9. Is P/E ratio a useful stock valuation measure

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

7. Be careful when buying a condo

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

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

4. Why asset class diversification is superior? 

3. Top ten reasons you can’t get rick buying FB

2. Why doctors don’t get rich

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

Also see Top 10 last month.

The Skill Sets Don’t Overlap!

What would making $1.5mm a year look like? How about living pay check to pay check, and one bad real estate deal away from bankruptcy.

This is exactly what happened to one physician before he became my client. He is a partner of a very large practice and brings home more than $1.5mm a year, and yet he has only $100,000 in his bank account. If he stops working today, the money will run out in three months.

How did he get into such a quandary? In short, real estate.

He owns two plots of empty land in Florida, an office building in the most economically depressed county of Maryland, several condos and townhouses for rent in various states, and a few apartments in Shanghai. All told, his real estate investments total more than $7mm; these “assets” are not producing positive income for him. In a good year, they cost him more than $100k to own because of taxes, utilities, maintenance, and repairs.

When asked how he is going to make money from his real estate investments, he told me that he expects the real estate values to double when the market turns around. My jaw dropped at his unbridled optimism and … naïveté.

In my book, he has spent millions to buy a bunch of “liabilities” for himself. They cost huge sums of money from the get-go, and cost more money on an ongoing basis. What kind of assets are these?

Worse, when this doctor was dragged to see me by his wife, he was thinking about another $2mm real estate investment. To do that, he would need to take out a $1.7mm bank loan using his own house as collateral. Now, that’s one real estate deal away from bankruptcy.

This doctor’s story is not uncommon among very successful doctors. Here are the problems I see.

1. Their success in medical practice leads them to believe they are equally savvy in real estate.
2. They are so flushed with cash they don’t need to be careful, or so they think.
3. They are magnets for unscrupulous advisors and relatives.

Take this doctor, for example; all his real estate investments are brought to him by his “good friends.” These good friends know the kind of money he makes and apparently treat him as a moneybags.

My advice for very successful doctors who are thinking about investing in real estate: Your profession is medicine, not real estate. You don’t know what you don’t know. If you have to invest in real estate, try a real estate investment trust index fund such as VGSIX or DFITX.

Financial Plan for FB Employees

My friend Sally has a friend who is a software engineer at Facebook. The recent Facebook IPO made him a millionaire, many times over. According to Sally, he is overwhelmed by this sudden wealth and wondering how to deal with this mountain of money.

I have a suggestion: put the money in nine buckets.

Let me explain. All you newly rich Facebook employees need is a framework to deal with your money. It is a 3 by 3 box. Horizontally, it is divided into Need, Want, and Aspiration. Vertically, it is divided into Short, Med, and Long.

Need, Want, and Aspiration

Need is money needed to pay for basic lifestyle needs. Most of you software engineers out there are not extravagant, so $60k a year is probably enough to pay for your basic lifestyle needs. You will need $2mm to $3mm there.

Want is money needed to buy a Lamborghini and travel the world every year. You don’t need a Lamborghini to live a good life, but you can afford it and you want to impress your girlfriend, so go ahead and budget for it. Just don’t buy one every year. You can probably set aside $1mm to $2mm for your lifetime Want.

Many Facebook employees have the aspiration to follow in their boss’s foot steps, that is, to start a company that changes the world. That will take some money. Some may like to be like Bill Gates, dedicating his life to giving his money away for worthy causes. After Need and Want are addressed, the rest can be put into the boxes for aspiration.

Short, Med and Long

Short is the timeframe of the next four years; Long is what beyond ten years and Med the time between these two.

Why divide money along the time you need it? Because you want to invest it differently. Money for Immediate Need, Want and Aspiration should be mostly in cash; money for Intermediate can be in a 40/60 portfolio and money for Long-term should be in a 60/40 or 70/30 portfolio.

Most important: Don’t keep all of your money in FB stock!

Caveat

The above is a stylized mental exercise. It does not take into account investment returns, nor does it take into account evolving lifestyle needs and wants. However, the framework helps you to think about the money and to avoid the mistakes of this entrepreneur who sold his business for multiple millions of dollar and yet found himself live in poverty in retirement.

If you need some help to do more rigorous planning, find a fee-only financial advisor near you, or schedule a discovery meeting with me.

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

1. Facebook is a great service to help you keep in touch with friends and family. But a great service does not equal great investment.

2. When was the last time you clicked on a Facebook ad? I can’t recall when I ever did. The click-through rate for Facebook ads is 10% that for Google ads, for good reason. Google ads are delivered at the moment you have actionable intent, while Facebook ads are delivered when you don’t want any distraction.

