The Investment Scientist

Archive for the ‘Prudence & Fiduciary Duty’ Category

images-82Recently, a doctor nearing retirement age approached me with the question of how to maximize his social security income. He is 62, and his wife is 4 years his junior. He made substantially more money than his wife, and as a result, his PIA is $2400, and his wife’s PIA is only $1000.

PIA, or primary insured amount, is the monthly amount a retiree would get if he or she retires at the normal retirement age, currently 66. For every year earlier (or later) that one retires, one would get 8% less (or more). The youngest one may retire is 62 and the oldest is 70.

I’ve found over the years that many people give very little thought to maximizing their social security income, and they jump at the first opportunity when they turn 62 to claim their benefits. But in so doing, they could be leaving nearly half a million dollars on the table. Read the rest of this entry »

images-46Following the post I wrote about deep risk vs shallow risk, I went to Amazon and flipped through Bill Bernstein’s latest book “Deep Risk” to see if he feels the same way as me.

It turns out there is a lot that we agree on, but not everything.

Here’s where we see eye to eye: 1) our definitions of deep and shallow risks are almost the same: 2) we both see market fluctuation as a shallow risk and 3) we both see inflation as the #1 deep risk.

Our agreement stops there however. Bernstein does not seem to believe behavior risk and agency risk are deep risks, as I do. Instead, he mentions the following three risks as deep risks in addition to inflation risk.

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images-54Recently, a prospective client of mine sent me an email asking about my thoughts on Bill Bernstein’s new book “Deep Risk.” I have not read the book yet, but I do have my own ideas about deep risk vs shallow risk.

I define shallow risk as a potential loss that you can recover from and deep risk as a loss that you cannot recover from.

Market volatility, for example, is a shallow risk. It is very visible and it is scary, there is even a TV channel devoted to it. (That TV channel is called CNBC.)

But taking on shallow risk is how you earn your investment keep. Thus, it should not be feared, it should be welcomed.

Now what are the deep risks you should ardently avoid? I can think of three: inflation risk, behavior risk and agency risk.

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ImageA few days ago, my wife came home telling me the story of a sweet old lady she had met at her army clinic.

She is a 75 year old lady from Thailand, married to an American veteran for 40 years. Her husband just passed away a few months ago at the age of 92.

She couldn’t stop telling my wife how much she missed her husband, that he had married her despite the fact that she was a divorced woman with kids and that she could barely speak English. She went on and on about how he had treated her like a queen, buying her all the pretty things women like and so on and so forth.

Now everytime she passes by her husband’s picture, she still cries; and yet the memory of her husband is all she’s got left, now that she has no income and the home she has lived in for 40 years is being foreclosed.

What happened?

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ImageThat was a message I got from a new client of mine. I must admit, it really bites. Yes, I sold his Apple stock. And yes, since then the price has gone up 15%. So of course, I can understand he’s upset and beginning to question whether I know what I am doing.

Having studied improvisational comedy, I’m aware that regardless of how I feel, it is wise to always validate others’ feelings. So I replied, “Yes, I should have asked you before I sold it.”

Afterward, I sent him some data to mull over.

Nasdaq just crawled its way back to 4000 a few days ago, and this time Apple is the biggest and hottest stock in the Nasdaq 100.

Last time when Nasdaq passed 4000, the top ten tech stocks (try saying that ten times fast) were, Microsoft, Cisco, Intel, Qualcom, Oracle, JDSU, Nextel, Sun Micro, Veritas and MCI Worldcom.

Since the last time Nasdaq passed 4000, Microsoft has gone down 34%, Cisco 59%, Intel 53%, Qualcomm, the only up stock in the group, has gone up 25%, Oracal has gone down 67%, JDSU 98% and the remaining four are no longer in business; they were either merged out of existence or end ignominiously.

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My Financial AdvisorWhen I am approached by a prospective client, the question they always ask without fail is “Are you properly licensed?”

This is actually the wrong question. The right question should be, “Which license do you have?”

Generally, there are two types of licenses for people who call themselves a “financial advisor.” People who passed the series 65 test and people who passed the series 7 test. The nature of these two licenses are as far apart as heaven and earth.

Series 7 is a securities license. People who have passed this test can legally be a broker. They are actually prohibited by law to give financial advice, except incidental to the financial products they are selling.

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ImageRecently a business owner asked me to review his investment portfolio. He is currently with an Ameriprise financial advisor and his gut feeling tells him something is amiss.

He is paying the advisor 1.6% in fees. First of all, this fee is quite exorbitant. For the size of his portfolio, he shouldn’t be paying more than 1% in advisor fees.

Adding insult to injury, for the fee that he is charging, this advisor puts his money into a collection of very expensive mutual funds like ODMAX.

It is very easy to check the expenses of a mutual fund. I just googled ODMAX and I found out it has a load of 5.75% and an expense ratio of 1.36%. (For those who don’t know, load is a one time charge to pay commision to the Ameriprise advisor who doubles as a broker. Expense ratio is an ongoing annual charge.)

ODMAX is a mutual fund that invests in emerging market stocks. If you use the low cost alternative, aka a Vanguard fund, you will pay no load and the expense ratio is only 0.33%, a saving of 1.06%.

Don’t ever underestimate these tiny savings. Because in ten years, the savings will be more than 10%, in twenty years, more than 20%. This businessman is in his 50s; he can easily live another 30 years. I asked him: “How would you like to be more than 30% poorer in retirement?” That is exactly what this financial advisor will make him.

