New York Stock Exchange

Recently, I got a call from a physician client of mine who asked a fantastic question. The Shiller PE of the S&P 500 index is at 24 now, much higher than the historical mean of 16 – is the market headed for a fall?

What is the Shiller PE?

This is a stock market metric invented by Yale Professor Robert Shiller. Basically, it is the average of the PE ratios of ten consecutive years. Because of that, Shiller PE is also called PE10.

Professor Shiller found it to be a reasonably good measure of valuation of the whole market: the higher the Shiller PE, the more expensive the market.

Back to my client’s question, I told him right away that I don’t know the answer. I don’t make investment decision based on opinion. I have to research historical data. After I hung up the phone, I asked my assistant to study the relationship between the Shiller PE and forward one-year and forward three-year returns.

Here are the results (scatter plots):

Fig. 1: Forward one-year return vs. Shiller PE

Fig. 2: Forward three-year return vs. Shiller PE

Here is what I learn from the plots:

1. The higher the Shiller PE, the lower the one-year and three-year returns.
2. Return variability was so high as to render the Shiller PE’s predictive power very weak.
3. Only when Shiller PE is over 35 are the three-year forward returns overwhelmingly negative.

So after much research, I can answer my client’s question. No, the market is not headed for a fall, but we do need to lower our expectation of future returns.

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

Tax planning tips

Last week, I went to a luncheon seminar hosted by Fidelity Charitables, a division of my custodian company Fidelity Investments.

I went there because 30% of my clients are business owners. I know that one-third of them have strong charitable intent, and helping them do well by doing good is part of my responsibility.

Part of the dilemma of successful business owners who have charitable intent is this: They make a lot of money when they are running their business, and especially at the time they sell their business. But they give away their money to the causes they care about usually in retirement when they do not have as much income to write off. Without careful charitable planning, they will end up paying a lot more in taxes and have a lot less to give to charity.

Here comes the rescue plan: Donor Advised Fund (DAF).

A DAF is a vehicle through which a business owner can donate money or, better yet, shares of his own company. He can set it up when he is still running the business and his charitable intent is not yet clear. Doing this has three major benefits:

    1. Elimination of capital gains on the sale of assets donated;

    2. Eligibility for the fair market value tax deduction when his income is still high;

    3. Flexibility in the timing of donations to his preferred charities.

Let’s look at this example: John is about to sell his business for $20 million. In the five years prior to the sale, he drew an income of $1mm from the company, but he donated $1mm worth of company shares to a DAF he setup every year.

All of his income five years prior can be offset for income tax purposes because of his donations. On top of that, $5mm worth of the shares already in the DAF are exempt from capital gains taxation. He is going to save millions of dollars.

Such is the power of charitable planning using DAF. If you want to learn more, schedule a discovery meeting with me.

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

Morgan Stanley Smith Barney

Last weekend, I went to New Jersey to meet a potential client who is an executive at a pharmaceutical company.

He told me that, as part of the executive benefit package, the company refers executives to Morgan Stanley where they get “free” financial advice. I smirked and said: “Well, we will find out how free it is. One thing I know, though, Wall Street firms are not known for charity.”

It turns out that Morgan Stanley advised him to open several, separately managed accounts (SMA), each with a management fee of 1.5%. The reason for the multiple accounts?

Each account manager, according to Morgan Stanley, tries different tactic to beat the market. This makes me wonder why Morgan Stanley doesn’t use these managers, since its stock price lags the market by a huge margin.

I dug a bit deeper into the investment and found that a good chunk of the money is invested in expensive mutual funds, such as LARCX and FTGMX.

The former is a bond fund managed by Lord Abbett with an annual expense ratio of 1.56%. By comparison, Vanguard only charges an expense ratio for 0.10% for its bond funds.

As an exercise, try to find out the expense ratio of FTGMX and post your answer below. (Hint: use Google.)

In total, this pharmaceutical executive is paying about 3% of his assets for Morgan Stanley’s “free” advice. Upon pointing this out to him, he became a client of mine right there. I can’t thank Morgan Stanley enough for making my life easy.

