personal asset / liability management concept

hello clients, friends, and family.  what an enjoyable day outside!  time to finish professional efforts and enjoy the outdoor environment...it's friday, right?

thought that i should post this topic not just on my linkedin profile but also on my independent practice's blogosphere.  gil weinreich with adviserone, www.lifehealthpro.com/author/gil-weinreich, wrote the piece on january 16, 2012. 

Stark Advice on Risk Avoidance From a Leading Academic

By Gil Weinreich, Advisorone

January 16, 2012

 

Zvi Bodie (left) has long been a lone wolf in the financial services industry. The Boston University finance professor and veteran risk avoidance advocate has himself risked being pelted with eggs, or worse, at industry gatherings more disposed to hearing his Wharton nemesis Jeremy Siegel’s message about stocks for the long run.

Now the author of the classic college text on investments has written a new book targeted to the general public, and appropriately titled “Risk Less and Prosper.” In a year in which the U.S. stock market has trounced its world peers with a nearly 0 percent return, on top of a dismal decade of stock performance, investors’ heightened sense of risk may make them receptive to a message that was tuned out in previous bull markets. In an interview with LifeHealthPro.com’s sister website, AdvisorOne, Bodie discussed some of the ideas in his book, co-written with financial advisor Rachelle Taqqu.

How did U.S. investors come to be so risk-prone? 

Because of the positive stock market experience of the ’80s and ’90s. People don’t have memories that go back that far, so they thought you can’t lose if you hold on.

But you shouldn’t think you’re going to earn a potential risk premium without taking risk. It was always a crazy idea to think that you could, but that idea was drilled into people’s heads by a whole industry campaign.

The vast majority of investment advisors are telling people: “History proves that in the long run you’re going to do best by staying in stocks. And the worst thing you can do is lose your nerve when the stock market goes down; on the contrary you should be doubling up.”

That conventional wisdom is very comforting to people who have lost money. But everyone has a finite horizon. You can only postpone using the money so long.

If you don’t need the money, you’re investing for future generations or some charity; those are the people who should be taking risks. Ironically, the people who are high-net-worth are the ones who make sure they have ironclad guarantees on their standard of living. [Not because they are smarter but because] people don’t like to see their living standard go down.

What is the message of your new book?

In my previous book, “Worry-Free Investing,” I started out by talking about inflation-protected bonds. In this book, I want them to understand that investing is all about you and your goal. I think we’re going to see a popularization of GDI investing [goal-driven investing].

LDI [liability-driven investing] is popular among institutional investors. LDI is matching your assets to your liabilities. In the individual investor world, the one advisors are concerned about, you don’t have liabilities, you have goals. Those are going to determine what you consider a risky or non-risky strategy. If you can save enough to cover your basic needs and lock them in, I believe that’s what people really want. And that’s a form of asset-liability matching.

Investment advisors don’t talk about asset-liability matching; they talk about diversification. But diversification comes in second. The first thing you want to do is cover your assets. In the book, we call it matchmaking.

Since investing is all about trading off risks and rewards, the natural starting point–the benchmark–is to say, “What if I want to take as little risk as possible?” That is where you should start the process. “Now that I know what it will take in terms of what I have to save, what’s the earliest date I have to retire?”

That involves matching. You might be 100percent TIPS in that situation. “So what if I put 20 percent of my money into stocks? On the upside, that means I can save less or consume more; or I can retire earlier.”

But the downside is you could do worse than if you hadn’t done that. You have to look at worst-case scenarios. You won’t be able to retire till you’re 80. Or you have to save 30 percent of your income. [The financial services industry says] you have to take risk, but they don’t say that if you do take risk your outcome could be worse than they describe.

What do you think about financial advisors who recommend annuity products as a means of mitigating risk?

I am very much in favor of insurance products, but, hey, have a cost. So you have to ask the question: Is it worth it? In my view, [annuity products are] a better framing of the real trade-off than ignoring the risk, which is what is being done now.

