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Welcome to the Chapel Hill Financial Advisor Blog!

My name is Kent Fisher, CFA® and I work as a Financial Advisor at Old Peak Finance in Chapel Hill.  Please stop by in the future for my thoughts, ideas and general ramblings about all things finance.  I might throw in some local color as well.

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Nothing on this site should be taken as financial advice – it is only the opinions and ideas of one person.  Only for entertainment purposes some might say.

Please visit http://www.oldpeakfinance.com for greater details.

or send me an email:  kent.fisher@oldpeakfinance.com.

Market Too Expensive? – Reversion to the Mean at work.

As the Dow Jones Industrial Average hits new highs, there are many claiming it to be “over-valued”, “ready for a correction”, or “expensive”.  Most of these explanations share the same basic premise – reversion to the mean.

Reversion-to-the-mean (RTTM) simply implies that there is some “true” or “appropriate” level for valuations in the stock market.  Most of these values are derived from historical analysis.  Pundits compare today’s values to some sort of average (or mean) .  They then conclude that the market will be headed back towards its historical value in the future – hence the use of the term reversion.  So, the concept is that the market is off its long-term average value, and will be drawn back to this value over time.

Two big problems with these arguments.

1.  What is the “force” that drives the market back?  The RTTM concept works well in physical sciences where all behavior of particles is driven by the four fundamental laws of physics.  What fundamental law is at work here?  It’s just us humans using our minds.

2. The whole argument rests on the notion that we know what the “correct” or “appropriate” level is.  In statistics, they use sampling techniques to estimate what the “mean’ value is for a given population.  Works well if the population being studied is normal, follows fundamental physical laws, and the size of your sample relative to the size of the overall population is known.

But what do we know about the history of capitalism?  Will it continue for another 100 years? 500?  What makes us think what we have seen in the past is indicative or typical?  Maybe it was just an abnormal episode?  Do we want to look at the “mean” of an abnormal episode?

The best example of how these arguments can lead us astray was our last “great recession”.  We had only seen a national home price decline of large magnitude during the great depression of the 1930s.  We assigned AAA values to securities because we thought we knew the range of possible outcomes by looking back at history.  We were not ready for the national home price decline we ended up experiencing which was worse than implied by looking at the stats.  Oops.

All this to say that you need to know what you do not know.  We really do not know the ‘correct” or “appropriate” values for the stock market.  History can serve as a guide at times, but it does have fundamental flaws that will never be solved.  Be wary of the RTTM arguments that pop up every time we are above some long-term average – it really does not tell you much about where we are headed next.

 

Insurance part II – why competition isn’t everything.

This post is going to be simple and straightforward. Intense competition is not the appropriate solution for all the challenges we face. Insurance is one of them.

The insurance industry is regulated for a reason. The industry has a large informational advantage over its customers (most of the time), and failure by a firm can have devastating effects on its clients. You are counting on a back-stop that needs to be there. Life insurance, Home, Auto all need to have solid firms writing the policies, investing the premiums, and being in business during the time of need.

Purely competitive markets could have ill-timed bankruptcies leaving many clients out in the cold. Failure is part and parcel of a competitive market. By contrast, risk sharing is communal in nature, and very powerful when properly structured.

We still need some competition to help drive down costs and inspire innovation. However, it is unlikely that a purely competitive/highly de-regulated market is going to benefit the general public. It may work for television sets or other manufactured goods, but unfortunately, a highly competitive insurance industry might not deliver the outcome we are depending on. Wanna risk your little guy’s future on it? Didn’t think so.

 

Our understanding of Insurance…….Part I

It is interesting to watch the healthcare debate on TV as I study insurance theory. It seems we have fallen in love with the concept of insurance, and it is invading larger and larger parts of our lives. But is this a good thing?

Let’s start with what makes a risk that should be insured. Well….it would:

  •  Be unpredictable in timing,
  •  Infrequent,
  •  Large in negative outcome,

These are the characteristics of risks that are well served by insurance.

In this lens, let’s take a look at Dental Insurance…….I go every 6 months. Unpredictable? No. Infrequent? No – I go twice a year. Big in negative outcome? Maybe. This is the only grey area where I can see one can make the case for needing dental insurance. Normally the cost is relatively low. I have only had one root canal in 55+ years. Only time it really cost me. So overall, I have to give it a low insurability grade.

