Warren Ward Associates

Ten Years After

My Christmas present from my niece Deb was a book of recollections by various people who attended the 1969 Woodstock music festival. One recurring theme was that attendees had no idea what the event would eventually become. That was certainly true for me and my girlfriend (now wife). We went in order to hear her (then) favorite band but I have a much clearer memory of an outstanding performance by the British blues band whose name provides the title for today’s article.

A look back at an iconic occurrence like Woodstock or other historical event provides a chance to obtain insights that simply weren’t available as it unfolded. Ten years into the new millennium, I think it might be instructive to reflect on parts of the past decade. Perhaps we can learn something that could help us prepare for the future.

The year 2000 brought the end of the dot.com stock bubble. In the late 90’s, immense amounts of money were raised through Initial Public Offerings (IPOs), which allowed individuals to invest in new  tech companies. Unfortunately, that money was raised in support of a very few really good ideas. Among those enterprises which burned through their cash and disappeared were Webvan, Boo and Etoys (all ending in .com). Some of the successful companies include Google, Amazon and The Learning Company. Since many millions of dollars were lost, it seems that predicting the winners wasn’t as easy as people hoped. Because of the long odds against making money in IPOs, we continue to suggest that our clients avoid them.

Of course, 2001 was the year of the World Trade Center disaster, something so out of the realm of possibility that no one could have planned for it. Yet, the reason most of us maintain at least some insurance coverage is that we find it prudent to anticipate that something might go wrong, without having to know exactly what that might turn out to be. Fire, flood or terrorist attack, insurance is almost always available and we believe regular insurance reviews are simply part of good planning.

In 2001, actual US government spending was about $1.9 trillion. For 2011, it is expected to be about $3.8 trillion. This doubling is due, at least in part, to the cost of the beefed-up Department of Homeland Security and the various wars in which we are engaged. Such spending requires that the US borrow money, building up deficits. These have been with us for years but few elected officials are courageous enough to face them and make the difficult decisions required to reduce or end them. Since most politicians seem primarily interested in getting reelected, I doubt if deficit spending will be dealt with anytime soon.

I have seen recent articles which declare the first ten years of the 00’s to be the “lost decade” for investors since the S&P 500 ended 2009 about where it began 2000. That has certainly made things difficult for many investors, although some of our asset management clients have done better. We recently completed a review for the couple who have been our clients longest. They actually did quite well from 2001 (when we began managing their money) through 2009. Although we are not allowed to advertise our results, they prove, at least to us, that asset allocation does its job of providing a hedge against the unexpected.

Past Secretary of Defense Donald Rumsfeld and I have little in common but I do appreciate his bringing a little known concept from game theory (one of my interests) into the public eye. At a press conference in 2002, he made this statement: “ ...There are known unknowns. That is to say, there are things that we now know we don’t know. But there are also unknown unknowns. These are things we do not know we don’t know.” This is a slightly obscure but extremely valuable insight, one which is critical to the financial planning process. Whether planning for peoples’ lives or structuring their investment accounts, we always consider the “known unknowns” such as interest rate changes and adjustments in relative currency values. We know those are going to change and try to plan for them, even though we have no way to know just how they will change. To do a truly effective job for our clients, we must also attempt to plan for the “unknown unknowns”, those unpredictable events like floods, earthquakes, terrorist incidents and recessions. It is our intention to be able to report to our clients in 2020 that we have helped them successfully navigate past both of these types of risk.

Warren Winston and Forest

I learned long ago that I’ll never have all the right answers, although that doesn’t stop me from trying to improve my percentages. I spend a lot of time reading articles and books by different authors covering a wide range of fields. Let me turn to the thoughts of a couple of them as I close the year with an update on the markets and resultant changes in our investment strategy at Warren Ward Associates.

I am one of many who appreciate the work and wisdom of Warren Buffett, arguably the most successful investor of our age. He has always maintained that his investment process is basically the application of common sense and that he never invests in a business he can’t understand. He is very conscious of the extreme swings which markets endure, having offered this insight on the topic: “Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.” Here’s another of his thoughts, regarding how he makes the decision about whether to be in the market or not: “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful”. With consumer confidence at its lowest level since the index was created in 1967, perhaps fearful is not too strong a word to apply to the current situation.

