shows the percentages of three types of assets that I now hold, versus percentages that the financial planner recommended

The second row is the historical average rate of return (the gain in value per year, assuming all dividends or income are reinvested) from 1927 to  the present, for these investment mixes.  For the investments I now hold, that return would have been 7.03% per year. The average return over the same period for the new investment mix recommended by the CFP was 8.34% per year -- about 1.3% better than the long term performance of the mixture I now have.  

You might think that such a difference would be pretty insignificant.  But we have to remember that "compound interest" can become a very large number over a long enough period of time.  During  the remaining 25 years of my life expectancy,  the net growth of an investment at 8.34% is about one-third larger than at 7.03%.  So I'll concede that the planner seems to be trying to help.  What bothers me is the bottom three rows of the table. 

In the bottom rows of the table, the left side tells us that my present mixture of investments had a maximum gain of 30.69% in value for any year during the last 77-year period.  The maximum loss was -15.77% in one year.  The term "standard deviation" refers to the famous "bell-shaped curve" of statistics.  This is a measure of the year-to-year variation in rates of return -- both above and below the average value for the whole 77 years taken together.  

As a book about statistics will tell you, for a "normal" (bell-shaped) distribution of results, about 60% of all the rate of return numbers above or below the average will fall within plus-or-minus one standard deviation from the average. About 93% of all differences will fall within plus-or-minus two standard deviations.   

The left side of Table 2 tells us that from year to year, the standard deviation on rate of return is plus or minus 8.43% (compared to 7.03% average gain). So, for about 45 out of 77 years,  rates of return will be different from the long term average by +/-8.34% or less.   In other words, a bit less than 60% of the time, I'll make money -- even it it isn't a lot of money in some years.  However,  in the remaining 33 out of 77 years, the difference from the average would be even larger than 7.03% (I would either have a sizeable gain or perhaps a serious loss).   In about one year out of five, I would have had a net loss of value in my investments, if I had held the same mix for 77 years.    

The right side of Table 2 tells an even more interesting story.  For the financial planner's recommended allocation of assets,  the maximum one-year investment gain during the past 77 years was about 5% better  than in my present investment mix. But the maximum one-year loss was 9% worse (24.7% -15.77%).   The year-to-year variation in return around the average was also considerably larger than for my present mix.  For the past 77 years, my rate of return would have been more than +/-12.5% different from the long term average, in  about 27 out of 77 years.  Thus in about one year out of every four or five,  my losses will have been even larger than in my present portfolio.  Indeed, in at least some instances, such losses might have occurred in two or more years in a row.  

Woof!  That's a pretty scary prospect, if you're watching stocks take a nose dive!  With this kind of performance, it's little wonder that millions of small investors got out of the stock market entirely during 2001 to 2003!  And for those who didn't, a lot of folks took a real roller-coaster ride. 

It seems to me that the financial adviser interpreted my risk-related questionnaire to mean that I wouldn't lose sleep if I watched  my stocks or bonds jumping around on a yo-yo from year to year.  I suppose I should offer him thanks for the vote of confidence.... I think! 

However, I suspect this amount of market volatility would make most people pretty nervous.  I know it would make me nervous.  It isn't the unexpectedly pleasant surprises that turn an investor's hair gray -- when we do much better than average returns.  It's the down-side losses when markets go into recession and we lose money.  Since the mid 1990s, we've seen a rather large amount of that.  So why do we expect the next 25 years to be different? 

Problems With Advice Based on 77-Year Averages

The kind of results I've reviewed above have an important sequel.  In my first telephone interview with the Certified Financial Planner, I asked several questions about the tools he used to come up with the advice he offered.

(1) Why is a planning model based on 77 years of data appropriate to help me plan the next 25 years?

(2) What organization originally created the Monte Carlo model that you use?

(3) What data were used to populate this model?

(4) What other organization has independently validated the model against the historical performance of various types of investments?

(5) What major first-order assumptions will most influence the model's behavior and outcomes?

(6) How does investment performance for the past 15 years compare with the 77-year averages?  How should these differences affect my financial plan?