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

9. Are Financial Advisors Required to Disclose Fees?

8. Lessons learned from three prospective clients

7. How Often Do Market Corrections Happen?

6. Physicians: Qualified Retirement Plan for Asset Protection

5. Variable Annuity Fees You Don’t Know You are Paying

4. Why doctors don’t get rich

3. Profit from Harry Dent’s predictions? Think again

2. The High Cost of Fee-based Financial Advisors

1. Be Careful When Buying a Condo as a Rental Property

Also see Top 10 in February.

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

I met with three prospective clients on my trip to Los Angeles last week. I did a quick financial review with each one of them and gathered some lessons learned as well.

Prospective client A is a physician in his late 60s. He has already reached retirement age but he needs to keep working since he has less than $1mm saved for his retirement.

All that money is in tax deferred accounts, meaning far less than $1mm is available for his retirement. This is NOT retirement security.

Client A is not an extravagant person, so why is he in such dire straits?

It turns out he owns an extravagant house – 10,000 square feet with marble floors, multiple bedrooms and bathrooms – all for just himself and his wife. He still has a $2mm mortgage on the house and he has been paying $8,000 per month in mortgage payments for decades. God knows how much he spends on maintenance and utilities.

Lesson 1: If you buy more house than you need with a mortgage, you are transferring wealth from yourself to the bank.

Prospective client B is also a physician in his early 50. He is in a family practice that does not make a lot of money, but he has already saved more than $2mm. The big difference with Client A; he lives in a modest house and he dutifully puts aside $200k into savings every year.

Financially, he is in good shape. However, he has a financial advisor from a major Wall Street firm. Part of his money is in stocks, part in funds, and part in life insurance and annuities. The stock portion is churned frequently, and the fund portion is invested in funds with high expense ratios. By my estimate, the investment cost is about 2.5%  a year.

After I informed him of these facts, Client B told me that he is more and less aware of the cost, but he can’t cut it off because the financial advisor is a good friend. This friendship is quite costly, to the tune of $50k a year.

Lesson 2: Never mix money with friendship. 

Prospective client C is a retired salesman. He is not yet 60, but he already has more than $4mm in his portfolio. Needless to say, he made a lot of money. But that’s not the key to his wealth accumulation.

He told me that, early on in his career, he put away 20% of what he made and invested it automatically. Not only that, he always spends time studying finances and he makes sure his portfolio is well diversified. Upon hearing that, I told him: “You don’t need me.”

Lesson 3: Getting wealthy is really not that complicated, but it takes time and discipline.

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

The survey also reveals that physicians 55 years and older are eight times more likely to get sued than physicians 40 years and younger.

Not that they make eight times more medical errors, just that they are richer lawsuit bait.

That reminds me of a joke. Why won’t a shark attack a lawyer? Professional courtesy.

Back to the topic at hand, many physicians in solo or small practice simply use a SEP IRA as their retirement plan. It is very simple to set up, and the contribution limit is a generous 25% of earned income or an annual limit of $49,000. What is there not to like about it?

Click to get my white paper Wealth Management Guide for Physicians.

Well, from an asset protection perspective, they are not as ironclad as retirement plans qualified under the Employee Retirement Income Security Act (ERISA).

ERISA applies to all employer-sponsored plans, including 401(k) plans, 403(b) plans, profit sharing plans, defined benefit plans, etc. ERISA states that the employee benefits under qualified plans “may not be assigned or alienated.” This puts assets in these plans out of reach of claimants and creditors.

IRAs, including SEP and SIMPLE, are not covered by ERISA; they do not enjoy blanket federal protection. They are protected by state laws which vary greatly. Therefore, for asset protection purpose, physicians should put their retirement assets in ERISA-qualified plans as much as possible.

Unlike IRAs, setting up a qualified plan is not as easy as walking into a brokerage. There is much paperwork involved, and physicians should only do it themselves when their patients can treat their own disease.

Many insurance companies exploit this by pushing pre-packaged qualified plans that have high hidden expenses and limited investment options. Avoid them. Instead, look for an independent fiduciary plan administrator.

Click to get my white paper Wealth Management Guide for Physicians.

