Warren Ward Associates

Money for Nothing

My articles tend to be at least somewhat topical, often attempting to answer a question from the headlines or being asked by our clients. Today’s deals with interest rates, as have several in the past. I am readdressing the topic because current rates may tempt investors to take risks they don’t understand in order to earn a little extra income.

The title of this article was borrowed from a Mark Knopfler song describing that fact that he loves playing music so much that he feels as if he’s able to make his living doing something he’d willingly do free. That’s a very rare situation indeed. Most individuals and institutions earn their income for doing at least some amount of work. Considering risk and reward instead of work and pay, people can be thought of as earning their money by accepting a range of risks. Quite appropriately, the safest investments pay the lowest rates. Towards the end of 2009, treasury bills moved to a negative interest rate, as buyers overwhelmed sellers and paid more than face value to get those extremely safe bonds into their portfolios by year-end.

With rates sitting near historical lows, we are again hearing about investment strategies that promise to deliver above-market rates of return while assuming little or no additional risk. Of course, this is virtually impossible to achieve. We only need to look 18 months into the past at the government agency-backed bonds which were popularly deemed failsafe, at least until banks began to close.

In my 2006 article The Quest for Yield, I described some interest-paying investments I thought made sense for that time and others that didn’t. Toward the end of that article, I pointed out that our recommendations change over time, as well as being tailored to each individual client’s situation. As an update to those comments, here are some thoughts for your consideration.

We do not recommend these investments for anyone today:

Fixed annuities   These CD-like investments are sold by insurance agents. Typically, the first year rate is guaranteed (and usually enticing) but subsequent year’s rates often are not. Since there is usually a multi-year period during which a penalty for early withdrawal is in effect, we are not comfortable having future interest rates governed by a company’s generosity.

Bond mutual funds   Open-end bond funds have provided good performance over the past 18 months and we see many of them being sold to investors on that basis. Unfortunately, if the falling rates which helped past performance are replaced by rising rates, investors will face loss of principal value instead of experiencing growth. We would stay away.

Reverse Convertible Notes  These are another class of “manufactured” investments like the mortgage-backed bonds which got our economy into so much trouble in 2008. These are also extremely complex. While forecasting the income stream is fairly easy, determining the amount of principal which will be returned is quite difficult. Please avoid these too.

We believe these investments are currently worthy of consideration:

Dividend-paying stocks   Although stocks can certainly be risky and are always subject to fluctuation in value, over the long-term they have been a sound investment. In addition, they are the only investment of which we’re aware that offers the potential for a rising income stream. Like any stock investment, these must be chosen carefully but this can be a very rewarding approach.

Floating-rate funds   Each of these is backed by the loans which businesses take out to meet their day-to-day cash flow needs. Typically, these loans are very short term (almost always less than a year) and rates are readjusted at the end of each term. This makes them a reasonable choice should interest rates rise. We feel that whatever additional risk comes from investing in these smaller businesses is offset by the large number of companies in each portfolio and the higher rates they are charged.

There have been times, and probably will be again, when we recommend both annuities and bond mutual funds, although I doubt we’ll ever become comfortable with Reverse Convertibles. Likewise, the time may come when we don’t think dividend paying stocks or floating rate funds make sense. We always offer investing advice in the context of individual situations, considering the current economy. We don't believe there is any practical way to “set and forget” an investment portfolio.

Getting back to the author of today’s title, in addition to receiving “money for nothing”, Knopfler’s song goes on to extol the value of being famous when it comes to meeting women. He describes them as a side-benefit which accrues “for free”. As rock stars and sports figures are constantly re-learning, nothing in life is truly free, whether an improved social life or higher interest rates.

Dining Room Economics

My in-laws are wonderful people from several perspectives. They welcomed me into the family 39 years ago, raised eight children and are now comfortably retired following a lifetime of saving and investing. I am in no way surprised that they have been successful investors as they began teaching practical lessons in behavioral economics right at the dining room table.
 
Behavioral economics, you may remember, is the study of why people - regardless of their education or sophistication - sometimes make less than optimum financial decisions.
 
