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How Volatile (Dangerous) Is Today’s Stock Market?

Based on conversations with clients, I’d suggest that most investors view the market of the new millennium as more volatile and fragile than it’s been in the past. New concerns that could affect a portfolio are seemingly always coming to light – think of the near-financial collapse of the U.S. economy during the last recession, the U.S. debt downgrade, the potential bailout crises in Europe and the possible devaluation of the euro, domestic unemployment concerns, and the perennial concern about the inflation/deflation of the dollar.  Add to this the idea that the world has become a more unstable place and the reality that supercomputers make thousands of trades every second.

To determine the validity of these perceptions, Allan Roth analyzed the performance of the Wilshire 5000 (an index of the market value of all stocks actively traded in the United States) since 1980 in the May edition of Financial Planning Magazine. Surprisingly, Mr. Roth found that market swings of more than 30% weren’t much more common during the past 10 years than they were from 1980-2002. In fact, on a monthly basis, market swings of more than 10% actually occur less these days than in the past.

On a daily basis, the mean standard deviation of returns (a measure of volatility) over the entire 32-year period was 1.01%. In other words, during 68% of trading days, the index increased or decreased by less than 1.01%. Further, on 95% of trading days the index went up or down by no more than 2.02% (or two standard deviations). While daily standard deviation hit a record in 2008 of more than 2.5%, last year actually had lower volatility than the overall average. Consequently, while volatility hit a high in 2008, it has been at a very normal level since.

So why do investors perceive more uncertainty in today’s environment? Mr. Roth mentions a few hypotheses:

  • Magnitude Effect – To suffer a 2.5% decrease in 1972, the S&P 500 would have needed to decrease by 2.54 points. To endure a 2.5% decrease today, the index would need to decrease by 41.25 points. Although both represent the same investment loss, we perceive the double digit point swing as larger and more dramatic.
  • Availability Bias – Humans overestimate the probability of events associated with memorable or vivid occurrences. Memorable events are further magnified by excessive coverage in the media.  Because the market crash of 2008 was so remarkable, investors tend to overestimate the probability of a similar crash and underestimate the probability of market appreciation, which historical data says is significantly more likely.
  • Access to Information – Jason Zweig, a columnist for the Wall Street Journal, says “today between websites, Facebook, Twitter, the TV and smart phones, an investor couldn’t escape knowing about a big move in the stock market if he or she tried. Whatever you pay attention to, while you are attending to it, will always seem more significant than it really is.”
  • Simple Fear and Pessimism – Meir Statman, a finance professor at Santa Clara University, suggests “people who think the U.S. is in decline view investing as riskier now than in the past, when they believe the country was better off, and no amount of data showing actual volatility would change their minds.” Similarly, Daniel Kahneman, a Nobel laureate and Princeton professor suggests “people always think the present is more volatile than the past. Because we know that historic crises have resolved themselves, we may simply remember the past as being less volatile than we viewed it at the time.”
It’s likely beneficial for investors to evaluate their behavior and determine if they exhibit any of these biases.  History tells us that the most dominate factor leading to investment success is to keep your asset allocation steady. Being aware of tendencies that might encourage us to make rash investment decisions could save us a lot of stress during critical market movements.
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When Did You Last Review Your Insurance Coverage?

When is the last time you compared rates on your home and auto insurance policies? Unfortunately, a stellar safety record doesn’t always translate into lower insurance rates. Even if you think you have a good rate, shopping around periodically is smart.

After receiving my April newsletter and attempting to follow my advice of maintaining an umbrella insurance policy, one of my readers contacted his insurer to add coverage. This reader was shocked when his insurer informed him that he didn’t qualify for an umbrella policy because he didn’t carry sufficient liability insurance on his auto policy. (Minimum auto liability insurance – frequently $500,000 – is required in order to purchase umbrella coverage.) Although this individual had owned his policy for eight years, he was unaware that the policy only provided $50,000 of liability coverage. This amount was clearly insufficient for an individual approaching retirement.

