Archives for April 2010

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Online Investment Advisors

By pure coincidence, in the last week I’ve encountered two investment advisors who have online-only practices (John from Flat Fee Portfolios and George from Invest it Yourself).

Their businesses are quite different from each other, but in each case, the idea is that client-advisor contact occurs via email only–no face to face consultation, no option to talk on the phone when you have a question. In exchange, the costs are significantly lower than you’d typically pay for investment advice.

Until now, I hadn’t encountered any investment advisors that operated exclusively online. The idea intrigues me.

What do you think?

This type of practice brings up two questions about which I’d be interested to hear your thoughts:

  1. What do you think of the idea of personalized, though online-only investment advice?
  2. What are your thoughts on the value of investment-only advice? (Meaning that there’s no assistance with retirement planning, tax planning, etc.)

(For the moment, let’s set aside discussion of the best way to pay for an advisor–hourly vs. annual vs. percentage of assets, etc.)

Update: No, I’m not pondering starting such a business. My current business keeps me more than busy enough. 🙂 I’m just curious to hear what you think about the concept.

Arbitraging a SPIA and a Life Insurance Policy to Create an Inheritance

This is a guest post by Evan, author of the Blog My Journey to Millions.

Mike recently wrote an interesting post about using a Single Premium Immediate Annuity to protect the inheritance you intend to leave behind. He suggested creating two separate buckets for your assets:

  1. A Single Premium Immediate Annuity (SPIA) for your income needs, and
  2. A portfolio of other investments, intended to be left for your heirs.

Just so I don’t confuse myself I will call them Insurance Bucket (used to buy the SPIA) and Investment bucket (Investments).

But what if we turn what Mike suggested on its head? Can we use the investment bucket to provide income and the insurance product(s) for inheritance?

Note: The following strategy will only work in a small percentage of cases. We need an older person, who has a really good amount of money and is healthy.

SPIA-LI Arbitrage

In this planning technique we play two life insurance companies against one another. One will be betting on the fact that you die and the other is betting on the fact that you’ll live a long life.  Let’s use an imaginary man named Bob:

  • Bob is a really healthy 70 year old male (DOB: 1/20/1940)
  • Bob is living off his investments, but he doesn’t “need” all of them. (That is, he can get by with a withdrawal rate well within the “safe” range.)

In Mike’s plan, we would let the investment bucket be the inheritance and use the SPIA bucket to provide income.  I am flipping that around. We’ll leave enough in the investment bucket to live off of. Then we’ll purchase two competing insurance products with the SPIA Bucket (which, as an example, we’ll assume to be $350,000):

  • $350,000 will buy $2,379/month in income from a 150 year old, AAA Rated Insurance Company;
  • We’ll then use $2,000 of that monthly payout to pay the premiums on a Guaranteed Universal Life Insurance Product which provides a little over  $800,000 in Death Benefit!

Why did I use $2,000 instead of $2,300? To cover income tax on the SPIA’s payments.

Why does this strategy work?

An arbitrage is created because life insurance companies go through medical underwriting on a life insurance contract, but not on an annuity product. On annuity products they just use life expectancy tables based on your age.  So in my example:

  • Life Insurance Company A (knowing about your good health) is betting that you will live for a long time and that they will get to collect your premiums, and
  • Life Insurance Company B (unaware of your good health) is betting that you will die exactly in keeping with typical life expectancy tables, at which point they can stop paying your monthly annuity payment.

But, Evan you stacked the deck!

Of course I did. I said above this is only going to be used in a small amount of cases. If you have a struggling retiree who weighs 285 pounds and has 42 years of smoking behind him…no dice.

Benefits of Creating a SPIA-Life Insurance Arbitrage

We took $350,000 and turned it into $800,000 for heirs – this is the biggest benefit.

Another side benefit that can be looked into (if the numbers were bigger) is that the Life Insurance can be owned by a Trust and then not included in your estate when calculating your estate taxes.