Winston Churchill, while not quite as approachable as Mr. Buffett, proved to be exactly the right leader for his time. One of his better known quotes is: “Pessimists see problems in every opportunity. Optimists see opportunities in every problem.” I consider myself more a pragmatist than either of those but must confess to feeling somewhat optimistic right now, at least about the future of the markets.

I have written before that, among its other activities, the St Louis branch of the Federal Reserve keeps track of the “immediately available” segment of the domestic money supply – what is known as Money at Zero Maturity (MZM). This figure now stands at its highest level since I have been following it. At the end of November, it was over $8.8 trillion and increasing at a compounded rate of about 3.8% annually. If it gets much higher, it will reach the gazillion level made famous by Tom Hanks in the movie Forrest Gump. To put that number into perspective, the US government stimulus package signed into law in early October totaled about $700 billion. US consumers and businesses have more than ten times that much on the sidelines and ready to put to use. It is our experience that most of those MZM dollars make their way into the stock and bond markets as people’s fears subside. We hope to keep our clients positioned so their account values are lifted as that tide rises.

A common thread running through many of the investment-related articles and newsletters which have appeared recently is “there’s been no place to hide”. Regardless of which of many investment strategies is being discussed, the song has remained pretty much the same. Our approach to investing has always centered on the prudent allocation of assets among multiple segments of the stock and bond markets. The reason is simple: in the past, that strategy has offered our clients protection against market downturns, in part because investors typically buy bonds as they are selling stocks. This time around, bonds have been sold as well and, as others have reported, there has simply been no refuge other than cash – which has led to the increase in MZM.

Although our managed accounts have shown losses, in many cases they appear to have been smaller than those suffered by the broad markets. Asset allocation has not eliminated losses for our clients but it has buffered their account values as we intended. We will continue to utilize that strategy even as we attempt to refine it.

The US economy is clearly not the only one in the world but I do think it remains the most important. It seems to me that both recessions and recoveries have a tendency to begin and end here, with the rest of the world following in turn. Although WWA invested in Japan on behalf of our clients about a year ago, we have closed those positions and have also reduced our broader overseas exposure. We will redeploy those assets domestically, adding to the large cap value and small cap growth sectors. Also, since oil and most other commodity prices have fallen dramatically, we are adding a small position in the natural resources sector as a hedge against a future upswing. We will also begin to transition to a less volatile approach to owning bonds on behalf of our clients and will include tax-free municipal bonds in those accounts where it makes sense.

As always, these changes will be made automatically for our wealth management clients. We suggest that those who read my articles but are not yet clients discuss ongoing strategies with their own advisors.

This has been a very difficult period to be an investment advisor. I am an almost compulsive reader, perhaps hoping that the next book or article will be the one that provides the key to unlocking even better performance for our clients. Although no single right answer has appeared so far, we continue to make incremental improvements and use the wisdom of people like Warren Buffett, Winston Churchill and even Forrest Gump to guide us. Life’s “box of chocolates” has included some pretty unpleasant selections this year but WWA continues to employ a diversified strategy aimed towards improving our clients’ returns in both up and down market situations.

One Day You're Eighty . . .

I was having dinner with a friend not too long ago. He had recently visited a woman he’d known for many years who now lives in a nursing home. While they were talking, she spoke about how quickly time seems to pass, commenting: “One day you’re eighty and the next you’re ninety-four. Where does the time go?”

Five years ago, a childhood friend suffered a heart attack and died at the age of fifty-seven. As I shared the news with some other friends, I said it didn’t seem fair – heart attacks were supposed to happen to older folks, going on to define older with an age younger than some of those in the group. As you might suspect, this led to some bemused comments around the table. For many people, the definition of old is “about twenty years older than I am right now” and rich is “about twice what I have”.