In addition to realizing that he was severely under-insured, this individual discovered he was also paying excessive premiums. For only $50,000 of auto liability coverage, this person was paying $914 per year. Moreover, the individual realized he was paying $351 per year for the $350,000 of liability coverage the individual had on his condo. Consequently, in total, this person was paying $1,265 per year for $50,000 of auto liability and $350,000 of home liability coverage.

This individual then spoke with an independent insurance agent to increase auto liability coverage to an amount that enabled him to obtain an umbrella policy. This was critical, as it dramatically decreased the individual’s liability exposure, a risk an individual with accumulated assets clearly shouldn’t have. Even better, the individual was able to obtain dramatically improved rates on his policies. For a total of $1,207 (less than he was previously paying!), the individual was able to secure $1,000,000 of auto liability coverage, $350,000 of home liability, and an additional $1,000,000 umbrella policy.

Clearly, it can be beneficial to occasionally review and compare rates on your insurance policies. People tend to believe that policies that have been owned for extended periods of time are efficiently priced, but it may be the opposite. If you haven’t verified that you are adequately insured and conducted a cost comparison recently, speak to an independent insurance agent and minimize your exposure with cost-effective policies.

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Did You Survive The Flash Crash Of 2013?

Within three minutes during April 23, 2013, the Dow Jones Industrial Average lost nearly 150 points, and approximately $136 billion of market value was wiped out. The recovery was just as fast, and markets returned to having a profitable session (both the Dow and the S&P 500 were up over 1% for the day). The crash and recovery both happened so fast that many Americans weren’t even aware of the events.

So what happened?

Believe it or not, the crash was caused by a tweet – a 140 character message posted on Twitter. The Associated Press Twitter account — which has nearly 2 million followers — was hacked and a false tweet of “Breaking: Two Explosions in the White House and Barack Obama is Injured” was posted. The message was quickly debunked by the President’s staff and markets corrected themselves. Both the crash and recovery took place in less than five minutes.

Several lessons were learned that day. First, the power of social media is now undeniable. This was caused by a simple twelve-word lie on the internet. Further, information about the market collapse and recovery were widespread via Twitter and Facebook instantaneously, while the whole episode was over before television networks had a chance to report the events.

Second, it’s amazing how fragile our world is these days. News regarding terrorism has the potential to dramatically affect the market as well as other important aspects of our lives. It’s concerning how the world might respond if the President really was injured. (Interestingly, however, the market didn’t suffer after the Boston Marathon tragedy.)

Third, it is fascinating to examine how different asset categories responded in a time of perceived crisis. Investors build diversified portfolios hoping that when one asset category collapses, another asset class will rally. Some investors swear that gold will be the asset to own when the world struggles. Yet, when the market experienced a flash crash, gold did not rally but treasury bonds and the Japanese Yen did. Gold investors shouldn’t be as confident in their investment after this experience.

Finally, automated trading platforms have become more prevalent in the stock market. These tools execute mandatory, instant sell orders in defined market environments. When the crash occurred, algorithms read headlines and saw the initial market reaction and computers created automatic sell orders at what turned out to be the worst possible time. Traders utilizing automatic trading mechanisms with stop-loss orders suffered exaggerated losses, as they sold right after the market dip and didn’t participate in the recovery. This is a potential weakness of automatic trading that many didn’t recognize.

Why are many investors unaware of this unusual market event? In reality, this drastic swing didn’t affect most investors hoping to improve their retirement. Individuals with a long-term investment strategy built around their risk tolerance don’t need to worry about these types of short-term market errors. At the end of the day, “buy-and-hold” investors had nothing to worry about and came out ahead. Perhaps we should be bragging via Twitter…

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Free Tax Preparation For Qualified Utah Residents

April 15th is around the corner. Did you know there are programs that offer free tax preparation for those who qualify? UtahTaxHelp.org is a statewide initiative powered by Community Action Partnership of Utah, a nonprofit organization dedicated to providing free online and in person tax help you can trust.

Who qualifies to file state and federal taxes for free with UtahTaxHelp.org?

