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Net Worth Advisory Group Strengthens Senior Management Team

By Lon Jefferies | Published: April 20, 2011

Net Worth Advisory Group is pleased to announce the hiring of Merrit Arnell as Director of Operations and Finance.  Merrit began his employment with Net Worth on April 1, 2011.  His responsibilities include general management of operations, accounting and finances.  Merrit has over 25 years of experience in business and project management.  Most recently he was the Head Estimator for Arnell – West, Inc., where his responsibilities included project management, contracting, planning and scheduling, financial analysis, cost controls and manager of estimating personnel.  Prior to this, Merrit worked as a financial accountant and financial analyst on Wall Street.

“We are very excited to have Merrit join us and are looking forward to many great contributions from him,” said David Swapp Managing Director at Net Worth Advisory Group.  Additionally, David said “Merrit is a great addition to the senior management team at Net Worth Advisory Group. His extensive operational and management experience along with proven leadership skills will be instrumental in managing the continued growth at Net Worth Advisory Group.”

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National CFO Survey Results

By Lon Jefferies | Published: April 20, 2011

Today Grant Thornton LLP released the results of a national survey of U.S. Chief Financial Officers (CFOs) and senior comptrollers. The study concluded there is growing optimism about the U.S. economy as 48% say it will improve over the next six months (up from 30% six months earlier).

While still tepid, 39% intend to increase head count (up from 28% six months earlier), and 54% are optimistic about their own company’s outlook over the next six months (up from 46% six months earlier).

Regarding the disaster in Japan, 94% say it will at least be somewhat impact the U.S. economy. Meanwhile, the majority believe that Japan will not fully recover for at least 3-5 years.

Although probably expected, it is interesting how concerns seem to be growing over inflation. 50% of survey respondents say their company intends to raise prices for its goods over the next six months. That figure is up from 31% six months ago and 24% one year ago.

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A Moment To Focus On The Good

By Lon Jefferies | Published: March 30, 2011

One of my favorite economists, Jeff Thredgold, pointed out in his recent newsletter that society tends to focus on negative information. Consequently, he dedicated some time to focusing on the positive developments within the U.S. Here is a sampling of the information he mentioned:

  • The 0.9% decline in the nation’s unemployment rate during the past three months was the sharpest three-month fall in 28 years.
  • U.S. economic growth has now been positive for seven consecutive quarters.
  • Productivity of U.S. workers rose an average of 2.6% annually during the past 10 years, the largest gain in 40 years. Rising productivity is a long-term key to higher standards of living.
  • The number of people who have quit smoking (46 million) now exceeds the number who still smoke (45 million). Less than 21% of adults smoke today, versus nearly half in the early 1950s.
  • Substantiated cases of childhood sexual abuse have fallen 49% since 1990. Physical abuse of children is down 43%.
  • Economic output of the average American worker is 10-12 times that in China. Americans won 30 Nobel prizes in science and economics during the past five years. China? Just one.
  • A record 30% of men have earned a bachelor’s degree or higher, versus 29% of women, also a record. This compares to a combined 7.7% in 1960. A record 85% of adults over age 25 now have at least a high school diploma, versus 24% in 1940.

To view Jeff’s entire newsletter, visit www.thredgold.com/tea-leaf.

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Should We Fear Global Uncertainty?

By Lon Jefferies | Published: March 29, 2011

Recent “cataclysmic” events will be approximately the fifteenth time the world was supposed to end since 1981, when some individuals at Net Worth Advisory Group began their careers as financial advisors. Think about all the crises that have happened and been predicted over the years. Thirty years ago, a Utah man became popular by predicting an earthquake that would devastate the entire earth. He had it nailed down to the very year. Hundreds of his followers in Utah added earthquake coverage to their homeowner’s policies. The earthquake never came. At least insurance companies did well.