As I found out when sharing the news of my friend’s death, age is relative. Back in 1909, 62 was pretty old. Today, with all the advances in nutrition and health care, those of us who are that age may not feel quite so old. This was brought to mind recently as I read an article in Science News about different ways that age can be measured. One of the newer approaches is to consider both a person’s current age and the number of additional years she or he is likely to live. This research suggests that the world’s average age is about 30 (with 44 years left to live) and North America’s average age is about 37 (with 43 years left to live). While it’s not surprising that we are among the group with the longest expected life span, that fact certainly influences the way financial planning must be approached.

While providing planning services to our clients we often hear the desire expressed to “not be a burden” on anyone, especially children. That requires us to plan so that our client’s assets last as long as they do, even when they live to age 94 or beyond. One of the strategies we sometimes suggest is purchasing long term care (LTC) insurance as retirement nears. Although I once shied away from recommending it, a couple of things have changed. First, some insurers have now been offering such policies for almost 30 years. Hopefully, that gives them enough experience to calculate premiums with a reasonable degree of accuracy. Second, Indiana was one of the very first states (and is still one of only about twenty) to have joined the government’s Partnership Program. This allows a certain level of LTC coverage to exempt an individual from Medicaid’s spend-down requirement. These changes combine to make LTC worth considering by most of our clients as they approach retirement.

Another way to “not be a burden” is by being candid with your family. This usually means that, at some point, parents must have that often difficult discussion about finances with their adult children. In our experience, people are generally reluctant to speak about their financial situation, even with family members. Perhaps they have been raised to hold that type of information closely or are simply uncomfortable revealing that there’s either more or less than might have been expected. Whatever the cause for reticence, holding back is rarely a helpful strategy. Trusting your family with such information is likely to have a positive outcome. While every situation is unique, we have helped people hold this discussion many times and might be useful in facilitating a meeting. Interestingly, we have been asked to help about an equal number of times by each generation.

Several years ago, I wrote that dying is not a decision we are allowed to make, although we are often able to make certain choices about how we live our last years. I was reminded of that by this quote from George Burns, which provides a fitting way to close this article.

"You can't help getting older, but you don't have to get old."

The Best Things in Life Are Free

Depending on one’s definition of “things”, the title of today’s article may or may not be true. I suspect most would agree that love, laughter, kindness and beauty are some of the best things in life and that they basically come without a price tag. However, once you cross over into the material realm, I think many would side with author Robert Heinlein who popularized the phrase “There ain’t no such thing as a free lunch.” (also known by the acronym TANSTAAFL). In spite of all the things which can be enjoyed without cost, Heinlein reminds us that bars which used to serve a free lunch to noontime patrons necessarily charged more for their drinks than bars that didn’t.

During the final quarter of 2008, we watched the end of the “free lunch” of limitless increases in home prices, the failure of the investment banks behind the complex mortgage-backed bond deals which enabled continued home purchases, the California public pension system booking losses in the billions of dollars and a large number of wealthy investors and charities losing many billions more through a Ponzi scheme allegedly perpetrated by Bernard Madoff.

While each of these situations was different, they share a common thread. You learned as a grade-schooler that if something seems too good to be true, it probably is or, as Heinlein would have said: TANSTAAFL. As adults, our education and sophistication sometimes overshadow our early understanding of how the world works. Any of us can be blinded to what’s happening right before our eyes.

As financial advisors, Warren Ward Associates regularly reviews investment alternatives on behalf of our clients. There are so many to choose from that our process consists of two parts. First we attempt to rule out those which appear inappropriate, then we try to select the best of those which remain. We begin by asking the question “Who is going to buy this when our clients are ready to sell?” This eliminates many of them because we try to be rigorous in applying the “no free lunch” concept. Did this approach help our clients in 2008? Well, we invested in no high-priced homes to flip, no investment banks, no California land deals and no “sure things” offered to a very exclusive group comprised of “friends of friends”.