  • Families who earned a combined income of $57,000 or less
  • Individuals who earned $51,000 or less

Additionally, UtahTaxHelp.org offers three tips for avoiding hidden tax filing fees:

1. File your state and federal taxes 100% free with qualified IRS-certified volunteer tax preparers

The average Utah tax filer pays $211 to file their taxes. Beware of hidden charges some paid preparers disguise as “application,” “administrative,” “e-filing,” “processing,” “service bureau” or “transmission” fees. Other paid preparers may offer free state tax filing but charge for federal tax filing.

2. Don’t pay a fee to get your own money

Some paid preparers charge you to get the credits you deserve; the more forms they fill out to get those credits for you, the more they charge. Don’t pay extra fees to save your own money.

3. Avoid refund loans

The IRS has cracked down on many refund anticipation loans (temporary loans of your money at interest rates as high as 500%), but many paid preparers are disguising these practices under new names, like “personal line of credit.” Don’t pay excessive interest rates for early access to your refund.

Call 2-1-1 for more information or visit UtahTaxHelp.org to file your taxes for free — online or in person at one of 90 locations throughout Utah.

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Should You Own an Umbrella Policy?

As a financial planner, a good portion of my job consists of identifying and dealing with potential risks and liabilities for which my clients are exposed. One of the most comprehensive, cost-effective tools for reducing risk exposure is an umbrella insurance policy. Quite simply, if you are reading this newsletter, the purchase of an umbrella policy would be a wise decision.

What is an Umbrella Policy?

An umbrella policy protects both your current and future assets against the cost of losing a lawsuit involving your car or real estate property. Such a policy is in addition to your auto and homeowners insurance. For example, suppose your auto insurance pays $300k of medical expenses per accident, and you have a $1 million umbrella policy. If you are sued for $800k because of an auto accident, your auto insurance will pay the first $300k of damage. This also serves as the deductible on the umbrella policy, so the umbrella coverage would pay the remaining $500k of damages.

Additionally, umbrella policies cover legal expenses involved with a lawsuit. Even better, since it is the insurance company that will be paying any damages, they are likely to assign a strong (expensive) legal team to your case. Consequently, purchasing an umbrella policy is an indirect way of strengthening your legal defense team.

What Does an Umbrella Policy Cover?

An umbrella policy protects you in car accidents for which you are found to be at fault, as well as accidents that occur on your real estate property. Additionally, these policies protect you from personal injury lawsuits arising from slander, defamation, libel, malicious prosecution, mental anguish and more.  Even better, this coverage will protect you from accidents caused by your dependent children.

As you might imagine, certain factors increase your need for an umbrella policy. For instance, if you spend a lot of time in your car, or you own a swimming pool or a dog, the need for an umbrella policy rises.

Some people think they don’t need an umbrella policy simply because their low net worth doesn’t justify it. This is inaccurate because losing a lawsuit can result in the loss of both your current assets, and your future earnings. For this reason, I believe nearly everyone should have an umbrella policy.

How Do I Purchase Coverage?

In most instances, an umbrella policy can be purchased through your current insurance providers. A $1 million policy usually costs approximately $200 per year, with additional coverage purchased in $1 million dollar increments and costing approximately $100 per year. At such a low cost while providing critical catastrophic coverage, there is no reason for you to not own such a policy.

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Are You Protecting Your Credit Standing?

A clean, accurate credit history is a critical piece of the personal finance puzzle. Staying on top of your credit standing over time can mean big savings since credit scores often determine your access to loans, interest rates, and monthly payments. An error on the report of any of the three major credit agencies – Experian, Equifax, or TransUnion – could be catastrophic next time you apply for a loan.

There are multiple credit-monitoring services you can utilize that charge approximately $15 per month, but these fees likely aren’t necessary. You can order a free credit report from each of the three major credit agencies every year by visiting AnnualCreditReport.com.

