What Is Fiduciary Responsibility and Why Should It Be Important To You?

 

Lost in the shuffle of President Obama’s recently proposed regulatory overhaul is the proposal to hold all brokers to the same fiduciary standard as registered investment advisors.

First, a little background.  A quick check of Wikipedia finds this definition of fiduciary duty as ‘… the highest standard of care at either equity or law. A fiduciary (abbreviation fid) is expected to be extremely loyal to the person to whom he owes the duty (the ‘principal’): he must not put his personal interests before the duty, and must not profit from his position as a fiduciary, unless the principal consents.  The word itself comes originally from the Latin fides, meaning faith, and fiducia, trust’.

Under current regulations, registered investment advisors, like our firm, are required to accept fiduciary responsibility in all our actions.  Brokers, like those found in most of the large brokerage firms aren’t held to the same high standard.  The only requirement they have is to recommend investments that are ‘suitable’ for the client. 

Sounds like the same thing, right?  While the difference in responsibility between the Investment Advisor and Broker might seem like semantics, it can mean a real difference in practice.  

For example, your advisor at XYZ Brokerage has determined, correctly, that a mutual fund that invests in Large Cap companies is a suitable investment given your risk tolerance, age and circumstances.  Among her many fund choices, your advisor at XYZ has available to her Fund A and Fund B.  Fund A is a proprietary fund run by the firm and Fund B is a fund run by an independent mutual fund company and both have similar performance results.  Fund A, though successful and clearly suitable, carries a higher expense ratio and higher turnover than Fund B but also pays the advisor more.  Both of the funds are ‘suitable’ for your portfolio and the advisor would be well within the rules to recommend Fund A over Fund B.  

If your advisor worked for a Registered Investment Advisor (RIA), they would have a fiduciary responsibility to recommend a fund that is not only suitable, but that is in your overall best interest.  That means that despite the fact that they would make more money recommending Fund A, they are obligated to recommend Fund B since it carries lower overall expenses.

If adopted, this proposal could fundamentally change the way the brokerage business operates.  Firms would be required to change their compensation structure to de-emphasize proprietary products and would most likely cause them to reduce expenses and improve the performance of those same proprietary products in order to make them more compatible with the fiduciary standard.  The result would be better protection for the consumer, something the Obama administration is pushing aggressively for as part of this overhaul.

This article was written to illustrate one aspect of President Obama’s regulatory overhaul proposal and to highlight some of the differences between advisors that work for Investment Advisors and those that work for brokerage firms.   It is in no way intended to imply that advisors at the brokerage firms are anything but ethical.  I truly believe that the vast majority of people in the financial services industry, whether they are technically subject to fiduciary responsibility or not, act in the best interest of their clients on a day in and day out basis.

If you’d like more information on fiduciary responsibility or if you’d like to schedule a portfolio review to ensure that your current advisor is adhering to the standard, drop us an email at info@rtjfinancial.com or call our office at (310) 587-3370.

Health Insurers Are Shooting Themselves In The Foot

 

If the large health insurers are trying to improve the chances of nationalized health care, they’re doing a fine job.  Tesitfying before Congress, the heads of Wellpoint, United Health and Assurant when asked if they would stop rescinding policies unless they could determine the misrepresentation was intentional, replied ‘No.’

As a wealth manager, I spend more time than I care to calculate dealing with health insurance issues for my small business clients.  Premiums continue to increase while coverage is decreased and deductibles/co-pays rise.  Add to this the chance that , when the coverage is needed most, namely in the case of serious illness, the policy could be rescinded due to a simple oversight and it’s no wonder there’s animosity toward the carriers.

There are legitimate cases where an applicant fails to disclose health issues that would impact the pricing or acceptability of the policy.  Instead of looking for ways to avoid paying claims through use of recission, the insurers should limit their recissions to cases where:

1. The applicant clearly knew about the condition and concealed it from the insurer.
2. The insurer would not have issued the policy had they known the information.
3. The unreported information is directly related to the illness the policyholder is currently being treated for.