Drawbacks of this Technique

The most obvious downside is that this strategy only works in a small number of cases. The second negative is that once you put this into place, it is very hard to get out of.

Evan is an attorney, admitted to practice in the State of New York and works as a Director of Financial Planning overseeing the firm’s high net worth gift and estate planning. His blog covers topics ranging from Estate Planning, to his personal financial situation, to libertarian views and hatred for big government.

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Can I Retire Cover

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to calculate how much you’ll need saved before you can retire,
  • How to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"Hands down the best overview of what it takes to truly retire that I've ever read. In jargon free English, this gem of a book nails the key issues."

Renters Insurance: Cost and Tips on Buying

Last time we moved, I made a bonehead mistake: I forgot to buy a new renters insurance policy. We got lucky and had no uninsured losses, but for somebody who spends his time writing and thinking about personal finance topics, you’d think I would know better!

Regardless, the process of shopping for renters insurance is worth discussing.

How much does renters insurance cost?

Short answer: Not much.

The exact cost will naturally depend upon how much coverage you need, whether you’ve had losses in the past, where you live, what type of safety features your residence has, and so on. Our own policy provides coverage for $19,000 of personal property for an annual premium of just $100.

Note: It’s worth shopping around. Some of the quotes we received were more than twice as high for coverage that was no better.

Get the Right Amount (and  Types) of Coverage

Most renters insurance policies have limits on the amount of coverage they’ll provide for specific types of property. For example, a policy might provide $15,000 of coverage, but only cover $1,000 of jewelry. If you need more than that, you’ll have to increase the jewelry coverage specifically rather than just increasing the amount of total coverage.

When you’re shopping for quotes, be sure that you’re comparing apples to apples. The policy that initially looks cheapest may not be the best once you realize you’ll have to add more coverage for jewelry, personal computers, and so on.

Also of note: Most policies don’t cover earthquakes, landslides, or floods. If those are significant risks where you live, you’ll need to purchase separate coverage specifically for the sake of insuring against them.

Where to Shop for Quotes

There are several websites that allow you to enter your information and receive quotes from various companies. I tried two such sites and wouldn’t recommend either of them for two reasons:

  1. The quotes provided are unofficial (meaning that in the end, you need to contact the insurance company directly to get an official quote), and
  2. They give out your contact info to insurance reps with several companies. (Forgive me for not thinking this is a valuable service…)

Instead, I’d shop directly with the insurance companies–State Farm, Allstate, Esurance, and GEICO, would all be good places to start.

Be sure to read your policy.

After you purchase a policy, the insurance company will send you a paper copy in the mail.

Be sure to read it.

If your policy doesn’t cover something that you expected it to, better to find out now rather than later. (Note: I’m not talking about reading the glossy brochure, though you can read that if you want. I’m talking about the boring, legal-looking document that’s printed on pages that look like they came from a Bible.)

What’s the Value of Active Management?

In the aggregate, the value of active management is zero by definition–if somebody is outperforming the market, it’s only because somebody else is underperforming.

But there are times when you have no choice but to make an attempt at answering the question, “What will this fund’s active management be worth?”

For example, what if your retirement plan at work gives you access to two international stock funds: One is a not-particularly-cheap index fund. The other is an actively managed fund that costs just 0.05% more per year than the index fund.

  • Is it worth paying that little bit extra for active management?
  • What criteria should you use for making the decision?
  • And what if the costs were exactly the same? (Or what if the actively managed fund actually cost less?)

People ask me about this scenario (or similar ones) from time to time, and I don’t have a very good answer.

My first response is to go with the fund that’s likely to have the lowest portfolio transaction costs (portfolio turnover being the best indicator of such costs, as far as I’m aware). But if there’s no meaningful difference there either, I’m at a bit of a loss in terms of what to suggest.

The most obvious things to look at–past performance and tenure of the fund’s manager–have both been shown to be nearly worthless as predictors of long-term future performance. (At least, that’s what every credible study I’ve read has indicated. If you’re aware of one indicating otherwise, please share.)