3. As more and more people use mobile devices to access Facebook, this will present a big challenge since it is nearly impossible to display distracting ads on tiny mobile screens.

4. Facebook faces steep competition from Google+. Within one year of launch, Google+ already has 170k members, about one fifth the number of Facebook members. That number is expected to go up to 400k by year-end.

5. Facebook currently has the network effect on its side. People don’t migrate to Google+ because their friends are all on Facebook. But the network effect could come back to bite Facebook. If people do migrate to Google+, they will migrate en masse.

6. With Google+ being a better alternative to Facebook, this will limit Facebook’s options to monetize its users. For instance, Facebook can’t charge even a $1 membership fee per year now. This could cause its users to defect to Google+

7. Google has a powerful search engine. In fact, it is much easier to search for interesting content and people on Google+ than on Facebook. In the short run, this search capability is no match for the network effect; in the long run, it’s a strategic advantage that Facebook can’t match.

8. Google has the Android mobile phone and controls half of the mobile market. The future of social networking is through mobile devices.

9. The Wall Street money machine has been busy at work creating a mini-bubble surrounding the Facebook IPO. It has been so successful that Facebook shares will be sold at around $38, valuing the company at $100b, half of Google’s valuation, with less than 10% of Google’s profit. The more successful the Wall Street money machine is, the less likely you will get rich.

10. If you could get rich with Facebook stocks, Zuckerberg would not have allowed his company to go public.

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

Facebook Scam

Two months ago, I got a call from client of mine, who asked my opinion about an opportunity to invest in pre-IPO Facebook shares. He explained that he and his business partner were offered the opportunity to invest in a private fund that will hold Facebook shares.

I know nothing about these funds, but I told my client to stay away. As a general principle, I always steer my clients away from private funds unless they run the funds themselves. The reason is very simple: these are unregulated vehicles where there is no government oversight and there is no transparency whatever. You don’t know what monkey business they do with your money. Most business people intuitively grasp that if the private deal is about starting a restaurant; but once the deal is about buying Facebook shares, many of them throw caution to the wind.

The Reformed Broker has a great piece explaining what’s going on behind the scenes, and it confirms my suspicion:

… their clients aren’t actually getting pre-IPO shares. What they’re getting instead is shares in a fund that may or may not hold a good amount of these shares. The funds are loaded with all kinds of contingencies and miscellaneous fees and caveats. They are also able to do whatever they want with the money raised, including taking shots on other venture deals that sound social media-y enough to qualify. The PPMs (private placement memorandums) are written so as to protect the firm from everything and anything that could go wrong (and it will all go wrong). The money is being held in escrow and the clients are signing their lives away.

The bottom line is, as we race toward the Facebook IPO, the brokerages are out in full force this week and next, milking this cow with both fists until its udders squirt blood. They are pounding the phones from morning til night, taking breaks only to smoke butts and holler at girls on Broad Street. Then it’s right back upstairs looking for the next Midwestern farmer to call with this deal. … And when it melts down and the customer complaints start rolling in, the principals of the firms will lawyer up and claim that everything was “fully disclosed” and that the buyers were “accredited investors”  

I don’t recommend buying Facebook shares – that’s the subject of another post – but if you have a burning desire to buy them, at least get them at the open market when you will get the real deal.

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

They don’t necessarily overlap

I met Joseph in a startup networking event. He was trying to attract investors for his latest venture. He has an impressive resume: he founded a tech company that was later sold for tens of millions of dollars in the 1980s.

I was immediately struck by the “never say old” motto of this 75-year-old entrepreneur. But one thing did come across as odd: he was trying to raise a mere $500k for his new venture. Why didn’t he just fund the venture out of his own pocket?

A few months later, I invited him to a charity fundraising dinner where the ticket is $100 per person. He finally admitted to me: “Michael, I don’t have an extra $100 to spare.”

How could a successful entrepreneur who founded, built, and sold a company for tens of millions of dollars end up without an extra $100 to spare? Well, after retiring in his 50s, he dabbled in a number of failed business ventures, speculated in tech stocks in the late 1990s, and got hit again by the housing bubble in the 2000s. Now in his 70s, he is near personal bankruptcy.

Over the years, I’ve talked to many entrepreneurs in different stages of their lives. I found they share a few common traits that would be conducive to business success but may be hazardous to financial well-being.

One, they are perpetually optimistic. If they were not, they wouldn’t have gone through the trouble of starting and building a business. However, their optimism also leads them to be carefree about their financial security. They believe money will always come, so why worry.