Like Ken Lay did at Enron, it appears that Bernard Madoff simply lied to auditors and regulators, not to mention at least some employees and apparently all investors. A creative and well-documented lie can be very tempting, especially when used to support an “above market” investment return. The problem, of course, is that no investment strategy can really outperform the broad market year in and year out. While the hedging strategies that Madoff said were being employed can be used to protect a portfolio from downside risk, the huge volume of trades required in this case would have moved the markets all by themselves. As I write this article in early January, the Securities and Exchange Commission has confirmed that they received credible allegations of improprieties as far back as 1992 and failed to act decisively. Perhaps Madoff’s stature in the investment community (he was past chairman of the industry association NASDAQ), simply lifted him above suspicion. No doubt new rules will be forthcoming in hopes of really getting the barn door closed this time.

Although no one at WWA is participating in any sort of fraudulent scheme, our firm does have one thing in common with Madoff’s: most of our new clients are introduced to us by current ones. In the Madoff case, these “middlemen” were rewarded financially for their efforts. Our referrals, on the other hand, originate with current clients who simply believe that WWA can be of assistance to someone they know. Of course, we have a range of safeguards in place to ensure that our clients’ assets are protected. These are detailed in the documents we provide when beginning a new relationship. In addition, we are happy to answer questions regarding any aspect of our business dealings, something Bernard Madoff conspicuously declined to do.

Madoff’s investors thought they were being let in on a special deal. They were told they were being treated “like family”, when in reality they were being duped from beginning to end. Ponzi schemes like this one range from simple chain letters to one in the early 1880’s involving the son of former President U. S. Grant. The best available protection from fraud is the liberal application of the “smell test” to every opportunity which presents itself, keeping in mind what you learned in grade school.

With that thought, let me stop and welcome you to the new year. I certainly hope your holidays were enjoyable and that 2009 will be a great year for you and all those you love. WWA is honored to serve as an advisor to many of you and we are looking forward to a productive, if much less eventful year for us all.

More "General" than "Electric"

One of the most commonly asked questions in the investment world is whether people are better off investing through active or passive strategies. Most mutual funds feature active management (specific stocks are chosen) while the lower-cost index funds (in which a specific index is mimicked) do not. This leads to the obvious question: are the managers "worth it"? As with so many issues related to financial planning, this question is harder to answer than it first appears. As we understand things at Warren Ward Associates, each strategy involves its own share of "management". For example, back in May of 1896, when Charles Dow published the members of the first Dow Jones Industrial Average (DJIA), he selected ten very large and well-known companies for inclusion. 

• American Cotton Oil
• Laclede Gas
• American Tobacco
• North American
• Chicago Gas
• Tennessee Coal & Iron
• Distilling and Cattle Feeding
• US Leather
• General Electric
• US Rubber

If you follow investing at all, you probably recognize that only one of them remains a part of that index today and it has become much more General than it is Electric. GE was founded in 1878 by Thomas Edison to commercialize his invention of the light bulb. The company has remained a component of the DJIA through the years by changing with (and sometimes ahead of) the times. It is now active in six broad market areas: commercial finance, consumer finance, healthcare, industrial, infrastructure and the diversified media company, NBC. Two things have not changed: it still sells light bulbs and its continued membership in the DJIA is at the discretion of the editors at Dow Jones.

Another well known index is the Standard & Poors 500 (S&P 500) to which GE also belongs. The S&P is not comprised of the 500 largest companies in America (although that’s not a bad way to think of it) but 500 companies which a group of S&P editors believe to be of the greatest interest to investors. I thought about calling this article "The S&P (1)500" because over the years, more than 1500 different companies have been members of the "500".

Neither Dow Jones nor S&P publishes a timetable for making changes but adjustments among one or the other happen almost every year. The DJIA hit a record of 13,000 in 2007. Did you know that if IBM and Coke had remained a part of the index, instead of being removed then later added back, it would have already hit 15,000? That’s a fact and it highlights the issue that WWA sees with passive investing.

In spite of being thought of as passive, each of these famous indices is "managed", at least after a fashion. We prefer active management for our clients for one simple reason. Since changes in portfolio composition are going to be made, we think the best strategy is employing investment management professionals to make investment selections for our clients rather than the editors at Dow Jones or S&P. It is true that index investing generally offers lower costs but we believe that utilizing active managers provides us with an opportunity to control portfolio volatility while still providing competitive rates of return.

