Third Quarter 2016 In Review

Third Quarter 2016 In Review

Investors were on edge at the start of the third quarter after it became clear the UK would withdraw from the European Union. Fortunately, the crisis passed without major declines in the stock markets. That left investors to worry about volatility caused by an increasingly unhinged US presidential election. We all know things haven't improved on that issue. Thankfully, it's almost over. At least I hope it is.

The good news was that both domestic and international markets posted decent gains during the third quarter. The S&P 500 gained 3.85% and the average diversified U.S.-stock fund returned 4.8%. The MSCI EAFE, which is the benchmark used to track developed international markets, gained 6.43% and the average international stock fund was up 6.2%.

The average intermediate-term bond fund was basically flat, with a return of 0.8%. Despite the low returns, investors flocked to bond funds, which saw inflows of $65 million. US stocks and international stocks saw outflows of $68 million and $19 million, respectively. The large outflows out of stocks and into bonds demonstrate that investors are still wary of what's to come in the stock markets. One analyst even referred to this seven-year run as "the most hated bull market ever". It appears investors want to park their money in “safe” investments.

In September, the Federal Reserve decided not to raise interest rates but left the door open for a rate increase in December. Maybe.

I expect markets to be volatile in the coming weeks. That's because we just entered earnings season, which will provide insight into how publicly traded companies are performing. Oh, and there's the election to consider. Expect markets to bounce around depending on what the candidates say and what new information is released about them. Hang in there!

My Takeaways From The NAPFA Fall Conference

I attended the National Association of Personal Financial Advisors (NAPFA) fall conference on October 13th and 14th. Here are some of the highlights from NAPFA's annual fall conference:

  • A different perspective on retirement. The nature of retirement is changing as people live longer, healthier lives. The idea of retiring to play golf or pursue other leisure activities doesn't always bring happiness. Staying productive, perhaps working part-time or pursuing a new career may be a better approach. I like the idea of creating an Autonomy Fund rather than a Retirement Fund in order to achieve this goal. I plan to implement this approach into my practice.
  • Financial exploitation of seniors is a problem. To clarify, the session I attended on this topic did not teach us how to exploit seniors. Instead, it gave us tips for identifying exploitation as wells as tools and organizations we can use to stop it from happening.
  • A looming exodus of fee-planners. There will be quite a few planners retiring in the next 10-15 years - and there aren't enough planners to replace them.
  • How to identify super trends that affect financial markets. I really enjoyed this session! We discussed how changes in, among other things, global age wave, globalization, artificial intelligence, autonomous cars, and urbanization will affect the world. The goal is to determine how we can help our clients by planning for changes that will ultimately ripple through the economy. Bonus: I added some great books to my reading queue.
  • This presidential election is a mess. Okay, I already knew that. Judy Woodruff of the PBS NewsHour spoke about the current election. After that, she led a great discussion about how we got to this point and what could happen depending on who wins in November. Of course, all of this was from a financial perspective.

Listening / Reading / Watching

Here's what had my attention this week:

  • News about the election. It's a trainwreck that I can't stop watching.
  • Westworld on HBO. I'm in sci-fi nerd heaven right now. Who wouldn't want to watch a series about androids who appear to have realized their sole purpose is to entertain their guests' dark fantasies? So far, there's been some excellent commentary about the nature of violent open-world video games.

A Taxing Problem

In case you haven't been paying attention, the topic of taxes has been in the news a lot recently. One reason for the interest in taxes revolves around the following question:

Can you learn anything by studying someone's tax return? (Spoiler: You can)

He Who Shall Not Be Named once said, "There's nothing to learn from them". I disagree, but this post isn't meant to start a debate about whether or not candidates for president should be required to release their tax returns. With that in mind, let's explore what we can learn by reviewing someone's 1040:

  • Income, and sources. W-2 wages, self-employment earnings, investment income, alimony, retirement income, rental income, business dividends, annuities, bank interest, tax refunds, capital gains, unemployment, Social Security benefits, on and on. That's a long list!
    • A good planner can use this information to derive more information – lots of bank interest means lots of cash on hand, maybe not enough, maybe too much? Lots of capital gains might mean a tax-inefficient portfolio structure. So could lots of ordinary vs. qualified dividends or taxable bond interest vs. municipal interest. Big tax refunds might mean poor planning of estimates throughout the year.
  • Participation in a retirement plan. Here you can find out just how much someone saved for retirement during the year.
  • Participation in a Health Savings Account. This lets us know they participate in a high-deductible health plan.
  • Self-employment taxes. This tells us the structure of self-employment income vs. business entity income.
  • Deductible or non-deductible IRA contributions and eligibility, Roth IRA contributions and eligibility.
  • Payment/deduction of tuition and fees. This tells us if the client might be supporting a student (or putting themselves through school!).
  • Itemized deductions tell us many things, such as:
    • How much mortgage the client is carrying, or, if we know that, if the rate is competitive.
    • If there have been large medical expenses in the past year, which might be a key planning topic.
    • Payment of state/local income, sales and property taxes.
    • Charitable giving, leading to lots of planning topics surrounding effective giving.
    • Payment of absurdly high investment management fees (can’t help myself).
  • Eligibility and receipt of child tax credits, child care tax credits, tuition credits, etc, etc.


