Making Cents | John P Napolitano

Saturday, December 8, 2012

MAKING CENTS: Active or passive investing requires attention

When building an investment portfolio, there are two considerations regarding how you may construct and monitor that portfolio. One is with active management and the other is passive management. Neither is right or wrong, and the current condition of financial markets may favor one over the other from time to time, yet some investors are passionate about their methodology to a fault.

Receiving a lot of attention over the past decade or so is passive investing. The primary argument that indexers raise is that few investors actually outperform indices and they are often a lower cost alternative than their actively managed counterparts.

The premise with passive investing is kind of like a set it and forget it style. Passive investors typically invest in index based products. Some are broad based indices such as the Standard and Poor’s 500 index while others may represent a specific sector, industry or region. Within the indexed investment product of your choice, the manager will frequently own literally every single stock that makes up the particular index.

This means that you will participate in the gains from that index as well as the losses. This feels great in good times, but when your index is not performing, you’ll also receive 100 percent of the down side of that index.

When a passive approach is utilized, most investors would benefit from actively managing their basket of indices held in the portfolio. Your active management may be as simple as regular re-balancing or as sophisticated as altering your allocations based on market conditions within the particular market, sector or region that you hold. This is particularly important if your index selection has you owning very specific and volatile sectors such as energy or emerging markets.

Active management, on the other hand, is when you or a fund manager is actively trying to manage the holdings within a portfolio to select what the manager feels are the best choices for appreciation and the least probability of losses. While the statistics for individual investors do indicate that do it yourselfers have not often fared well with their actively managed choices, the same is true for passive do it yourselfers.

In any economic environment, some choices will win and some will lose. Even during tough economic times, certain companies will out compete others, and gain market share and profitability – the underpinnings of value. Consequently, one would expect these out-competers to also out-perform over the long haul.

What investors should care about is net results. Are your net results meeting your needs and goals? Do you even know what you need to earn on your investments to meet your life’s goals and dreams? Managing your investments to meet your required rate of return is what you should be focused on and not benchmarking to a specific index. In fact, benchmarking to a broad index such as the S & P 500 or the Dow 30 is inappropriate for most investors because most investors do not, and should not own all U. S. large cap stocks.

John P. Napolitano is CEO of U.S. Wealth Management in Braintree, Mass., and 2012 president of the Financial Planning Association of Massachusetts. He may be reached at jnap@uswealthcompanies.com or on Facebook as JohnPNapolitano and US Wealth

John Napolitano is a registered principal with and securities offered through LPL Financial. Member FINRA/SIPC. He can be reached at 781-849-9200.

Securities offered through LPL Financial, Member FINRA/SIPC.

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Wednesday, December 5, 2012

Market Outlook 2013

In 2013, many different forces will combine to influence the direction of the markets to follow the path of least resistance leading to modest single-digit returns in the U.S. stock and bond markets.* The path for the year may be set at the end of 2012, or in early 2013, as critical decisions are implemented: Details here.

(Produced by LPL Research)

Outlook 2013 from JP Marketing

Saturday, December 1, 2012

MAKING CENTS: Do your homeworking when picking a financial advisor

If part of your plan for the New Year is to hire or change financial advisors, it is never too early to start that process. Many people do not ask enough questions when vetting out a new advisor, and simply hope for the best.

Ask is what the prospective planner feels is his or her most helpful service for their clients. This will give you a glimpse into what that particular advisor also favors. If the answer is investment dominated, then you know that investing is likely to be a big part of the deliverable. If the answer is insurance oriented, it would be reasonable to assume that the advisor sells insurance. There may be no right or wrong answer to this question, but make sure that it is an answer that suits you and matches what you are looking for.

Ask about the resources beyond those of the advisor that you are interviewing. Some clients prefer the large brand name behind the advisor and others may prefer a smaller independent practice. Some like a specific expertise, such as investments, estate planning or insurance while others will want a deep bench of subject matter experts across a wide range of expertise within one firm. Ask who specifically will be assigned to your situation besides the person you are interviewing.