Tax Dates to Remember

I suspect that most everyone who reads my periodic comments about financial planning and investing is familiar with April 15th, tax day for most US citizens.

Another, less well-known tax date is Tax Freedom Day®, a date which has been calculated by the Washington DC-based Tax Foundation (www.taxfoundation.org) since 1971. For 2008, they figure it to be April 23rd, meaning that, on average, we work the first 113 days of the year to pay for our governments and their services. While there is legitimate debate about what this figure/date actually means, it is at least a stab at answering the question: "What does our government cost us?"

Income taxes have been imposed by most countries at one time or another but, in the United States, it took ratification of the Sixteenth amendment to make it clear that the federal government could legally do so. The first rate was 1% on yearly incomes above $3000 (about $60,000 in today’s dollars) with an additional 6% surcharge for incomes above $500,000 (about $10,500,000 today).

Services like police protection and maintaining a standing army appear to be here to stay. Even the staunchest advocates of "small government" agree to the need for at least some services which can only be provided by the government. These services, whether provided at the federal, state or local level, obviously require taxes to fund.

I avoid debates about the fairness of taxes, since I know I’m unlikely to influence the outcome. Instead, I try to help my clients understand the system and orient their financial planning and investment decisions to accommodate it.

Seventeen years ago, when I earned my first brokerage license, interest rates were relatively high and tax-free municipal bonds were often a very appropriate investment. As interest rates fell, we searched for a strategy to replace tax-free bonds in our clients’ portfolios. Over the past couple of years, we have implemented a process for selecting dividend-paying stocks which provide a similar result. Our clients receive tax advantaged income (in the form of dividends) but we are able to choose when to take any capital gains by deciding when to sell the stocks.

Recent changes in interest rates have made municipal bonds somewhat more attractive, so we have begun to consider that option again, at least for some clients.

When we choose managers for our clients’ assets (usually through mutual funds), one of our screening elements is tax efficiency. Different managers employ different strategies but we generally try to place our clients’ non-retirement assets with managers whom we expect to be able to minimize current-year taxation.

Here’s one final tax date to think about. On December 31, 2010, our current federal estate tax structure will expire and we will revert to the 2001 rules. The original estate taxes were enacted largely to help break up the huge family fortunes amassed by the early steel and railroad "barons". The effects of inflation eventually brought those taxes to bear on most middle class families. The 2001 revision of the law brought a phased adjustment, moving most of the middle class back out from under them. As this revision approaches its "sunset", debate continues about the fairest way to implement estate taxation.

I spend more hours in continuing education every year on taxation than any other topic. Our hope is to always be able to make suitable options available for our clients, regardless of what form taxation might take.

The “R” Word

Like most other professionals, financial planners live in a world which requires a high degree of accuracy. Columns of figures must add up, reports must be filed on time, details must be attended to. I almost said that words must have exact definitions but I’m not sure that one is always true. My wife and I recently watched a cute movie which followed a year in the life of some teenagers. Unfortunately, we didn’t understand the meanings of all the words they used. While we were almost always familiar with the words themselves, about half of the time we had never heard them used in quite the way they were in the film.

Since I’m not a high school teacher, being a little out of date on the latest teen-age slang is really not a problem for me. In the case of the movie, the context allowed me to keep up, even without understanding everything that was said. However, not staying abreast of words which are part of my professional language is a different story. The word I have in mind today is recession (sometimes referred to in our industry by the title of today’s article). People are sometimes afraid to say it aloud because just mentioning it might make it a reality, especially when uttered by an important government figure.

Recession is properly defined as "two consecutive quarters of negative growth in a country’s real gross domestic product", i.e. six months of reduced output. Headlines questioning whether we are in a recession have been a media staple recently (as of April of 2008) and I recently saw a website where a poll was being conducted to decide whether we were in one or not.