(7)  What is a "high yield" bond? Is it a junk bond?  And what are the risks of default for that class of investment?

As we talked, it turned out that this young fellow didn't have a clue about the answers to my questions. 

Now I ask you:  would you do business with a financial consultant who knows nothing about the tools he uses?  I sure as heck wouldn't!  I also learned that this guy had been with my insurance company for three and a half years.  This is his first job, starting fresh out of school with a bachelors' degree in business. He's obviously studied (coursework for a CFP certification takes about two years). But he's also not very experienced.

More important to me and maybe to you,  reader,  this guy simply does NOT understand the professional tools that his company requires him to use in developing my financial plan.  That doesn't make him a planner. It makes him a salesman.  He and his technician were little more than input/output clerks.  Would you trust the judgment of such a person to plan your retirement?  Hmmmm?   I also wonder how many of his colleagues know as little as he does.

A Senior Professional Weighs In

Based on the concerns above, I wrote my insurance folks a long letter and asked them to refund their financial planning fee. They must have gotten a bit concerned, because one of their senior directors called me to offer answers to my questions.  This was what I learned:

(1) Their planning model was created by an outfit that you and I have never heard of, out in California.  The company that wrote the model is considered competent and reputable in the asset allocation modeling field, by experts -- or at least, by my insurance people.  But very few investors have any personal first-hand knowledge of how such models work.  And moreover, very few of us bother to ask.

(2) The data used in the company's model were supplied by a second company (Ibbotson) that is widely regarded by experts as the best source of investment performance statistics in the US.  I've since verified that  Ibbotson actually exists and that most financial planners trust the data they produce.

(3)  No other organization validated the financial model, except the company that wrote it.  The idea seems to be that if the model didn't produce results that fit the economic data, nobody would be using it.  I suppose that makes a kind of sense -- though I admit that I'm still not really satisfied with that answer. It seems as if I have to trust the priest of one secret society to verify the honesty of a priest in some other secret society.  I'm also not convinced that the 77 years of economic data that they used has much relevance to the next 25 years of my life. 

(4) The major assumptions that went into my financial plan were (a) that inflation will continue at an average rate about equal to what it is now, and (b) the average rate of return for the recommended investment mix in the next 25 years will be about the same as it has been for the same mix during the last 77 years.  I find the latter assumption to be particularly shaky.  After all, we're living in an economy that doesn't remotely resemble that of the 1930s, -50's or even -70's.  

(5) I also learned that investment rates of return for the past 15 years don't compare well with those over the longer 77-year period.  In fact (the senior adviser claimed) rates of return since 1989 are significantly better  than the 8.34% rate of return in the recommended asset reallocation mixture.  The adviser felt that 15-year statistics would not be a good set to start from, in forecasting for the next 25 years.  He would rather use a more conservative set of numbers -- but that preference seemed to be more a matter of instinct than of any fundamental knowledge of economics.  

(6) Finally, t turned out, high-yield bonds are quite risky.  Last year, the default (also read "failure") rate for this class of bonds was two percent per month (roughly a quarter of all high yield bond issues defaulted last year!).  Why on earth would anybody advise a 60-year-old middle-class investor to put money into something that risky?  I'll be darned if I know. 

My Retirement Future

In fairness to these financial advice-givers, I must say that the information they provided was valuable in some ways.  At the very least, they startled me out of my trusting complacency.  In one key area, these discussions also forced me to take a much closer look at the questions I had been asking about financial planning.  I learned that I had been asking some  wrong questions. 

For instance, using their Monte Carlo model and the assumptions above,  my financial plan indicated that the chances would be 95% that my wife and I should be able to preserve our present net worth through the next 25 years -- without having to seriously reduce  our family expenses after retirement.  How nice.  However, buried deeply in my financial plan was an important "yes.... BUT!"  If social security benefits do not continue to increase at the same rate as inflation, then our likelihood of preserving our family net worth is only 15%. 

WOW!

Will somebody please tell me who in their right mind would assume social security benefits could possibly keep up with inflation for the indefinite future?  