Another one worth looking at…….Eye/Vision Insurance. Unpredictable? No – I go for an appointment every year. Infrequent?  No – every year.  High Negative cost?  No – these are glasses that you can get at LensCrafters. This is a product/service that clearly fails Insurance 101. (I had someone tell me that as vision plans have become more popular, the price of glasses has doubled. Go figure.)

What these “insurance benefits” all share is the insurance company’s ability to separate paying for a service from receiving the benefits of that service. This is why costs sky-rocket. Once you have “paid” for your insurance, you become cost insensitive. Someone else is paying – gimme the best. Is this a good thing?   Maybe we are all going to pay the price in the long-run?…..

I Like Wine…..and prefer to alter my SWR, Thank You!

As time goes by, I am learning a lot more about personal finance blogging. There are literally thousands of sites out there where people are blogging about their financial lives. Someone once said a first cut to understanding these sites is to separate those that are savings maniacs from those that are chronicling their battle with debt. This site is neither……….it is about practical application of solid financial principals as a way to achieve financial peace of mind.

I am not in debt of any kind, and am not a maniac saver………I Like Wine! Wine can be an expensive hobby that offers great olfactory/gustatory rewards. However, it is kryptonite to the maniac saver. These guys/gals are saving like mad, retiring super early, and watching their pennies with a magnifying glass. Not my cup of tea.

SWR = Safe Withdrawal Rate. This concept is the rate at which one can safely withdraw funds from their retirement nest-egg and not run out of money during retirement. It is a big part of financial planning. For a maniac saver, it is the Holy Grail. Get enough money saved up so that you can live on a budget determined by your SWR, and kiss that job good-bye! However, the safer you want to make your SWR, the larger your nest-egg must be.

{For example, if your goal is to live on 100K, you need 3.3mm saved for a 3% SWR and  2.5mm saved to live on a 4% SWR. Big difference in savings required to generate the same yearly budget.}

There is an alternative to this draconian math – and that is to be flexible with your budget during retirement. If you are able to spend less in years when the market is down, and more in years where the market is up, you can use a higher SWR to help figure out the size of nest-egg you will need.  All at the same level of risk.  Pretty powerful stuff. (A good financial planner can help you set the “guard rails” for this approach)

So, this is all to say that I’ll continue to drink my wine and alter my overall budgetary expenses in retirement as opposed to obsessing over every nickel. Conversely, I can have a larger budget from the same nest-egg – if I am willing to be flexible with my spending as outlined above. This will allow me to retire sooner and enjoy the ride while getting there! Flexibility in your spending pattern is powerful. Cheers!

 

 

 

 

Why have a Mortgage at all?

I’ve been contemplating this question recently as I have the means to make mine go away forever. (hopefully!)  It is surprising how tough this question is to execute.  As Americans, we are totally in love with any tax deduction we can find, and mortgage expense is usually one of the biggest.  But why have a mortgage at all?  When should it go away?

Classic economic theory uses a utility function to model the non-linearity of the joy we experience in life.  Not all dollars bring us the same amount of pleasure.  The first million changes your life a lot more than the second will…..etc. etc.

In order to maximize life-time enjoyment, it might make sense to even-out our consumption pattern.  i.e. spending a little extra money on comfort when we are young will bring us more joy than spending that same amount of money years later.  In essence, we are borrowing future dollars to spend now when we will get the most utility from that money.  That is what a mortgage does – lets us have joy today – but it does come with a cost.  We are going to have less dollars in the future – (please look-up how much interest you pay over the life of a 30 year mortgage) – but we will have maximized our utility!  Life mantra:  Maximize Joy – Not Dollars!!  This decision was easy – getting a Mortgage makes sense!

But when do you make it go away?  When the home is paid off, or later?  At a base level, a mortgage is leverage.  It is borrowed money which will create extra volatility on your personnel balance sheet.  Historically, a mortgage has been a good decision, as the value of the asset (house) has kept up with inflation and the increase in value has often exceeded the interest rate being charged.  A big winner for almost anyone in my parents generation.

