Walking on salmonella-laced eggshells, wondering whether we’ve finally seen the worst of the BP oil spill, it’s clear that the world remains as risky as ever. By the time I post this blog, there will probably be yet another new headline with another unlikely risk that few of us saw coming.

As a  financial planner, I think about unlikely risks all the time. While we can only do so much to avoid a bad egg before it’s been recalled, there are reasonable steps you can take to mitigate some of the bigger “unlikely” risks. Here are some examples.

Premature Death. For most people, the chance they will die tomorrow is remote. But the consequences are too severe to ignore. Just in case, almost everyone needs a will. In addition, people who have substantial estates need expert planning to minimize possible estate taxes.

Contrary to what a life insurance salesman might tell you, not everyone needs life insurance. Nevertheless, in our comprehensive financial planning process we always examine whether the risk of death should be transferred to an insurance company by buying a life insurance policy. Life insurance most often makes sense for the younger client whose estate is not yet large enough to provide for the family if the breadwinner dies. But as the breadwinner nears retirement age, the need for life insurance as a risk management tool wanes. For this reason we usually recommend “term” life insurance policies, which expire after a certain term, and we avoid the much more expensive “whole life” policies.

Living Too Long. The flip side of premature death is outliving your money. Average life expectancy is around age 78. But if you’re a non-smoker, add six to nine years to the average. Moreover, constant medical advances are gradually extending life expectancy. Referring to the MoneyGuide Pro Annuity 2000 Mortality Table, the bottom line is that, for the average non-smoking couple, there is a 50% chance at least one spouse will live to age 91, and a 10% chance that at least one spouse will live to 101.

Health and Disability. Health insurance is a must, and disability insurance (though often expensive) should at least be considered. Depending on the situation, long-term care insurance may be appropriate too.

Cars and Trucks and Things That Go. When it comes to liability claims, every wealthy person is a potential target. Everyone who has a high net worth needs an umbrella liability insurance policy to protect their assets against potential lawsuits resulting from events like car accidents. Yes, it’s a remote possibility that you’ll get into a car accident, that it will be your fault, that someone will be seriously injured and that they will successfully sue you for millions of dollars. But it can happen, and it is a relatively cheap risk to insure against. Typically we recommend at least a million dollars in umbrella coverage, and often more.

We take our risk management analysis beyond insurance to “asset protection” strategies, legal strategies that can protect assets from lawsuits after the insurance runs out. If you’re not sure you have adequate personal risk protection, call us. We don’t sell products or prepare legal documents ourselves, but we help you provide an objective risk review, strategy recommendations and appropriate referrals.

Market Risk. Finally, some risks are far from remote, but when they occur many people are shocked anyway. Take the U.S. stock market. Since 1926, we’ve seen negative annual returns about a quarter of the time, usually in the double digits. If the stock markets weren’t subject to periodic ”head for the hills” panic runs, more people would invest, and remain invested. Supply and demand then would drive prices up and returns down. 

But, while periodic bad markets are expected, they aren’t predictable; nobody knows when they’ll begin or end. Our goal is to help investors (1) remain committed, ready to capture any upswings that may occur and (2) dampen some of the stock risk by blending stocks with bonds in well-diversified portfolios that meet the client's investment objective, bearing all of their financial goals in mind.

If you’re not sure whether your personal risks have been adequately addressed, give us a call.

It’s no news that our military personnel put themselves in harm’s way every day they serve our country. Sometimes they pay the highest price in our defense. Their families pay the price too.

Now the New York Attorney General’s office alleges that insurance companies MetLife and Prudential prey on our fallen heroes’ families by holding onto the death benefits from their life insurance policies.

Most of us assume that, if we die, our life insurance policy will pay off in the form of a check delivered to our family. Instead, these insurers put the service member’s death proceeds into an interest-bearing corporate account, delivering a book of drafts (similar to checks) to the policy beneficiary. The insurer argues this arrangement is a win-win: The account pays a modest interest rate, and the beneficiary can use the drafts like checks. The insurer profits from a portion of the interest if the account stays put.

Some military families feel they have been taken advantage of at the very time when they are most vulnerable.

My bet is that the insurers are mystified as to why military families (and the New York Attorney General) are so upset. After all, the family can write a check on the balance. And it does earn interest. Where’s the beef?

The beefs are two. First, unlike most bank accounts, the insurer’s corporate accounts are not FDIC-insured. That’s a big deal if the insurer goes out of business. Second, the military families miss a tax opportunity by leaving the death proceeds in the insurance company account: For up to one year after receipt, they are entitled to put all or part of the proceeds into a Roth IRA or Coverdell education account, where the proceeds can grow tax-free to fund retirement or education.