Inquire about how the advisor gets paid. There are two parts to this question. The first part may be about the method of compensation. Advisors may get paid in a variety of ways ranging from flat fees to commissions, and all combinations in-between. You should understand how your advisor will be paid. The second part you want to know is what percentage of their overall revenue comes from what sources. If you have an advisor who receives commissions, ask what the breakdown of commission income is from investments, insurance, annuities etc. Also ask about the companies whose products they sell and whether any one company occupies more than 25 to 50 percent of their commission income in a given area. For advisors who are fee-only advisors, ask what percentage of their income comes from the financial planning and what percentage comes from asset management. Also ask if there are any related parties who they regularly use for insurance or other services.

Learn about the disciplinary history of the firm, the advisor, and anyone else on that advisory team who will work with you. This information is readily available from the state, the SEC or FINRA online.

Ask the advisor to describe their best clients to you. Force the advisor to be detailed about the income, net worth, age and fee ranges that these best clients pay. From there, decide if you fit that profile and feel believe that they can meet your needs.

Evaluate whether you can feel comfortable enough to let the possible advisor know about your most private personal and financial matters. Do they speak in plain English, listen carefully to your needs and answer in a language that you can understand? If not, keep shopping.

Saturday, November 24, 2012

MAKING CENTS: A time for taking stock.

Now that Thanksgiving is behind us, don’t leave behind the expression of gratitude for what is working out well in your life. Today, instead of reminding you of yet another financial issue that you should attend to, we are here to give celebration for those things that you have done to improve your financial situation in the past 12 months.

With record low interest rates, were you able to get a lower rate on any outstanding loans? Bankers tell us that the mortgage markets have become more available to many, but I still see many FICO credit scores that are crushing people’s ability to take advantage of the low rate situation from late payments dating back to the height of the financial crisis in 2008. If you were not able to take advantage of low rates, hire a specialist to help with your credit score.

Have you paid down debt? The trend in the U.S. is still one of de-levering, or paying down debt. If you made progress reducing your debt, celebrate. This step is vitally important to the U.S. economy as a whole and may mean the difference between a successful financial plan and one plagued by interest expenses.

How about helping out a family member? Were you able to lend money or other resources to help out a friend or family member in need? If you did, celebrate that act of kindness. If it is your intention to collect repayment for that loan, document the loan with an interest rate that perfects your right to receive repayment.

Did you finally get a current will and the other estate documents needed to protect your dependents should you not make it until next Thanksgiving? While obtaining or updating an estate plan is not most people’s idea of a fun date, you should feel good about not leaving your dependents and financial realities up to your state of residence to decide what happens to your assets upon your death. And for those with greater than $5 million in assets, this could be the last call for estate tax savings.

Have you had a sit down with the family about money? All levels of wealth may benefit from this. At the lower level, your kids need a basic understanding of budgeting, fiscal responsibility and coming to grips about your financial realities - and what you can do to make them more to your liking. This discussion is even more significant for those with a family business or an estate plan that involves your children’s services as a trustee or executor. This is especially significant where assets such as a family business or a family vacation home are involved.

And the last word of celebration is for you. Congratulations to those who took control over what you can control to make the most of your one and only life on this planet? Do you love your job? Did you get professional advice? Are you taking the time to be with loved ones? Did you get involved in activities that make your life more meaningful or fun?

Saturday, November 17, 2012

MAKING CENTS: Who do you trust when it comes to your investments?

Have you earned your own trust? I recently signed on to a popular financial site, and there was one of those quick pop up polls. The poll was asking who you trust when it comes to your investments. Seventy-four percent of survey respondents said that they trust themselves first. Roughly 9 percent voted their dog as second and almost 7 percent said that they trusted their independent financial advisor.

It doesn’t take a math major to realize that the rest of the investment field combined only garnered about 10 percent of the survey respondents’ trust. Considering that nearly every day of the week I am presented with a do-it-yourselfer’s portfolio that looks more like a monkey and dartboard portfolio, I wonder how these self-trusting investors would rank themselves in terms of the quality of their do-it-yourself portfolios?

For those with enough courage, put your portfolio through some of the diagnostic and review tests that a professional would do, and see if you have earned the trust that many apparently have in their money management skills.

The first test most want to do is a performance test. Sure, performance matters, but relative performance is even more meaningful than absolute performance. Absolute performance means your actual raw returns expressed as a plus or minus. But relative performance takes that absolute performance number and asks questions regarding risk.

Exactly how much risk did you take in order to earn that rate of return? If you took abnormally high risk, and returned market-like returns, your absolute performance would not be very good. If on the other hand, you took very little risk and earned market-like returns or better, your absolute performance is good.

