Tuesday, October 26, 2010

Ground Rules & Constraints – Asset Accumulation: Part I

First, delineate the ground rules to stop leaks (asset protection) which ironically is addition by subtraction (via transference of capital & income depletion potential impacts) Next, is accumulation ground rules and constraints (hopefully to avoid premature accumulation which typically requires ‘more’ (personal financial Viagra that disappoints or for the alternative complementary devotees Extends which financially typically less-ends.)

Unfortunately, the nomenclature for most typical asset accumulation ground rules/ constraints is the word ‘risk’ and secondarily a description of what the asset provides. (As to the latter, there is only so much juice in an orange – which will be the metaphor relative to these factors in the discussion of retrofitting.

“Risk Ground Rules”

Per previous entries, I have defined risk as ‘not making the goal – the chance of not making the goal.’ That said the following considerations, which are either “prone” or “offset” in part or in total depending upon your defined parameters – become a basis for ground rules and are typically referred to in terms of risk:

· Inflation or Deflation Risk – fluctuation in purchasing power of assets and or income is a function of inflation or deflation. For example, in general, cash’s purchasing power is eroded in inflation while increases in purchasing power in deflation

· Systemic Risk - occurs when the failure of one party to meet a financial obligation causes others to also not be able to meet obligations. For example, a person who purchase a home for investment purposes may depend on rental income to make the mortgage payments. If the tenant is unable to pay the rent, the home owner in turn may not be able to make the mortgage payment. A more recent example: you pay make your mortgage month in and month out, year in and year out, and you wind up paying your deadbeat neighbor’s mortgage through government bailout due to Barney Frank, Chris Dodds, Andrew Cuomo and Bill Clinton’s Fannie Mae& Fredie Mac policies making renters into owners who could not afford the mortgage and default impacting the value of your house as well!

· Interest Rate Risk – the value of an investment goes up or down with interest rate changes. For example, there is an inverse relationship of bonds to interest rates. When interest rates go down, bonds typically go up and vice versa.

· Liquidity Risk – the potential that one will not be able to sell the investment quickly enough or in sufficient quantities because of selling options are limited often resulting in a dimunition of value of the investment at the time. See forced sale.

· Market Risk – market risk exposes our intangible assets (stocks, bonds, and alternative investments trades as stocks) to the fluctuation of the market and potential capital depletion or appreciation

· Market Timing Risk – attempting to time market movements, investors ‘risk’ being out of the best markets and going into the worst markets

· Reinvestment Risk – that risk that market interest rates/dividend rates have decreased at the time payments/dividends/interest from an investment are received. The investor will be forced to reinvest his or her payment amount at a time when rates are not as favorable as they may have been previously

· Repayment (Credit) Risk – chance that a borrower will not repay an obligation

· Monetary Risk – the value of currency declining

· Political Risk – the possibility of nationalization or other unfavorable governmental actions or Obama being reelected.


· Divorce Risk – the up to 50% risk of first marriage dissolution, and 70% of second marriages dissolution causing capital depletion (see previous section on asset protection)

Offsets & Prone

I’d advise you to make three spread sheets consisting per each objective the assets dedicated to the objective running down the column vertically and across two columns for each risk – the amount of the asset ‘prone’ (to that risk), and the adjacent column ‘offseting’ amount (if applicable). For example, the amount of a $200,000 position in intermediate bonds prone to interest rate risk may be $200,000 with no offset. However, the same $200,000 invested in short term bonds (1-2 years) one might say is but $100,000. Relative to deflation risk, the same $200,000 in intermediate bonds (assuming high quality) might be put in as $200,000 offsetting deflation risk whereas if the intermediate bonds were junk quality – maybe the number is $50,000. The net effect, inflation risk – prone versus offset should be divided by the total value of the objective’s portfolio value as a percentage. This analysis should be run three times:
· First baseline relative to each risk if you do nothing per the objective
· Second, what the prone to offset should look like ideally
· Third, after you retrofit your portfolio per objective what each risk would look like (prone to offset) to make tradeoffs between the requirements of the goal and you concern for the risk –prone/offset ratio.