Bullet train

I just came back from a long trip in China and Taiwan. During the trip, what impressed me the most was China’s bullet train. We rode the longest high-speed rail line in the world – Beijing to Guangzhou – which started services only a few months ago.

The train is futuristic, comfortable and extremely smooth. Zipping at speed of 300 km/h or about 190 mph, the water in my glass sitting on the table stayed still.

With such a speed, one could travel from New York City to Washington DC in one hour and 15 minutes, or from New York City to Chicago in three and a half hours. High-speed rail truly shrinks the country.

China was able to start from zero and build 6,000 miles of high-speed rail in seven years. The goal is even more ambitious – to have 30,000 miles of track by 2020, a mere seven years from now.

As I was riding in the train, I said to myself – this could never happen in America. Recently, Montgomery County, where I live, just finished an expressway of 18 miles called the cross-county connector. It took the county 50 years from planning to finish.

Because we are a democracy, every opposing view needs to be listened to and addressed. Bold, broad and forward-looking infrastructure projects like high-speed rail are very hard to undertake and complete in America.

This leads me to ponder – we can not compete with China on speed of decision and boldness of projects, where is our competitive edge going forward? I’d love to hear your thought on that question.

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

New York Stock Exchange

The S&P 500 closed the first quarter at a record high. Should that worry investors? The short answer is, No.

When the market was 30% below the high three years ago, I did some research. I categorized all market conditions into:

1. Breaking a new high.

2. Less than 10% below historical high.

3. Between 10% and 20% below historical high.

4. Between 20% and 30% below historical high.

5. Between 30% and 40% below historical high.

6. More than 40% below historical high.

Then I calculated the one year forward returns of the six conditions.

The contrarian in me expected to see a linear relationship: the further away from the historical high the S&P was, the stronger the one year forward returns would be.

Boy, was I surprised! Other than condition 6, there are no statistically significant differences in return distributions between conditions 1 through 5.

In other words, the fact that the market is breaking a new high does not by itself change the return outlook – as far as historical data can tell us.

So what’s the true danger of the market reaching a new high? Alas, mostly psychological.

We humans are conditioned to remember the last thing best. The last thing that has happened to the market is that it has gone up, up and up. This may lead our human minds to discount the possibility of a market fall and over-expose us to the market. In 2000, there were people who sold their houses to invest in the market – just in time for the market to fall and the real estate market to boom.

The best way to guard against human frailty is to have an asset allocation plan and always stick to it no matter what the market does.

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

9. Email Scam Targets Financial Advisor Clients

8. Why Asset Class Diversification is Superior

7. How Often Do Market Corrections Happen?

6. Variable Annuity Fees You Don’t Know You are Paying

5. Why doctors don’t get rich

4. Profit from Harry Dent’s predictions? Think again

3. The High Cost of Fee-based Financial Advisors

2. What is Wealth Management?

1. Be Careful When Buying a Condo as a Rental Property

Also see Top 10 last month.

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

How Can I Help?

“What makes you smile every day? What fills up your tank?”

These are questions a friend of mine asked me recently. For my wife, it is hosting dinner parties. She loves seeing people come together and enjoys conversations with friends. She does this almost every week now. It is also a great way for me to see her doing the thing she loves.

For me, it is learning improv and performing comedy on stage. English is not my first language, and I never thought I could do that. Now, I regularly go on stage to make people laugh.

I love getting out of my comfort zone to learn a new skill. Life is so much more exciting and fulfilling when I take on and conquer a challenge.

If you pause your busy life for a moment and ponder what fills up our tank, you will likely come away with one of three answers:

1. Relationships: loving and being loved by friends and family
2. Flow: taking on a challenge
3. Causes: working on something higher than yourself.

None of the above takes a lot of money, but it does take time and energy. This leads to the purpose of my work.

When I first started doing wealth management, I thought my purpose was to get a high return for my clients. As my practice developed, I realized that my clients have other financial issues, such as tax mitigation, asset protection, wealth transfer, etc. So my purpose is to watch over all of their finances, making sure everything is taken care of.

Now, I often hear from my clients that they appreciate my services because I give them peace of mind. They know that, as far as financial matters are concerned, someone is watching out for them.  If they ever wonder where they are financially, the answer is always a phone call away.