With the one-day decline in the stock market on October 19, 1987, again, the world was coming to an end. Three months later it had totally recovered. Other crises occurred in 1982 (global credit crunch), 1989 (junk bond collapse), 1994 (bond market massacre), 1998 (Russian currency crisis), 2000 (Y2K), 2001 (tech bubble), 2008 (sub-prime loan crisis), and 2010 (foreign debt crisis), just to name a few. During the last thirty years, many Cassandras have regularly issued their dismal prognostications. Sometimes an event occurred that temporarily fulfilled their dire predictions. Yet, the economy and market always recovered. The world continues to turn and function. It can be very dangerous to follow the advice of doomsayers. If you had been out of the stock market the last 30 years, you would have paid a very high price. The S&P 500 closed at 122.55 on December 31, 1981. It’s now above 1300.

If we have learned anything about the stock market during the last thirty years, it is that the greatest risk doesn’t occur when fear is rampant. The most dangerous environment is exactly the opposite: when people are wildly optimistic and buying any investment in sight. Those are the times when risk is the greatest. The building of the tech bubble in 1998 and 1999 is a prime example of this infectious group mentality.

The challenge for investors is to step aside and develop the ability to view world events and market activity apart from the crowd of human sheep. Granted, this is easily said but very difficult to do. Remember that your feelings are most likely the same as everyone else’s. Unless you develop the skill of isolating your emotions from those of the vast majority, you will become a market timer who buys high and sells low – not a good strategy for making money.

The recent events in the Middle East and the earthquake in Japan may have triggered a “correction” in the market that was long overdue. A correction always has a triggering event, but we should remember that the “event” is an excuse, not a cause. What was the market psychology that existed when Middle East tensions erupted? Were investors buying any and every stock with reckless abandon? Was the market greatly overvalued? No — none of these conditions existed. By answering these simple questions, we can conclude that recent events didn’t signal the emergence of the bear from his hibernation. Last year, we had the “PIIGS” European debt crisis. Despite that event, the market did very well in 2010.

History has shown that human beings have remarkable resilience and an amazing ability to overcome catastrophe. People pull together and solve problems. The Chinese character for crisis contains two parts: one is danger, the other is opportunity. People deal very well with poverty and trials. What they can’t handle well is success and wealth. A patient, long-term view is the price investors must pay to profit from the stock market’s attractive returns.

At Net Worth Advisory Group, we believe that our clients should accumulate a reasonable supply of resources, including cash, to prepare for a disaster — be it natural, man-made, or personal. But anyone who sincerely believes that capitalism is dead and that all human creativity and technological advances have come to an end should sell all his/her financial assets. Then go buy farmland, weapons, ammunition, gas masks, and all the other survivalist paraphernalia. Sit on the porch of your farmhouse in a rocking chair, shotgun cradled in your arms, and wait for the end. It may be a long time coming — and that will take a lot of patience as well.

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How Do Equity Indexed Annuities Stack Up?

By Lon Jefferies | Published: March 21, 2011

Sales of equity indexed annuities (EIAs) have grown considerably in recent years. These products are positioned as simple investment vehicles that enable the investor to participate in market gains but offer protection from market losses. In reality, these are complex investments and because salespeople are paid large commissions for promoting these products, it’s difficult to get an objective opinion on whether they are right for you.

How Do Equity Indexed Annuities Work?

EIAs produce an investment return that is tied to a market index, most commonly the S&P 500. Each product has a minimum guaranteed return (currently, 1% is common) and a cap rate, which is the highest annual return the investment can generate (currently, 8% is common).Consequently, an EIA with these common parameters would generate the same return as the S&P 500 of that return was between 1% and 8%. If the S&P 500 produced an annual return of less than 1%, the EIA would guarantee 1%. Similarly, if the index produced a return greater than 8%, the annuity would be capped at an 8% return.

Further, EIAs have participation rates that commonly range from 70% to 100%. For instance, if the index increased in value by 10% during the year, an EIA with an 80% participation rate would produce an 8% return (80% of the index’s 10% return). Also, it is important to note that minimum guarantees, cap rates, and participation rates can change at the whim of the insurance company.

Other Important Factors

As mentioned previously, salespeople are handsomely compensated for selling EIAs. To protect the insurance firm from paying a large commission to a salesperson only to have the investor sell the annuity, these products have a surrender charge if the investors sells within a certain time frame, which can be as long as 10 years. This surrender penalty can be as much as 10%. Thus, liquidity is severely limited with these investments.