One of this era’s most successful money managers is Forbes magazine columnist Ken Fisher. In his new book, he questions the point of "asking people" if there’s a recession going on. In his mind either there is or there isn’t – per the definition. Although I usually agree with Mr. Fisher regarding investment issues, I’m not sure he’s right about this one.

I am a close observer of the activities of the Federal Reserve Board of Governors (the Fed), that group of bankers charged with keeping our economy on track. One of my regular concerns is that, at least under previous Chairman Alan Greenspan, they always seemed to be driving by looking in the rear view mirror. That is, they were waiting for data to be posted before making a decision - looking to the past to decide what to do about the future.

Although knowing exactly when a recession begins or ends might be of historical importance (or political importance in an election year), how people feel about the economy is probably more important to most of us. People tend to feel better about their lives when they are comfortable with the level of their savings, whether through increases in the value of their homes or their other investments. Naturally, the opposite is also true, with reduced assets bringing on concerns about their future. Many people incurred significant losses during the 2000 market correction which followed the "dot-com boom" of 1998 and 1999. In today’s market, however, most people are not going to lose their homes through foreclosure related to the sub-prime mortgage problem. Yet enough of us have become cautious in our spending that "the ‘R’ word" is being uttered. It seems as if the more it’s talked about, the more worried people become and the more likely a true recession might be.

How does this debate affect us and our clients? Very little, in fact. Although there are a few circumstances which would make us consider cashing out our clients’ investments, we have not seen any sign of them yet. We have faith in the process of asset allocation and believe it is possible to avoid the worst of a market correction by being properly diversified. Although we have made several recent changes in our client’s asset allocations, we continue to be fully invested and are likely to remain so, regardless of the latest poll declaring the presence or absence of a recession. Long term investing is what we do.

Vilfredo Pareto, Financial Planner

Not long ago, I suggested that TV’s Ben (Pa) Cartwright might have made a good financial planner. In one episode, he offered his son Hoss a helpful lesson in problem solving by suggesting that he break a bundle of sticks one at a time. While the idea of breaking a complex problem down into smaller tasks is a useful one, to some extent it begs the question of which stick to break first. Perhaps Vilfredo Pareto can help us with the answer.

Pareto was born in 1848. The well-educated son of an Italian father and French mother, he is generally considered the first person to state what is now commonly known as the 80/20 Rule when he said "Twenty percent of the population of Italy owns eighty percent of the property". He and many others had expanded upon it by the time I first learned of its usefulness while working as a mechanical engineer in the 1980’s.

As a profession, engineers had become concerned with the level of quality that our plants were producing. We began to understand what now seems obvious: making good parts the first time is almost always going to be cheaper than fixing poorly-made ones later. We learned to conduct a Pareto Analysis and were thus able to rank the various problems from most to least common. That suggested the order in which we would try to solve them, allowing us to make the most impact in the least time. Achieving Six Sigma quality is now the goal of all serious manufacturing operations and Pareto’s techniques are "still a part of the toolbox" as a Six Sigma Black Belt friend recently told me. This type of analysis can be profitably applied far beyond the world of manufacturing. We see it used by businesses of all kinds, across virtually all departments and around the world. In Columbus Indiana, it was recently applied to the "Book Buddies" program which pairs volunteers with poor readers in elementary schools. It is even used by financial planners.

One of the reasons people turn to a professional for financial planning help is that they have become overwhelmed by numerous issues which impact their wealth and their well-being. Some are quite serious, others less so. Yet each problem is clamoring for attention. We often hear that there’s so much going on that no progress is being made on any of them. Although Pareto is not a well-known name in the planning profession, the approach he developed is a useful tool and is often among the first to be employed at Warren Ward Associates.

Our years of experience in financial planning would be of little use to anyone unless we were able to provide individualized solutions in specific situations. While we do hear the same questions from different clients, we rarely hear them asked in the same order, so getting to know people and understanding their specific situation is where all our planning relationships begin. We subscribe to several testing services, including one which helps us understand how our clients’ feel about money and another which helps us evaluate their tolerance for risk. Although we serve our clients in many ways, we really can’t do anything for them until we have learned what is most important to each of them and why.