But what does one do in 2017?  I have decided to get back to basics:  figure out why I had the mortgage to begin with, see if I have accomplished my goals, be sure I have adequate liquidity………and if they all check out……..see you later monthly payment!!!  Time to do the Dave Ramsey debt-free scream!!

 

Flawed Question: Why pay someone to manage your investments?

This is a question that comes up often from investors in a bull market. They see their account balances rising, might have bought a stock or sector that is moving hard to the upside. All is good. Who needs advice/coaching?

They read a blog – like this one – that highlights the dangers of paying 1% too much in fees. Yet, at the same time, Financial Advisors working to the highest ethical standards often charge 1%. How can this be? 1% is bad on the one hand, yet is being charged on the other. This apparent conundrum can be explained by understanding that two closely related concepts are being confused: you are asking the wrong question.  A flawed question.

First, overpaying for investment management services should be viewed as a sin.  One that will eat up a ton of your retirement nest-egg.  The actual size of the damage is related to how long you endure this bad practice.  [Please see Dropping the Hammer (June 15 blog) for some illustrative numbers….] This stuff is non-debatable.  It is math in action.

The second (and key) issue is why are you paying a Financial Advisor in the first place?  The 1% charge should be for a variety of services/coaching around issues such as tax-minimization, goal setting, goal attainment, portfolio monitoring, appropriate re-balancing, etc. etc. (there is even a far more qualitative set of issues such as simplification through outsourcing.)  These issues also have a tremendous impact on your long-run portfolio performance.  Vanguard and Morningstar have each done extensive research to try to put a number on the value of these services.  The bottom line is that investors – in general – with good coaching will outperform investors with no coaching. That is what you should be paying for;  the ancillary services that complete the investment landscape.

Today, many refer to this basket of services as Comprehensive Wealth Management. This is what I do at Old Peak Finance. This is why you should be paying a Financial Advisor – not just to help you pick mutual funds or other investments – but to help you simplify and optimize your financial life.  The positive impacts are enormous. Anytime you hear someone blabbing at a cocktail party about their investment acumen – and not needing any advice – please remember that this person is special. Like the disclaimers at the bottom of almost all financial marketing pieces state…….your results are likely to vary!

Best performing accounts at Fidelity?

Which group of investors had the best performing retail accounts at Fidelity between 2003 and 2013?  Yep, you guessed it…….dead people.  Closely followed by those that had forgotten they had an account there.  This is reportedly from a Fidelity document that came out a couple of years ago.  Google away for more citations.

I just need to be sure folks see this.  Nothing new really – just shows that low turnover, buy-and-hold investing works better than almost any other strategy for the vast majority of individuals.  What the dead people and forgotten accounts did, was not sell at market lows.

Simple advice that simply works.  Just thought this effective idea deserved more time in the sun!  (and boy do we have beautiful sun here in Chapel Hill today – 74 and low humidity!)

 

Dropping the Hammer – why investment fees matter so much.

OK, I’ve hinted at this in past posts – time to bring the big evidence to the party.  Over-paying for fees (12b1 fees, active management fees, custodial costs, etc. etc. – anything that takes away from your potential return) has a massive impact on your accumulated savings.  Just how large will shock many.  It was on the front page of the WSJ last weekend, but I bet many missed this key nugget of info.

The cause of any surprise has its roots in the mathematical capacity of our brains.  Firstly, we like to think intuitively – fast thinking which hates math.  Secondly, higher order concepts like continuous compounding are stretching what we can understand.  Fractal or Mandelbrotian Geometry?  Beyond me, yet is said to be the best descriptor of what is going on in financial markets.  Unfortunately, our brains do have limits.  (and I am not going to spend my weekend giving myself a headache reading Fractal Geometry – I have more fun ways to give myself a headache!)

So, Joe Average is paying 1% too much in fees.  Getting 5.5% instead of 6.5% on his investments (starts with $25,000 and no additions/subtractions for 35 years).  Not a big deal, right?  Getting 85% of the 6.5% return, right? (5.5/6.5 = 85%). This does not translate into 85% of  what a 6.5% investor will accumulate over his/her lifetime.  Instead, a 5.5% investor ends up with only $163,000 of accumulated savings vs a 6.5% investor who ends up with $227,000. (source: Dept of labor, WSJ)  Huge deal!  In this case, $64,000 in forgone savings.  39% of your nest-egg eaten by a measly 1% mistake.