EIAs offer tax-deferral, meaning an investor doesn’t pay taxes on investment gains until the annuity is sold. This tax-deferral is similar to the benefit offered by a 401(k) or IRA. However, unlike investments in a 401(k) or IRA, investments in an EIA don’t reduce your current income or tax bill when the investment is made. For this reason, many financial planners encourage their clients to maximize contributions to other tax-deferred vehicles before considering an annuity.

It’s important to note that most EIAs only count equity index gains from market price changes, and exclude any gains from dividends. Since you’re not earning dividends, you won’t earn as much as if you invested directly in the market. For example, the S&P 500 earned 15.1% in 2010, but 2.3% of that return came from dividends which would not be included in an EIA.

Lastly, the guaranteed return on an EIA is only as good as the insurance company that gives it. While it is not a common occurrence that a life insurance company is unable to meet its obligations, it happens. Information about the financial strength of insurance companies can be found on the SEC’s website.

Investment Return

Suppose a 45 year old with a 40 year investment horizon was looking for an investment that offered impressive returns with relative safety. Would an EIA be a good choice? Let’s consider a $10,000 investment in three unique options: an investment in the S&P 500, an investment in a conservative diversified portfolio* consisting of 75% bonds and 25% stocks, and an investment in an equity indexed annuity tied to the S&P 500. For illustration purposes, let’s assume the annuity has extremely favorable conditions: a 100% participation rate, a 3% minimum guarantee, and a 10% cap rate. Further, let’s give the EIA the benefit of the doubt and assume it includes the portion of the S&P 500’s return due to dividends, which few EIAs do. All and all, this annuity is significantly more favorable than any real product you are likely to find. Since the investor intends to live another 40 years, let’s look at what would have happened to these three $10,000 investments during the last 40 years, starting in 1970.

As you would expect, the $10,000 investment in the S&P 500 grew the most over 40 years, to $495,551. However, this investment endured significant volatility, losing as much as -37% in one year. Clearly, this investment is too risky for an investor willing to endure only a small amount of risk. Alternatively, the $10,000 investment in the diversified 75% bond, 25% stock portfolio grew to $433,838 — still an impressive return. However, the largest loss this portfolio suffered in a calendar year was -6% (1974), which might be tolerable to an investor with a low risk tolerance. Finally, while the equity indexed annuity with unrealistically favorable terms never gained less than 3% per year, our $10,000 investment only grew to $195,479. What if we consider an EIA with more realistic terms: 100% participation rate, 1% guarantee, and an 8% cap rate? Our $10,000 investment would have grown to only $103,767. Clearly, when comparing an EIA to investing in a diversified portfolio with a conservative ratio of bonds to stocks, an investor benefited of accepting a small amount of volatility in their portfolio.

Did you recently purchase an equity indexed annuity without full knowledge of the product? Annuities have a “30-day free look” that enables you to surrender the product free of charge within 30 days of signing the contract. If you recently purchased an EIA, speak to a fee-only financial planner immediately to ensure the product was right for you. If you decide the annuity wasn’t what you thought, a fee-only financial planner can help you exercise your free look provision and find an alternative investment that is more appropriate.

* Model portfolio returns were derived using the following allocation and indexes; STOCKS: 25% DJ Wilshire Large Company Growth Index, 25% DJ Wilshire Large Company Value Index, 10% DJ Wilshire Midcap Growth Index, 10% DJ Wilshire Midcap Value Index, 5% DJ Wilshire Small Company Growth Index, 5% DJ Wilshire Small Company Value Index, 20% Morgan Stanley EAFE Index NR USD; BONDS: 40% Lehman Bros. Long-Credit, 40% Lehman Bros. Long-Term Govt. Bond Index, 20% Citigroup Non-$ World Gov. Bond Index;

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Does the Threat of High Inflation Justify Portfolio Adjustments?

By Lon Jefferies | Published: March 3, 2011

Inflation has been an increasing concern in the investment markets during the past year. Many wonder what actions they should take to protect their portfolios in the event of hyper inflation. To address this issue, let’s look at the worst 10-year period of inflation on record – 1973 thru 1982. This is a great time period to examine because it provides insights into how inflation impacted financial markets during both the horrific market crash of 1973-1974 and the impressive market recoveries of 1975-1976 and 1979-1980.

