Where’s the common sense financially-speaking?

Personal finances column
By: Paul Apfel Inside Lincoln
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There is no shortage of investment gurus, advisors and pundits. But there is a shortage of common sense. Over the past year, I have explained and promoted some common sense approaches to managing your financial life. But I’ve scrupulously avoided getting into detail on investments. I have done this to avoid liability as I am not an investment advisor and do not wish to be seen as such. So don’t take any of what you read here as investment counsel. I would, however, suggest that you view any counsel you seek and receive with a healthy dose of skepticism. One of your first questions should be how your investment advisor is being paid. If they are paid on a commission basis and those commissions are derived from financial instruments they recommend and then sell you, be cautious. I have always found it curious that advisors can claim to place your interests above their own when they are paid to sell what they recommend. Having stated my position, I find a greater degree of comfort in dealing with those who are fee-based, salaried or compensated on a percentage of the funds they manage. Financial managers in this latter category often deal primarily with reasonably-high net worth individuals or families and are paid on a sliding scale, often around 1/2 to 3/4 of a percent of the funds being managed. Thus, it is in their best interests to ensure your portfolio grows or at least doesn’t shrink too much, as that affects their bottom line as well as yours. Remember, basic personal financial management continues to include accumulating sufficient capital for various family requirements, emergencies and retirement. Most of us acquire that capital as wages and salaries from an employer or from our own business, and ideally, that income routinely exceeds our outgo. Retirees typically receive their benefits from pension funds, IRA’s, 401k’s or some combination thereof. Your first demand on that capital is paying the family expenses. Second, put enough in the savings to cover emergencies. Three-to-six months of living expenses is considered standard. Put that in a savings or money market fund where you can get it quickly if you need it. And handle your risks with sufficient insurance to cover death or disability. Next, ensure you participate in a defined benefit plan at work - that’s accounting-speak for an employer-controlled retirement plan where employee benefits are paid based on a formula using factors such as salary history and duration of employment - or a 401k or deferred compensation plan. Individual retirement accounts are also a great idea. Once you have those bases covered, you can consider how to invest any remaining capital to provide for growth. But the current markets are sending conflicting signals. Amidst some signs that the U.S, economy continues along a slow growth path and may avoid an earlier-in-the-year forecast for another recession, the financial turmoil in Europe continues to dominate the news. But what should we take from the European markets and why should we care? We spoke with Roger Britton, editor and publisher of the trading newsletter, “Fund Trading” to get an assessment. Britton believes a Greek default is a “100 percent certainty.” The potential exists, according to Britton, for another Lehman Brothers experience, citing the global financial services firm’s bankruptcy in 2008. Britton said that the current negotiations are merely stalling for time as the European leaders and their banks buy some time so they can figure out how to write down the inevitable losses. But should Lincoln readers care? The answer is yes because a massive default in Europe could bring the worldwide banking industry to a standstill. Britton concludes that the financial markets around the world would freeze, markets would fall and we would see a credit squeeze affecting industry as well as individuals. But 17 European nations have to unanimously agree on steps to avert a European emergency. Given the historic political dynamics in Europe, the real risk, according to Britton, is that the problem will not be solved quickly enough. Nevertheless, Britton sees some light ahead with an anticipated growth in U.S. Gross Domestic Product in 2012 in the 2-3 percent range. Emerging markets such as Brazil, Russia, India, and China could see a 6-9 percent jump. Whether you believe in a strong cash position, as many who abandoned the market in 2008 apparently do, or continue to find some nuggets in undervalued stocks, most advisors are urging that panic be avoided. Stocks always recover or at least they always have. It’s the timing that gets scary. In the current environment, too many investors are responding to the wrong advice, according to editor Britton. Advertising is driving and controlling investor behavior in unhealthy ways, notes Britton. That plus the advice received from family members and others at the office confuses and misleads many investors, continued Britton. And some, he says “are listening to their brokers,” implying that they may have conflicting objectives. Britton reasons that investors tend to over-diversify, thus spreading their investment dollars too broadly. This can dilute dividends as well as profits from securities sales, assuming you made a profit. Other investment professionals have pointed out over the years that over-diversified portfolios are also difficult to manage. Assuming we have day jobs or activities claiming our time, following the securities markets on a day-to-day, hour-by-hour basis becomes an impossible task. Investment legend John Bogle, founder of the Vanguard Mutual Fund company, was an early advocate of index funds. These are mutual funds with a portfolio designed to mirror the movement of a selected broad market index, such as the Standard & Poors 500, a weighted index of the prices of 500 large-capitalization common stocks actively traded in the United States. Then along came exchange traded funds, popularly known as ETFs. These take the mutual fund concept a step further and permit the funds to be traded like stocks. And, Britton contends, ETFs allow for more diversification than most mutual funds and have a lower cost structure. Remember, I said we’re not investment advisors so we won’t get into specific funds or securities. But some concepts should now be clear. Stay on message and make sure you have enough money to handle the family living expenses and keep the reserve in place. If you’ve had to dip into it, restore it as quickly as you can. If you have a 401k, IRA or deferred compensation plan at work, maximize your contributions. After all this is firmly in place, consider your investable capital. Diversify, but not too much. Look positively at mutual funds or ETFs. Consider individual stocks if you have enough time and capital to make the investments worthwhile. Finally, consult with your broker. You should be confident in their abilities and that they are giving due consideration to your needs rather than just theirs.