The past eighteen months have given us an perfect example of behavioral economics at work, albeit one that I certainly hope isn't repeated anytime soon. Although none of our clients chose to take their money out of the markets during the recent correction, several of them called asking for reassurance that remaining invested was truly in their best interests. Other individuals with whom I spoke had chosen to withdraw from the markets and they too wanted confirmation that they had made a good decision.
 
Investment management firms like Warren Ward Associates are staffed by human beings who are in no way immune from experiencing fear. However, our clients depend on us to process that fear very carefully before responding to it. In the case of both the 2000 and 2008/9 corrections, we avoided making a fear-based decision to sell. We kept our clients in the markets, thus allowing them to participate in the subsequent upturns.
 
The decision to sell stocks and bonds (i.e. leave the market) necessarily involves two different steps. First - obviously - is choosing the right time to sell. As fear levels increase, people are more likely to take that step. When fear reaches the point that the idea of actually taking a loss becomes more appealing than worrying about how much more might be lost, they act. Once that happens, investors face the second decision: when should the money be returned to the markets? A fairly common answer is "when things look better" but using that rationale guarantees that the investor will have sold low and bought high (or at least higher). This is one of the very few life situations in which generally rational people resist buying things which have gone "on sale".
 
Such apparently irrational decisions led researchers to study behavioral finance. A very simple example involves two people being asked to play the "ultimatum game". The players are known as the proposer and the responder and each starts with no money. The proposer is given a sum of money to be shared with the responder in the proportions of his or her choice. However, neither gets any money unless the split is agreed to by the responder. Logic would suggest that any split would be a good one since, regardless of the percentage the responder might receive, it is greater than nothing. As the game is played, however, it is common for the responder to reject any offer very far from 50:50, even though such rejection means that neither player gets any money. Whether that response is driven by a sense of fairness or the same fear of loss that makes people decide to sell investments below cost, the most common response isn't a rational one.
 
By standing between investors and their investment decisions, planners can ask their clients to pause and reconsider their fear-driven urges, encourage them to take the longer view and try to help them achieve better long-term results.
 
Incidentally, in case you were wondering about my in-laws' dining room lesson, it was really quite simple. The family rule was that one child got to cut the dessert, then another choose the first piece. Behavioral economics at its most basic level.

What a Difference a Year Makes

Investments are rarely the most important thing in anyone's life, yet the 24/7/365 coverage of markets can make them seem so. Recent headlines suggest that people are becoming more optimistic about the economy, a significant contrast to the mood which permeated society last year around this time.
 
In mid-September of 2008, the venerable brokerage firm Merrill Lynch was forced to merge with Bank of America and investment bank Lehman Brothers was allowed to fail. The next day, the multi billion dollar Reserve Primary (money market) Fund, which owned nearly $800 million in Lehman bonds, endured a "run" on its assets. That forced bond sales which briefly took share values under $1.00, something that had never happened to a "retail" money market fund before. In response, the government began a series of almost unprecedented interventions in the day-to-day activities of the markets. Among other steps, it guaranteed the value of all money market funds to halt the run on the bond market. Although most of us prefer that the government keep its distance from our personal affairs, there were very few complaints about its actions, due to the general level of fear which affected the populace.
 
Today, people seem to be more confident in some sort of reasonable future. Stock and bond markets have rebounded significantly. President Obama spoke of "green shoots" and, two weeks ago, Federal Reserve Chair Bernanke suggested that the recession was "very likely over". The Fed met last week and kept rates near zero, hoping to keep costs low for borrowers.
 
I think the term "mixed message" sums up the current year's situation fairly well. Our economy is certainly on the upswing. There is an improving market for stocks and real estate transaction are once again being completed. However, things are not back to normal yet. The stock market has risen on very little volume, suggesting that a significant selling trend would be difficult for the limited number of active buyers to absorb. Similarly, even though some areas of the country are enjoying a rebound in housing sales, portions of Florida, Nevada and California may face real estate illiquidity for years to come.
 