Let’s first consider a $10,000 investment into a diversified portfolio* at the beginning of 1973. In this example a diversified portfolio consists of 60% stocks, 25% bonds, and 15% cash. The chart below documents the annual rate of return of our model portfolio and the growth of our $10,000 investment.

March 2011 1st Chart

Despite the significant market pullback of 1973-1974, our $10,000 investment grew to $22,456. This equates to an annualized rate of return of 8.43% over the 10-year period, which many people might find satisfactory. However, let’s examine the growth of our investment after accounting for inflation:

March 2011 2nd Chart

After a decade of nearly double-digit inflation, in real terms our $10,000 investment in 1973 was only worth $9,732 in 1982. Consequently, the annualized real (inflation-adjusted) rate of return achieved by our portfolio over the 10-year period was -0.27%.

Now let’s explore some potential alternative strategies. First, let’s examine a portfolio consisting of 100% stocks in an attempt to stay ahead of inflation:

March 2011 3rd Chart

As you can see, when compared to a diversified portfolio a 100% stock allocation was only able to improve the performance of our $10,000 investment by $161 inflation-adjusted dollars over the 10-year period – hardly a significant benefit. At the same time, the 100% stock portfolio was subject to vastly increased volatility. For instance, while the 60% stock, 25% bond, and 15% cash portfolio lost -15.10% and -22.69% in real terms during 1973 and 1974, the 100% stock portfolio lost -22.91% and 33.26% during the same time period. Clearly, the small improvement in return didn’t justify the vastly increased risk.

What if we had attempted a strategy of investing the $10,000 in 3-month Treasury Bills in hopes of keeping up with inflation while avoiding any serious market pullbacks?

March 2011 4th Chart

Unfortunately, this strategy was unable to spare us the loss experienced by the diversified portfolio. In fact, in real terms the 100% cash approach suffered a loss during seven of the ten years analyzed. Further, history suggests this strategy could never be an effective approach to retirement planning. While a 60% stock, 25% bond, 15% cash portfolio achieved a 5.38% annualized real rate of return from 1970-2010, a portfolio consisting entirely of 3-month Treasury Bills has produced only a 1.08% real return during the same period. Obviously, a 1.08% return is not sufficient to enable most individuals to achieve their investment goals.

Conclusion

In summary, as opposed to making drastic adjustments to a portfolio during the worst 10-year period of inflation in US history, an investor would have been rewarded for sticking with a diversified, buy-and-hold investment approach. No additional advantage would have been gained by making rash changes to the investment strategy. Meanwhile, a diversified model portfolio kept up with inflation as well as any alternative strategy and was well positioned for a market recovery and long term success.

* Model portfolio returns were derived using the following allocation and indexes; STOCKS: 25% DJ Wilshire Large Company Growth Index, 25% DJ Wilshire Large Company Value Index, 10% DJ Wilshire Midcap Growth Index, 10% DJ Wilshire Midcap Value Index, 5% DJ Wilshire Small Company Growth Index, 5% DJ Wilshire Small Company Value Index, 20% Morgan Stanley EAFE Index NR USD; BONDS: 40% Lehman Bros. Long-Credit, 40% Lehman Bros. Long-Term Govt. Bond Index, 20% Citigroup Non-$ World Gov. Bond Index; CASH: 100% 3-Month Treasury Bill

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Is the Bond Market a Concern?

By Lon Jefferies | Published: February 7, 2011

Lately, I’ve had more than a handful of clients express worries that the bond market will continue to decline in value. Consequently, many individuals have wondered whether they should sell their bond positions.

When addressing these concerns, I first remind my clients that my goal is not to predict what the markets will do, but to prepare their portfolio for long-term growth regardless of short-term market trends. Then, I point out that we have seen turbulence in the bond markets before, and over the long-term people have been better off maintaining their asset allocation in good times and bad.

In fact, over the last 85 years long-term government bonds have actually decreased in value during 21 calendar years. By comparison, large cap U.S. stocks have decreased in value only 24 times during the same time period, and 7 of those declines occurred during the Great Depression. When considering this, one could argue that bonds and equities are essentially equally likely to suffer a short-term decline. Of course, the difference is the degree of the losses suffered. Large cap stocks worst single-year decline was -43.34% (1931), while bonds largest decline during an individual year was -12.19% (2009).