MetLife and Prudential informed the beneficiaries that the money could be withdrawn from their accounts, but reports say that the insurers stayed mum about the right to transfer the balance to a tax-sheltered account. The insurers had no legal obligation to brief the family on the Roth IRA opportunity, but surely the families of our fallen service members deserve more consideration. I can understand why the AG is upset.

If you’re a beneficiary of one of these insurer’s accounts, what should you do? According to CPA Sheri Allshouse in Houston, if you want to contribute part or all of the proceeds to a Roth IRA but the one-year deadline has passed, it’s probably simply too late. Nevertheless, she says, there have been cases in which the IRS has shown some leniency in late transfers between Traditional IRAs and Roth IRAs. Talk with your CPA before you conclude that there’s no hope.

In addition, Houston CPA Laura Conway warns that the Roth IRA rollover is available only for life insurance proceeds from Servicemembers' Group Life Insurance (SGLI) and military death gratuity policies, both programs sponsored by the Veterans Administration. Other life insurance benefits are not eligible.

Given the tough financial times we’ve all lived through recently, you may be concerned that your account is not FDIC-insured. Two thoughts here. First, rating agency Standard & Poors assigns a relatively strong AA- rating for financial stability to both MetLife and Prudential, implying that these insurers are unlikely to go belly-up anytime soon.

But you may still prefer to have an FDIC-insured account, and if so you’ll need to transfer your balance to a bank. Be careful that you don’t go from the frying pan to the fire: With some exceptions, FDIC insurance generally covers only the first $250,000 you have at the bank. These days lots of banks aren’t nearly as financially strong as some of the major life insurance carriers, so if you transfer money to one or more banks, be sure to keep the amount at each bank under the FDIC-insured limit. You can use the FDIC’s calculator to determine exactly how much of your bank account is FDIC-insured. And remember that not all banks are members of FDIC. Click here to be sure the bank is a member.

Don’t hesitate to call on us if you have any questions or if we can help in any way.

Many in the media have laid the blame for recent stock market volatility at Greece’s door.

The fact is that, economically at least, what happens to Greece just doesn’t matter much to the rest of the world. Why? According to the World Bank, the total economic output of Greece is less than 2% of the European economy and only 0.6% of the world economy.(1) The economy of the Dallas-Fort Worth metropolitan area is the same size as Greece. Houston’s economy is bigger.(2)

With that perspective, the Greek debt situation doesn’t seem as alarming for U.S. investors as many of the news headlines have made it out to be. A Greek debt default would be no more likely to sink the U.S. economy than a Dallas- or Houston-based default would be to sink Europe.

That said, it would be more serious if a Greek default precipitated defaults in other countries — Spain, Italy, Ireland, Hungary and Portugal being those most often named. The economies of Ireland, Hungary and Portugal are no more significant than Greece, but taken together Spain and Italy make up 20% of Europe’s economy, and 6.8% of the world. A default in Spain and Italy would be much more serious than a default in Greece.

Spain and Italy, however, are far stronger than Greece. Greece is simply a third-world country that, having vastly overspent for years, has no hope of ever repaying its debts. Apparently Greece had to manufacture fraudulent figures even to gain admission into the EU.(3) Spain and Italy, in contrast, are core EU members whose economies are much stronger and more resilient.  Thus, the odds that Spain or Italy will default on their sovereign debt at this time seem remote.

Also bear in mind that even a government default in an economic basket-case like Greece would not mean that all sovereign debt would go unpaid. Recent publications suggest that even with no EU assistance the Greek government could repay all but about a quarter of its debt. Even worst-case, debt strain in Spain and Italy is far less severe.

This is not to deny that there is real investment risk in Europe. Indeed, the European debt situation is likely to result in austerity programs across the continent that will somewhat reduce European economic activity for the next few years. And reduced economic activity in Europe will probably reduce economic activity around the world, simply because the Europeans will be buying fewer products and services. It’s reasonable to expect the market to factor these considerations into stock prices, as it apparently has lately.

But ultimately the question is, what should you do about the European debt situation as an investor? Sell European stocks? Sell all stocks? Sit tight?

If you have a well thought out, well-diversified portfolio, my recommendation is to sit tight. Current stock prices already reflect all the information that is known today. Remember that the markets don’t go down on bad news. They go down when news is worse than expected. Stock market participants already expect a worsening European economy, and stock prices reflect that prospect too. So while markets may go down further this summer, there is no guarantee that they will. In the short term markets are unpredictable. They could turn around at any moment and start back up. If you dumped all your stocks just before a market recovery, where would that leave you?