In all other cases, the insurers should be allowed to deduct the additional premium they WOULD HAVE received had they known about the undisclosed condition but should be required to pay the claim as indicated in their contract.

By taking a short-term profit view and using technicalities to avoid paying claims, they simply shooting themselves in the foot.  This type of bad ‘corporate behavior’ is making it easier and easier for the public to decide that a government-run, single-payer system is preferable to the shenanigans of a for-profit system.

Is Traditional Buy and Hold Investing Dead?

 

The last 18 months in the financial markets have been described as a once-in-a-lifetime event.  With financial and credit markets in turmoil, it seems that most investment portfolios, from individual 401(k)’s to large endowments suffered staggering losses.  The result is that many advisors are now rethinking their investment philosophy.

Most mainstream investment theory has traditionally fallen into two distinct camps.   Those that advocate a buy-and-hold strategy with periodic rebalancing of a diversified portfolio and those that espouse active trading based on short-term technical indicators. 

Traditional Buy and Hold

Those that adopt this philosophy feel that over the long term, nobody can accurately predict the short-term movements of the markets and therefore cannot outperform the overall market.  They argue that in order to maximize long-term results and reduce volatility, the best approach is to build a portfolio made up of numerous asset classes like stocks, bonds, real estate and private equity.  The thought is that the different asset classes are not closely correlated, meaning that they don’t all go up or down at the same time.  While one asset class (i.e. large cap stocks) may be dropping, another portion of the portfolio (bonds or commodities) should be rising.  By periodically rebalancing back to the original allocation, as different asset classes over or under perform in the short term the overall volatility of the portfolio should be reduced and returns increased.

This latest bear market however, has seriously put to doubt the basic tenets of the buy-and-hold strategy.  In 2008, while we saw some asset classes rise quickly for a short time (oil and commodities) eventually almost every asset class, except Treasury bonds and cash, showed negative results, decimating even the most diversified portfolios.  Markets like the one we’ve seen recently add credence to those that favor active trading.

Active Trading

Active traders feel that by analyzing price patterns, they can capitalize on short term inefficiencies and broader movements in the financial markets, both up and down, to maximize returns over the long run.  These traders are not concerned with which asset class they are trading, or whether that asset is trending up or down.  Their approach is to get in and out of markets quickly, taking small profits as they go.

2008 was a potentially great year for active traders since there were large movements in numerous asset classes like stocks, bonds and commodities.  By being able to profit from both up and down markets, some active traders were incredibly successful.

A Hybrid Model

After the last bear market, many advisors, including our firm, moved to a hybrid model, calling it things like ‘Buy & Hold with a Tactical Overlay’ (quite a mouthful) or ‘Core and Explore’.  No matter what they call it, these advisors are using the same methodology.  In this approach, they build the core portfolio across numerous asset classes just like the traditional buy-and-hold philosophy, periodically re-balancing to maintain the original asset allocation.  For the balance of the portfolio they will use a limited form of active trading, taking advantage of shorter-term trends in the market to over or under-weight certain asset classes based on their judgment of their relative value.  This allows them to reap the benefits of long-term investing while taking advantage of very real, short-term circumstances.

Which Approach is Right for You?

Like any long race, there are many ways to reach your destination and as a result, there is likely no single right approach to investing.  The important thing to remember is that it’s the end result that’s important, not how you got there.  Your choice of advisor and approach should come down how well the advisor articulates their particular philosophy to what you’re comfortable with that approach.  The best thing you can do is to ask your advisor what their investment philosophy is and whether or not it suits your personality.  The most important thing is that you understand how they do things and that you have a plan in place that you can stick to, even in challenging markets.

Next Steps

If you’d like to learn more about how RTJ Financial Management builds its portfolios and the investment approach we take, simply drop us an email at info@rtjfinancial.com with ‘Portfolio Review’ in the subject line, and we’ll schedule a free, no-obligation one hour portfolio review with you.