Clearly, we’ve seen bonds decrease in value before but level heads still consider them an essential element of an investment account. Why? The answer involves diversification. Of the 21 years since 1926 that bonds suffered losses, only in 5 years did stocks also decline in value. As a result, only in 6 of the 21 years when bonds suffered loses was a portfolio that was 50% stocks and 50% bonds worth less at the end of the year. In fact, in 2009, when bonds suffered their largest loss on record (-12.19%), large cap stocks increased in value by 26.46%. Thus, a 50/50 portfolio actually increased in value by 7.14% that year.

The bottom line is that we’ve seen bonds suffer setbacks before, but very rarely has turbulence in the bond markets lead to significant declines in diversified portfolios. However, having bonds in your asset mix has constantly reduced volatility during rough times in the equity markets. This trade-off of simply too attractive to pass up.

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Excessive 401(k) Fees and What You Can Do

By Lon Jefferies | Published: January 21, 2011

401(k) plans can involve a long list of costs and fees, some of which are covered by the employer and some by the employee. Below is a quick sampling:

• recordkeeping fees
• annual audit fees
• back-end loads
• brokerage commissions
• contract administration fees
• distribution expenses
• expense ratios
• front-end loads
• installation fees
• investment transfer expenses
• loan fees
• participant education fees
• plan document filing costs
• termination fees
• trustee service costs
• wrap fees
• 12b-1 fees
• management fees
• mortality & administrative fees
• non-discrimination testing fees

These costs and extra fees can eat away at your retirement account and your hard-earned money. Currently, some 401(k) plans are costing participants as much as 3% to 4% per year. However, with some effort and diligence, you have the ability to drastically reduce these costs.

Reducing these costs just slightly can help increase your nest egg. If just 1% of annual cost is eliminated and you achieve a net return of 8% rather than 7%, an account will be worth 32% more in 30 years. In dollars, this would turn your $758,000 nest egg into a $1 million dollar retirement account.

In an effort to make fees more transparent to plan participants, amended provisions of ERISA Regulation 408(b)(2) must be implemented by July 16, 2011. This legislation will require investment managers and advisors to disclose all investment costs in a written itemized format. These new regulations will help you know the costs you are paying for your 401(k) plan.

This is a big step forward, but it doesn’t eliminate the personal responsibility of plan participants to demand information about their plan’s costs. You must take an active role in requiring your employer to choose low-cost retirement programs. If you find the costs of your employers’ 401(k) plan to be excessive, put pressure on the HR department to consider alternative plan providers.

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What if the Medical Profession Operated Like Financial Services?

By Lon Jefferies | Published: January 18, 2011

Bob Veres has always been a strong supporter of transparency in the financial planning profession, and a constant supporter of the fee-only minority within the industry. Allow me to sum up an excellent article he published in the January 2011 issue of Financial Planning Magazine:

Janice and Ralph arrive at the medical healing center to find a confusing scene. There are many individuals wearing white coats walking in different directions, and standing near signs designed to attract potential clients. Ralph sees a line of patients waiting to see someone holding a sign that says “Free Evaluation and Professional Recommendations.” He quickly jumps in line.

When Ralph meets with this individual, the consultant wraps the blood pressure device around his ankle, and applies his stethoscope to his forehead, then nods with a wise expression on his face. Stranger still, the advisor recommends the same prescription not just to help him recover from his heart attack, but to cure a fever, stop vomiting and diarrhea, and cure bunions.

While Ralph wis being inspected, he nervously asks “how much is this visit actually going to cost me?”

The practitioner cheerfully replies “nothing.”

When Ralph makes it clear that he doesn’t see how the practitioner can treat people for free, the consultant says “Oh, I get paid. I make a great living. Whenever I sell you my magical drug, the drug company pays me half of what you pay for it in the first year.”

At that point, Ralph wonders what would happen if he needed something other than this practitioner’s magic drug. To answer the concern, the practitioner sulks “I’m not licensed to sell you anything else.”