As I've said before, stock markets are leading indicators of an anticipated strengthening of the economy. The phrase "jobless recovery" often appears in the headlines during the early stages of an economic recovery. Unfortunately, such recoveries don't offer much help for home purchases, increased 401(k) investing or retail sales.
 
Dinah Washington's 1959 release What a Difference a Day Makes earned her a Grammy and provided me with a framework to approach this subject. The second verse of that song begins: "My yesterday was blue, dear, Today I'm a part of you, dear". If you will accept the substitution of year for day, you may agree that the song captures the change in mood from last year to this. While Dinah declares her love as "being a part of" someone else, all of us are part of our economy locally, nationally and globally. None of us will enjoy a sustained economic recovery until all of us have an opportunity to participate.
 
In managing money on behalf of our clients, Warren Ward Associates concentrates on the strategic allocation of their assets. Our aim is to use this diversification to do better during market pullbacks while generally matching the markets during upswings. We did not sell investments during the correction, so remain fully invested on our clients' behalf.  We do expect to begin hedging some of their gains as the S&P moves above 1100 or so. Over-optimism isn't likely to be good for the long-term economic heath of our clients, regardless of how big a difference a year may have made. 

There's Safety in . . . ?

During times of financial upheaval, people often exhibit renewed interest in the safety of their investments. A few weeks ago, I wrote an article about CDs issued by a bank headquartered in Antigua. They offered great rates and the CDs sounded safe but they were not insured by our FDIC and, when the bank turned out to be yet another Ponzi scheme, billions of dollars were lost by investors throughout the Americas.

One of the truisms in my world is that risk and reward are intertwined. Safety of principal is relatively easy to obtain through investing in government-issued or -guaranteed securities but finding a combination of safety and increased yield is a little more difficult. For example, locating the highest yielding money market fund might seem like a good approach but those funds are not checking accounts, so are usually not guaranteed. Switching from CDs to government agency bonds gets you higher interest rates but leaves you with unpredictable return of principal. Selecting the “stable value” option in your 401(k) plan might sound safe but be sure to check to see if AIG happens to be the guarantor of the return.

When purchasing something complicated, people sometimes feel overwhelmed and simply depend on the salesperson to guide them. As buyers of Stanford Bank CDs learned, you do so at your own peril.

Anna Quindlen wrote an article in Newsweek about a month ago and I have linked to it because I think it’s worth reading in its entirety. She expresses concern that most people don’t know enough about finances and seem relatively uninterested in learning more. She suggests there’s hope, however, comparing the way medicine was practiced a generation ago vs today:

“Once doctors, like financial managers, were seen as keepers of a mysterious flame and patients as people who should simply do what they were told. Today many more patients think of themselves as partners and work hard to educate themselves about their health and their ailments before having surgery or taking medications.”

Toward the end of the article she confesses that, even while covering the investment beat, she understood little of what she was writing about. That’s quite an admission for anyone to make, let alone a writer for a national publication. Her candor makes for interesting reading.

After eighteen years in the world of financial planning and investments, I have come to believe that there’s no such thing as pure safety or pure risk. Many seemingly safe investment strategies did not behave as anticipated during the recent market correction. Even when things do work as planned, such safe investments have a tendency to offer approximately the same return as inflation, meaning that your assets are unlikely to provide additional purchasing power in the future. An investment strategy which includes stocks certainly entails risks but it also offers at least the possibility of making money with your money.

Most of us wear our seatbelts; doing so is just a prudent step toward completing a trip safely. The first cars didn’t have them and they were not generally available until the late 50’s. Through educational programs and changes in laws, they have become almost universally accepted today. I suspect most drivers also consider their financial lives important and could become comfortable learning more about their investments and trying to make better decisions.

Habits can be changed and lessons learned. Why not read Ms Quindlen’s article, then take steps toward understanding your investments and how they relate to your life goals. There are numerous books available on the subject, not to mention magazines, radio & TV shows and web sites. If you’d prefer your education to be a bit more personal, Jalene and I stand ready to answer questions, offer advice and do our best to help you learn.

What's in a Name?