How can investors manage this trade-off between risks and life goals?

The core asset should be a TIPS ladder that is matched to the person’s spending needs. Young people don’t even know what level of consumption they’re going to have. Most of their assets are in human capital. So it doesn’t matter if they put it all in stocks. I’m talking about people over the age of 50 who have to start thinking what they want to lock in in retirement. They have to think of it like insurance, and if they’re putting it in all in TIPS, they’re not paying big fees.

What can financial advisors do to help ordinary investors?

The challenge that advisors face is to turn themselves into life coaches.

The way advisors are currently compensated is through assets under management. Even those who don’t take commissions, the so-called good guys, the fee-only advisors, are basically pretending to manage people’s assets. But most of these people are getting people to take more risks. It certainly is not the case that they’re doing more for the client than if the client would hold 80 percent of their portfolio in TIPS and 20 percent in a stock index fund.

If I convince [investors] at an intellectual level [to avoid risk], that’s only half the battle. The issue is how to you get it from the frontal cortex to the brain stem–the autonomic system where your feelings reside. Advisors could help these people.

How should people managing for risk as you advise invest in tax-deferred accounts?

With respect to a tax-deferred account, if you have a person who is investing both in stocks and in bonds, the taxable bonds should be held in a tax-deferred account and the stocks in a taxable account. With stocks, most of the gain is going to come in the form of capital appreciation. First, you can defer gain; the other reason is that inevitably you’re going to have losses in some years and in those you can realize the gain and get the tax-loss benefit.

Why are you often a lone voice calling for this risk-off approach?

If you were to talk to any other finance professor, you would hear the same thing. It’s just that there is this huge gap between the academic world and the advisory world today.


from mendez & co. financial counselors - thank you professor bodie! 

blake mendez
www.menco-finco.com

financing strategy covering extended care expenses

we know that establishing a flexible, robust extended care strategy makes sense sooner rather than later.  ideally, you should begin broaching the topic with your family and financial professional in your early 40's or even sooner; however, if you have not done so, you can begin today.

we should all enjoy a blissful second act in our lives and express our right to define our own life.  to express yourself on your own terms, you should not worry about uninsured healthcare expenses and outliving income.  easier said than done, right?

holistically managing current and future cash flows remains the focus.  this concept dials down asset-focused strategies that your risk hungry advisors serve up.  we as a society should devote significant energy to managing future liabilities not merely chasing yield.  

you can use the following tactics, in isolation but preferably in combination, to finance your future uninsured healthcare expenses:

a) pay out of pocket dollar for dollar

at some point, you may have to cover uninsured healthcare expenses dollar for dollar from your legacy and/or pension funds.  we should remain realistic knowing that we may not 100% immunize your legacy and pension from some monetary reduction; however, the fewer dollars allocated towards this tactic the better.

b) invest in a premium based extended care policy

why not share uninsured healthcare expense risk with a financial counterparty, such as a life insurance company?  instead of paying dollar for dollar, you can utilize cents to cover that dollar.  this concept has served consumers well and will continue to do so, but stay alert.  

many extended care carriers have left the market due to overly aggressive pricing practices in the past.  remaining players have increased rates across cohorts as well.  few clients favor uncertainty, but avoid letting this short-term shakeout spook you.   

as an example, one client with significant cash flow, a strong pension, and productive mineral right interests purchased a lifetime pay policy.  we chose this plan because his current and future cash flow matched future rate increases.  he did not want to allocate other funds to funding a policy and wanted to pay out of cash annually.

when the time comes for a rate adjustment, we will make preparations using saved funds and/or adjust the policy benefits.  reducing policy benefits has an opportunity cost, so it would remain wise to save more as a precautionary element; moreover, we can offset future rate increases when he turns on different pension cash flows.

the client could have chosen a limited pay, paid-up policy but did not due to current cash flow considerations; however, limited pay, paid-up policy structure immunize rate uncertainty more effectively than lifetime pay.  this tactic requires significant upfront investment but can payoff handsomely if you want to not think about rate increases.