Two, they are risk takers. This trait is good for business, but when applied to personal finances, it becomes problematic.

Three, in business, they usually surround themselves with counselors. So their ideas are vetted and the execution is generally carried out by others. They usually don’t give themselves the same luxury of wise counsel in personal finances. They do what they please.

That’s why a good many of them are in financial trouble in their old age. I personally know more than a few.

At the risk of sounding self-serving, I think all successful entrepreneurs need a wealth guardian working for them in a fiduciary capacity. The most important job of the wealth guard is not to beat the market, but 1) to watch over the financial big picture; 2) to serve as a wise counsel to the entrepreneur and 3) to help the entrepreneur make sound and prudent financial decisions.

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

9. Irrevocable life insurance trust

8. Is P/E ratio a useful stock valuation measure?

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

6. Recession and stock market performance

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

4. Why asset class diversification is superior? 

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

2. Why doctors don’t get rich

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

Also see Top 10 last month.

Read Condo Agreement!

The condo with two bedrooms and two baths was being sold through a short sale. The asking price was only $80,000. We did our research; the condo could rent for $1,300 per month in the market. So it’s a no-brainer.

At the time, there were four other bidders. We decide to be aggressive and employ an escalation clause. We would bid $80,000, but if someone bid higher than us, we would increase the bid by $500 increments, up to limit of $95,000.

In the end, we won the bidding for a price of $88,500. The next aggressive bidder was only willing to pay up to $88,000.

With condo fees less than $2,000 and taxes less than $1,000, the cash-on-cash return on this property is over 14%. Where are you going to find such a good investment in today’s world where 10-year Treasury bonds are yielding less than 1%.

All was hunky-dory until one day we decided to stroll the neighborhood where the condo was located. We bumped into a gentleman who happened to be the president of the condo association. He told us that the association has a 30% rental cap imposed on owners of the units. In other words, no more than 30% of the units can be rented out at one time. Condo owners who want to rent their unit need to get approval from the association, then wait until the percentage of rental units dips below 30% and a rental slot opens up. As a new condo owner, I can expect to wait for years (if ever) before a rental slot is available.

If the condo can’t be rented, it has no value to us. For whatever reason, the seller did not disclose this key information. Armed with this new information, we decided to void the contract. The seller threatened to sue us.

He has absolutely no ground because he is liable for incomplete disclosure. I am writing up this experience to serve as a cautionary tale to all condo investors – check the condo documents to make sure there is no rental cap provision before you sign the contract.

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

A Muppet

If you had a busy March, you are forgiven for not paying attention to Greg Smith’s open letter explaining why he is leaving Goldman Sachs. In his “resignation” letter, the Goldman Sachs executive sheds a bright light on the culture of this premiere Wall Street investment bank. Let me quote at length:

What are three quick ways to become a leader? a) Execute on the firm’s “axes,” which is Goldman-speak for persuading your clients to invest in the stocks or other products that we are trying to get rid of because they are not seen as having a lot of potential profit. b) “Hunt Elephants.” In English: get your clients — some of whom are sophisticated, and some of whom aren’t — to trade whatever will bring the biggest profit to Goldman. Call me old-fashioned, but I don’t like selling my clients a product that is wrong for them. c) Find yourself sitting in a seat where your job is to trade any illiquid, opaque product with a three-letter acronym.

…I attend derivatives sales meetings where not one single minute is spent asking questions about how we can help clients. It’s purely about how we can make the most possible money off of them…

It makes me ill how callously people talk about ripping their clients off. Over the last 12 months I have seen five different managing directors refer to their own clients as “muppets,” sometimes over internal e-mail.

Now you may take comfort in the fact that you are not rich enough to be one of Goldman’s muppets – reportedly you need to have $10mm to be in their sights. Don’t worry, your friendly financial advisor from a different Wall Street investment bank will put your interests first, or so says its glossy brochure.

Don’t for a moment believe that. As part of my services, I have reviewed hundreds of portfolios handled by “famed” Wall Street brokerages; I can tell you these firms all try to make the most money off of their clients by stuffing their portfolios with complicated financial products with hidden costs.

Goldman Sachs may be the foxiest of all the foxes, but the Wall Street firms are all foxes – they want to eat your nest egg. Don’t let them guard your hen house.

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

9. America’s top financial advisors: how they are made?

8. An investment rule for young people

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. Why asset class diversification is superior? 

3. Why doctors don’t get rich

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.

