Healthy Lifestyle

Longer life spans, rising medical costs, declining retiree medical coverage, and Medicare and Medicaid insolvency all add up to making health care costs a serious challenge for folks preparing for retirement.

According to Fidelity research, a couple retiring today at age 65 will need current savings of $200k to supplement Medicare and pay for out-of-pocket health care costs in retirement. In another five years time, the number could balloon to $275k. And that’s before we talk about long-term care.

For Americans who are turning 65, the odds that they will be admitted to a nursing home at some point in their life is about 60%. Half of them will stay for six months or less, but 10% will stay for more than three years. The unlucky 1% will stay for more than 10 years. A nursing home could easily cost $10k a month; you can do the math of how much it will cost you if you fall into the unlucky 10% ($360k) or even 1% ($1.2mm.)

If you are in your 40s or 50s and you are facing this prospect of escalating health care costs, what can you do? I suggest three things:

1. Revise your retirement money needs. The common wisdom is that in retirement you will spend 20% to 30% less because, by then, you would have paid off your mortgage, and your kids would have all finished college. That may be true, but what you save from mortgage payments and kids’ education will go towards your own health care. In a nutshell, you will not need less money to live; you will need at least the same. With this in mind, you may need to save more now.

2. Consider buying long-term care insurance. The optimal time to start considering that is between 60 and 65. If your personal assets are over $2mm, you may be able to self-insure. If your personal assets are below $1mm, you definitely should consider long-term care insurance.

3. Live a healthy and active lifestyle. A recent study of health care costs has found that 5% of the sickest people in the population use up 50% of all health care expenses. That is to say, by merely being not among the sickest 5%, you will only need to pay half of the average health care costs. If you are among the more healthy 50% of the population, you only need a fraction of the $200k to $270k to cover your out-of-pocket health care costs.

It is with this in mind that I watch my diet closely with the help of my iron lady wife and work with a physical trainer to help me exercise. Let me tell you hiring a professional trainer is a great investment. It costs me about $200 per month now, but I am living healthier and happier – exercising does make people happy – and I can expect to save hundreds of thousands of dollars when I retire.

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Financial Salesman

In an online forum, a doctor’s wife shared with me her story that should serve as a cautionary tale for all doctors.

Her husband had a solo medical practice. They had a “financial advisor” who advised them to put their saving into a $5mm cash value life insurance policy. They believed the product not only provided protection in the event of the doctor’s death but also was a great savings vehicle.

Last July, her husband was struck by an uninsured drunk driver. He suffered brain damage. Though he recovered from the coma, he was unable to practice medicine any more.

In one night, the family’s livelihood was turned upside down. He was not killed, so she could not claim the $5mm death benefit. They had not saved much outside of the life insurance policy. The cash value of the life insurance was only a fraction of what they had put into it in premium payments.

On top of that, the practice took a few months to close down, during which, rents and overhead expenses had to be paid.

Now the family lives on a meager social security disability income, and the wife is struggling to get back into the job market.

There are three lessons all doctors and their families can learn from this:

1. You must have disability insurance. I have found that most doctors have more than sufficient life insurance, thanks to all the salesmen out there, yet few have sufficient disability insurance. In reality, after an accident, disability occurs four times more frequently than death, and its financial impact on the family is often more severe than death.

2. If you own your own practice, you must have business overhead and expense (BOE) insurance. This insurance pays for business overhead expenses for up to two years in the event the owner is disabled.

3. Most important, you should hire a fiduciary financial advisor; in other words, a financial advisor whose advice is not slanted by the commissions he or she receives. Generally speaking, there are three types of financial advisors: 1) those who are licensed to sell products (they are compensated by commissions paid by the financial firms); 2) those who are licensed to give advice (they are compensated by fees paid directly by clients); and 3) those who are licensed to do both (they are compensated by both commissions and fees). You should always opt for type 2, since they have the least conflict of interest.

Type 2 advisors are called fee-only financial advisors. I am one, but I am not the only one. You can find other fee-only financial advisors at the National Association of Personal Financial Advisors (NAPFA) website.

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Lost Retirement Money?

John took his options to his financial advisor from Smith Barney (now absorbed into Morgan Stanley Smith Barney.) Guess what the advisor recommended? He recommended that John take out the lump sum and let him manage it instead.

By the time John came to me for a second opinion financial review four years ago, his retirement account had only $265k left. John decided to become my client, and I have been able to restore some of his money, but not all.

