Unexpected Loss

Behavioral Finance defines several investor biases that tend to inhibit financial success.  The recent news of JP Morgan’s $2 billion loss demonstrates the danger that an overconfidence bias can be to your portfolio.  Overconfidence bias is fairly self explanatory, but usually occurs when people believe they are smarter than others.  Through the financial crisis, JP Morgan CEO Jamie Dimon was praised for keeping the company profitable.  This may have led to overconfidence in both the CEO and JP Morgan employees, who overestimated their ability to hedge risks in derivatives trading.  Dimon admitted to reporters, a “flawed, complex, poorly reviewed, poorly executed and poorly monitored” trading strategy.

The firm’s recent fall from grace illustrates how an overconfidence bias can negatively impact your portfolio.  Making one or two great stock picks may lead an investor to think they have an edge and resist adherence to a proper allocation or diversification strategy.  However, as history indicates, no one approach to investing produces superior returns year after year.  Hot performance tends to shift from industries, countries, sectors and market caps; highlighting the need for a diversified long term approach.  This also brings to mind the tired statement on the bottom of all of your account statements…”past performance is not a guarantee future results.”

Stay tuned for more investor biases and the hazards they can have to your wealth…

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How well do you know your target?

A few years ago I wrote about the rise of target date funds in retirement plans.  At the time, the Senate Special Committee on Aging was proposing legislation that would require target date fund managers to take on fiduciary responsibility.  The evaluation of target date funds continues and a recent SEC investor survey found that the funds are frequently misunderstood by investors.

While the move toward making long term investing easier is positive, we also tend to recommend against a “one size fits all” approach.  We have also found that the use of target date funds can leave investors with a false sense of security.  While the intention is to reduce risk as the target date approaches, this does not necessarily mean that the fund will be risk free at the end of the period.  There will likely still be some stock exposure and risk even past the target date.  All target date funds are not created equal and the amount of stock exposure from one 2030 fund to another can vary significantly.  The costs may also be higher than investing directly in the underlying funds.  Due diligence is still required and further regulation and standards for these funds are necessary.  While a “set it and forget” strategy may be appropriate for some investors, we have found a customized approach to be more successful over the long term.

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Tax Refund?

In the midst of tax season, the American Mustache Institute is proposing a tax benefit for people with facial hair.  The Institute is planning a Million Mustache March this April 1st to support the “STACHE ACT,” Stimulus to Allow Critical Hair Expenses.  The Act was conceived by Dr. John Yeutter, Ph.D., CFP® and based on his whitepaper, “Mustached Americans and the Triple Bottom Line.”  The movement is in good fun and has even attracted the support of H&R Block, which will make contributions to the charity Millions From One (link), for every march participant.  Millions From One provides clean drinking water for people in need.

Missing out on Free Money?

Are you making the most of the employer match in your 401k plan?  Getting the full employer match in your retirement plan is one of the closest things to free money in our economy.  Forbes recently ran an article titled “The Big 401(k) Match Mistake,” that highlighted an easy to miss provision in many retirement plans that can prevent high income earners from receiving the full match on their retirement contributions.  This can happen when plan contributions are “front-loaded” in the first few months of the year due to a high percentage contribution coupled with bonus income that causes you to hit the contribution limit early.

In theory this sounds like a great plan-max out your retirement plan early in the year, than you don’t have to worry about it until next year.  The problem occurs if your plan matches your contribution each pay period; this can leave substantial dollars out of your account vs. extending the contributions throughout the entire year.

Now is a great time to check your plan provisions to make sure you are getting the most out of your employer match, before spring bonuses are paid.  While you’re at it, make sure you are contributing as much as possible; the limit for 2012 is $17,000.

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Are you ready for the New Year?

Consider taking capital gains

For taxpayers in the 10% and 15% brackets, the capital gains rate is currently 0%.  This is scheduled to last through the 2012 tax year.  Maxing out your pre-tax retirement contributions or a period of unemployment may allow even individuals with typically high incomes to take advantage of this provision.  If you have significant unrealized capital gains and low income this year, this strategy might be right for you.