I could go on, but I won't. Sorry, I know you were hoping for a longer post about taxes, but I'll save that for a future post.

The takeaway is that financial planners - or anyone - can learn a lot by looking at a tax return.

I can't take full credit for this week's post. I had planned to write about this topic but a colleague of mine, James Osborn of Bason Asset Management in Colorado, beat me to it.

Listening / Reading / Watching

Here's what's got my attention this week:

  • How the Education Gap is Tearing Politics Apart by David Runciman, writing for The Guardian. This is an interesting piece focusing on education (or lack of) and its effect on politics.
  • Revolution Radio by Green Day. Okay, so this isn't at all related to personal finance. Green Day's albums have been in constant rotation at our house since Monday's amazing concert at the 9:30 Club. They just happened to release a new album today and I've had it on repeat since I woke up.

To Merge, or Not to Merge

Several years ago, my then-girlfriend (now wife of eleven years!) and I called our respective parents to give them the Big News: No, we weren’t engaged. We were taking a big step and opening joint checking and savings accounts! While they were happy for us, it wasn’t quite the Big News they were hoping for. Regardless of our parents’ feelings, I believe merging our finances was an extremely important step to building a healthy relationship. So, whether you’re newly married or contemplating moving in with your significant other, read on for my thoughts on the subject of merging finances.
           
All couples bring different financial strengths and weaknesses to their relationship. Most couples I meet with did not learn personal financial skills in school – which is unfortunate and something I’d like to change. Personal financial skills, habits, and beliefs (or lack thereof) were usually taught or modeled by family members. As you can imagine, these differences often cause stress in a relationship.

In addition to bringing their individual financial strengths and weaknesses to the table, it’s not unusual for one individual to take on most of the financial responsibilities, such as paying bills. This is great for the individual that doesn’t like dealing with finances. However, I believe imbalances such as this cause unneeded stress and can make it more difficult for couples to achieve their short- and long-term goals.
           
So, how do you reduce financial stress and have a better shot at achieving joint goals? Here are some tips:

  1. Share all financial information: This means assets AND liabilities. For example, it’s important for both parties to know how much student loan or credit card debt the other has. Once you know how much debt there is, if any, you can come up with a plan to pay it off.
  2. Establish joint bank accounts: At a minimum, I recommend opening a joint checking and savings (AKA the emergency fund) accounts. Other accounts, such as house or travel funds, can be opened later.
  3. Share your short- and long-term goals with each other: Take some time to discuss what each you want to achieve. My wife and I set goals when we first moved in together. We no update them at least once a year.
  4. Get a joint credit card: You’ve been building up your personal credit, right? Now it’s time to have a shared card. Make sure both of you review the transactions on the monthly statement.
  5. Agree upon a spending threshold: Come to an agreement about how much either of you can spend without checking in with your significant other. For example, you could agree that buying anything over $200 requires a conversation.
  6. Allow yourselves some “fun money”: Think of this as an allowance. You each get to set aside some money that can be used for whatever you want – no questions asked. Do you want to buy something more expensive? Save some or all of your monthly allowance until you have enough for it.

I understand couples may be wary of merging finances because it can mean giving up some financial freedom. From personal experience, at home and in my financial planning practice, couples that merge finances have a stronger relationship and are much more likely to achieve their goals.