Recently, I met a group of government employees who are on the cusp of retirement. All of them are looking for some help, and naturally they look to those whose names they hear a lot – namely, Wall Street firms that have huge advertising budgets.

I shared John’s story with them because I want them to learn two things:

• Don’t ever give away your government pension. You have the full faith and credit of the US government standing behind your retirement, and you are getting 6% to 7% return on your money. There are no other investments out there that are better than this.
• Don’t ever trust a Wall Street firm. Their financial advisors have only one goal in mind: to separate you from your money. If you need help, go find an independent fee-only advisor.

Here is how I help John. I manage his money prudently with a 40/60 portfolio. I meet with him every quarter to make sure his spending is balanced with what he has now. I also discussed with him using single premium immediate annuity to stretch his wealth.

As for John, he finally has peace of mine that someone putting his interest first is watching over his retirement security.

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As a new parent and a financial advisor, I can offer you a few absolutely necessary to-do items to safeguard the financial well-being of your family and your new baby.

1. Have a will.

Now that you have a baby, you don’t just live for yourself any more. You have the responsibility of seeing your baby grow up. What happens if both you and your spouse die in an accident? If you don’t have a will, the court will determine the baby’s guardianship. Do you want to leave that decision to the court without your input? If you don’t, get a will.

2. Buy life insurance

Along the same vein, if you are the main bread earner of your household, make sure you buy term life insurance before you are run over by a truck. What else could your spouse rely on to raise the baby? I suggest buying a 20-year term life policy worth a half million dollars. For most folks, this can be purchased for less than $100 per quarter, a small amount to pay for peace of mind.

3. Start saving money in a 529 plan

Now that you’ve cheated death and lived to see your baby going to college, you don’t want to put your child in a situation where he or she has to flip burgers to pay for tuition.

My wife and I decided to put aside $416 every month into a 529 plan for a total of $5,000 a year. The money will grow tax free, and if we can get a return of 8%, the money will grow to $180k by the time he is 18.

You should help your baby based on your financial capability. If you can’t afford to put aside $400 per month, $100 per month over many years will be a great help as well. You can set up an automatic contribution and then forget about it. You will be glad 18 year later, when you have some money to help your child go through college.

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1. Globally diversified
2. Small cap value tilt
3. Short duration tilt

This approach endured extraordinary challenges in 2011.

1. Globally diversified

Even though the US equity market largely ended up where it started, the global equity markets did a lot worse: the MSCI EAFA Index (world developed markets) dropped 15% and the MSCI Emerging Market Index dropped 20%. To the extent that your portfolio is globally diversified, it will suffer along with the rest of the world. Despite that, global diversification is still a sound principle. We should not regret just because the US market did better. In fact, the market that did the best last year was Venezuela; it went up 110%! Should we regret not concentrating on the Venezuela market? (The answer is no.)

2. Small cap value tilt

2011 was also a year in which the small cap value tilt did not work in your favor. Small cap stocks are down about 7%, while large cap stocks are flat and mega cap stocks (as represented by the Dow Jones) are up about 5%. Was it a mistake to have a small cap value tilt? The answer is no. Over a 10-year period, small cap value nearly always outperforms.See the historical data. On an annual basis, however, the odds that small cap value would underperformed are about 1 in 4. It had a bad year, but we should still like the odds.

3. Short duration tilt

Long duration bonds have done extraordinary well in 2011. For instance, 10-year Treasuries are up about 16%, 30-year Treasuries are up a whopping 35%! Your portfolio has an exposure to long duration bonds through the TIPS fund DIPSX. The fund itself increased 15% in 2011, partially making up for the loss in global equity.

My approach to bond investing is not to expose you to too much duration risk. The longer the duration, the more sensitive is the value of bonds to interest rates. Take 30-year Treasuries, for example. They could go up 30% when the rate decreases; they could also drop 30% when the rate increases. We don’t want to take that chance since the bond portion of your portfolio is for safety.

Though your portfolio did not grow much in 2011, we largely achieved the goal of wealth preservation despite global market challenges. I was able to add excess returns by:

• Disciplined rebalancing – systematic buy low sell high.
• Delaying purchases of equity until prices had dropped significantly – leveraging my knowledge of stock market seasonality.
• Timely communication so that you have the peace of mind to stay the course.

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Saving for College

My son is 6 weeks old. Today, he received his social security card. The first thing I did for him after receiving the card was to open two Maryland 529 plan accounts for him: one with myself as the account holder, and the other with my wife.