c) invest in a life insurance or annuity combination policy

this tactic generally involves funding extended care policies with prepaid investment proceeds totaling over 50,000.  most consumers fund policies through pension funds, brokerage accounts, or personal savings; however, using pension fund sources may necessitate professional tax counsel.  

short of having 50,000 around, you can save your current i.r.a. funding limit per year into a non-qualified account.  non-qualified accounts include annuities and non-retirement stocks, bonds, and cash.  saving 5,000 per year alone would yield 50,000 over a decade even without a return.

with cash in hand, you can purchase a life insurance or an annuity policy with extended care benefits.  the prepaid cash generally will purchase a multiple of benefits based on age and health; plus, health examinations are rather limited since you essentially reserve money against your future uninsured healthcare expenses.

a 60 year old husband and wife client household lacked sufficient life insurance and extended care coverage on the wife.  she recently retired from the school district and had begun drawing her state pension.  when she annuitized her pension, she chose the option to allow a partial lump sum transfer totaling 100,000.

using that money and after consulting her c.p.a., she purchased a universal life insurance policy with extended care benefits.  the benefits covered not only her but also her husband.  it made sense to use the life route since her husband would need the funds in her absence.

d) conduct a 1035 exchange on inforce life insurance and/or annuity policies

owning permanent life insurance with annuities has its benefits.  you can exchange your inforce life insurance and annuity policies within the i.r.s. 1035 section and purchase a combination plan. 

the client that chose the premium based extended care policy had an option to use his universal life insurance policy's net cash value.  we could have exchanged part or all of the proceeds to purchase a combination plan; however, we avoided that tactic since he still needed the life insurance protection. 

he also did not want to use part of the policy's net cash value.  exchanging part of the proceeds can cause properly funded universal policies to lapse if not refunded back to the original level.  hitting the target cash value again did not appear appealing to him.

a bonus example: grandparent life insurance gifting not only provides core coverage but serves as an extended care funding source.  imagine the intergenerational wealth transfer benefits!  your grandchildren could purchase an extended care policy and manage uninsured healthcare expenses with a couple hundred thousand in cash.

...thank you grandma and grandpa for the paid up policy you purchased for me sixty years ago...

know that consulting with your financial professional or your team and saving aggressively will pay off.  addressing uninsured healthcare expenses does not sound sexy, but living a long life free from worry surely does.  you deserve nothing less!

you can count on my professional judgment, my resource access, and my practical counsel.

blake mendez

www.menco-finco.com

funding extended care - optimal age question

last column piece, we touched on extended care implications on your family and you.  this piece shall concern the optimal age when you should begin consider funding your own private extended care plan.  next piece shall concern the various financing strategies towards maximizing your dollars.

our conversation becomes more relevant in the context of the national debt crisis.  even though both political parties posture grandiosely, you can count on disruption to the medicare, social security, and medicaid entitlement programs.  we can reasonably assume that you will have undependable future federal government pension and social safety net benefits.

within the national debt crisis context, you may ask what can i do about the future problem.  you can do nothing, and someone will have to pay, more than likely your own future kin; or, you can put your foot down by putting your own extended care plans in your own hands.

so, the question becomes, where to begin?  consider beginning your core extended care coverage funding in your early 40's, when most insurance carriers consider underwriting extended care plans:

a) your health and age in your early 40's may stack the odds that you can obtain coverage at a discounted rate.  although carriers can change future premium rates based on experience across a group, they generally do not require future medical underwriting.  the health and age rate factor remains substantially relevant when you consider postponing similar coverage to your 50's or 60's.

b) your employer and/or you can completely pay-up a premium based policy beginning in your 40's and ending at your retirement age.  this policy could serve as your extended care core coverage, avoiding any potential future rate increases with a paid-up structure.  the investment remains more palatable starting at age 40 to age 65, rather than age 50 or 60 to age 65.