Turning once again to William Shakespeare for the title of an article, I’d like to consider some ways that commonly understood words might be used for uncommon purposes.

Members of “The Greatest Generation” knew Packard Bell as a well respected manufacturer of radios and other consumer electronic devices. The company later became a defense contractor and was eventually bought by Teledyne in 1978. Once the famous old Packard Bell name was no longer in use, it was bought by some Israeli entrepreneurs in 1986 and applied to an inexpensive line of personal computers. Although there was no connection between the original and subsequent companies, there was still name recognition and the new company went on to briefly become the largest seller of personal computers in the US with 15% of the market in the mid 1990’s. In 2005, PC World magazine ranked their computers the worst PCs of all time. The name is now owned by a competitor but is unused in the US. If you were the owner of one of those Packard Bell machines, my guess is that you do not remember the experience fondly.

Moving on to two more words that seem familiar, let’s consider Stanford and Certificate of Deposit (CD). It seems that a man who shares his last name with the honored past governor of California and founder of a great university has been issuing Certificates of Deposit from his bank, headquartered in Antigua. His assertions to the contrary however, R. Allen Stanford is no relation to Leland Stanford. And, unfortunately, CDs issued by such non US-based institutions are not “insured by an agency of the US government” as are those available at banks located on almost every street corner in the US. Offering returns that were much higher than legitimate CDs, Stanford’s salespeople pitched them to investors in the US and several Eastern Caribbean nations. According to our Securities and Exchange Commission, those sales totaled about $6.7 billion in 2007. Stanford’s institution is now in receivership and it may be years before the total of the (un-insured) losses is known.

It might seem that a single multi-billion dollar scandal would be enough but apparently not, as Stanford has joined Madoff in allegedly having stolen enormous amounts of money from trusting investors. Although his modus operandi was different, the underlying lure was the same: a return that seemed too good to be true.

I have said before that we begin our investment research at Warren Ward Associates by asking “Who will buy this from our clients when they are ready to sell?”. Another question that’s part of our process is: “If a risk-free investment (a direct obligation of the US government) is paying X%, what additional risk will our clients have to assume in order to achieve some multiple of that?”. In the case of stock investments, we know (as do all who read newspapers or watch TV) that volatility is part of the equation and it is possible to lose money on a specific investment. In the case of bond investments, while we know that they too can fluctuate in value, we generally expect something quite different. 

Let me close this article with one more name: FDIC. The Federal Deposit Insurance Corporation is the agency which guarantees domestic CD investments. It’s name means exactly what it says. Although the FDIC takeover of a financial institution is somewhat cumbersome, it absolutely works. If someone promises you a “secure” investment without an FDIC guarantee, investigate further. Always be sure you know what the name of your investment really means, especially if it promises an unusually high rate of return and especially if the promise includes a “guarantee”.

At Sixes and Sevens

Any one of several things might come to mind when the number six is mentioned. Maybe you think of it as a common package for your favorite canned beverage, the atomic number of carbon, Bert’s favorite number on Sesame Street or the number of geese a-laying. However I doubt that the number of steps in the classic financial planning process is likely to be among the more obvious answers.

As I have written before, it was not my lifelong ambition to become a financial planner. I made a successful mid-career change from engineer to stockbroker in my 40’s. However, after a few years, found myself increasingly uneasy trying to answer people's investment questions outside the context of their entire financial lives. Understanding that I needed to address those concerns, I left the world of selling investments. After several years of study I became a Certified Financial Planner® certificant with Jalene following soon thereafter. During the course of study, we both became believers in the six-step financial planning process.

One of the most common questions we hear is, “What’s the difference between planning and simply investing?”. Hopefully, this article will shed some light on the issue and maybe even provide an answer. There are certainly some financial questions with fairly simple answers so the entire process is not required for all clients. Still, we utilize it whenever we can since it has proven such an effective way to identify issues and help provide answers.

Here are the steps and some thoughts about how each is applied.

Step 1: Setting goals with the client. We try to learn about a potential client’s current situation but, more importantly, where that person hopes to be in the future. There is just no way to develop a meaningful plan without having accurate information about a client’s long-term goals.