Why is this?  What most people miss, is that a 1% error in one year compounds every single year for the rest of your life.  If you make the same mistake again in year 2, that too will compound out over your remaining investing horizon.  Keep at it, and the compounding of errors really pile up, and you end up with a much smaller nest-egg than your intuition would have you believe.  And this is not debatable – this is math.  Like the CREE add on TV says……”if you argue with mathematics………you will lose.”  Your nest-egg will follow the rules of math whether you want to believe them or not.

So there you have it – small mistakes on fees compound to leave you with a lot less spending power than you might have guessed.  What the brain tends to miss is the continuing nature of a small mistake.  The knock-on effects (compounding) are difficult to visualize, so we tend to miss them.

No need to worry, you can change your behavior immediately after reading this post. However, the longer you delay, the smaller is the benefit of the change you will be making.  This too is continuous compounding in action.

Frog in a pot, or why am I still with a wirehouse?

Financial Advisor is a term that covers a whole range of people in the retail finance space.  There are few criteria for the title – no educational requirement, no experience requirements, virtually no ethical requirements.  Depending on where you live, you might have to register.  It is just a title that covers both highly ethical Fee-Only Advisors and Annuity Sales folks….and everything in between.   It is no wonder there is confusion about who has whose best interests in mind when making financial recommendations.

But how do people end up in this situation?  If you ask them, they will state they want a Financial  Advisor that always puts their financial interests first.  Explain the difference between the Suitability Standard and the Fiduciary Standard, and they will choose the Fiduciary Standard  almost all the time.  So, how did they get into this sub-optimal place?

My thought is that they are like the proverbial frog in a pot of boiling water.  You know the story…..put a frog in a pot of water and heat it up and they do not notice the rising temperature, but throw a frog in a pot of boiling water and they will hop out immediately to save themselves.  The point is you are often not aware of a slowly growing menace.

In the retail finance world, the seduction starts early……..you roll into your local bank branch with some new found wealth and ask for some help.  The conservative architecture, people in suits – all lead you to believe you will be helped and not sold a product paying someone a high commission.  Besides, this is early in your investing career, the amount is small, the bank may not be the best place – but at least it is a start,   you’ll fix any issues later.  etc. etc.  The seduction is almost complete…..just a add a couple of kids, busy lifestyle, and before you know it, you have been at a wirehouse for 20 years getting so-so advice and probably paying high fees.  So what to do?  Who wants the added hassle of changing Financial Advisors?  The guy/gal is nice enough in person, and it will not be fun giving out the bad news that you need to move on.

True, it is not pleasant having to deliver bad news when changing advisors.  However, you owe it to yourself to right the mistakes of the past.  Realize you have been a frog in a pot and need to make a jump to the place you have wanted to be all along.  It may be a little unpleasant as you execute, but you will be far happier (and wealthier) in the long run. In the frog parable,………the boiling water kills the frog.

Instincts can hurt.

The photo attached to this post is from my home in Chapel Hill, NC.  It is a 4 ft Black snake that made the unfortunate error of sliding into my garage and being discovered by my wife.  After I scraped her off the ceiling, this little guy/gal met an unfortunate ending due to its instincts.

Black snakes move slowly, like to climb, and will coil up in an aggressive looking crouch when frightened.  (I wish I knew this when I first met this guy/gal)  I spent 20 minutes clearing a path to the door, and another 40 minutes trying to coax him/her to make an escape.  Unfortunately, instinct kicked in and he/she refused to move, just kept trying to strike when prodded.  Instincts that might work well in the natural world, but not when in contact with humans.

Humans face a similar problem in the investing world.  Our natural tendency to want to fight or flee – instincts that have been honed for thousands of years – but are not compatible with financial markets.  I strongly suggest to clients that they read Daniel Kahneman’s Thinking, Fast and Slow to get an understanding of how our natural responses can work against us.  The key concept is that we want to think fast, when thinking slow is what is required.  We are not wired for financial success, just as a Black snake is not wired for interactions with humans in a garage.

This is not trivial stuff.  I will highlight in another post the scale of the damage that we can do to our portfolios if we think fast instead of thinking slow.