If you own only a few investments, you may have relative returns that look pretty good when examined in a vacuum, but then you must consider the risk of a large concentrated position. That inherently adds risk to a portfolio simply because of the inherent risk of any given single holding.

Next examine the volatility of your portfolio. Volatility is a measurement of instability or the range of expectations for your investments, either one-by-one or for your portfolio as a whole. Most individual investors have not been exposed to how much volatility may be inherent in their holdings. This may be enlightening to those with the courage to check.

It may also be wise to look at each individual holding, and examine how your holding compares with alternative holdings in the same industry, sector or country. If you learn that you have a dog compared to the alternatives available, consider a change.

Saturday, November 10, 2012

MAKING CENTS: Precautions can mitigate losses in next storm

Witnessing back-to-back storms right in our backyard sends a strong message. Stuff happens, and there are obvious natural disasters that no one can prevent. But getting your house in order to protect what is important to you is something that you can start to fix today.

What would bother me, for example, are the drawers of old photos from my childhood and then of raising a family myself. While I don’t frequently look at these old photos, losing them would feel like a material loss to me. The solution could be to get these photos and negatives scanned and saved in some digital format, and then stored in a safe place.

If your house includes things that are of material value, take a look at insuring these possessions. Most homeowner policies have limitations on home contents, and items of great value will frequently not be covered for full value unless specifically identified and separately named in the policy. Items that may fall into this category include collectibles, art, jewelry and furs.

Take time to inventory your valuable items, and save this inventory in a safe place. Be specific with the details of each item, and back them up with an appraisal or an invoice from the purchase. Some insurance professionals even recommend a photo or video library to show exactly what you are protecting.

Also look at your coverage for a second home, a rented home or one that a dependent child may be renting while away at college. Do not assume that everything is covered through your homeowner’s policy without having a discussion with your insurance agent.

Financial records often reside in the basement. When these documents get destroyed, praying that you never need them simply isn’t strong enough. Like your old photos, either store these offsite in a protected place or scan them into electronic files.

Discard most records older than 7 years. Older documents that should be retained are items such as invoices and cancelled checks for material home improvements, purchase documents for a residence and any original information regarding insurance policies or loan agreements that are still outstanding.

While you cannot control or determine when the next storms will hit, you can call a tree company now to rid yourself of dead trees and limbs that may cause harm in a future weather event. As you may have learned, if you wait to make that call until the wind blows your tree down, you’ll pay a lot more for the same service.

Friday, November 2, 2012

MAKING CENTS: The election won't end all uncertainty for the markets

The next time you read this column, some of the uncertainty clouding the financial markets will begin to unravel.

We will know our next president, the Senate race will be over and the financial markets will begin the process of digesting the consequences of each.

But don’t think for a minute that these are the only issues that will continue to weigh heavy on all of the financial markets. Issues such as tax rates, interest rates, Europe and the Middle East will linger just like issues we haven’t considered yet shall arise.

You cannot control any of these issues. Yet if these issues keep you awake at night, fearful of the consequences to your tax bill, the rate of inflation or the return on your investments, address them one by one.

Start with the expiration of the Bush era tax cuts. If you feel that the increase in the capital gains tax rates and the increase in the taxation of dividends is more than you can tolerate, consider the consequences of selling now. These consequences may include the amount of current taxes that you’ll pay and the implications of this type of drain to your nest egg. It also raises the question of what to do with the money after you sell your holding.

Some feel that these tax increases alone may cause investors to reduce their exposure to these assets if the tax cost will rise so dramatically. And even if there are not more sellers than buyers to depress prices, others wonder whether these types of assets may be worth less in general because of the additional taxes to pay on the dividend income and eventual capital gain.

If your anxiety is from the possible volatility increase in financial assets as these issues come to a head, assess the consequences of both selling and holding. Ask yourself what type of annual returns you need on your nest egg to reach savings objectives? If you need a rate greater than what is available in today’s low interest rate environment, but simply can’t stand the volatility, then look at how much you may need to reduce your monthly spending in order to minimize your mental anguish.

At the end of the day, there are only a few items that matter. They start with who you are and what you want to do with your time. Beyond that, the financial issues that you control and will matter the most in your financial future are how much you make and how much you spend. Don’t guess, know what you spend each month.

How much you save and how much you earn on those savings is the second component.