In Maryland, the 529 plan deduction limit per parent per child is $2,500. So I put $2,500 into each of the accounts, for a total of $5,000. I invested the money for a target date 2030 fund since that’s the time my child will be of college age. I further set up an automatic contribution going forward: $2,500 will be deposited into each account every year.

Why I am doing this?

With college costs skyrocketing, I’d like to start saving sooner rather than later. There is also another reason …

Two months ago, I was approached by an OBGYN doctor who is making half a million dollars a year. His two kids go to private schools. Because of a lawsuit, he is now $1mm in debt and his oldest kid will be going to college next year. I asked him how much he had saved for his kids’ college education: the answer is a grand total of zero. I think it is very cruel that their children have to find their own money for their college education; they will most likely not qualify for any financial aid because of their parents’ high incomes. Here is the thing; if they had done what I am doing now – putting aside $5,000 every year, a blip in their total incomes – they would have close to $200,000 now, and the money would not be accessible to creditors or plaintiff in a lawsuit. How much of difference this would have made in his children’s lives.

Here are my recommendations regarding a 529 plan:

1. Start early.
2. Contribute up to the deductible limit of your state. States usually set the limit so that if you contribute the limit every year, you will likely cover most of the in-state tuition and mandatory fees.
3. Make contributions automatic. It’s a chore to remember to make a contribution every year. Why not make it automatic so you can set it up once and forget about it.
4. Invest in a target date fund. Again it’s a chore to manage investments. Investing in a target date fund saves you all the trouble.

Here are more advanced considerations regarding a 529 plan:

Maryland has a pretty lousy 520 program. In fact, neighboring Virginia has a much better program with lower costs. I am a Maryland resident, but I can contribute to the Virginia plan. If I do, I lose the state tax deduction. The better approach is to contribute to the Maryland plan; after the money accumulates to a certain amount, rollover it to the Virginia plan. This way you get the benefit of a better 529 plan without losing state tax deductibility.

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How Can I Help?

In the past, I would have gently turned him away: “Sir, my practice has a limited capacity of serving only 50 clients. To make the most of it, I only work with doctors and small business owners who have at least $500k in investable assets or a combined household income of $400k and above.”

Maybe it’s because of my newborn son’s sickness, but I did not say no this time. I took him through the discovery process to find out where he was financially, what he wanted to achieve, and how he planed to get there.

I was able to quickly help him identify holes and gaps in his personal finances:

1. He is funding his children’s education using custodial (UTMA) accounts. With these types of accounts, he will lose control of the money as soon as his children turn 18. On top of that, they will make it harder for their children to get financial aid.
2. He is paying too high a rate on his mortgage. A refi would save him thousands of dollars.
3. He is not maximizing his tax deductions. He could open two IRA accounts and deduct up to $5,000 each for him and his wife, saving them thousands in taxes.
4. He does not have sufficient disability insurance. His family would be in a bind financially if he got run over by a bus.
5. His financial advisor from a major insurance company is advising him to invest in expensive annuities and permanent life insurance. I pointed him in the direction of Vanguard for investments.

When all is said and done, it took me only 26 minutes. Though I did not make any money from the time I spent, I accepted his gratitude and I felt happy and energetic.

How can I help you with your personal finances and investment in 2012? You don’t have to be my ideal prospect to schedule an appointment with me.

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9. Why asset class diversification is superior? 

8. The 2011 estate tax changes

7. Recession and stock market performance

6. Bill Gates: 11 Things You Don’t Learn in School

5. Variable annuity fees you don’t know you are paying

4. 2011 year end tax-planning tips for individuals

3. Why doctors don’t get rich

2. Profit from Harry Dent’s prediction? think again!

1. Bonus depreciation: Congress wants businesses to invest in 2011

Also see Top 10 last month.

Or did it?

From January to April, the market staged a four-month rally of 8.5% to peak at 1364 on April 29. For the next six months, it collapsed nearly 20% to bottom at 1098 on Oct. 3. Then, it staged a late rally to close the year at 1257.

At the market peak, I got calls from my clients asking why I kept cash in the account? At the market bottom, I got calls asking why I did not pull out of the market all together? If I had listened to those clients, they would have lost 20% in a flat market.

Investing according to the market’s past performance is like driving by looking in the rearview mirror. It is the quickest way to ruin. Keep that in mind! Next time, when the market goes wild, sit there, don’t just do something.

Get my white paper: The Informed Investor: 5 Key Concepts for Financial Success.