Next: Ground Rules & Constraints – Asset Accumulation: Part II Retrofitting
(The Tease: Most people’s portfolios consist of what they have been sold – not what they have bought)

Monday, October 11, 2010

Ground Rules & Constraints – Part I: Asset Protection

Though my practice was overwhelmingly dealmakers (energy, cable, and real estate), I had one client, an heiress to quite a large position in a publically held oil refiner. Yes, she wanted to be passively financially independent of her large position, without selling a portion of this position – it wasn’t possible.

Thus, not selling any of the stock in this oil refiner became a ‘ground rule / a constraint’ on her personal financial life planning goal of passive financial independence regardless of my mantra ‘an asset is just an asset is just an asset, we manage personal financial life goals not assets’ nor fall in love with the asset.

Another client who bought into Enough – needed his financial Vegas fix. No he didn’t go to Las Vegas but he had a need to speculate. Thus, with a portion over and above Enough as defined, together we recognized what he called ‘his need for speed’ into his Las Vegas fund (which he could afford to lose – and did). Again, another constraint/ground rule that had to be recognized in planning.

Then there is the ‘world is coming to an end, everything should be safe, liquid but I still need to make 15%’ type client. I referred this individual to another planner as there was no way – enough would have been enough as he was a Worry Butt on Steroids.

In Management by Objective terms, there are four Effectiveness Areas (EA) in personal financial life planning:

· Asset Protection · Asset Accumulation · Income Conservation · Asset Conservation
Asset Protection – Addition by Capital Depletion Subtraction!!

Asset protection is typically about capital depletion due to:

· Health/Illness
· Property & Casualty loss
· Liability
· Disability
· Long Term Care Needs
· (Some would include Divorce)

Examples of Ground Rules on Asset Protection (which typically involves shifting risk (large losses – capital depletion) via insurance in return for taking a small loss (premiums & minimum self insurance- deductibles, stop losses, company financial rating, complaint ratio etc.)):

· Health Coverage
1. Deductible
2. Stop loss
3. catastrophic coverage

· Vitamins – “supplemental health insurance!”

· Homeowner Coverage –
1. deductible
2. full replacement value of structure
3. full replacement value of contents
4. replacement value by ordinance (check your policy most don’t have this – and specifics are beyond the scope of this writing
5. underlying liability coverage

· Automobile –
1. deductible
2. collision
3. comprehensive coverage
4. liability coverage

· Liability –
1. underlying coverages on home and auto
2. preferably a blanket excess liability on top of the underlying liability coverage
3. a separate flood insurance policy where applicable
4. where applicable Director’s & Officers insurance as well as Malpractice Insurance .

· Disability Coverage (income replacement due to disability – remember you are the working active asset creating asset accumulation etc until the goals are funded).
1. Loss of income upon partial and or total disability
2. wait period would be chosen before the benefit kicks in
3. inflation rider
4. (Social Security offset is again another subject)
5. coverage to age (65 – lifetime?)

· Long Term Care Coverage
1. Qualification (number of ADL’s activities of daily living out of 6 to qualify,
2. home health care coverage,
3. wait period, coverage years (or lifetime)

· Divorce Insurance – prenuptials, post nuptials – please no Sleepless in Seattle clap trap when 50% of first marriages result in divorce and 70% of second marriages. This is ASS-et protection. You have wills and trusts for contingent events (death) - and I never heard a spouse against those contingencies - why not prenupts, post nuptials. PS you can always change the pre and post nupts later if desired.

The point of the above is illustrative of ground rule/constraint concepts in the asset protection effectiveness area all of which are intended to minimize capital depletion (addition by reducing capital subtraction!) to allow asset accumulation and asset conservation.