Listening / Reading / Watching

Here's what's got my attention this week:

  • Hillbilly Elegy: A Memoir of a Family and a Culture in Crisis by J.D. Vance. I'm about two hours into this book and really enjoying it. Summary from the publisher: Hillbilly Elegy is a passionate and personal analysis of a culture in crisis - that of white working-class Americans. The decline of this group, a demographic of our country that has been slowly disintegrating over 40 years, has been reported on with growing frequency and alarm but has never before been written about as searingly from the inside. J. D. Vance tells the true story of what a social, regional, and class decline feels like when you were born with it hung around your neck.
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Takeaways From the 2016 XYPN Conference

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I returned from San Diego late Wednesday night after spending a few days at The XY Planning Network's (XYPN) annual conference. Here are some of my takeaways:

  • There are a lot of planners excited about improving the financial planning profession. I believe the XYPN had about 100 members in 2015. The network has grown to more than 300. And we will act in our clients best interests. Not because we're forced to, but because we want to. And it's the right thing to do.
  • Student loans are a big problem. There are millions of people who need who need help navigating confusing loan types as well as their repayment and refinancing options. I've started work on a project to address this problem.
  • Robo-advisors, such as Betterment and Wealthfront, cannot replace a human. Sure, they can invest efficiently, but their algorithms can't handle disruptions in financial markets (Brexit) nor can they hold their clients' hands while on life's emotional roller coaster. And a human financial planner augmented with a computer? That's a force to be reckoned with.
  • This next generation of planners is willing to work hard for their clients, but they also want time with their families. The panel I was on, "Full-Time Parent, Full-Time Owner" was well-attended by planner/parents looking for advice on how to juggle work and life. I can't speak for the other planners on the panel, but I don't consider myself an expert on this subject. It's a work in progress. That said, judging by the responses from planners in attendance, I think we are on the right track.*


*True story:
I told the audience my wife and I came to an agreement when I started my firm: She was now the primary breadwinner and working a demanding job at a public affairs firm. Naturally, my income had decreased because I was building my firm. I may not have been able to contribute to the household financially, but I could contribute in other ways. I could drop-off and pick-up the girls from school and take the lead on laundry, grocery shopping, and cooking. So that is what I did.

Later that day, one of the attendees approached me and said he called his wife after attending my panel discussion. He told her that while launching his firm he was going to take over drop-off and pick-up, laundry, grocery shopping and cooking.

Well done, Sir.

Listening / Reading / Watching

Here's what had my attention this week:

  • Loads of great information about all aspects of financial planning.
  • Survivor: Millennials vs. Gen-X. This long-running reality show has become something of a family tradition in our house. The four of us enjoy watching the physical challenges, scheming, and strategies every season. In addition, our nine-year-old has declared that she plans to win when she's old enough to compete. Oh, and that's after she wins American Ninja Warrior. And becomes a professional soccer player.

Fundamental Analysis vs. Technical Analysis: Fight!

The Rebel Alliance vs. the Galactic Empire, Less Filling vs. Tastes Great, Batman vs. Superman, Cain vs. Abel, and Seinfeld vs. Newman.

These are among the greatest matchups in history. Allow me to add one more to the mix:

Fundamental Analysis vs. Technical Analysis

I know this matchup may not be as exciting as the ones listed above, but it is fascinating. At least to me. And really, it's all about me.

Both methods can be used to analyze financial markets and investors have been debating the pros and cons of each for decades. Before I tell you which method I prefer, let's explore each in turn...using references from Star Trek.

Fundamental Analysis: The Method for Logical Vulcans

If this was the Star Trek universe, investors using fundamental analysis would be from the planet Vulcan. For the uninitiated, this means investors who use logic and reason with zero emotion to analyze financial markets and companies. Here are examples of some metrics used:

  • Macro and microeconomics
  • Growth rates
  • Risk levels
  • Earnings per share (EPS)
  • Price to earnings (P/E) ratio
  • Dividends paid

In other words, fundamental analysis involves using quantifiable metrics to better understand financial markets and companies.

Technical Analysis: The Method for Irrational Humans

If fundamental analysis is the method of choice for cold, emotionless Vulcans, then technical analysis is perfect for irrational humans. Investors who use technical analysis are often known as "chartists" because they use charts to determine when to buy and sell in financial markets. Specifically, chartists make use of past trading activity and price to determine future prices in financial markets and companies.

Which Method Do I Prefer?

It may be obvious by my choice of wording, logical versus irrational, that I favor fundamental analysis. I'm sure I drive my wife crazy with my logical, rational take on life and investing. Still, we make a good team. Yin and yang. But I digress.

The following quote, which you may have heard at one time or another, sums up my rationale for choosing fundamental over technical analysis:

Past performance does not necessarily predict future results.

I cannot fathom why anyone would base investment decisions on past trading activity and price.

But Wait, There's More!

First, I have an intern. His name is Zach Snyder* and he's studying econ at my alma mater, the University of Maryland at College Park. Fear the turtle! Zach is seriously considering a career as a financial planner, so he'll be working with me over the next several months.