Our pastor Lon Solomon has a daughter with brain damage. If it comes to that, we have an example to follow. Here is what he shared in Esquire magazine:

Jill was born perfectly normal. At three months she started having seizures, and they got worse. Eventually she lost the ability to speak. She’s probably had five thousand grand mals or more, and has serious brain injury. She’s sixteen now, and nonverbal. It took nine years, but finally the doctors figured out that she had mitochondrial disease. The mitochondria are the parts of your cells that produce energy, and hers don’t work right. Her brain doesn’t get enough energy. She used to have six or eight seizures a day. Once, she had nineteen. We never slept through the night.

My daughter has taught me humility. She requires constant, permanent care. She’s not fully potty trained. She has simple pleasures. Taking a walk, picking up sticks, is what she loves to do. Riding in our van and looking out the window gives her great pleasure. I think we get so caught up in the complexity and the speed of things that we forget that that doesn’t bring real happiness. My daughter is amazingly happy. She doesn’t know she’s retarded, that she’s disabled. She needs love. She has been Walden to me, in reminding me what is important. It’s not having a BlackBerry. Or having your name in Esquire magazine. It’s serving somebody. God has given Brenda and me the gift of serving Jill, who will be one year old forever. At first I despised this fate and viewed it as a curse. Now I know that it is a privilege.

Already, Caden’s health issues have an impact on me. I am much more appreciative of all the good things in life and my heart is much more sensitive to other people’s sufferings.

The doctors – we are lucky to have many highly trained specialists working on him – did bring us good news.

1. Thus far, Caden is just like a normal baby. He shows no symptoms.
2. The MRI scan has revealed that the tumor did not cause any damages to surrounding brain tissues.
3. The lipoma is a benign tumor that will not grow.

So, no kidding, my family is having a Merry Christmas this year, merrier than in the past.

Wish you a Merry Christmas or a Happy Hanukkah! If you believe in God, keep Caden in your prayers.

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Credit: behaviorgap.com

In my previous article, “The perils of chasing hot fund managers,” I showed that the average investor in a mutual fund run by “star” manager Bill Miller would be better off buying and holding an S&P 500 index fund.

There is only one problem. Most index fund investors are not immune to the buy high and sell low tendency, as illustrated by the table below. Between 1991 and 2005, the Vanguard S&P 500 Index Fund (VFINX) returned an annualized 11.51%, but the average VFINX investor only earned a return of 7.96% during the same period.

This begs the question: Is there any hope that an investor could capture the full return of a fund? My answer is affirmative. In fact, I have helped my clients capture roughly 106% of fund returns! The key to achieving that is to have an effective mechanism to counter the tendency to buy high and sell low.

1. Spend time to draft an investment plan. The process of drafting an investment plan is a pre-commitment device. With a written plan, you are much more likely to stick with it when the going gets rough.

2. Have a target allocation. This is a device to enforce a buy low and sell high plan, the opposite of our natural tendency.

3. Extend your perspective. In August and September, when investors were captivated by the daily market swings of 5+% up or down, I sent communications to my clients showing them historical statistics of the last 5, 10, and 20 years. Historical perspective is much more informative than daily market swings. So develop a long-term perspective.

4. Reset the frame. When the market dropped in a very short period of time this summer, you could see this as a loss of wealth, or you could see it as a buying opportunity. Different framing leads to different action. Seeing a market drop as a buying opportunity is a much more productive frame for your long-term wealth .

If you can do the above four, you will be able to harness your emotions and greatly increase the odds of capturing all that the market can give you.

She explained why she came to see me: she bought a permanent life insurance policy because her financial advisor told her it is a great investment. She has been paying $3000 a month for that, and so far she has put in roughly $80k. Recently, she needed some cash and called to redeem the policy. Much to her surprise, the surrender value is only $1,300. She became suspicious of everything in her portfolio and wanted me to examine it for her.

It took me only five minutes to figure out that her financial advisor is screwing her, no punt intended.

Her financial advisor is charging her 1.2% a year to manage the investment. One would expect for the amount, he would put his clients’ interest first. Yet, the portfolio consists of multiple high-kickback mutual funds. I put the first fund (VAFAX) and the last fund (ODMAX) under the microscope, i.e., Google. Here is what I found.

Front load can be thought of as a mutual fund’s kickback to the financial advisor for directing his clients’ money to the fund. This business woman has about $1mm in investable assets; by putting her assets in high-kickback funds, the financial advisor made over $55k before she left the door.

Expense ratio is the cost of managing the fund. Why is it so much higher than Vanguard’s? Because it contains an ongoing kickback to the financial advisor for his effort in keeping her sedated, while the financial industry goes on to surgically remove her wealth.