Plan contribution rates for 2012

The New Year is a great time to increase your retirement plan contributions.  In 2012 the limit for 401k contributions will rise to $17,000.  If you are 50 or older you will be able to contribute an additional $5500 as a catch-up.  The limit for Roth and Traditional IRAs will stay the same at $5k/year with an additional $1k catch-up.  You also have until April 15^th, 2012 to make your IRA contribution for the 2011 tax year.

Make Catch –up contributions to your retirement accounts

If you are 50 or older you can contribute an additional $5500/year to your 401k as a catch-up.  If you are over 50 and have already hit the $16,500 limit for 2011, you may still be able to contribute more from your last paycheck of the year.  Contact your HR department to set this up.

Take your RMD

Once you turn age 70.5 the IRS requires that you begin withdrawing money from your retirement accounts.  The penalty of not taking your mandatory required distribution from your IRA, is one of the highest the IRS imposes. Failing to take your Required Minimum Distribution before the end of the year will result in a 50% penalty of the amount that was not withdrawn in addition to the tax due.  To make your RMD before year end, contact your plan provider.

Compare actual spending to your budget

Most of us have a tendency to go on a spending binge this time of year.  The price competition between retailers and constant sales are a shopper’s dream.  Now is a great time to revisit those saving and expense targets set earlier in the year and compare your progress.  For help setting targets and monitoring your progress please contact us to develop a financial plan.

This is also a positive piece of news for our economy, which has been struggling with a shortage of demand.  Most of the increased income is likely to be spent leading to some increased economic activity.

Does the value equal the cost?

As a new mom I am always trying to do what is best for my child.  Whatever the decision-whether to swaddle, use a pacifier, or let him cry-I frequently second-guess myself and wonder if I should be doing things differently.  At the end of the day I know that we have to do what works best for our family.  One decision that I thought I was sure of was funding a college education.  My husband and I are both college graduates and value not only the opportunities that a degree provides, but also the experiences and maturity gained in those college years.

However, I have been reading a lot about the “Return on Investment” of a college education and that self-doubt is starting to creep up again.  In Bill Gross’ recent Investment Outlook , he questions, “A mind is a precious thing to waste, so why are millions of America’s students wasting theirs by going to college?”  He is not the only well respected name questioning the value of a college education.  You may have also seen Peter Thiel on the news.  Theiel, head of Clarium Capital, established a foundation to give $100k grants to students to drop out of school and pursue entrepreneurial ventures.  What are well-meaning parents to do?

Luckily the latest Journal of Financial Planning has some food for thought:

• “Three-quarters of Americans believe college is too expensive and more than half (57%) say there is not an adequate value return for what students and families pay.”
• The U.S. Census Bureau reports that the median annual income gap between a college graduate and a non-graduate is $19,550
• “The strong majority of college graduates (86%), feel their higher-education experience was worth the investment.  Three-quarters believe that experience was very useful in helping them grow intellectually.  About 70% believe it helped them grow and mature as a person and 55% mention its use in preparing them for a job or career.”
• “Many Americans say a young person’s success depends largely on a good work ethic (61%) and knowing how to get along with people (57%).  Fewer than half (42%) point to a college education.”

This is all a lot to digest, but just another instance where I know I need to follow my instincts.  The financial planner in me is also telling me to practice what I preach-contribute to a 529 plan after fully funding retirement accounts and Roth IRAs and avoid over-funding those plans.   For more about this strategy read “Thinking Outside the 529 Box.”

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Ofunato, Japan

The tragedy in Japan continues to be the top news story and warrants international support.  While the human aspect of this crisis continues to be devastating, we can’t discount the economic impact as well.  Well respected international fund family, First Eagle Funds, was heavily allocated to Japanese investments before the tsunami hit.  To find out how they are reacting to current events and their outlook for the future in Japan, please read their recent Manager Insights.

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