Second, Zach will be writing posts for my blog, www.frugalplanner.com. His first post, titled "Gen Y Got Off to a Bad Start, but it's Not Too Late to Get Back on Track" was published this week. Please take a few minutes and check it out.

*Thankfully, Zach is not the Zach Snyder responsible for directing Man of Steel or Batman vs Superman: Dawn of Justice.

Listening / Reading / Watching

Here's what's got my attention this week:

CPI: DOA or A-OK?

Personal finance blogger Financial Samurai noticed the traditional CPI-based approach to determining inflation may not be accurate.

"See this latest price change chart for various consumer goods and services. Unless you plan not to go to college, not have kids, not get sick, not eat, and not live under a roof, you are feeling inflation at work. At least we can buy all the TVs, software, and toys we want!"

What Is The Consumer Price Index (CPI)?

The CPI is calculated by the Bureau of Labor Statistics and is the weighted average of prices in a basket of consumer goods and services, such as food & beverages, housing, education, and medical care. Think of the CPI as a measure of the cost of living. It's a number that's incredibly complicated to calculate. Hundreds of federal employees have to go to stores all over the country - every month! - and price thousands of different things.

The Federal Reserve Board, Congress, and the president monitor changes in the CPI to determine whether the US economy is going through a period of inflation or deflation. Armed with this information they can formulate fiscal and monetary policies to aid the economy. The Federal Reserve's goal is to maintain a 2% rate of inflation and that goal has been achieved with some consistency since the mid-90s.

Pardon Me While I Put On A Tinfoil Hat

Run a Google search and you'll find plenty of people questioning the accuracy of the CPI and inflation. That's because certain variables in the calculation have seen dramatic increases in price over time. Check out the graph above and you'll see what I mean. Consumer goods and services such as textbooks, college tuition, childcare, and medical care have seen significant price increases since the mid-90s. While we know which goods and services are price-checked to determine the CPI, the weightings of those goods and services is a secret. There's a reason for the secrecy: People could probably make some serious money if they could figure out the CPI before the numbers are released.

Would the government underreport or manipulate the CPI? I can think of at least two reasons why they might:

  1. The desire for social and economic stability. Obviously, this is important. Keeping the economy running smoothly ensures stock markets perform well, unemployment remains low, and prices for good and services are held at reasonable levels.
  2. Low CPI = Low(er) government spending. The higher the CPI, the more the government has to spend on income payments to, among other things, Social Security beneficiaries and food stamp recipients.

While the CPI may be manipulated to some degree, I honestly don't believe there's a nefarious group working to control society. I'll leave the conspiracy theories to the writers of entertaining TV shows like Mr. Robot.

Okay, tinfoil hat removed.

The Takeaways

I'll break this down into three important points:

  1. Consumers need to remember that inflation estimates from the government may not be entirely accurate. Anyone who regularly pays for food, housing, medical care, or childcare knows this because prices on these items have outpaced the Fed's target inflation rate.
  2. Even with higher-than-stated inflation, you have control over what and where you consume goods and services. Let's use food as an example. Everyone needs to eat, so there's no way to avoid higher prices for food. However, we can choose where we buy food. Buying groceries from Whole Foods will almost certainly cost more than shopping at Giant or Safeway.
  3. Financial planners should review the inflation assumptions used when developing plans for their clients. The planning tools I've worked with have always provided the option of using either a default inflation assumption or one set by the user. My fellow planners: Be sure to check your settings!

Would You Like To Know More?

NPR's Planet Money Episode 222: The Price of Lettuce in Brooklynprovides a great lesson on the CPI and how it's calculated. The segment is 14 minutes and 27 seconds long.

Listening / Reading / Watching

Here's what's got my attention this week:

  • Framed: A Mystery in Six Parts by Christopher Goffard of the L.A. Times. A PTA mom and afterschool volunteer. A power couple, both lawyers. Accusations of verbal and physical abuse to a child. Drugs found in a car, most likely planted by the lawyers. This is a fascinating story about a petty fight that gets out of control.
  • Paradigm Shifts, Parts 1 through 4 by Alex Danco of Social+Capital. This is a lengthy, but worthwhile read about how technology is changing our world. As a big fan of Tesla, I found part four especially interesting.

Your Credit Score Demystified

At one time or another most of us have heard how important a credit score is for our financial well-being. Unfortunately, how your credit score is calculated remains a mystery for many people. If you know your credit score, and it’s above 690, you’ll want to keep it that way. If you don’t know your credit score, or if it’s below 630, you’ll want to raise it. Either way, keep reading.