I’d love to hear your thoughts: When given the choice between an actively managed fund and an index fund with similar costs, how do you choose between them?

Using Annuities to Protect Inheritance

If you’re at the point where your portfolio is large enough that your annual spending can be satisfied using a withdrawal rate that’s likely to be sustainable, you don’t need to annuitize any of your portfolio.

But should you do it anyway?

What about buying a single premium immediate fixed annuity large enough to completely fund your living expenses? That would allow you to treat the remainder of your portfolio as an “accumulation portfolio” rather than a “distribution portfolio.” The benefits being that:

When you don’t need to annuitize, the question of whether or not to do it anyway is basically a “break even point” calculation. If you end up living long enough, the return provided by an annuity will make it a great investment, even if you didn’t need it as a risk management tool.

A Silly Example to Make a Point

If you knew with 100% certainty that you were going to live to be 150, an annuity would be a super idea, regardless of whether or not you needed to buy one. The guaranteed payout provided by the annuity would be far higher than the payout that could be safely provided by drawing down a portfolio of stocks, bonds, and cash over that time frame.

The end result: Annuitizing would dramatically increase the amount that you leave to your heirs. (In fact, it could even be wise to annuitize your entire portfolio. The portion of the annuity’s payout that you don’t need to fund living expenses could be used to start building a new “inheritance portfolio.”)

Annuities and Inheritances in Real Life

Of course, in real life you don’t know how long you’re going to live. So–as with much of investing, and retirement planning in particular–it’s somewhat of a guessing game. My analysis would look something like this:

  1. What inflation-adjusted payout can you get from a single premium immediate fixed annuity?
  2. If you used that payout as the withdrawal rate for a portfolio, when would you expect the portfolio to run out?
  3. Do you expect to live longer than that?

If so, an annuity makes sense even if you don’t need one. And the more certain you are, or the longer past that date you expect to live, the more sense it makes to annuitize.

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire Cover

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to calculate how much you’ll need saved before you can retire,
  • How to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"Hands down the best overview of what it takes to truly retire that I've ever read. In jargon free English, this gem of a book nails the key issues."

Learning about TIPS (Inflation-Protected Bonds)

I recently finished reading Explore TIPS: A Practical Guide to Investing in Inflation Protected Securities by fellow blogger The Finance Buff.

It was actually my second time reading it. You see, the author mistakenly thought that I might have something meaningful to add to the book, so he sent me a proof copy during the editing stage.

Instead, I found myself scribbling down several pages of notes. (The second time through the book resulted in two more pages of notes.) The honest truth is that, while I have a pretty good grasp of the basics of how TIPS work, I still had much to learn.

Random example #1: I never would have guessed that, when purchasing TIPS in the secondary market, it’s often more cost effective to place a buy order over the phone rather than online, despite the higher commission. (Reason being that the rep on the phone may be able to find you a better price on a given bond.)

Random example #2: At any given moment, every financial website may be quoting completely different yields for a given TIPS fund. The Finance Buff explains how to figure out what each of the yield figures means, and he provides advice on which figures to pay the most attention to if you’re trying to figure out what yield you’re going to get if you buy the fund. (Hint: Look for something forward-looking that’s inflation-adjusted.)

Explore TIPS covers everything that you’d need to know about investing in TIPS, things like:

  • When to buy individual TIPS and when to use a mutual fund or ETF,
  • How individual TIPS are taxed (and why you might want to consider a fund rather than individual TIPS if you’re investing in a taxable account),
  • How to buy TIPS at auction, and
  • How to buy TIPS in the secondary market (both how to understand the quote screens as well as how to minimize transaction costs).

For as much of our portfolios as bonds–and TIPS–make up, they sure get a lot less coverage than stocks and stock mutual funds. If you’re like me in that you could use a little more background on the other half of your portfolio, I’d suggest picking up a copy of the book. It’s short, it’s easy to understand, and it’s only $10 (and change) on Amazon.

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