At this rate, the business woman’s financial advisor will definitely have a secure retirement, at her expense.

There is one very simply way to tell if your financial advisor is a crook: use Google. It will show you the load and expense ratio of funds your financial advisor recommended to you. If it contains any load at all or an expense ratio higher than 0.5%, you are having a fox in your hen house.

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Bill Miller's Legg Mason Value Trust

On November 17, Bill Miller announced that he would step down as manager of Legg Mason Capital Management Value Trust (LMVTX).

From 1991 to 2005, under Miller’s stewardship the fund outperformed the S&P 500 index for an astounding 15 straight years. Since then, the fund has underperformed the index in all but one year, and by a significant margin.

So what’s the problem? The problem is many investors bought the fund only after Miller had become a mutual fund rock star, just in time for his hot streak to end. They missed much of his upward ride, but were fully onboard when the fund went down the toilet. See the table below.

Judging by how his investors did relative to the S&P 500, I could argue that Miller, a legendary fund manager and poster child of the mutual fund industry, destroyed wealth for his investors, while charging them a 1.6% annual fee for the privilege.

Now the financial press is trying to convince you that all the hot managers are in hedge funds. I am convinced! Since the unregulated hedge fund industry is where these hot managers can charge you 2/20 (2% annual fees and 20% profit sharing, if any) to destroy your wealth.

Get my white paper: The Informed Investor: 5 Key Concepts for Financial Success.

9. Buying Investment Property

8. The 2011 estate tax changes

7. Why asset class diversification is superior? 

6. Recession and stock market performance

5. Variable annuity fees you don’t know you are paying

4. Why doctors don’t get rich

3. 2011 year end tax-planning tips for individuals

2. Bonus depreciation: Congress wants businesses to invest in 2011

1. Profit from Harry Dent’s prediction? think again!

Also see Top 10 last month.

That night, my wife had a nightmare. Caden grew up and went to school. One day, he came home with a bloody face and cried: “Mommy, my classmates laughed at my nose so I tore it off my face.” My wife woke up crying.

All of a sudden, I could feel the pain of parents giving birth to a baby with a facial defect. We are very thankful, however, for the following reasons:

1) Caden was not born with a cleft lip. Every year, there are 160,000 babies born with cleft lips; they can’t even suckle. In many poor countries, they are left to die.

2) Caden was born in America, only 10 miles away from the National Children’s MedicalCenter where he will get the best medical treatment in the world.

3) Caden was born into a financially well-off family with great health insurance. Not every American family can claim that.

Upon pondering how lucky we are, our hearts went out to less fortunate parents, and we decided to donate to a nonprofit for children with cleft lips.

What’s the one thing you are most thankful about this year? Pause to think about it and if you like, share it with me. I promise you will have a happier thanksgiving.

1. School district

My two sons will grow up in this house, so the right school district was of the utmost importance. My wife did thorough research, and she declared Whitman to be the best school district in the whole state ofMaryland, followed closely by Churchill. The first is inBethesda, the second is inPotomac. These two areas happen to be the most expensive areas in Maryland.

2. Surrounding home prices

Home prices there range between just below $1 million to over $5 million. We wanted to buy a house in the cheaper end of that range. First of all, we wanted to pay for a good school district in the most property-tax-efficient way; secondly, cheaper houses in exclusive areas simply keep their values better.

Based on the first two criteria, my wife, the chief house hunter, went online. She searched all the houses below $1mm in the Whitman and Churchill school districts and found a house that had been sitting on the market for nearly two years. Its price had just been reduced to $99o,000 from an original asking price of $1.15mm.

3. Feel it out.

We visited the house, and I liked it right away. It’s open, and it has plenty of natural light – even the walkout basement has natural light. The house has a solid feel.

It is a rather atypical house, however, since it was designed by an architect for his own family, and he had apparently experimented with the avant-garde. That’s why it did not sell quickly, since most home buyers in this area like the traditional colonial. Not my wife and I. We like the contemporary architectural style.

4. Sanity check

We did not bid on it right away, however, since we needed time to check out our gut feeling. We visited five other houses in the area, and they just didn’t give us the love-at-first-sight feel like the first one.

5. Build rapport with sellers

Once we more or less made our decision, we arranged another visit to the house. We took the time to engage in small talk with the sellers. To our delight, we found out this Jewish couple’s best friends are a Chinese couple. It turned out the rapport we built was crucial. In the end, there were three bidders. We were the lowest bid, but the sellers decided to sell the house to us.

Is there anything you can take away from our home buying experience?

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