Credit Score Ranges

  • < 630: “Bad” credit
  • 630 – 689: “Average” credit
  • 690 – 719: “Good” credit
  • 720 – 850: “Excellent” credit

I’d like to note that having “bad” credit does not make anyone a bad person. It’s simply a number that our financial markets rely upon as a measure of risk. This system has its advantages and disadvantages – more than enough for me to write another post.

Components Of Your Score

Finding Your Score

The first step in managing your score is finding out what it is and keeping a close eye on it. There are many sites which offer this service but only a handful come at no cost.

  • Federal law entitles you to one free report every 12 months. Go to AnnualCreditReport.com to get yours.
  • CreditKarma.com is a free site that allows you to see your credit score, track your credit history, view all your credit cards, and attain credit education and management suggestions.

Taking Control Of Your Score

Once you know your score, it’s time to take control of your credit by setting up payment reminders and automating monthly payments. This is absolutely critical to helping you make payments on time. Remember, timely payments are the most heavily weighted component of your credit score.
 
In addition to making timely payments, here are three things you can do to boost your credit score:

  • Always use less than 1/3 of the available credit per card
  • Do not open multiple credit cards too quickly because your score will temporarily decrease
  • Do not close more than one account per year because closing an account decreases your total available credit, which lowers your credit score

All of the aforementioned tips will help raise your score, but that Visa you opened when you were 18 is probably your most valuable tool. Keeping old cards open and making timely payments will increase your credit score over time.

Listening / Reading / Watching

Here's what's got my attention this week:

  • Outliers: The Story of Success by Malcolm Gladwell. So far, this has been a great book that asks "what makes high-achievers different?"
  • I Always Loved You: A Novel by Robin Oliveira. This audiobook came highly recommended by a client. The story follows the relationship between artists Mary Cassatt and Edgar Degas.

Adventures in Home-Buying

Adventures in Homebuying

The opening credits for House of Cards features our street in the Bloomingdale neighborhood of Washington, D.C.

Sadly, Kevin Spacey AKA Frank Underwood is not running for president.

An Eye-Opening Experience

My wife and I have lived in the wonderful Bloomingdale neighborhood of Washington, D.C. for 12 years. While we love our house and the neighborhood, we recently embarked on a search for another house. Our two bedroom row house is cramped for two adults and two growing children.

It was exciting to start our search. We made a checklist of all the must-have features the next house should have. Then we added some nice-to-have features to our list. Finally, we agreed on a price range for the search. My wife was happy, the children were happy, and all was well.

Then our real estate agent started sending us listings and showing us houses. It quickly became clear the D.C. real estate market is insane. D.C. isn't the only city dealing with a tough spring market; a recent article in Bloomberg Business suggests a nationwide problem.

After losing two houses to other buyers and still searching, I've learned a few things that I'd like to share with you.

Tips For Your Home Search

We've seen quite a bit of shoddy construction during our search. I'm pretty sure we saw a load-bearing poster in one of the gems we saw.

1. Figure Out What You Want

Make a list of the must-have and nice-to-have features you want in a home. You might even consider prioritizing the features just in case you are forced to make some tough decisions before buying.

2. Location, Location, Location

You need to decide where you want to live. Remember, you can change the house but you can't change its location.

3. Tour Multiple Properties

I found this tip particularly helpful when starting our search. Initially, our agent took us on a quick tour of several properties of differing conditions in the neighborhoods we expressed interest in. The cross-section of properties helped narrow our search.

Shout out to Chris Chambers of A-K Real Estate. Thanks for being awesome!

4. Speak With a Lender

Submit a loan application to a lender before going to look at houses. You'll want to know how much house you can afford so you don't waste your time or your agent's.

5. Seek Advice From a Professional

Find a house you really like? Great! In a hot market, it's helpful to have a contractor do a walkthrough of the house. A pre-inspection may help you pinpoint problems with the house or confirm that you're making an offer on a good property.

In addition, I suggest checking whether or not the developer obtained the necessary permits to renovate a house. There have been horror stories about shady developers in the D.C. region. If you're buying in DC, you can check permits using this link to the D.C. Department of Consumer and Regulatory Affairs.

6. Set Your Price - And Stick To It!

You're probably going to be excited by the time you're ready to make an offer. It's easy to get carried away when you're bidding in a competitive market. Set your maximum price, make your best offer, and let it go.

7. Be Patient

Okay, even I have a difficult time with this step. Buying a home in a hot real estate market isn't always easy. You might not be successful the first time (or two!) you make an offer. Be patient and will eventually find success.

Switching Topics...

Recently, I was interviewed for the Bloomingdale Buzz section of Capital Community News. Here's a link to the article!