Tuesday, October 5, 2010

THE WORRY BUTTS© aka Getting’ To The Bottom of the ‘But-t’

aka Getting’ To The Bottom of the ‘But-t’

You’re really a smart person….BUT
There is another …. BUT
I know I should have told you… BUT
You’ll always be special … BUT
Don’t be offended…. BUT
Different Times with Different Lines, by Jim Schwartz, 1971, Denver University Clarion

Confession: the above was written when I was a rationalizing testosterone driven BUTT HEAD of 19 or 20 trying to ‘win the affections’ (euphemism) of Wendy L. (And to answer the question, no, I didn’t ‘bag the babe’ - there was no shtuppee, whoopee and thank God, no chuppie.) (1)

Testostorone driven But-t Headedness is excusable for 19-20 year olds, however, after 20+ years in practice as a fee only personal financial life planner and an additional 16 years of writing etc in the area, I have a BUTinski Schwartzism © relative to BUTs:

When BUT #1 is fixed BUT #2 is promoted by the Butt Heads”

Oh, yes, as we grow older our “but’s” are more sophisticated with a little song, a little dance, a little seltzer down the pants – with a repertoire of excuses rivaling the yellow pages.
Why is there one but after another but after another in personal financial life planning?

Here’s an interesting personal financial life planning ‘But’ cascade:
· But, I don’t have ‘enough’
· I have ‘enough’ but I need a cushion
· I have enough and a cushion – the means to the end but I need to move the ends apart

Buts escalate even with ‘more and more’ money and resources.
· But Obama could reinflate the currency
· But I could have a bad year (even though I’m the last ice man)
· But What if the water is cut off?

There is no rest for the WORRY BUTT’s but’s – only but promotions. They just escalate exposing the underlying fear which despite the above sarcasm is very real and haunting.
And what is that underlying fear?

The fear of physical extinction (which we identify as ourselves) due to:

· The lack of faith in trust in God (or a higher power)
· The lack of faith in our own proven adaptability and resourcefulness overcoming past difficulties and challenges

No wonder the push for certainty, permanence, continuity stirred and shaken (olives optional) with a chaser of the dreaded secondary fear of being beholden. No wonder the BUTTressing- one BUTT after another BUT-T.

An exercise:

Suggestion: In one column, write down difficult times and challenges and in the other column write how you correspondingly overcame the problem, worry, difficulty, challenge. Then read the sheet in total – reduce it to size and stick it in your wallet for when the next WORRY BUTT wave hits.
(You may even be impressed with your own adaptability and resourcefulness – which earned the necessary current currency and or other resources to overcome the past WORRY BUTTs).

Oh, yes, I know, you’ll say:
· (But) That was then, this is now
· (But) I don’t have the same energy
· (But) I’m older now
· (But) This is different…BUT, BUT, BUT

The point is you have, you did overcome as the track record of the exercise proves, yet still WORRY BUTTs rarely give themselves credit for the evidence of meeting and beating these past challenges.

How come?

Because of the ‘if they only knew(s)’

The ‘if they only knew(s)’ is the deep down belief in being an imposter – derived from the conviction/ironically faith in one’s lacks (lack-tose intolerances) when one scratches underneath the bravado, Gucci and Rolex..
And so it goes, BUTT-er Cups (really only BUTT-er Flavoring).

The fact is we are not self sufficient regardless of personal financial resources. Today’s current currency is tomorrow’s money in a wheel barrow. Unfortunately, especially in an industrial and post industrial society with increased specialization – we need other people.
But if you remember to take out the above reduced piece of paper with the above exercise on it, you might just minimize the anxiety, the buts, and the pain in the butt. You might even remember from those difficult times, you were adaptable and resourceful such that no matter what the current currency – you have adjusted. (This is BUTT management (Preparation BUTT) not BUTT cure ).
Even better yet, I believe, is trust and faith in God to provide strength for one’s latent and or minimized adaptability or resourcefulness to manifest. I am reminded what The Rebbe (2) said relative to health, ‘listen to the doctors instructions, but one’s fate is in Hashem’s hands.’ We have more faith in the dollar or euro (the current currency) than we have in The ‘Everlasting’ Currency.

Of course, you could say all the above is projection. We do teach what we need to learn ourselves, BUTT-er Cups.

As a Rabbi once said, ‘you don’t get rid of Shtick (3), you manage it.’
ENOUGH said. Don't BuTT-er me UP?

1.-Chuppah – The Jewish wedding canopy, that is, the cloth under which the Jewish wedding cere-money is conducted.
2.- The Lubavitcher Rebbe, Rabbi Menachem Mendel Schneerson
3.- Shtick – a contrived gesture or routine done by anyone, often an actor or comedian i.e. my baseball cards for business cards etc.