Step 2: Gathering relevant information about the client. We usually do this at the same time as Step 1. We ask each client to complete one or more questionnaires to help us learn more about them. Of course, we also review relevant financial documents.

Step 3: Analyzing the information. After seventeen years in the business, I can confirm your suspicion that every person’s situation is unique. Analysis is required so we can understand a client’s circumstances as well as what resources can be brought to bear on meeting the desired goals.

Step 4: Constructing a financial plan. After we have a clear picture of the situation, we develop a personalized strategy to guide the client in achieving his or her goals.

Step 5: Implementing the strategies in the plan. Usually, plan execution is accomplished jointly. For example, we might review and make recommendations regarding the funding of a college education while the client might begin contributing more to his or her retirement account.

Step 6: Monitoring implementation and reviewing the plan. A plan is of little value without some sort of follow-up. No matter how carefully we plan, life doesn’t always follow the script. We schedule periodic follow-ups so we can evaluate how things are going, which also gives us a chance to be sure nothing significant has changed.

Although managing investments is often the reason people come to Warren Ward Associates, it is only one of the services we typically provide. The six step planning process allows us to learn a great deal about our clients, their immediate situation and their long-term goals. While the process is more time-consuming than simply selling them an investment, we believe it greatly increases the likelihood that our clients will be successful in achieving their goals.

Oh and the sevens mentioned in the title? Well, an investor can always decide to simply depend on luck . . .

When Bad Decisions Happen to Good People

Fear isn’t always logical but that doesn’t make it any less real. For example if you had a scary dream, would it be more likely to feature an alligator, a bear, a shark, a snake or a deer? According to author Jason Zweig, the deer is by far the most dangerous animal in the United States because deer-strikes (and attempted avoidance thereof) cause many more deaths every year than do fatal encounters between humans and alligators, bears, sharks and snakes combined.
 
How do fears play out in the world of finance? Research in the somewhat obscure field of behavioral economics suggests that losing or gaining the same amount of money is perceived quite differently. For most people, losing $100 is about two and a half times more painful than gaining $100 is pleasurable. That being the case, perhaps it’s not surprising that, when it comes to investing, people seem to be more afraid of a market crash leaving them destitute (less than a 2% chance in any year) than of inflation eroding their nest egg’s purchasing power (a 100% chance during most normal lifetimes).

Even though some people are reluctant to join the fray of investing in the stock and bond markets, Warren Ward Associates’ long-term focus almost always requires us to propose some version of that strategy to our clients. Very few people have so much capital that CDs alone will provide enough money to last a lifetime. As new clients hear (and regular readers have already learned), we begin our investment process with a series of evaluations. These help us discover an individual’s likely tolerance for market fluctuations and what role money plays in her or his life. After that, we employ a customized version of a Nobel Prize-winning strategy known as Modern Portfolio Theory. This process apportions investments into multiple sectors of the markets with the intent of reducing portfolio volatility. Although far from perfect, it is a tool we utilize to help our clients avoid as much of the “pain” as possible, while still maintaining sufficient performance to deliver most of the “pleasure”.

Everyone knows that “beating the market” is difficult, especially over long periods of time. My recent article called Time in the Markets vs Timing the Markets, features some very revealing data on the topic. According to multiple studies, not only do most individual investors not beat the market, they often do significantly worse due to the poor timing of their investment decisions. A common scenario involves fear keeping an investor out of the market during a period of rising stock prices. At some point, perhaps after a couple of good years, that investor may go ahead and take the plunge, only to find that the market is about to correct again. For example, consider the “dot com” boom of the late 1990’s. As has been true in every previous market correction, those who waited and invested only after repeatedly hearing others talk about how “easy” it was, suffered losses during the correction of 2000. Having joined that party late, they probably sold their tech stocks at a loss, making them that much less likely to return to the markets than before - even as lower prices became available.

Even though a vast amount of “do it yourself” information exists, especially since the advent of the internet, survey results have not changed: individual investors still struggle. Because investing has proven so difficult for so many, let me suggest that attempting to achieve an “average return” might be a more sensible goal for most investors than “beating the market”. Using that as a target, investors might find themselves under reduced pressure, thus less fearful and perhaps better able to make decisions.