Remember why you are in the stock market in the first place. The best reason to invest in stocks is for long-term inflation protection. Inflation seems dormant now … but it could pick up at any time. Personally I think that rising inflation will become a significant concern within the next two to three years, fueled by all of the government budget deficits around the world.

And remember why you own European stocks. All the data available indicate stocks worldwide provide good diversification. Stocks in all countries have their good times and bad times, but spreading one’s assets around the world has been shown to increase long-term return while reducing portfolio volatility. That’s a hard combination to beat.

Assuming your allocation to European stocks is part of a sensible plan that continues to reflect your long-term goals, I recommend you hold onto them. Now is not the time to bail.

 I enjoyed reading Jason Zweig's most recent column, "Holding Brokers To a Higher Standard,” in The Wall Street Journal, and I think you will too.

 Under current regulations, Registered Investment Advisor firms like Posey Capital are subject to the fiduciary standard, which means we must put clients' highest interests before our own, and we must tell you about any conflicts of interest we may have. In contrast, most brokers and insurance agents are only subject to the suitability standard. If two equally "suitable" products are available and one earns the broker a higher commission (read: may cost you more),  he or she can recommend the costlier product ... and then keep mum about the conflict of interest. Really.

Currently under hot discussion in Congress is whether all financial intermediaries -- advisors, brokers and agents alike -- should be subject to the same standards. However the debate is resolved, Posey Capital will continue to consider our clients' highest interests first. We intentionally accept no commissions for any solutions we recommend -- that's $0.00. I think it's a lot easier to simply not have any conflicts of interest than to worry about disclosing them. It's my legal obligation, but it also just makes good sense. As one individual commenting on the WSJ article observed, "It really is too simple to be this complicated."

I’ve had it. I’m calling out an all-too-popular financial fallacy these days. It goes like this: “Stocks? Diversification? Who needs ‘em! Just look at the last ten years. 'The Lost Decade.' The S&P 500 Index was down for the whole decade. Stocks did nothing for us.”

Did stock investors really experience a “Lost Decade” from January 2000–December 2009? No. Where did this fallacy come from, then? It came from the mistaken belief that the S&P 500 Index represents all stocks.

Let’s get a grip. Sure the S&P 500 was down slightly from 2000–2009. But is the S&P 500 the only way to invest in stocks? Not by a long shot. The S&P 500 is an index of 500 largest US stocks. It leaves out over 8,000 publicly traded stocks. Consider the following:

As you can see, during this so-called Lost Decade there were plenty of positive returns to be captured around the world – and even here in the USA. The stock investor who wisely diversified across an appropriate range of the many stocks available via sensible, low-cost mutual funds (such as those available from Dimensional Fund Advisors) did not experience a Lost Decade. To illlustrate, a portfolio with 70 percent in the four equally weighted domestic stock asset classes and 30 percent in four equally weighted international asset classes would have ended the decade up by about 75 percent.

What does this mean? It means the investor who invested in stocks over the past ten years and didn't make money has only himself to blame. It means the S&P 500 is not the only stock asset class. It means that, despite its many recent obituaries in the popular investment press, diversification is alive and well.

This is not to say that you should invest all your money in stocks (far from it!), or dump all your money into far-flung asset classes you don't understand. Investing well is complicated, and you may need an expert financial advisor to help you build an intelligent portfolio of stocks and fixed income holdings that make sense for you. But don't give up on long-term, well-diversified investments. 

I ended my last blog by referencing an interesting study that demonstrated we humans tend to err on the side of optimism in our lives. Generally, a positive outlook is good for you. It’s probably helped many parents raise their teenaged children to adulthood, for example, without changing the locks on them even once.

But when it comes to expected returns on your investments, it’s best to be as realistic as possible. “The faith in fancifully high returns isn’t just a harmless fairytale,” says Wall Street Journal columnist Jason Zweig in a recent article exploring what financial experts had to say on the subject of market returns. He examined the expectations of trustee-level investors, economic professors, seasoned investment advisors and fellow financial journalists, and received opinions on hoped-for long-term market returns (after inflation, expenses and taxes) ranging from an anemic 0.5 percent per year to a feverish 22 percent per year.  

Overall, the data suggest that most investors’ expectations are too high. Way too high. Zweig cited a 2009 nationwide survey that indicated investors were expecting annual U.S. market returns of 13.7 percent during the next 10 years. He quipped, “What are we smoking, and when will we stop?”