Does Money Bring Happiness?

 

The financial news has been decidedly grim for the better part of the last 18 months.  Many people have seen their wealth, both actual and perceived diminish substantially over that time frame.  While many more people are concerned about their financial future than they were before, has this reduction in wealth led to a reduction in happiness and it again raises the question of whether there’s a correlation between money and happiness.

 

Most psychologists and sociologists will tell you that happiness derives primarily from social interaction.   Those with good relationships with their family and friends generally describe themselves as happy.

 

As to the link between increased wealth leading to increased happiness, surveys have shown the following:

 

·         American wealth has increased dramatically in the 20^th century, but on average,
Americans are no happier than they were a century ago.

·         Once your level of wealth allows you to have basic creature comforts, happiness doesn’t increase markedly as wealth increases.

 

So, if more acquiring more wealth doesn’t increase happiness, does increased spending help improve happiness?  We all know somebody that loves to indulge themselves in a little ‘retail therapy’ when they’re feeling down.  The reality is that spending can increase happiness, but it depends on where the money is spent.  For example:

 

·         Spending money on oneself can actually decrease happiness.  Too many people fall into the trap of having to work so hard to achieve the appearance of ‘wealth’ that their happiness is actually decreased due to stress.

·         Study after study has shown that $1 given to somebody else provides much more happiness than the same $1 spent on oneself.

 

Finally, from my completely unscientific standpoint as a financial planner helping clients acquire and maintain health, it is my firm opinion that money does not lead to happiness but instead simply magnifies your innate state of happiness.  If you are a generous, happy person when you have no money, there’s a strong likelihood that you will be equally or even more happy with more money.  If you are a naturally unhappy person, the increase in wealth will simply provide you more reasons to be unhappy and more things to complain about.

 

Money is clearly an emotional topic for a lot of people and this topic is one that has fascinated me since I started working in the financial services field and I would love your thoughts on the topic.

 

 

Is Now The Time to Convert Your Traditional IRA to a Roth IRA?

 

With great adversity comes great opportunity. While nobody likes to see the account balances in their IRA drop 40% or more, the reduced value in your IRA may make it an opportune time to convert your Traditional IRA to a Roth IRA since it will cost you much less in taxes than it would have in any of the past 4 years.

Traditional IRA vs. Roth IRA Basics

A Traditional IRA allows you, with some limitations, to deduct your IRA contribution when you make it. Over time, your account grows tax-free until you start taking distributions. Once you begin to take distributions, the amount you take each year after age 59 ½ is taxed at your rate at your current income tax rate.

A Roth IRA on the other hand, does not provide you with an up-front tax deduction. Like the Traditional IRA, your account grows tax-free but, unlike a Traditional IRA, when you take distributions there is NO tax liability.

Why Convert?

Roth IRA’s have four big advantages:

1. Tax-free growth. Like a Traditional IRA, the growth in your account is not taxes.
2. Tax-free withdrawals. As long as you’ve owned your Roth IRA for five years or have reached age 59 ½, the amount you take out of the account is not taxed.
3. Contributions can be made after age 70 ½. While you can longer make contributions after age 70 ½ in your Traditional IRA, there is no such restriction for the Roth IRA.
4. No mandatory distributions. In a Traditional IRA, one you reach age 70 ½, you must start taking Required Minimum Distributions (RMD’s) each year from the account. Because you didn’t get an up-front tax deduction for your Roth IRA, you’re not required to take RMD’s.

Reasons Not To Convert

1. Taxes. When you convert from a Traditional to a Roth IRA, you’ll need cash to pay taxes on the earnings and pre-tax contributions you made. Warning: you can’t use your IRA to pay the taxes since the amount you use for taxes would be considered an early withdrawal, subject to income tax and a penalty.
2. You anticipate being in a lower tax bracket in the future. If you’re currently in the 35% tax bracket and you think you’ll be in the 25% bracket in retirement, you’ll be paying taxes at your higher current rate.