Think about all of the companies that were Asset Rich, Cash Poor and ended up on the shores of Bankruptcy. Lack of currency sunk the ship.

Imagine that you owned $100,000,000 worth of land in the Brazilian Rain Forest – BUT – there were no buyers! Lack of currency is a huge impediment when it comes to paying the bills.

The above examples are real and far-fetched, yet, we offer them to illustrate the point that ‘Maintaining Financial Wellness’ starts with ‘Maintaining Access To Currency For An Extended Period Of Time’ – WHILE SIMULTANEOUSLY – ‘Maintaining An Inventory Of Other Assets That Can Be Systematically Liquidated At Terms That Achieve The Investors Goals and Well Before “Currency” Assets Are Exhausted’!

In closing, if you would like to talk about Financial Wellness, please view us as A Resource. We are passionate about ‘Planning Toward Goal Achievement’ and would be pleased to meet and explore whether or not it makes sense for us to work together.

We encourage our clients to spend a purposeful amount of time in pursuit of fulfilling their personal goals, so, we’ll close with an observation from the Irish – yes we think of you Paddy O – writer, poet and philosopher, Oscar Wilde:

“No Man Is Rich Enough To Buy Back His Past”

Wishing you Financial Wellness and Balance In Your Life, we remain truly yours.

This exercise sends us on an initial quest to ‘Figure out How Much Money We Need’ and how to ‘Accumulate That Amount’.

Maybe you’ve seen the advertisement on TV where the guy is ‘trying to figure out his number’.  The neighbor has a number under his arm and the comic figure of the commercial thinks his number is ‘A Gazillion’!

Well – we think we’ve figured out what ‘The Number’ is for most folks. As a general guideline:

• Multiply Your Net Monthly Need By 300.

If you are 65, the above will be close. (Of course, individual age, health, facts and circumstances vary, so, we would need to meet with you to confirm the accuracy for you – which we are happy to do.)

Having derived ‘your number’, there are a number of paths one can go down to ‘amass that amount’. Some paths are quick and easy while some are slow and tedious.

• Quick And Easy:
  • Inheritance
  • Win The Lottery
• Slow And Tedious:
  • Build A Business And Sell It For A Handsome Amount
  • Work For An Employer With A Generous Retirement Account
  • Possess Assets Today Which Grow – Unmolested – Over A Long Period Of Time
  • Save Systematically And Let Those Assets Grow – Unmolested

It really doesn’t matter how you get there…you just want to get there!

Which of the above seems most likely to work for you?

This is a point we would be pleased to concern ourselves with toward assessing realistic probabilities…and plans for Financial Maintenance thereafter.

• What Is Important To You About Money?

This leads to a variety of responses, and, frankly, there appears to be a strong correlation between age (or maturity or wisdom or whatever) and the answers our question solicits.

• Youngsters Often Say Things Like:
  • I Like Money So I Can Buy Stuff
• Older Folks Often Say Things Like:
  • I Don’t Want To Outlive My Money
  • I Want To Take Care Of My Family
  • I Like To Give It Away
  • Money Gives Me Freedom
  • Money Lets Me Live The Way I Want To Live
  • Money Represents Security…However Illusory

So – when it comes to defining Financial Wellness, permit us to synthesize the responses of folks as the following:

• Financial Wellness Exists When A Family Or Person Can ‘Live Worry Free The Way They Want To Live For As Long As They Live‘

Let’s think about that for a minute.  We live for an indeterminable period of time, so, throughout that life period – be it 5 more years or 50 more years – Financial Wellness implies a reality where:

• At Some Point In Your Life Work Is Optional
• You Are Free From Financial Worries
• Living The Way You Want To Live Is Practical
• You Won’t Outlive Your Money

FANTASTIC.  Work Is Optional!  No Financial Worries! Your Lifestyle Is Sustainable!  It Doesn’t Matter How Long You Live!

As I mentioned in 2010, there is an order of priority in which beneficiaries inherit assets under intestate statues. Order of priority is governed by the familial relationship of the beneficiary to the decedent. In other words, family members related closer to the decedent generally get a share and cut-off those family members not as closely related. But, every state’s laws are different when determining this order or degree of familial closeness.

Intestate statutes also dictate what percentage a beneficiary will receive from the decedent. Each state has different rules related to that percentage a beneficiary is entitled to receive from the decedent.

The best way to demonstrate what I am talking about is to demonstrate how each local jurisdiction (Virginia, the District of Columbia and Maryland) divides out the probate estate of a person dying without a will. In our case, the decedent was a husband that was on his second marriage and has children (one from this marriage and another from the previous marriage). To further complicate the scenario, I will say the children were not minors and assume that the probate estate amounted to $100,000 after all taxes, estate expenses, allowances and debts were settled.

For Virginia, this scenario is governed by § Title 64.1, Wills and Decedents’ Estates, Chapter 1, Descent and Distribution), and it reads:

To the surviving spouse of the intestate, unless the intestate is survived by children or their descendants, one or more of whom are not children or their descendants of the surviving spouse, in which case two-thirds of such estate shall pass to all the intestate’s children and their descendants and the remaining one-third of such estate shall pass to the intestate’s surviving spouse.

In plain English, the second wife will only receive one-third (1/3) of the husband’s probate estate and the remaining two-thirds (2/3) will be split evenly between the children. In this case, the wife gets $33,333. As you can see, if the wife was going to rely on the full probate estate to live off of, then 1/3 of the estate is not likely going to cut it.

If there were no children from a prior marriage, the wife would have inherited everything and received the entire $100,000.

For Maryland, this scenario is governed by Maryland Code: Estate and Trusts, Title 3. Intestate Succession and Statutory Shares and it reads:

No surviving minor child, but surviving issue.- If there is no surviving minor child, but there is surviving issue, the share shall be the first $15,000 plus one-half of the residue.

In plain English, the second wife will receive the first $15,000 of the estate plus one-half (1/2) of the husband’s probate estate. The children split the remaining half. In this case, the wife received $57, 500. If the children were minors, the wife would have received only one-half (1/2) of the husband’s probate estate or $50,000.

For the District of Columbia, the scenario is governed by Division III, Decedents’ Estates and Fiduciary Relations, Title 19, Descent and Distribution and it reads:

Share of spouse or domestic partner.- One-half of any balance of the intestate estate, if one or more of the decedent’s surviving descendants are not descendants of the surviving spouse or surviving domestic partner.

In plain English, it means the second wife will receive one-half (1/2) of the husband’s probate estate. The children split the remaining half. In this case, the wife receives $50,000.

Three separate jurisdictions resulted in three different results and a perfect demonstration that estate planning is vital in second marriages.

Fee-based financial advisors are the financial industry’s response to the rise of independent fee-only financial advisors. Fee-only financial advisors are paid solely through fees for service paid directly by clients; they are not licensed to receive third-party commissions. Consumers rightfully associate this compensation model with integrity and unbiased advice.

What can the financial industry do to confuse the consumer? Answer: Invent “fee-based financial advisors.” Though the name is very close to “fee-only financial advisors” and indeed they charge clients fees for advice, they also put their clients into high-commission (and high-priced) products. They make money from both sides, most of the time without the knowledge of their clients.

Take my newest client for example; he is a retired doctor. He has been using a fee-based financial advisor for many years with lackluster result. Last year, his portfolio shrunk 9%, which finally helped him make up his mind to change.

His fee-based financial advisor charged him 1.2% annual asset management fees. For that kind of money, you would think the advisor would direct investments to low cost funds? Not so. Upon close examination, I found the average expense ratio of funds in the portfolio is 1.03% and the average load is 5.1%.

For those who are not familiar with these terms, loads are a one-time charge that fund companies give to the financial advisor as a kickback. Expense ratios usually include 12b-1 fees, which are ongoing payments to the financial advisor as long as his client stays with the fund.

So this doctor was set back more than 6% in explicit and hidden costs in the first year and roughly 2% thereafter. It’s very hard to build wealth when your financial advisor is taking most of it.

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

Old Age

Believe it or not, you are a stranger to yourself. That’s the finding of Hal Ersner-Hershfield et al. in their published research detailed in Social Cognitive and Affective Neural Science.

This unconscious assumption of a different self in the future is demonstrated graphically by brain scans. In their study, Ersner-Hershfield et al. found that when people think about their future selves, the same brain region lights up as when they think about strangers. The implication for saving behavior? Saving for the future instinctively feels like giving money away to a stranger. No wonder only 9% of Americans are saving enough for their retirement.

However, all hope is not lost; Research subjects who are confronted with vivid visual images of themselves that have been digitally aged often freak out – “Whoa, I look like Grandma.” But they more than double the money they say they would put aside for retirement.

How can you use this research? If you find yourself having a strong disinclination to save, you can invest in a $0.99 iPhone app called AgingBooth. Use it to take a picture of yourself and let it age digitally. Once you can see yourself in the future, you might care more about him or her. You might be willing to put more money aside for his or her benefit.

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