That’s why I am here for you.

I clear the financial worries from your mind, so you have the time, mental energy and financial resources to do what fills up your tank.

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

House for sale

Recently, a client called to tell me that he had finally got the big boulder off his back, and it was such a relief for him.

The “big boulder” he referred to was his big house, with a swimming pool and a tennis court. The house had been costing him $100k a year in property taxes and upkeep, more than 50% of my client’s retirement income. No wonder he called it a big boulder on his back.

He bought the house 25 years ago for $2.2mm, and he just sold it for $2.1mm. After all the costs associated with selling the house, he took home $2mm and change.

I did a back of the envelop calculation: he lost $200k in home value, and he spent $2.5mm in property taxes and upkeep. He is set back $2.7mm, and that is before taking into account the time value of money and lost opportunity cost.

If he had invested the $2.2mm in the S&P 500 25 years ago, do you know how much his portfolio would be worth? He would have over $11mm in his portfolio and he would have received all the dividend income along the way as well.

Now I don’t mean you should stop buying a comfortable roof for your family. What I am suggesting is that you should avoid these mistakes that many home buyers make:

1. Buying a glamorous house to show off.
2. Buying a bigger house than your friends to impress them.
3. Buying at the top of the market since everybody else is buying.
4. Ignoring the cost of property taxes and upkeep.

Some of the biggest financial holes I have seen are caused by people buying the wrong house at the wrong time.

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

New York Stock Exchange

With the market up about 5% in January, a prospective client of mine called to let me know he is not going to invest in stocks at this time – in fact, he is going to pull all of his money out of the market.

This may not be the best course of action for him.

According to research done by Cooper and McConnell, what the market does in January has a strong predictive power for what the market will do for the rest of the year.

Using data since 1940, they found that if the market is up in January, it will rise an additional 14.8% for the rest of the year; if the market is down in January, it will rise only 2.92% for the rest of the year. This gives rise to a spread of almost 12%, a highly statistically significant number.

Other research has found that if the market is up in January, the odds that it would go down for the rest of the year are less than 10%; on the other hand, if the market is down in January, the odds of it going down for the rest of the year are about 50%.

More than a few economists have pulled their hair out trying to explain why the market behaves this way; they have yet to come up with a convincing theory.

What can you make of this?

1. Either there is something to this effect – the fact economists can not explain it does not mean we should not take advantage of it; or
2. There is nothing there, and it is pure coincidence that there appears to be a correlation. There is a statistically term for this situation – spurious correlation.

The most important thing

Regardless of what you believe about this data, the most important thing is to keep a balanced portfolio.

For my personal portfolio, I am increasing my equity allocation from 65% to 70% in recognition of the fact that there might be something there. I definitely would not increase my equity allocation to 100% or to 0%.

What would you do?

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

Email scam

I recently received an email from a client of mine. The mail contained only one line: “What’s the balance of my account?”

“It’s $978k as of close of yesterday,” I replied.

“I need $500k for a business transaction,” my client responded.

I went into an explanation of the tax consequence of selling long-held investments to fund a business transaction, but my client insisted that he needed the money urgently. So I emailed him: “send me your wire instruction, and I will make sure the money will be in your account tomorrow.”

I received this:

Bank Name: OCBC Bank
Bank Address: #301-11A Oversea chinese Banking cooperation,1 pasirris Central Street, White Sands Singapore 518457
Bank Account Number: 555-7-037586
Swift Code: OCBCSGSG
Account Name: Recto Mariecel Dejesus

I immediately noticed this was an overseas wire and was an account not under my client’s name. I was suspicious, so I emailed back: “Can you give me a call to verify your intention?”

“I am overseas now and away from any phone, I can’t call but I can write you an authorization to wire the money.”

I became more suspicious and called my client immediately. I left a message asking him if he indeed needed half a million dollar for a business transaction. A few minutes later, my client called back. He was at his California home. Apparently, somebody hacked into his email account and tried to lure me into sending half a million dollars overseas.

Rest assured, I am very alert to this type of scam. On top of that, all of my clients are set up with what we call level 1 authorization, that is, I am only authorized to send money to accounts under my client’s name. I purposefully do not use the less secure level 2 authorization, which would give me the authorization to send money to accounts not under my client’s name. Because of my ex ante precaution, my client’s money was never at risk.