Who Is Eligible to Convert?

In 2009, in order to be eligible to convert your IRA, you must have an Adjusted Gross Income (AGI) of less than $100,000. In 2010, there will be no income limitation on a Roth conversion.

Do-Over

If the market continues to tank through 2010, the government has provided you with the ability to take a mulligan. Otherwise known as a ‘re-characterization’, this give you until October 15, 2010 to reverse your decision to do the conversion in 2009 and re-do it on the new lower amount in your IRA.

Consult a Professional

The tax code is a fluid, complex animal. Before undertaking this type of conversion, be sure to consult your CPA or tax professional to ensure that you do everything right to avoid an unnecessary complications.

How Barack Obama’s Economic Policies Might Affect You

Congratulations to Barack Obama on becoming our 44^th President.  It’s truly an historic moment when an African American man can ascend to the highest office in the land and it shows how far this nation has come in the last 40 years when it comes to racism.  Whether you voted for him or not, you have to admit that it is once again going to be an interesting time in America.

Mr. Obama comes into the office with an economy clearly on the decline and financial markets still largely in turmoil and he admitted that it will be an uphill climb for his administration to fix these issues.  How that will be done remains to be seen, but we can glean some insight into his economic philosophy from his comments at the debates to the numerous press interviews he’s granted over the course of the campaign.  Here are some of the trends you can anticipate during the Obama Presidency.

Capital Gains Taxes

Throughout the campaign, Mr. Obama has said that he would like to increase the tax rate on long-term capital gains.  Currently the rate sits at 15% and Mr. Obama has said he might raise them as high as 28%, which was the rate when Bill Clinton took office.

What should you do?  If you’re convinced he will raise the capital gains rate next year, you should realize as many gains in this year as possible so you can benefit from the low current rate.

Income Taxes

Mr. Obama has said that he intends to reduce income taxes on those making less than $250,000 per year and raise taxes on those making more than $250,000 per year.

If you’re currently make less than $250,000 per year and you anticipate you will make less than that in 2009, then pushing income into next year should save on your taxes.  If you make more than $250,000 then you should push as much income into this year in anticipation that your taxes will go up under the Obama plan.

Infrastructure Upgrades

We all know that our roads and bridges are, in many places, in dire need of repair or replacement.  During the campaign, Mr. Obama indicated that one of the tools he might use to prop up the economy is to use Federal money to do those repairs, thus pumping billions of dollars to construction companies, heavy equipment manufacturers and construction-related jobs.

If Mr. Obama is successful, you should position a portion of your portfolio to take advantage of those industries that would benefit, like construction and equipment makers.

Barack Obama has certainly sparked the imagination of many Americans and it’s good to see a sense of enthusiasm out there again.  The few items we’ve listed is far from an exhaustive list and I’m sure that, as we transition from the Bush Presidency to the Obama Presidency, many other trends will begin to develop.  All we can do is to try to stay on top of those trends so that we can all benefit to the greatest degree possible as this country recovers from our current economic malaise.

America rocks!!

What’s a Terrified Investor Supposed To Do?

The Dow Industrial Average is down more than 35% so far this year, with an almost 679 point drop today alone.  There’s not doubt about it, but this market is in the midst of a full-blown panic.

Stocks are down, bonds are down or barely hanging on, oil and gold are down, real estate is down.  So given all the doom and gloom, what’s a shell shocked investor supposed to do?  Here are few tips to help you ride out the current market.