Evaluating investment returns does not necessarily involve complex formulas. Many print and on-line services offer historical data, allowing you to contrast your own results to those of various indices. Simply comparing your account values “then” and “now” with index values over the same period will automatically take into account all costs related to the investments, along with the performance of the markets themselves. As you evaluate your portfolio’s performance, it might also be a good idea to consider the value of the time spent away from work or leisure activities, time which is an integral part of the “do it yourself” equation.

While obtaining information has become ever easier, the challenge of interpreting and applying the data has not. Deciding whether to invest on your own or with the help of an advisor like WWA is not likely to be easy. Our clients tell us that the time and anxiety saved are easily worth our fees. Perhaps trying to reduce your own fears about investing through considering a less ambitious goal would be a good place to begin. If you are having trouble setting goals, scheduling one of our no charge “get to know you” meetings might be a good first step. Please feel free to contact us if you’d like more information.

 

Money Managers We Have Known

With the Grammys just completed and the Oscars right around the corner, I found myself thinking about awards. Every year, various publications weigh in with their honorees for best mutual funds (or money managers) of the year. I have written before that Warren Ward Associates rarely invests with those "best" managers because, over the years, we have found that their outstanding results are often the result of some unlikely-to-be-repeated event. While that philosophy certainly remains part of our investment strategy, I had to smile when I read about Morningstar’s 2005 domestic equity fund Managers of the Year, Christopher Davis & Kenneth Feinberg. Never say never . . .

Those of you who have been with us since 2001 may recognize their fund, Selected American Shares (SAS), as our year-in-year-out recommendation in the Large Cap Value area. The team of Davis & Feinberg has been co managers of that fund since 1999 and prior to that, Davis managed it alone.

Our process for selecting money managers is quite methodical and emphasizes consistency in investment strategy, manager tenure, reasonable costs and long-term thinking. It does not incorporate ratings given by any outside source. However, you may be interested to hear that Morningstar’s rating for SAS is their highest (5 star) and in naming Davis & Feinberg Managers of the Year, they have honored them even more highly. While WWA doesn’t claim to be able to identify the best manager in any asset category (or for that matter the best allocation among categories), it is reassuring when the acknowledged authorities in mutual funds confirm our assessment, as happened 2005 with Selected American Shares and its managers.

As investors have become more sophisticated, they have begun looking beyond investment results and have started asking questions about how funds are operated. Consequently, Morningstar (among others) is now rating funds from additional perspectives. Their Stewardship Grade is based on evaluation of various operational issues including compliance, the quality of independent board members, how the managers are paid and general corporate culture. Of the 1,243 funds Morningstar has rated so far, only 11 have received an "A", including our old friend, Selected American Shares.

Winning an award like Manager of the Year has a way of attracting attention. It tends to draw money into a fund, sometimes more than the managers can effectively put to use. Our process requires periodic review of even the best managers so you may be sure that we’ll watch for any signs that SAS might be getting into trouble. For now, though, it is a pleasure to see the research and analysis that is an integral part of our recommendations to our clients affirmed by others. We hope to be able to continue recommending Selected American Shares in the future as we have in the past but, if we do, that recommendation will be based on our process, not the fund’s past performance or even receipt of prestigious awards.

The Silly Season

As the weather turns warmer, people’s minds just naturally turn to thoughts of . . . well, in many cases, taxes. As April 15th approaches (actually it’s the 17th this year), people become more susceptible to making an investment decision based on tax issues instead of common sense. At this time of year, products containing a tax "hook" are brought up by salespeople and sometimes even the most prudent investors find themselves considering an investment they wouldn’t look at otherwise.

