Oblivious Investor

Successful Trading Techniques

I recently received an email from a reader asking for my advice on trading. He was looking for “a successful trading technique with a good shot at beating the market.”

My reply–and this won’t surprise regular readers–was to ask what reason he has for thinking that an individual investor can reliably outwit the professionals.

His answer: I need a 12% return in order to retire on time. So normal market returns probably won’t cut it.

The Market Doesn’t Care.

Unfortunately, the market doesn’t care that you need a reliable 12% annual return in order to make your retirement plans work. Your need for a given return doesn’t increase your probability of getting it.

To use an analogy: “Going 60 mph won’t get me to work in time” is not a good reason to drive 120 mph. Similarly, “normal market returns aren’t good enough” isn’t a sufficient reason to try to earn above-market returns.

If you have no reason to think that you have a meaningful advantage over the professionals–and I would argue that most investors do not–then the only reasonable answer is to adjust your plans. Figure out a way to make your life work with market returns, whether that means retiring later, working part-time, or cutting your expenses.

May 5, 2010

Dave Ramsey Gives Bad Investment Advice

Dave Ramsey has helped many people get out of debt. And for that, he’s (rightfully) earned those people’s trust.

After somebody digs his/her way out of debt, the next step is often to start investing. And it’s only natural that people who have come to see Dave as a financial mentor turn to him for investment advice.

That’s unfortunate though, because Dave’s investment advice leaves much to be desired.

Dave Ramsey on Asset Allocation

Ramsey provides the following advice on asset allocation:

“I do not own any bonds and do not suggest them as part of your investment plan.”

He also recommends against CDs, fixed annuities, and REITs. In other words, Dave’s suggesting a portfolio that’s almost 100% stocks, regardless of your age.

He never even mentions the fact that such a portfolio would expose most retired (or soon-to-be-retired) investors to a meaningful risk of running out of money as a result of a poorly timed bear market.

Dave Ramsey on Roth IRAs

In several places on his website, Ramsey makes statements to this effect:

“The best way to start investing is with a Roth IRA.”

There’s no discussion of how to choose between a Roth or traditional IRA. Not even the briefest mention that, for many investors, going the tax-deferred route would be better.

Dave on Financial Advisors

Dave has the following to say about brokers (commission-paid salespeople who sell front-load mutual funds) as opposed to fee-only advisors:

“I do not personally choose fee based planning. (paying 1% to 2.5% annual fees for a brokerage account). With an A share mutual fund, I pay an upfront load of 5% to 6% once. But with a fee based account, also known as a wrap account, you agree to pay a 1% to 2.5% fee every year – forever. As your account grows, the 1% to 2.5% fee will really add up.”

Unfortunately, this is a grossly inaccurate comparison.

First, he ignores the additional ongoing costs of actively managed funds. Typical front-loaded funds (like those Dave recommends) include operating expenses in the range of 0.75-1% per year. In contrast, with a fee-only advisor, you’d have access to index funds and ETFs, which charge in the range of 0.2% per year.

Second, he overstates the cost of a typical fee-only investment advisor. The median fee for registered investment advisors is barely 1%. If you shop around, you can find advisors who charge significantly below that rate.

Dave Ramsey’s Endorsed Local Providers

Many people I’ve spoken with think that Dave’s recommendation of brokers over fee-only investment advisors has more to do with his business model than it does with giving good advice.

If you go to Ramsey’s website, you’ll see that most of his investing articles end with the suggestion to meet with an “Endorsed Local Provider” of investment services. If you fill out the form, your contact info is sent to a broker in your area, and Dave gets a fee for providing that broker with a prospective client.

But why does Dave recommend commission-paid advisors rather than fee-only advisors? Why send people to a broker–where there’s an inherent conflict of interest between the advisor and the client–rather than to an advisor who charges, say, a flat hourly or annual fee?

Best-selling author Eric Tyson puts it this way:

“By referring people to commissioned-based brokers, the referral fees don’t have to be disclosed as they would be with a fee-based advisor. A registered investment advisor would be required to disclose to the client that Ramsey’s company was acting as a solicitor and would have to disclose the fee being paid to Ramsey as the solicitor.”

Why give bad advice?

If I had to guess, I’d say that Ramsey doesn’t find investing to be as interesting or important as the get-out-of-debt side of personal finance. And as a result, he doesn’t spend much time learning about it. And for the record, I don’t think there’s anything inherently wrong with that.

I do think, however, that he does his readers/listeners/followers a disservice by discussing investing without taking the time to learn more about it.

May 3, 2010

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:

What do you think of the idea of personalized, though online-only investment advice?
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.

April 28, 2010

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:

A Single Premium Immediate Annuity (SPIA) for your income needs, and
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.

Retiring Soon? Pick Up a Copy of My Book:

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

See it on Amazon.

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."

Read other reviews on Amazon

April 26, 2010

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:

The quotes provided are unofficial (meaning that in the end, you need to contact the insurance company directly to get an official quote), and
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.)

April 21, 2010

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?

April 19, 2010

Get new articles by email: