Top 5 estate planning mistakes

I recently read a report that suggested that only about 20 percent of the population has a formal estate plan. After reviewing the points below, please take a minute to consider whether it’s time for you to create or update your estate plan.

Here are a few of the top 5 estate planning mistakes that people make that can be avoided.

1. Dying without a will or trust – If you die without a will or trust, the state in which you reside and the IRS will simply make one for you.  Of course, they have no interest in avoiding or reducing estate taxes, minimizing estate administration costs or protecting your family and legacy. The distribution of your assets will just be turned over to the Probate Court. The probate process is needlessly time consuming, frustrating and expensive. It is also open to the public, meaning creditors, predators or anyone else will have complete access to all information about your estate. For the vast majority of people, the benefits far outweigh any initial costs.

2. Having an “I love you” will – An I love you will is one in which all the decedent’s assets have been left to the spouse. On paper, it might seem to be a caring, thoughtful gesture, but the reality is quite different, because such a will simply passes the complex issues and problems associated with transferring and protecting wealth onto the spouse or other loved ones.  It creates more problems than it solves, particularly for future generations.

3. Giving property outright to your children – Here is another solution that might sound good at first, but ignores several important realities. For instance, what if the child in question is too immature to handle the responsibility of a large sum of money on his or her own? What if the child suffers a severe financial setback that puts the inheritance at risk to creditors?  What if the child marries a fortune-hunter, is addicted to drugs or alcohol, gets divorced or remarried? You may need to protect your children and heirs from their own poor decisions.  These assets are also gifted assets which carry potentially large IRS penalties if not handled properly.

4. Owning property jointly – There are two types of joint ownership, Joint Tenancy with Right of Survivorship (JTWROS) and Tenants in Common (TIC).  Problems with JTWROS include postponement of probate only until last tenancy, the loss of the double step-up in tax basis creating more to pay in capital gains taxes, and outright distribution.  With TIC, you also lose the double step-up in tax basis where it’s available, and your property is subject to the estate plan of each tenant as well as probate for each tenant.

5. Not having a trust – A trust is the single most effective estate planning tool available. There are many different types of trusts.  Among the better known and more commonly used are revocable trusts, irrevocable trusts and testamentary trusts. A Trust protects your privacy, and will help you leave what you want, to whom you want, in the way you want at the lowest possible cost overall.

Standard deviation measures the risk of an investment. For example, the Growth Fund of America has a 5 year standard deviation of 16.45 and a 5-year average annual return of 4.76. This means that the portfolio historically has moved 16.45% above 4.76 and 16.45% below 4.76 over a 5 year period. This gives you an idea of your downside risk and upside potential. In comparison, the PIMCO bond fund has a 5 year standard deviation of 4.25 and a 5 year average return of 7.17. Adding these two funds to a portfolio at a 50/50 ratio would give the portfolio a 5 year standard deviation and rate of return of 10.35 and 5.96, respectively. In this scenario, we just lowered the risk of the overall sample portfolio by adding bonds. You can use Morningstar.com, a free and independent research firm, to find the standard deviation and rate of return of each fund within our 401k plan. As you will see, some funds in our 401k plan, while they may be in the same asset class, do not have the same risk.

By Kyle Waller, Research Analyst Wiser Wealth Management, Inc & Casey T Smith, ASA ALPA 401k Specialist

In 401K investing, there is a major asset class that does not get the respect it deserves. In fact, it is largely ignored both by investors and plan sponsors. This asset class, small cap stock funds, is a very important element in a 401K plan.

Throughout the history of the stock market, small cap stock funds have significantly outperformed their larger counterparts.  There are some reasons for this that make small cap funds a category that should not be overlooked in your plan. That being stated, the potential for excess long-term performance comes with some serious risks that should also not be overlooked because of downside risks and excess volatility.

The JPMorgan ASA employee 401K plan has three small cap funds. Two of those funds have a management strategy designed to invest in growth stocks, while one fund is designed to invest in value stocks. Below is the Morningstar Style box, which simply categorizes large, mid and small in rows, while placing the “styles,” (value, blend and growth) in columns. Style is something to consider when choosing funds, but size is more important to consider. Size tends to be a larger determinant of returns relative to style. However, most mutual funds have both size and style directives and both should be taken under consideration before choosing one.

Small Cap Stocks as Building Blocks

Building a solid portfolio can be done with many different strategies, but most professionals believe that having a diversified portfolio based on asset allocation is most appropriate. Asset allocation would mean that a portfolio would include diversified investments from different categories, and apply different weighting based on the investor’s individual risk tolerance and how risky each investment is. Most allocations are based on age or years to retirement.

The three small cap funds in the ASA employee 401K plan are the Buffalo Small Cap, Columbia Small Cap Value II Z and the LKCM Small Cap Equity Advisor. When reviewing these funds, it is important to study risk, cost and track record, among other factors. Cost takes away from return, and there are hidden costs to consider like turnover, which is the fund’s trading frequency. This is an important consideration, because these trades incur cost for the mutual fund. A random track record statistic alone should not be the deciding factor; it should be compared with benchmarks. For example, it would make sense to compare a small cap growth fund’s return with a small cap growth benchmark. There are several ways to look at a fund’s risk. One way is to simply look at its standard deviation, which is a measure of variability from the mean. The higher the standard deviation, the higher the risk is perceived to be. Often, standard deviation is just called risk, like you see in the scatter-plot below.

The Importance of Small

Below, we see the difference smaller companies can make. Over last 15 years, we see that small cap companies significantly outperformed the large cap S&P 500, despite underperformance during the tech bubble. Going back further would reveal that this pattern does exist over long periods of time.

So, what is the cause of this higher performance? Put simply, smaller companies tend to grow at a faster rate and, over time, larger companies still grow, but much more slowly. Smaller companies have less economies of scale, less complex capital structures, less debt and lean more on a competitive advantage, which can quickly change. What it all boils down to is that smaller companies are more risky and the investor is compensated for that risk in the long run. This works just the same way a bank demands a higher interest from a person with a lower credit score or a higher risk of default. The market demands that same kind of compensation.

Below is a scatter-plot showing the risk of each investment, plotted against the return. Notice that the small stock index has more risk, (being further to the right) but a higher return as compensation for that risk relative to the S&P 500.

Source: Morningstar

Small cap stocks should not be a centerpiece for a portfolio, but certainly a building block. There is a case for small cap stocks outperforming larger stocks, but we need to remember that larger stocks tend to be more stable, which is why investors, over the long run, are compensated less. Of course, over short periods of time, we could expect small cap stocks to be punished more by the market for not being stable. We could say that many smaller companies’ stock prices reflect the potential for growth or future cash flows while larger firms typically have more established assets, which generate cash flows more steadily.

In this way, a solid investment portfolio will include small cap stocks in relatively modest amounts, while core holdings will be built using larger stock funds and bond holdings.  Small cap stock funds are typically considered satellite holdings.

Building With Small Cap Funds

“Investing has and always been, and will remain, an operation in which wealth is transferred from those without a working knowledge of the financial history to those who have one.” William Bernstein

Knowing your history is the key to building a portfolio that will get you to retirement and into retirement. Small Cap stocks have a place in portfolios. They are riskier than other investments and therefore should be limited in even the most aggressive portfolio. Where your personal portfolio falls in the risk spectrum is up to you, but should be based on the reality of your situation and not an attitude or appetite for risk and speculation.

By Casey Smith, ASA ALPA R&I Committee 401k Specialist and

Kyle Waller, Research Analyst, Wiser Wealth Management, Inc

The saving rate among Americans is decreasing, yet the need for income in retirement is as crucial as ever with pensions and social security becoming scarce and not as guaranteed as they once were.

There is a real cost to not saving, and that cost increases as retirement approaches. This is a particular concern for us as pilots with forced retirement ages, since we will not be able to choose to continue working into our 70s.  That being said, there is still hope at any age and it is never too late to start getting out of debt and saving for future needs. No matter the state of the nation’s economy, focusing on your personal economy should come first.

As we can see above, the saving rate among Americans has been on a sharp downtrend since the late 1980s, dropping to record lows during 2008. Recently, it has risen to just under 4% on average in 2009 and this year.

Saving has risen again recently due to the lower availability of credit. Since credit is never a guarantee, Americans need to adjust their dependency on easy access to credit and put away a higher percentage of what they earn. In general, the upcoming generation of retirees is more accustomed to widely available credit and is more optimistic than previous ‘thriftier’ generations.

Financial Knowledge vs. Time

Financial wisdom is an important key to having a successful portfolio. However, the more valuable factor that is often overlooked is time. Time gives the investor the ability to make it through both economic downturns and market booms. Historically, the market has behaved with large gains or losses over short periods of time. The secret to financial success is having a good strategy and the time to see those investments through the long run. You can see the value of time and saving sooner rather than later in the scenario below.

How Much To Save

A good rule of thumb is for an individual to be able to withdraw 3-4% in retirement without touching principle. This would generate $40,000 annually from a $1,000,000 portfolio.

Source: Morningstar, Inc using a 7% interest rate

Life isn’t as simple as the illustrated example since a professional pilot will most likely receive significant pay increases throughout his or her career. Another thing to consider is that as retirement approaches, it makes more sense to alter the investment portfolio to become more conservative, taking less risk and avoiding major market swings. This is another reason a younger person saving for retirement is at an advantage; they can take an aggressive investing approach and see that strategy through bad market cycles to success.

The ASA matching schedule is given below:  A healthy amount to save each month is 15-20% of your income. The sooner retirement is for you, the higher this percentage should be. At the very least, an ASA employee should be putting 6% into his or her 401K account out of every paycheck. Not doing so is taking a voluntary pay decrease. If you’re not saving this much, stop reading, log onto your account and change the percentage to at least 6%.

The ASA matching program matches a portion of the first 6% of your contribution based on completed years as an employee. Therefore, a second year employee (one year completed) will be matched 1.2% if they put at least 6% away in their 401K account (20% of 6%), this is in contrast to a 5% contribution rate which would be matched 1% (20% of 5%). Therefore, the real cost of not saving at least 6% is 1.2% for a second year employee.  The incentive is increased as the employee completes more years.  The program is designed to make a monetary incentive for saving through the program.

Behavior and Success

When making a plan for saving, it is important to note that good saving and investment behavior is as important as anything else. Saving should become systematic and so should the way you invest. This means no matter what the stock market is doing, you should be putting the same amount into your 401K and investment accounts every month. You should begin to think the same way about investing as you think of your monthly mortgage, a required bill.

Long term investing success really depends on playing great defense, which is sticking to the plan. This involves patience and endurance through market crisis, which will always come and go. An investor with a great strategy and the time to see it through will be successful and profitable in the end.

Why is behavior important? There is a gap in the stock market return and the average investor return, coined the behavior gap (see www.behaviorgap.com).

This behavior gap is caused by investors reacting to the ups and downs of the stock market, and can be very significant. When an investor reacts to the stocks market, i.e. buying stocks when they are rising, that investor is buying high. In the same way, selling stocks when they are falling is selling low.  A profitable strategy is obviously just the opposite, selling high and buying low. To pull off this strategy successfully, a great amount market insight and forecasting is required. Even with good information, it is difficult do profitably over the long run. The better strategy is choosing funds to create a diversified portfolio and sticking to that plan no matter what happens in the market. This is a simplified version of a buy-and-hold strategy, but the “behavior gap” will be completely erased when an investor properly employs a no-nonsense buy and hold strategy.

In Conclusion

Investment and retirement savings success does not depend on financial knowledge or complex strategies. When you are saving for retirement, create a hands off plan for saving, get on board with that plan and see it through to retirement.

You can view more 401k articles, the pilot retirement calculator, 401k model portfolios and research at www.wiserinvestor.com/resources/asa

What does that have to do with you, a US investor? Over 50 percent of the the revenues of the S&P 500, the 500 largest companies in the US, come from overseas. Declining foreign sales and a declining euro hurt our mega corporations. You might be wondering what you should do with your 401k. If you are properly allocated according to your age and risk tolerance, the answer is nothing right now except possibly increasing your contribution to take advantage of the sale. You should also make sure that your portfolio is properly diversified. Is your 401k in all cash? Do you have more than 30% in any one fund?

The biggest risk to your retirement is not saving. The second biggest risk is how you invest. Print off a copy of this connection email as a reminder to look at your 401k allocation. You can also visit www.wiserinvestor.com/resources/asa for tips on allocating your portfolio. Of course, you may also call me anytime to discuss your individual situation.

Casey Smith ASA ALPA 401k Specialist

I am sure that the recent fallout in the market has many of you wondering what Greece has to do with US investors and how we can see a such a large decline in the stock market, even with job creation in the US. We will address that below.

I want to remind you that just as in 2008 when the US markets caused the world’s financial instability, that because we stayed the course and maintained our index allocations, the portfolios recovered with the market. Last summer, we rebuilt our index models to include more short-term bonds and purchased protection for those of you who needed it with a large exposure to the S&P 500. This move to overall more conservative portfolios and equity protection will help us weather this European crisis even better than the US financial breakdown. As of Thursday, May 6^th, all models remain in positive territory for 2010. We will continue to monitor and learn more about the European Crisis to keep you informed.

European Problems and Our Portfolios,

By:  Kyle Waller – Research Analyst

“Because major developed markets are now so highly linked, there is no way for problems in Europe to remain isolated there; we will see a ripple effect here in the US.”

The Greek government has recently agreed to receive a Eurozone government bailout from stronger countries in the EU. This bailout is very similar to the way many large US financial institutions were bailed out at the US taxpayers’ expense. In that case, the US government purchased assets from non-government companies. In the European case, governments are giving money to another government to prevent the risk of default of on bonds and other obligations.

The Greek economy is made of mainly government jobs, either direct government employment or subsidized employment. Overall, they have a weak free market system, which may be why people rioted in the streets Thursday due to 2% tax increases and dissatisfaction that the EU central bank did not choose to do more than its $145 billion rescue plan to stabilize the Greek economy.

Greece may be the first of many other bailouts that takes place to secure sovereign debt of other European countries.

The Effect

Such actions have caused the Euro to decrease against other currencies, most significantly against currency alternatives to the Euro as a major trade and reserve currency, i.e. the US Dollar, Pound and Yen. Significant losses have also occurred in both European bond and stock prices due to future profits becoming less secure. However, with fast, panicked selling, it is likely that the market has oversold many stock and bond holdings. Therefore, the opportunity to profit from this news has passed and it is unclear whether the market will continue to sell or regain some stability.

Overall, any company linked with global trading will be negatively effected and has already been. According to S&P analysts, the companies in the S&P 500 make up nearly 50% of sales from outside the US in recent years. With the S&P 500 making up nearly 80% of the US market, it follows that this would make US products more expensive to Europeans and therefore drop demand.

As uncertainty in Europe continues, uncertainty in the US will as well.  A Greek stabilization plan was passed on Thursday and should begin to stabilize that economy and its problems. There is still fear that other Euro countries may require the same actions, but the EU is showing its dedication to market stabilization.

Because major developed markets are now so highly linked, there is no way for problems in Europe to remain isolated there; we will see a ripple effect here in the US.

Going Forward

There are many factors affecting what is happening in the global marketplace and the US is a major player in all of it. Global investors are flocking to US Treasuries, increasing price through demand, which will help keep rates low. Low rates, in turn, increase demand for borrowing. In the same vein, though, demand for the US Dollar has grown, which has a negative effect on US exports and will slow a full recovery in the US, just like failing stock prices.

Going forward is about positioning portfolios to be participants in the global marketplace while being keenly aware of potential risks. We know that markets can act irrationally during unstable times and the answer for portfolios is to hold the course, maintain diversification, and prepare for future risks.

Weekend Update

Just as I went to publish this note, the European Union in a 12 hour weekend meeting put their final stamp of approval on the Greece bail out. Many economists have dubbed the 1 trillion dollar package the “nuclear option”, but the EU sees the bail out as necessary to keep the euro from free falling in value. The risk going forward is repeating these steps with other countries. If Portugal, Ireland and Spain need the same type of bailout, Europe could easily spend another 500 billion euro’s. Today as this note is published, the US market is up 400 points in a positive reaction that maybe this is over. I believe that there is probably more to come and only hope that it only lasts a week like in the Greece scenario.

Sincerely,

Casey T. Smith

President

Wiser Wealth Management, Inc

While this is a very simplistic synopsis of the situation, and there are certainly more details to be heard from the defendants, there was a very interesting exchange yesterday between Lloyd Blankfein, the President of Goldman Sachs, and a Congressman. The Congressman asked Mr. Blankfein if he thought that his firm should be acting in the best interest of its clients. Mr. Blankfein paused for a great deal of time and then simply answered with a vague, “We do what we can” answer.

Mr. Blankfein could not answer yes to that question because financial institutions like Goldman Sachs, Bank of America, Edward Jones and AG Edwards cannot legally accept fiduciary responsibility for their actions. Fiduciary simply means to always act in your client’s best interest and to disclose all conflicts of interest. Was there a conflict of interest in this Goldman Sachs product? You bet.

Part of the problem here is that the government allows companies like Goldman and other brokers to act under suitability rules. This means that a client has to be suitable for the investment, but does not mean that the product is the best for the client. To give you an idea of what this means, think of a mortgage. You might be qualified to get a million dollar mortgage, but that does not mean it is your best interest to have one.

I believe that anyone acting under the title “financial advisor” should be held to a fiduciary responsibility, just like your doctor, attorney and even your real estate agent. Brokers, commonly called financial advisors, do not give advice! They are not in the business of giving advice-they are in the business of representing products and completing transactions.

The problem with financial advice comes down to this fact:  advice should be paid for separately from products and products should not pay the advice giver. And guess what, the overall cost of paying for independent advice will most certainly cost less than the expensive products being sold to you.

Brokerage houses have a lot of power in lobbying to Washington and have thus far kept themselves out of being fiduciaries to clients.

Currently, the only fiduciary advisors are independent firms that are not associated directly with any broker dealer, but rather a custodian like TD Ameritrade or similar. TD Ameritrade holds the client’s assets that are being managed, but the advice comes from an independent advisor hired by the client. Fee Only Independent advisors are regulated by the SEC or directly by individual states. Fee only advisors have the entire financial product world available to them, thus they can and should always act in a clients best interest. If they do not, there are serious consequences. In comparison, the broker can get off scot free, just like Goldman Sachs probably will.

The first ETF came about in the US in 1993 under the ticker SPY, also known as the “spyder.” The spyder enabled institutional investors to purchase the entire S&P 500. This allowed the investor access to market returns, while limiting specific company risk. This indexing concept through ETFs increased in popularity in 2000. Just seven short years later, investors could access virtually any worldwide asset class at a quarter of the expense of mutual funds.

It is these Exchange Traded Funds that have taken hold in America that are just now starting to take root here in Europe. I see a few roadblocks that may prevent ETFs from taking off here, though. A few of these obstacles were present in the US market during the rise of the ETFs, but Europe has some additional issues as well.

At Wiser Wealth Management, we are an independent wealth management firm with allegiance to no one to other than our clients. When we built our tool box of investment models and strategies, we only looked at products that maintained our investing philosophy of investing for the long term, keeping cost low, and always maintaining a diversified portfolio. We never chase returns, but rather manage overall portfolio risks adjusted for each client’s investment objective. We will not work for a commission, only a flat fee. This fee only approach to asset management binds our objective to the clients’ best interest.  The final seal to the sitting on the same side as the client is our regulatory responsibility as a fiduciary; something our brokerage and banker counter parts refuse to accept. They are regulated in a way that allows them to sell products that may be suitable for the investor, but not necessarily in their best interest.

It is this independent fiduciary fee only platform that is lacking in Europe, thus most advisors there are pushing high cost and high advisor commission insurance-based products. Most of Europe’s ETFs are traded by institutions. In the United States, the Institutional/Retail breakdown is 50/50. One of my reasons for coming to this conference is to be an ambassador for fee only advisors in the US and encourage our colleagues across the pond to take up a platform that is more beneficial to their clients.  My concept involves ETFs because ETFs do not pay a commission and are great tools in building portfolios. This does not mean that a commission broker will not use ETFs, it just means that they have an incentive to not too.

I was speaking with an Italian trader one evening. We discussed how fee only advice could start in Italy. He said that it was very difficult to start your own business in Italy and if it failed and the owner had to declare bankruptcy, he or she could go to prison. Maybe socialism has some drawbacks? So maybe in Italy advisors will not be jumping ship from the large banks and venturing out on their own, but there is always a possibility that they could make a policy change like that of the UK. In the UK, the government has passed a new directive to make their financial institutions look at all investing opportunities, not just their own financial products. This is an open door to more ETF usage in UK portfolios.

Another difference between the US and Europe is how ETFs are traded. This difference causes some liquidity issues in ETF trading. One reason for this is that ETFs can be traded on the local country exchange, OTC (Over the Counter), or directly from the issuer at NAV (Net Asset Value). Currently, the only reported trades are those done on the exchange. This multi-trading platform at times creates large bid/ask spreads. Trading volume would help close the bid/ask spreads. There was a lot of talk at the conference about reporting the ETF trade to a third party to help share information on pricing.

For the most part, ETFs in the US are simply purchasing an entire index, like one share of SPY buys you the entire S&P 500. Should the provider of the ETF ever fail, the ETF assets are not in question. The fund would simply be liquidated and you would receive your investment back at the current market value of the underlying securities. In Europe, some ETFs are not this straightforward, as there are two types. Physical ETFs are what we are using here in the States. Europe also has Synthetic ETFs, which are more complicated, and not necessarily straightforward for retail investors. If not used properly and with caution, these synthetic ETFs could get bad press and hurt the overall impression of Exchange Traded Funds. This is much like the inverse funds here in the United States.

Another challenge for ETF providers in Europe is that while each country shares a common currency, tax laws can be much different. Because of this, we see ETFs being purchased within each country’s own exchange. US ETFs are not purchased off our exchange as a European investor may have to pay US tax.

I will also note that the conference of several hundred delegates only had about 12 actual advisors. The others were institutional managers, traders, and lawyers. This tells me that ETFs have really not made it to the individual European investor. Next year, should I be invited back to the conference, I would expect and hope to see more retail advisors.

As of December 2009, the national unemployment rate was above 10%. In Cobb County, we are not far behind at 9.3%. Each month the unemployment rate increases and many agree that the real national rate is around 15%. (Chart HERE) The US Government has tried unsuccessfully to stimulate the economy.  It has spent more time debating the health care bill that we cannot afford and makes us more dependent on Government Bureaucracy than on ways to stimulate the economy and still plans to raise taxes in 2011, making small businesses reluctant to hire. What will return America back to solvency and prosperity? The same thing as during the Great Depression, WWII, 9/11 and many other times of hurt in America, the will of the American People. In times of crisis, the American people band together to help one another get back on their feet and once again work for the American Dream.

Wiser Wealth Management wants to help those currently unemployed by offering a free, CPA prepared 2009 Federal and State tax return. There are no strings attached. We want to use our tools to help those in our community in this time of need. We hope that other businesses follow our example and offer services to help those in our community get back on their feet. All you need to do  is to call our office at 678.905.4450 ext 1 or 3 to set up an appointment.

Casey T Smith

President

This report shows that only one third of funds managers had a positive alpha over the last three years. The report also goes on to show that expenses and taxes greatly degrade fund performance. Another interesting note is that active fund managers tend to outperform in poor performing areas of the market, but in “hot” areas they tend not to keep up with the index.

Overall, there is really nothing new, just a reminder that low cost passive investing should have a place in everyone’s portfolio. This report supports the Wiser investment philosophy of maintaining a diversified portfolio, keep cost low and always invest for the long term.

VIEW THE MORNINGSTAR BOX SCORE REPORT HERE