• Don’t panic. Now is not the time to sell all your stocks.  If you were going to do that, the time was 12 to 18 months ago.  By selling now, you’ll simply lock in what is still a paper loss.
• Remember your time horizon. If you’re young, this market will provide a great buying opportunity.  If you’re nearing retirement, you may want to follow the next piece of advice.
• Scale back your equity exposure. Don’t sell everything, but it would be wise to have a little more cash than usual.  We currently have our clients with a lot more cash than usual so we can start buying again when the panic subsides.
• Review your asset allocation. Some asset classes have gotten hit harder than others.  Now is a great opportunity to reallocate your portfolio without the tax bite you might get under more normal circumstances.
• Talk to your advisor. If you haven’t spoken to, or heard from, your advisor, now is the time to be proactive and schedule an appointment to review the above items.  You’ll most likely leave that meeting knowing you’re doing everything in your power to minimize the damage of our current situation.

This has undoubtedly been a brutal market that has tested the stomachs of even the most seasoned professionals.  While you may have to make small adjustments to your current portfolio to reflect current circumstances, remember that your investment portfolio is built for the LONG TERM and that, over time, your patience and fortitude will be rewarded.

House Republicans Need to Get a Clue

Well, as cynical as I am about politics, the Republicans in the House of Representatives just dropped my own cynicism to a historic low.  The House just now FAILED to pass the bailout package that was negotiated over the weekend.  The result?  As this is being written, the Dow Industrial Average is down more than 500 points.

Republicans, who overwhelmingly rejected the bailout package, just had a press conference wherein they blamed not the package itself, but a ‘partisan’ speech given by Speaker of the House Nancy Pelosi that apparently angered some Republicans enough that they voted no, despite previously indicating that they would vote yes.  The bailout package didn’t change, but apparently hurt feelings are enough to change somebody’s mind.  Seriously, a no vote because you essentially got your feeling hurt?  What are we, in third grade again?  Are you so clueless that you truly cannot put aside partisan politics to help this country avoid economic calamity and get back on the road to recovery?

While our economic system is wounded, clearly our political system is completely broken, when a group of ELECTED officials find it impossible to do what’s right for the American public because they got their feelings hurt.

Life on some tropical Polynesian island run by a king is starting to look pretty appealing right about now.

Congress Just Doesn’t Get It

Congress continues to debate the government bailout package proposed by Treasury Secretary Henry Paulson, Fed chair Ben Bernanke and SEC chair Christopher Cox.  In the meantime, the markets are spooked and the credit markets are on the brink of complete collapse.  It seems, as always, that Congress just doesn’t get it.

The Congress may have forgotten (or most may not know) that the Great Depression not caused by the stock market crash of 1929, but by the failure of the Government to provide the liquidity banks needed at the time to keep their doors open and lend money to their customers.  While I’m not saying that we’re on the brink of another Great Depression (I’m an optimist by nature), we’re in a similar credit crunch and failure to act could damage our already struggling economy and add years to the time it will take to recover.

Ron Paul was right in his CNNPolitics.com commentary that this mess was created by artificially low interest rates that magnified the real estate bubble, and while his solution of rolling back stifling laws and regulations, divorcing oursleves of Fannie Mae and Freddie Mac, reducing the Federal buget deficit and reducing regulation will work in the long term, in the immediate term, this bailout is the best alternative we have to stabilize not only the U.S. economy, but the world economy as well.

Congress needs to finally get a clue, quickly put together a proposal with the oversight and CEO restrictions they want and pass the damn bill so the financial markets can return to some form of normalcy.

This Time is Not Different

With the bankruptcy filing of Lehman Brothers and the shotgun wedding between Bank of America and Merrill Lynch, many investors are concerned with the viability of our financial markets.  Oh, how short our memories are.

Ten years ago, in 1998, a hedge fund, Long Term Capital Management, failed, creating market panic similar to what we’re seeing today.  The fear at the time was that, due to the size of the fund and its leverage, having to sell its positions could destabilize the entire financial system.

Similar to today, the Federal Reserve and other large banks worked to minimize the damage from the collapse and the world financial system was ’saved.’  Not only did the doomsday scenarios fail to materialize, but the stock market went on to log one of the longest bull market runs ever.

The moral of the story is that, altough financial crises like this are scary, even for the professionals, this time is most likely NOT DIFFERENT and our financial system will not only survive, but most likely survive.