At this point Ralph storms off and finds a new practitioner who at least knows where to apply the blood pressure gauge. However, before he and Janice are allowed to talk to this advisor, they are handed a large legal document to sign. As they read the form, they find a small section on page seven that states that the recommendations the practitioner makes might not be in their best interest. They wonder why something that important is all the way in the back of the document, but the practitioner states that only his legal department is allowed to address such a question.

Looking for at least a basic level of comfort, Ralph asks “But you’re going to recommend what’s best for whatever our medical problems are, won’t you?”

“I’ll recommend whichever of my company’s drugs most closely fits your medical condition,” the practitioner says cautiously. Ralph can’t believe his security can rest on such a principle, and storms away.

Finally, he finds an individual holding up a sign that reads “comprehensive practitioner.” This consultant examines Ralph and finds a few minor issues. Then he recommends another medical contract that would be paid for monthly.

“What do we need that for?” Ralph asks.

“There are a lot of terrific bells and whistles that mean you’ll get a guaranteed return.”

“Does our monthly fees cover the costs of those features?” Ralph asks.

“No.”

“Do we pay you for recommending it?” Ralph asks.

“I get paid a commission for selling it to you.”

“What?! Ralph exclaims. “I thought you were paid on fees that I pay, not on commissions!”

“Oh, that was just during the evaluation phase. Once I finished that, I put on a different hat and became a salesperson of drugs and my own wellness program.”

“I don’t get it,” Ralph says, “isn’t there somebody who simply evaluates our health and then prescribes what we need, for a fair price?”

“There are people like that, but not very many, and they mostly only work for rich people,” the practitioner says.

“Why rich people?” Rich asks.

“Well, they charge actual fees, and nobody but a rich person would think of writing a check, just for the privilege of not being sick.”

In financial terms, Ralph and Janice first visited an annuity or insurance salesmen — someone who recommends the same product to everyone, collects a large commission, and then never communicates with the client again. The second practitioner is similar to a brokerage firm, which often have binding contracts with their clients and only utilize the firm’s own products, which frequently aren’t the best options available. Finally, the third practitioner functioned similar to a so-called “fee-based” financial advisor. These individuals commonly communicate that they charge their client’s fees for looking out for their best interests, but they also have the ability to sell commissioned products to the same clients.

Of course, what Ralph was really looking for was a fee-only financial planner — someone he can pay to trust and look out for his best interests. Again, there aren’t many fee-only advisors, so be sure to ask your current financial planner if that is his model. Lastly, as you might expect, fee-only financial planners work with many different clients, not just the wealthy. Doesn’t it make sense to actually pay a fee in order to have someone sitting on your side of the table, looking out for your best interests?

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Lifelong Investing Resolutions

By Lon Jefferies | Published: January 5, 2011

As we welcome the new year, I thought I would share six sensible investment resolutions published by Dimensional Funds that everyone can utilize:

1) I will not confuse entertainment with advice. I will acknowledge that the financial media is in the entertainment business and their message can compromise my long-term focus and discipline, leading me to make poor financial decisions. If necessary I will turn off CNBC and turn on ESPN or HGTV.

2) I will stop searching for tomorrow’s star money manager as there are no gurus. Capitalism will be my guru since capitalism provides a positive expected return on capital and it is there for the taking. For me to succeed, someone else does not have to fail.

3) I will not focus my portfolio in a few securities or even a few asset classes, as diversification remains the closest thing to a free lunch.

4) I will ensure my portfolio is appropriate for my goals and objectives while only taking risks worth taking.

5) I will manage my emotions by learning about and acknowledging the biases and cognitive errors that influence my behavior.

6) I will keep my cost of investing reasonable.

I’d like to recommend one other resolution to the list:

7) I will decide what is most important — beating an investment benchmark or meeting my financial goals. If my portfolio lags a benchmark but I obtained my goals, I will be content that I likely reduced my investment risk but still achieved what I hoped to accomplish.

Lastly, I’d like to repeat the thoughts of my associate, Ken Weingarten, CFP, who points out that most of us find it hard to follow a sensible diet or a sensible investment strategy 100% of the time. Just as successful athletes rely on coaches and trainers to help them achieve their goals, most investors can probably benefit from having a ‘financial coach’ to remind them about their resolutions and keep them on track toward a more prosperous future.

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