A horrible (though apparently for some people still unacknowledged) fact of our National political life is that the Social Security system cannot remain solvent except as a pay-as-we-go system.  That is, younger people pay, and older people draw benefits.  For the past 65 years, this arrangement has worked fairly well, because older people died early enough not to strain the system.  But we live longer now, and there are fewer young people paying, for each older person who wants to retire.  

The actuaries who run Social Security tell us that in about the year 2018, the amount of money paid out of the Social Security Trust Fund to retirees may exceed the amount paid into the Fund in SSI taxes.  So what will happen then?  The liars we elected to Congress tell us that the Fund continues to be solvent for two generations (up to 2045), by liquidating bonds now held in the fund.   However, if you believe that load of horse-feathers, then I've got some good swampland in Florida that I'll sell you... cheap! 

The managers of the Social Security Trust Fund conveniently forget to remind us that the only way to liquidate the bonds in the Fund is for US government to pay them off... with your taxes and mine!  And that level of taxation is simply not going to happen, if we want our economy to generate new jobs or sustain the ones it already has. 

So what will happen?  My guess is that benefits paid by Social Security simply MUST begin to be reduced, starting about ten years from now. I don't think the system will collapse suddenly, because I cannot imagine Congress would be so stupid as to try to actually cash in any large amount of the paper IOUs (that's what a government bond is!) that make up the Trust Fund. If the process is managed with a bit of  intelligence, the total pay-out to elders will just about equal the total collected in SSI taxes from year to year.  And as more people retire and fewer younger people pay into the system, the amount of retirement benefits for each retired individual will be reduced over time.  

Stay tuned:  I'm still trying to locate a credible source for information on the long term cash position of the SSI Fund. 

Other Lessons Learned

One might think that the money I initially put into on my retirement planning analysis was a total waste.  However, it really wasn't.  Apart from prompting me to study more, the process also helped me learn about some basic principles that will guide my retirement planning in the future.  I offer those principles to you, the reader.  Please think about these ideas, even if you're tempted to ignore them because they are difficult -- or because they challenge your fantasies about dying rich without struggle or learning. 

(1) Recognize that retirement planning is about more than one thing. While you're figuring out where to put our investments, you also need to be sure that the rest of your life is in reasonable order -- or the investments may not last long in the face of unexpected events. Most people need an appropriate balance of life insurance, health insurance, and long term disability insurance. Everybody needs a will, a general power of attorney, and/or a revocable living trust. If you don't have those things, then your retirement plan is grossly incomplete. 

(2) You need to plan for expenses as well as for investment income. We can't control all of the expenses in retirement, particularly the medical variety. But many things that we spend money on are a lot more controllable than our income might be. So I intend to work out a detailed budget, to help my wife and I to decide where we can cut back and still live comfortably. I suggest that if you're near retirement age, you might force yourself to try the same project. I know it might seem tough on you emotionally. But please do it anyway. This is your future you are talking about (or maybe refusing to talk about)!

(3) When you get ready to invest for retirement, don't try to predict investment markets.  You can't. Investment market performance in the short term is event-driven (including government regulation as well as external politico-economic events).  Markets are therefore inherently unpredictable to everyone, including fund managers.  Market timers and technical analysts die broke or make their money on book royalties generated by fools looking for "a system."  So-called "technical analysis" and market timing schemes are just that -- schemes. If you play in that game as an amateur, you'll die broke.  Trading stocks often, will run up transaction fees and reduce your capital. 

If you aren't quite convinced of this idea yet, then I suggest that you do a bit of reading for your consideration:  http://tinyurl.com/47kax  

(The complete address is 

http://www.victoryconnect.com/vcn/DBObjectServlet?Return&RiskMajorIndices033104.pdf)

(4) Diversify. Just about all sensible financial planners these days (even the guys I talked to) will tell you that you're nuts to keep all of your retirement assets in just one class of investments (for instance, short-term bonds) or in just one mutual fund. Over-concentration leaves you vulnerable to unexpected events. And perfect safety means you get very little income, and may even lose your savings to inflation. So the real task is to find a sustainable middle point. This is an area where a financial planning professional might be able to help, if you can find one who is honest and ethical.  