The challenge of helping people realize their dreams is what brings us to work every morning and keeps us looking to earlier "planners" like Cartwright and Pareto for tools to do the job well.

The Hundred Year Flood and Other Appealing Folk Tales

For those of you who do not live in or near Columbus, ours is the southern Indiana community whose hospital was forced to evacuate due to recent flooding. I was attending a conference while the heaviest rain was falling and returned a few days later to find both our home and office untouched. Although we were spared, several friends and clients are cleaning up terrible messes and they are just a few of the many families in the area doing the same. FEMA is now on the scene and local volunteers have been hard at work since the rain stopped.

I have heard it said that lightning never strikes in the same place twice. Yet I know it can, because lightning strikes are governed by the laws of physics. The highest point in a landscape last week is probably still the highest point this week. If lightning has struck that place once it could easily strike there again. In the same way, the lowest point in any area is likely to be the one that floods, perhaps more than once.

Witnessing a flood is one of the scariest things that any of us is likely to experience. You can see the water rising but there is almost never anything which can be done to stop it. To help reduce the financial impact of floods, our entire country has been mapped based on the potential for flooding. Most property owners in an area which is likely to flood, even once every 100 years, are required to carry flood insurance. But last week, in Columbus and elsewhere, many of the flooded homes were uninsured because they were in zones considered likely to flood once in 500 years or even less often.

All of this leads to the question, "Should homeowners in the 500-year flood area in southern Indiana or the over-500-year flood area in Iowa have purchased insurance?" Such decisions are rarely simple ones. After watching TV coverage of the destruction, the answer might seem obvious but all insurance costs money and people tend to resist buying protection against an event which seems unlikely to happen. As I understand it, Columbus has experienced three "100-year floods" in the past 95 years. Whether due to changing weather patterns or the fact that our society is now paving areas where water was once absorbed into the ground, I suspect flooding may occur more, rather than less, frequently in the future.

One way to approach any question related to insurance coverage is to think of it as a hedge, a concept which originated with the game of roulette. Hedging allows a player to bet on two or more numbers at once, although with a reduced payout for a winner. In the world of financial planning, insurance offers one of our most useful forms of hedging. We help clients decide which risks to keep for themselves and which ones to share with an insurance company. Decisions about whether to insure, and for how much, can’t be made "in general". They must be considered in the context of a specific situation. A relatively wealthy individual might be quite able to afford insurance but might also be able to survive an uninsured loss. Someone who apparently cannot afford insurance might, in fact, lose everything by going uninsured.

Assessing risk can be very difficult. For example, the city of Columbus is undergoing a series of major renovation projects, including the tear-down and replacement of The Commons, a downtown mall, indoor park and gathering place. Those of you who have been inside The Commons will probably remember Chaos I, a kinetic sculpture by Jean Tinguely. When in motion, gears are turning, balls are traveling down a wire cage and there’s a lot of clanking going on. It is certainly a world class piece of art, yet from another perspective, it’s just a collection of scrap metal. It was constructed almost entirely from items found at Kroot’s, our local salvage yard. What is its value? How much should it have been insured for during the tear-down of the old mall?

Determining the cost of insuring against the risk of flood damage is fairly simple. Your insurance agent can almost certainly arrange coverage for your home (possibly through a FEMA sub-agency) but the decision about purchasing it is still yours to make. Of course, premiums are based on the likelihood of it being flooded. According to FEMA, the average premium in the 100-year flood zone is around $400 per year for structural coverage. Dwellings in lower risk areas can often be covered for less than $150 per year, again for structural damage. Most people should consider insurance on their contents as well.

Helping clients manage risk is an important part of what we do at Warren Ward Associates and helping them make decisions about insurance is a critical part of that process. As no two situations are identical, it isn’t always easy to answer the kind of questions I have raised. If you are a client of WWA, we will work with you on these issues. If not, your insurance agent should have ready answers for your specific case. If your agent is unable to meet your needs, we will try to help you locate one who can.