In approximate order of popularity, here’s a roundup of the usual suspects:

Variable Annuities (VAs) – These are basically mutual funds held within an insurance policy. Since they are insurance products, they receive the traditional benefit of tax-deferred growth. However, we often see them recommended for IRA rollovers which are already tax-deferred, making the added annuity costs a drag on investment performance. VAs do provide insurance in the amount of the original investment, even if the value of the mutual fund investments drop. On the other hand, accounts continue to be charged for insurance costs even when the investment value rises, providing something for nothing to the company and nothing for something to the investor. Typically, an investor will be penalized for withdrawal within the first five years, so these contracts should not be entered into lightly. We have researched "no load" VA’s and do recommend them when we believe they provide the best solution for a specific situation.

Equity Indexed Annuities – These are similar to the VAs above but are not considered "investment products" by regulators, so they are available through thousands of additional insurance agents who are not licensed to sell securities. Instead of having a mutual fund inside an insurance policy, these are [effectively] a stock index option inside a policy. Again, these commonly include layers of cost which are charged to the buyer and they often have even longer surrender penalty periods than VAs. We recently reviewed one with a 12 year penalty period which had been sold to a 62-year-old. We are not saying that an EIA is never the proper solution and we do not hesitate to suggest them, depending on specific circumstances. However, they are often presented as a "blanket" solution, appropriate for almost everyone, and we do not believe that to be the case.

1031 Property Exchanges – Like so many things in the financial planning world, the 1031 is named for a section of the tax code. It allows the owner of an appreciated investment asset (other than a business) to exchange it for another. These can be a very effective tool in a number of situations but are governed by a strict timeframe and should not be attempted without strategic consideration. Do not allow yourself to be rushed into a significant property investment because you have just sold another. Carefully review your overall investment objectives to be sure you are making a good long term decision.

Annuity Trusts – These have garnered significant interest following a 1969 IRS ruling. They have been used to attempt to avoid, or at least defer, taxes on appreciated property. The IRS came up with new rules in October 2006 and cited taxpayer abuses of the strategy as the reason for their clarification. If someone suggests one of these to you, I would be very careful, as I believe the new rules are sending the message that all such trusts are liable to be challenged.

It is our belief that a good investment must first make economic sense, then tax issues should be considered. It is an unusual situation indeed, when allowing the tax "tail" to wag the investment "dog" proves to be the most appropriate strategy.

The Physics of Investing

I was talking with a friend the other day. He is in his early 50s and has not yet begun saving toward retirement. He had asked whether it would make sense to start after waiting so long. After I assured him that it is never too late to begin, he mentioned the difficulty of implementing a saving/investing plan after many years of not having done so.

As we talked, we shared the observation that the "inertia" of his habit of spending pretty much all he earns might be keeping him from moving forward. I wondered if this might be the financial version of Sir Isaac Newton’s First Law of Motion. Could it be that since objects at rest tend to remain at rest, people who don’t save tend to continue not saving?

My friend said he had always heard that you should "pay yourself first" but found that easier said than done. I agreed and so, as we talked, I tried to offer some suggestions to help him. Since he thinks adjusting his budget to earmark money for investing would be difficult, I proposed that he begin by taking all, or at least part, of his next raise and contribute it to his 401(k) plan. Assuming the increase has not already been "mentally spent", that would allow him to begin investing without having to adjust his budget.

Quite sensibly, he followed up by asking if that would prove to be "enough" savings. My answer - probably not. However, I went on to say that I almost always see reluctant investors become more enthusiastic as their account balance starts to grow. That may be where Sir Isaac’s second law comes into play: an object in motion tends to stay in motion. That is, once people begin investing and see the results, they usually become heartened by the increasing account values, find more money to invest and, eventually, those investments do become "enough".

The question of where to begin, beyond utilizing the next raise, can be a difficult one. Basically, I think the marketing folks at Nike have probably provided the best answer: Just Do It. The hard part is getting started. If you start by contributing 1% to your retirement plan, your budget will adjust to the relatively small impact and next year you can raise the percentage. It doesn’t matter if you start with just a little: in order to reach your financial goals, you must get started.

Overcoming "I never seem to get around to saving", inertia is not easy. However, I believe that most people find regular investing, once begun, is like any other habit. The results become self-reinforcing, leading to a successfully funded retirement or whatever goals are most important to you.