Additionally, several services will send you updates from the credit bureaus at no cost. Credit Sesame will track data on your Experian report daily and instantly email you if anything suspicious pops up. There are over 35 triggers for alerts, including new accounts opened, late payments, credit inquires, and address changes. The website also provides a running credit score daily.

Credit Karma has a similar tool that provides free daily monitoring of your TransUnion report. This tool also provides valuable data such as how many lines of credit are evaluated on your credit report and your auto insurance score (used to determine your insurance premiums).

Again, both monitoring tools are free, don’t require a credit card, and take no longer than a couple minutes to sign up for.

Getting an instant heads-up that there’s been a change in your report could help you fix errors quickly, catch an identity theft at work, or get on top of a delinquent account. You’ve worked hard to establish your credit, so make sure you protect it.

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What If The Stock Market Crashes?

As the Dow has risen 138% since March 9, 2009, some investors worry the market is overheated and due for a pullback. An opposing view is the current price of the S&P 500 is comparable to its value in 1999, despite the fact that its earnings and dividends have doubled since that time, suggesting the market has additional room to grow.

What the stock market will do in the near future is anyone’s guess. As uncertainty is always a factor when investing, developing a portfolio that represents your risk tolerance and investment time horizon is critical.

Many investors realize they need to scale back the assertiveness of their portfolio as they approach retirement, but why is this important? The mechanics of an investment portfolio are very different for a portfolio in the distribution phase than for a portfolio still accumulating assets. If an investor is taking withdrawals from their account, it is much more difficult to recover from losses because distributions only serve to exacerbate the market decline.

As Craig Israelsen points out in the February 2013 issue of Financial Planning Magazine with the following illustration, a portfolio enduring annual 5% withdrawals faces a much steeper climb back to break even after a loss than does an accumulation portfolio:

Clearly, the conclusion is if you are taking distributions from your account, or intend to do so soon, it is vitally important to avoid large losses. As it may be realistic for investors still accumulating assets to recover from a -20% loss by obtaining an average annualized return of 7.7% for three years, it is unlikely that a retiree taking distributions from his account will get the 16.5% annual return required for three years in order to recover from a similar loss.

Protect yourself from unsustainable losses by maintaining adequate diversification within your portfolio. Bonds serve as a buffer against volatility and will likely decrease your loss during stock market corrections. Additionally, ensure your portfolio has sufficient exposure to various asset classes: large cap, mid cap, and small cap stocks; US, international, and emerging market stocks; government, corporate, international, and emerging market bonds. Investing in multiple asset categories will protect your portfolio from a catastrophic loss next time a bubble in a market sector pops.

Speak with a financial planner to ensure your portfolio is assertive enough to meet your retirement goals while maintaining an acceptable level of risk. If you wait for the market to turn before taking action, it may be too late.

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Dunbar’s Number

Russ Thornton, a fee-only financial planner in Atlanta, wrote an interesting article about the number of clients financial advisors should have. I’ve summarized his thoughts below:

Dunbar’s number is a research-based number of “stable social relationships” each one of us can maintain over time. Robin Dunbar’s studies suggest the number is somewhere between 100 and 230, but the most often used figure is 150.

I’m not going to declare that Dunbar’s number is an accurate measurement of your personal relationship limit, but I think it’s interesting to consider the relevance of this number as it relates to financial advisors.

According to research from CEG Worldwide, the typical investment advisor serves 269.3 clients. Of course, this number is in addition to any personal relationships the advisor might have. If there is any truth to the notion of Dunbar’s number, and the average advisor has 269 clients, how much of a relationship can you actually have with your advisor if you are “competing” with 268 other clients for his time and attention?

If you work with an advisor, I suggest you ask them how many clients they have. It might not reveal anything, but then again, maybe it will.

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Are Social Security Benefits Taxed?

Ever wondered if your Social Security benefit is subject to federal tax? The answer depends on your annual household income. The first step is to calculate your “provisional income,” which is a combination of all your taxable income plus half your Social Security benefit. Comparing your provisional income to the following chart tells you how much of your Social Security benefit is taxed at various income levels.

Social Security Tax

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