OK, then what sort of long-term return expectations would be realistic for stocks? Lacking a crystal ball, single digits seem a far more prudent assumption than anything even close to double-digits -- especially if inflation stays as low as it is now.

Here’s why. According to financial economics, stock returns are driven by the “equity premium,” which is the amount stocks earn above the risk-free rate of one-month Treasury bills. The risk-free rate, in turn, is the rate earned above inflation. Translating that into a simple equation, it looks approximately like this:

Rate of Inflation + Risk-Free Rate + Equity Premium =
Expected Stock Returns

So what numbers do we plug in? As described above, current inflation rates are around 2.7 percent. Historically, the risk-free rate has earned about 0.7 percent. (It’s a relatively small return, precisely because it’s essentially risk-free.) Conservatively, the equity premium has hovered at around 4.8 percent over long time periods. So plugging in these numbers:

2.7 percent + 0.7 percent + 4.8 percent = 8.2 percent

Will your expected returns be exactly 8.2 percent? Of course not. For one, the math is based on historical returns, and nobody can predict the future so accurately. In addition, most investors temper their equity investments with fixed income, which offers a more stable ride, but also lowers expected returns.

The point is, particularly if inflation stays so low, the average rate of return on stocks over the next 20 years won’t be anywhere near 22 percent. It probably won’t approach the average U.S. investor's expectation of 13.7 percent over the next decade, either. 

Does 8.2 percent sound low to you? If so, consider that this is 5.5 percent more than the current 2.7 percent rate of inflation. That means, with a long-term, compounded rate of return of 8.2 percent for the equity portion of your portfolio, you should still be able to beat inflation by quite a lot and build real wealth through appropriate portfolio construction strategies. In future blogs, I’ll cover some of these techniques. 

Tucked away within the credentials section of my Posey Capital biography is the fact that my academic career includes a bachelor’s degree in psychology. I’ve always been fascinated by the workings of the human mind. Plus, recognizing the tricks our minds play on us helps me advise clients on how to make more rational decisions about their money and their lives.

How do you unwind after a busy day? Personally, I’m a sucker for Science Daily, which I scan regularly for new insights that might (or might not) apply to financial management. Let me share with you a few of my favorite recent posts.

IMPULSE PURCHASES: NOT JUST FOR NEUROTICS ANYMORE (Science Daily, Oct. 20, 2009)

Synopsis: Scientific research says that the more you believe in social equality, the more likely you are to be an impulse buyer.

Investment lesson: If you feel you may be prone to impulse spending, especially if it tends to be beyond your means, it can be a good idea to work with your advisor to develop your ability to assess short-term spending wants versus long-term spending needs.

ARE YOU A GAMBLER? (Science Daily, Jan. 13, 2010)

Synopsis: There is evidence that genetics play a role in our differing attitudes about risk-taking. In a recent study, people with a particular gene were more inclined to take “long-shot” risks (such as playing the lottery) and less inclined to buy insurance.

Investment lesson: Understanding risk and reward in capital markets is key to successful investing, so increasing your familiarity with how you personally feel about risk-taking — and why — might help you make better investment decisions for yourself.

WISHING DOESN’T MAKE IT SO (Science Daily, Jan. 16, 2010)

Synopsis: This study concludes that people think desirable objects are physically closer than they actually are. 

Investment lesson: Avoid falling into the trap of assuming a particular outcome is more likely just because you wish it were so. What do you think the stock market will return over the next 5, 10, 20 years?  Maybe 10–12 percent per year? Think again. I'll address the subject of more realistic return expectations in my next blog.

In Part I of this blog, I covered the importance of a fee-only pricing structure as one of the two most important components in how my wife Šárka and I chose to define success when founding Posey Capital Management. In this Part II, I’ll address the second component: applying a passive investing strategy.

Passive investing seems deceptively simple, and yet it is the most disciplined and sophisticated way I know of to expect to achieve your investment goals.

·    Active investors -- Hope to beat the market by trying to make wily predictions about where stocks, sectors or the market as a whole is headed next. They try to buy future winners and sell future losers. 

·    Passive investors -- Assume that it is too hard to make these kinds of predictions in a generally efficient market. Besides, the increased costs of trying are highly likely to outweigh any benefits. Instead, the passive investor seeks to act on matters that are within his or her control: (1) fine-tuning the amount of market risk/reward in the portfolio to match personal investment goals, and (2) equally important, doing so as cost-effectively as possible.