After this incident, I now insist that my clients not use Yahoo mail. It seems to me 80% of email scams originate from hacked Yahoo accounts, with the rest coming from hacked AOL and hotmail accounts. Gmail is by far the most secure email server, especially if you use its two-step verification for login.

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

9. Why Asset Class Diversification is Superior

8. Small Business 401k, Big Plan Fees

7. Why doctors don’t get rich

6. An Investment Rule for Young People

5. Fiscal Cliff Deal: What does it mean for high income/high net-worth families?

4. Roth Conversion Decision Framework

3. Profit from Harry Dent’s predictions? Think again

2. Be Careful When Buying a Condo as a Rental Property

1. The High Cost of Fee-based Financial Advisors

Also see Top 10 last month.

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

Oil and Gas Investment Scam

In the last month alone, I’ve gotten calls from two clients asking me if they should invest in tax advantaged oil and gas investments being pitched to them?  Both of these clients are physicians.

The pitch is that oil and gas investments are like IRA accounts, but without the contribution limit. Whatever amount you invest can be written off right away.

The pitch is quite alluring to high-income professionals like physicians who are facing higher taxation. But it sounds too good to be true, so I did a study.

It turns out what is being pitched as “tax advantaged” is in fact the riskiest part of an oil and gas investment.

A full 75% to 85% of oil and gas investment goes to what is called “intangible drilling costs.” These costs are 100% deductible because once the money is spent, it is gone regardless of whether the well is dry or wet.

The rest is so-called “tangible drilling costs,” such as drilling equipment that can be depreciated over seven years.

There is no tax advantage to an oil and gas business relative to other businesses. It’s just that other businesses typically don’t burn through all their investment in one year for ONE shot at success.

The other problems with these type of investments are asymmetric information and moral hazard. There are economic terms to describe the fact that the two sides in a deal often have different knowledge levels, and the side with more knowledge will take advantage of the side with less knowledge.

To put it in layman’s term, if the well to be drilled is a sure bet, do you think it needs to be pitched as an investment option to physicians who have no clue about the oil industry?

Use some common sense. If something needs to be pitched by a salesman – be it a life insurance policy or an oil and gas investment, it’s probably not worth buying.

But then, common sense is the least common of all senses when it comes to investment. That’s why I still have a job.

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

When John first came to me to seek my help with his personal finance, I looked at his overall financial big picture and was pleased overall. He worked at federal and state jobs and enjoyed good pensions. On top of that, he had a decent investment account.

But there was a gaping hole in his retirement security: he was turning 70 then, was divorced, and his children lived far away. That meant if he were to get sick, nobody would be there to take care of him; he would need to hire caregivers. Right then, I insisted that he buy long-term care insurance.

According to research, 50% of seniors who are 65 and older will need long-term care at some point in their lives. The average duration of care is about three years, but about 5% of seniors need care for more than ten years.

The costs of care, depending on the type (home care, adult day care, assisted living or nursing home), could range between $20k to $100k a year. And the costs are going up about 5% a year.

John was employed then. Under my instruction, he found out that his employer offered long-term care insurance as a benefit (through an insurance carrier). The monthly premium was about $460.

John thought that was a steep price. In fact it was not – I did a back-of-envelope calculation for him. It turned out to be a very good deal. Assuming John needs three years of nursing home care, that would amount to $300k. John’s annual premium was about 12x$460 = $4600+$920 = $5520. If John paid 10 years of premiums before he needed the insurance, the total premium he would pay by then would be $55,200. You see the math?

In my opinion, the insurance was a good deal. Part of it was that it was group insurance; therefore, there must be some discount. A few months ago I read reports that many insurance carriers had mispriced the risk and charged too low a premium.

I did not misprice the risk, nor did I underestimate it.

I got a note recently from John’s daughter thanking me for watching out for her dad. In the note, she said her dad spoke very highly of me. That’s the reward of being a financial advisor: helping my clients financially prepare for the unforeseen and getting recognition and appreciation for what I do for them.

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