(5) Invest for the long haul.  If you frequently buy and sell stocks or bonds or much of anything else, you are not going to make money. Transaction fees and stock broker commissions will eat your income. When an investment adviser does this with your money, it is called "churning" -- and in extreme cases it should get him or her thrown in jail. So don't do it to yourself.  To make your money grow, you will need to select a strategy that is appropriate for the economy you're living in now and expect to live in for the next "few" (say, three to five) years -- and then stick with it as long as the major assumptions you originally made still appear to hold true. 

There's a balance to be struck between buy-and-hold-until-you die, versus making reasonable adjustments that preserve your assets when markets are doing screwy things. Your investment adviser should be able to help you figure out what that balance is -- and if they can't, then they aren't the right adviser for you.  

Finding Somebody Experienced to Help

I've been humbled by what I've learned in the last few months.  Part of becoming humble has been a matter of figuring out that I wasn't asking some of the right questions about my retirement planning.  From what I've read so far, I would guess that probably rather few people do.  Thus many of us who don't have a lot of time on our hands -- in which to study constantly -- may need some kind of experienced professional help to ask those questions and get sensible answers.  In the research I've done so far, I've discovered that there are two kinds of advisers to "help" in this area. 

(1)  One kind of adviser charges a commission that may be up to two percent of your net worth, or perhaps two percent of the total amount of the assets he or she actively manages for you.

(2)  The other kind of adviser charges by the hour. 

Which kind of adviser you use might depend upon what services you want or need.  If you need somebody to actively recommend investments and make stock trades for you on a continuing basis, then maybe paying a commission makes sense (provided that this worthy person doesn't burn up your assets by churning your accounts).

On the other hand, if you want someone to make basic recommendations about how to balance your portfolio, while you personally invest  your money in mutual funds of your choice, then your adviser isn't likely to spend a lot of hours assisting you.  If you happen to have $500,000 dollars in your 401K plan and personal investments, do you really want to pay somebody $10,000 dollars per year for 20 hours of their time?  I sure as heck don't! 

Clearly, you will also want to avoid the kind of salesman that I first talked to.  There are questions you might ask, that could help you to weed out the blithering idiots and find somebody who will do better for you. For instance: 

(1)  How long have you earned your living as a financial planner?  May I get a copy of Form ADV "Uniform Application for Investment Adviser Registration"?  [note:  this form identifies all of the services your adviser offers, and all of the fees your adviser might charge.  It also discloses how he or she gets his business and whether they get a commission for referring you to other brokers or sales people.] 

(2)  During your career in this industry, how much have you increased your own net worth by following your own advice? [In other words, if you're so smart, then why ain't you rich?]  You will almost certainly not get an answer to this question, but asking it will mark you as a person who should be treated with more than average care. Any adviser who is not seriously confident in his own abilities and ethics will drop you like a hot rock.  Since you don't want an amateur adviser, that's perfectly okay. 

(3) How much will you charge to provide an initial asset allocation and retirement investment plan on a one-time basis? How much will you charge each year to update it?  How many hours do you expect to spend accomplishing these tasks?  

(4) Why is your time worth $150 dollars per hour?

(5)  Starting with the assets I now have and the expenses I can reasonably expect to accumulate when I retire, what rate of return will I need on my investments in order to live comfortably in retirement and not lose my assets to inflation?  With current market rates of return, how much do I need to reduce my expenses or increase my income from other sources?

A Place to Start

A lot of certified financial planners won't work by the hour.  Several of the local professionals whom I contacted seemed almost to sneer when I asked about getting a few hours of help.  So where do you go if you want that kind of help?  I found one organization that seems to offer a much higher standard of ethical behavior and knowledge than the average:  The National Association of Personal Financial Advisers.

NAPFA financial advisers operate on a fee-only basis.  They submit to outside professional reviews and examples of their work are peer-reviewed before they are ever admitted to the Association.  

I will probably add other questions to this list over time.  In the meantime, I'll welcome any suggestions or questions that you have asked in a similar situation.  You may email me at webmaster@lawhern.org .