To me, passive investing makes a whole lot of sense. But it doesn’t make for catchy headline news. The strategy doesn’t change much based on market whims, so maybe it’s not exciting enough to report on regularly. Like most people, I had to discover it on my own by looking past the popular press and big-name fund managers.  

My personal path to passive came through a Morningstar analysis I was conducting in the early 1990s, while still an active investment advisor. I came across a Dimensional Fund Advisors (DFA) fund that looked good to me, so I placed a buy order. Or, more precisely, I tried to place an order. I was shocked to learn that, to purchase DFA funds, I first had to be on their approved advisor list, which required that I attend their two-day educational seminar. Oh and, by the way, I would have to pay my own travel expenses.

When we founded Posey Capital, my corporate goal was to establish a rigorous, intellectual approach to investing based on analytics rather than hunches. I wanted a strategy that would withstand the test of time and various market conditions. So, despite — or maybe because of — the unusual requirements, I wanted to know more about DFA’s “odd” approach. Šárka and I decided to attend the seminar.

It turned out to be one of the single most intellectually stimulating experiences in my life. I learned how DFA builds its fund solutions according to decades of academic inquiry into the science behind capital markets, asset allocation and passive investing. No wonder they first wanted me to understand what they were about.

I realized I had found a strategic alliance with a mutual fund company that would enable me to pursue my corporate goal. Next, I was faced with a decision. I was convinced that passive investing was the right way to go, and that I could use DFA funds and a few other resources to do it. But how was I going to communicate the strategy to clients? I didn’t guess most folks would be interested in a two-day seminar. My compromise solution was to devise a presentation (really, a conversation) I can typically do in about three hours, to educate clients on how passive investing works, and why I recommend it.

I chose this approach before I knew for sure if it would work as a business strategy. Would investors commit to this level of education? For me, it was a choice I felt I had to make, because I strongly believe that taking the time to help my clients understand how and why they’re investing is in their best interest. More than a decade later, it’s a choice I would make all over again, in exactly the same way.

Whether or not you’re the resolution type, the arrival of a fresh new year offers as good an excuse as any to revisit life goals. What does “success” mean to you and yours? Allow me to share how my wife Sarka and I defined it for ourselves when we founded Posey Capital Management.

Before Posey Capital I started life as an accountant/CFO, became a corporate tax lawyer and launched my investment advisor career from within the insurance industry. These weren’t bad ways to earn a good living, and the years of experience gained during that time certainly helped us shape our firm into an effective and multifaceted service provider.

During my days as a lawyer, I discovered, you’re always in contention with someone. That’s because there’s always another side to every negotiation, and your job is to ensure that your side prevails. As an advisor, there isn’t – or at least shouldn’t be – “another side.” You can advocate for your client, conflict-free. I like that a lot, and so that’s one important way I have defined “success” for my firm.

There are a couple of ingredients I’ve found key to fulfilling my role as client advocate, helping clients define and pursue their own definitions for success. These are:

1.       Delivering our services in a fee-only pricing structure

2.       Applying the principles of passive investing to your investment portfolio

The Importance of Fee-Only

The two most common ways financial intermediaries are compensated for helping you invest are commission versus fee-only. Here’s an illustration that summarizes the differences between the two models.

With fee-only pricing, we are compensated for the advice we provide. As your portfolio grows, so does our compensation, which means our incentives are generally aligned with your own: to seek portfolio growth. In contrast, if we were to receive commissions for trades completed or products provided, we would be paid whether your portfolio shrunk, grew or remained the same. It’s also possible to be a fee-based advisor, primarily compensated through fees, but also paid commissions under certain circumstances. When Sarka and I were filling out the regulatory paperwork for establishing Posey Capital, we got to Section 13 of the Form ADV, Part II, where it asked us to disclose whether we received additional compensation from non-clients while dispensing advice to our clients. In other words, were we receiving any commissions along with our fees?

Hold the phone,” we said to each other. If we’re going to do what’s best for our clients, how can we check “Yes” to having outside interests? Shouldn’t our only source of compensation be from the clients we serve; i.e., fee-only? On the other hand, checking “No” meant that several promising opportunities from my existing book of business would have to be abandoned.

As a new firm, passing up likely business isn’t a decision made lightly. But it’s what we did … and do. Let’s not bring over any commission-based business, we agreed. We checked the “No,” box and we’ve never looked back. We’ve lived fee-only happily ever after. In my next blog, I’ll describe how adopting a passive investment strategy represents another key to my personal definition for success. In the meantime, I hope you and your family enjoy a happy, healthy 2010.