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ImageI bet you didn’t know that this week, the third week of October, is … drum roll please … National Estate Planning Awareness Week!

Seriously! Congress established it in 2008 in House Resolution 1499.

I only know this after getting an email from my estate planning attorney friend. I think you should read it as well.

According to the resolution passed by Congress, “Many Americans are unaware that lack of estate planning and financial illiteracy may cause their assets to be disposed of to unintended parties by default through the complex process of probate.” The resolution goes on to state that “careful planning can greatly assist Americans in preserving assets built over a lifetime for the benefit of family, heirs, or charities.”

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ImageMany middle aged Americans are caught between a rock and a hard place financially. They are the so-called sandwich generation, having to take care of both kids and parents at the same time.

This has recently been a subject of discussion with clients of mine. They are a self made millionaire couple. their parents however, are relatively poor. They have enough to live on by themselves, but if they ever got sick, they would be financially dependent on their children for care.

To that end, my clients have set aside $1m just in case.

I suggested they fork over a few hundred a year to pay for their parents’ gym memberships. If their parents actually use the memberships, my clients may never need to spend the million.

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Image1. “The gross revenues for the financial services industry in 2010 were $1.129 trillion. That year, total US financial assets stood at $50.38 trillion, meaning that the financial services industry as a whole is skimming 2.25% a year out of everyone’s wealth.” This is an excerpt from a post on Wealthcare Capital entitled “Investment Expenses – The Other Millionaire You Make.” How about I help you cut those expenses by half?

2. Shocking! Shocking! Your elected representatives want the financial industry to continue ripping you off!

3. Ike Devji wrote a piece “Investment Fraud Red Flag for Physicians.” It is packed full of useful tips. I have one thing to add though, never work with a broker, regardless how clean his or her broker check record. These people are not legally obliged to watch out for your best interest.

4. A very succinct piece in Physicians’ Monday Digest about How Rising Interest Rates Would Affect You.

5. Taxpayers beware, AccountingToday has a piece on tax deductions expiring in 2014.

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images-11A physician client of mine called me the other day and asked my advice as to whether she should evict the tenant currently residing in her condo. This is advice I hate to give. Let me explain.

The tenant is a single mom with two young children, whose estranged husband just stopped paying child support because he is officially unemployed, but the tenant believes he is getting paid under the table.

My heart goes out to this tenant, I would never want her and her children to become homeless. But my head tells me that if my client lets her stay for free, she would most likely wind up staying for free forever and my client’s rental property would become a toxic asset.

So what should I advise my client?

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I read with disgust this news about a “financial advisor” stealing $1.3m from his client who also happened to be his father!

I want all of you to know that not all financial advisors are the same. In fact “financial advisor” is a free term. There is no educational requirement nor legal requisite. Justin Bieber and his grandmother could call themselves financial advisors and begin dispensing advice – and they would not get into trouble for it!

In reality though, there are generally four types of people who like to call themselves “financial advisors”:

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I had a fun conversation with a prospective client who I lost a few months ago. He actually got me to create an investment plan for him, then he shopped around and found an advisor who charges less.

He then had the gall to call me back and ask whether I think he is paying too much for his new advisor. Here is what he said.

My advisor puts me in low cost ETFs and meets with me every quarter. But otherwise he does nothing with my portfolio, so what exactly do I pay him $15k for?

I know this gentleman has a sizable portfolio, and $15k means a fee of well below 1%. So I told him what I thought.

  1. The fee is very competitive.

  2. The advisor did the right thing by putting his money in low cost EFTs.

  3. Doing nothing with a portfolio is the only right thing to do!

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ImageA few days ago, I interviewed Jim Ludwick using Google+ Hangout On Air (HOA.) This is the first time I’ve interviewed an expert live on air! Feel free to laugh as you watch me stutter and trip over my words left and right.

Jim is the owner of MainStreet Financial, he used to be an agent at NY Life. Now he is a licensed insurance advisor.

I did not waste his appearance and got right down to the nitty gritty. I asked about a client case during the interview. Specifically, this client of mine was talked into 1) buying a universal life insurance inside her defined benefit plan, 2) buying a whole life insurance policy for her young daughter, because “it’s a great investment” according to the agent’s illustration of 8% growth.

I asked Jim three questions:

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ImageI go to great lengths to meet with my clients regularly. For instance, many of my clients live across the country. I fly to them.

Some might ask: what value is there in meeting regularly? There can be about $100k of value in it, let me tell ya!

Meeting regularly allows me to uncover hidden issues and potential opportunities, thereby helping my clients make smart financial decisions.

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ImageA client of mine is trying to get his money out of an ill-conceived investment. I want to share this with you so you don’t make the same mistakes.

In 2009, he had a windfall of $1m. He asked a lady who had sold him a bunch of annuities where he should put his newfound cash. He further told her he was already up to his neck in annuities so he wanted to take some risks.

The agent pointed him to a celebrity business. Basically, some hollywood celebrity was trying to start an online gaming business, and needed $30m to do so.

My client went to their presentation and was mesmerized by the income projection. Then, when he saw that one of his relatives was a minority partner in the venture, he was totally sold. He signed a check for $1m on the spot.

He might as well have flushed it down the toilet.

Here is what he did wrong.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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