c)  your employer and/or you can begin layering coverage across your cash flow and asset wealth age spectrum throughout peak earning years.  with core coverage obtained earlier, you can allocate peak earning cash flow towards additional coverage through a single premium plan.  these plans may provide more flexibility but generally require upfront investments exceeding $50,000 and prior forethought.

some financial advisory professionals may consider obtaining core extended care coverage in your early 40's overkill.  overkill depends on the particular situation, but why wait to buy something tomorrow when you may get a bargain today?  pushing that decision off may also prevent you from getting coverage, period, even if you could afford it several times over.

consider beginning the conversation with your financial professional early in your prime earning, healthy years.

blake mendez

www.menco-finco.com

the sandwich generation's legacy challenges

sandwich generation members generically comprise those baby boomers caring not only for their grown children but also their aging parents.  although the grown children conversation has its place, we can focus our conversation on aging parents and caregivers.  the sandwich generation may ultimately find themselves in their parents' shoes in the next 30 years, after caring for their parents.

the center for medicare and medicaid services estimates that more than 70% of americans over age 65 will require custodial care.  custodial care becomes necessary when you cannot manage two out of your six activities of daily living (adl).  your adl's comprise bathing, continence, dressing, eating, toileting, and transferring.

many hope that either government entitlement programs, friends, relatives, and/or their own financial wherewithal can provide or pay for the care; however, the february 2011 medicare guide specifically notes within section 5 that it does not cover custodial care costs.  with that entitlement program nixed, you can consider medicaid, but why choose poverty when you can create options earlier in life?

industry experts wisely recommend that consumers consider other options towards financing your future custodial care costs other than entitlement care.  my professional opinion gravitates towards estimating future custodial care costs without governmental entitlement programs.  prudence demands that you estimate the worst case scenario as a starting point.

imagine building a million dollar legacy, and an unplanned and protracted custodial care situation reduces 75% of your wealth; or, imagine a loved one slipping into poverty without medicaid services, potentially creating your own financial bankruptcy providing that backstop.

preserving your family's financial legacy starts with understanding that unmanaged custodial care risk can potentially compromise intergenerational wealth transfer desires.  custodial care requires financial resources, whether personal, familial, non-profit charity, or government entitlement.  the various financial resources listed vary based on flexibility, control, and customization, with personally owned vehicles affording the most options.

consider custodial care insurance options or setting aside funds specifically earmarked towards satisfying future custodial care costs or insurance premiums.  most custodial care insurance carriers will consider applications for consumers over the age of 40 with varying medical underwriting methodologies.  premiums will increase year by year becoming more expensive as you age with medical underwriting becoming potentially dicier.

for clients with complex legacy needs, the conversation takes on a more pressing dimension, potentially benefiting or inhibiting intergenerational wealth transfer.  without proper guidance and strategic foresight, you may find that a lifetime(s) of financial asset accumulation may wither under a protracted custodial care situation.  most people generally do not want that situation.

we can save the optimal age to buy custodial care insurance and its financing strategy discussion for another time.  until that time, consider discussing your concerns with an adviser laser focused on meeting your legacy needs.  your adviser should coordinate your custodial care solution within an overall strategy context, such as addressing alzheimer's disease and legal competency.

blake mendez owns and operates mendez & co. financial counselors, an independent human capital practice specializing in intergenerational wealth transfer and pension development.  you can reach him directly at 00 + 1.432.288.3243 or via email at blakemendez-mendezco@clear.net.

blueprinting human capital

good afternoon clients + prospective clients + partners.  working with clients on intergenerational wealth transfer and pension development needs has shown that human capital matters tremendously.

you can find my posts on other sites, such as www.businessinsider.com and www.entrepreneur.com, as well as here at the www.menco-finco.com blueprinting human capital site.

we will enjoy our journey together as a new civilization dawns with the rise of the positive collective consciousness social-psychology within the information age.  thank you for joining up.

you can count on my professional judgment, my resource access, and my practical counsel.

blake mendez
www.menco-finco.com