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General Planning

Prevent and Detect Identity Theft

Prevent and Detect Identity Theft

It’s estimated that more than 17 million Americans are affected by identity theft every year. If the concerns over the latest Equifax data breach come to fruition, that number may increase precipitously. The best way to counteract the threat of identity theft is to prevent it. A secondary layer of protection is afforded by early detection. Below are resources for both.

Identity Theft Prevention

  • Credit Freeze (Equifax, Experian, TransUnion, Innovis) - Restricts access to your credit report, making it difficult for identity thieves to open new accounts in your name. This is one of the best ways to avoid fraudulent accounts being opened in your name but comes at a nominal financial cost and inconvenience. Whenever you are opening a new account or applying for something that requires a credit pull, you’ll need to temporarily unfreeze your credit report. Depending on your state, you may be charged up to $15 to freeze and unfreeze your credit. If you’ve already been a victim of identity theft and have filed a police report, the fees will be waived.
  • Opt Out of Prescreened Offers - Lets you opt out of receiving pre-approved and unsolicited credit offers in the mail. Credit card companies sometimes offer new lines of credit without pulling your credit report (making a freeze ineffective). A thief, with access to your mailbox, could easily use one of these offers to open a credit card in your name. By opting out of these offers, you’ll not only reduce your volume of junk mail but also reduce the probability of becoming a victim of identity theft. You can opt out for five years using the online form or permanently using the mail-in form.
  • National Do Not Call Registry - Significantly reduces the number of telemarketing calls you’ll receive, which lowers the probability of getting scammed. The Federal Trade Commission (FTC) requires all telemarketing firms to check this list every three months and purge registrants from their call lists. This is a free service sponsored by the US Government.
  • Call Spam Filter & Blocker - Many of the real scammers illegally ignore the National Do Not Call Registry and often use spoofed phone numbers to make it appear they are calling from a local number. There are a number of apps you can install on your smartphone that use a constantly updating database to alert you when suspicious calls come in and display the information on your Caller ID, so you don’t inadvertently pick it up and fall for the scam. Some popular examples of these apps include Hiya & Truecaller.
  • Unique Online Passwords & Two-Factor Authentication - Using the same password for all your online accounts is easy to remember, but puts your entire digital life at risk if even one of those sites gets hacked. A better approach is to use long unique passwords for each site and then store them in a secure password manager. Some of the most popular password managers are 1Password, LastPass, and Dashlane. Another layer of defense is to use two-factor authentication, whenever available. The idea behind this security measure is that to access your account you'll need both something you know (your password) and something you have (your smartphone). After entering your password, you'll be asked to enter a code, either received via text message or through an app on your phone. This greatly reduces the risk of unauthorized access to your accounts as simply knowing the password isn't enough. At the very least you should enable these security measures on your email accounts as that likely represents your most critical access point. If a hacker gets into your email, they can then go to all of your other accounts and click "forgot my password" at which point the password is reset and emailed to your compromised account.

 

Identity Theft Detection

  • Free Credit Reports - You are entitled to one free credit report per year from each of the three nationwide agencies. We recommend requesting only one of the agency reports at a time on a revolving four-month schedule. This will allow you to monitor your credit report throughout the year. Only use the official annualcreditreport.com website to do this. There are many other look-a-like sites that try trick you into paying for your credit report instead. Just remember that you will not need to submit any credit card information to get your free reports. They may try to sell you an add-on to get your credit score - just click “no thanks” and proceed to your report.
  • Free Credit Monitoring - There are many services that will monitor your credit for a monthly fee. In most cases, they aren’t providing anything you can’t get for free. One of the most popular services is Credit Karma which pulls credit report information and credit scores from TransUnion and Equifax. According to the company, they do not sell your information, but rather use the information obtained to target you with advertisements for credit cards, or other products that it believes are better for you than what you currently have. Occasionally it may propose something you actually want to consider, but in general, you should just ignore the advertisements while taking advantage of the free and easy credit monitoring and score reporting.
  • Free Initial Fraud Alert - If you don’t want to freeze your credit due to the inconvenience or nominal cost, the next best option is to setup a Fraud Alert with one of the three major agencies (they will notify the other two). A fraud alert makes it more difficult for a thief to open an account in your name because it requires the company who is extending credit to first verify your identity by contacting you. However, this is only a temporary measure, as it lasts for only 90 days unless you’ve already been a victim of identity theft or are active duty military.
     

How to Pick an Advisor (Quoted in Forbes)

How to Pick an Advisor (Quoted in Forbes)

As we begin the new year, a resolution for many is to get their finances in order. A good financial advisor can be the key to a successful plan. With so many holding themselves out as "advisors" of some sort, how do you narrow down the search and what should you be looking for?

Roger Ma, a contributor for Forbes just wrote an excellent article that covers what to look for regarding education, designations, fees, standard of care, and more. While he was writing the article, he reached out to me for my thoughts and ended up including a few quotes. The article is a worthwhile read for all and I'm honored to be included.

Inflation & Deflation Risk

Inflation & Deflation Risk

Throughout history two of the biggest long-term risks to investors have been inflation and deflation. Unlike the risks we examined in prior posts—personal goals, lifestyle considerations, planning assumptions, market volatility—investors have little control over their occurrence and limited tools to manage their risk.

Prolonged hyper-inflation is perhaps the most likely “long-term” risk to modern-day American investors. Such an event could severely erode the purchasing power of your savings for decades, possibly creating a big enough loss that recovery would not be possible within your lifetime. Over the past century, this very scenario has happened in many developed nations.

On the other side of the coin, severe and prolonged deflation may not seem like such a bad thing at first glance, since it would increase the real value of money. However, deflation is typically associated with unemployment and a struggling economy, which can further lead to significant geopolitical turmoil.

Prior to the 20th century, most of the world relied on hard-money, that is currency backed by silver and gold. During these times, a common cause of inflation and deflation was simply the changes in the supply of these precious metals. After the World War I and the Great Depression, nations abandoned the gold standard, established central banks, and issued fiat currency (not backed by silver and gold). With these changes, deflation has mostly disappeared, since central banks now have the ability to print money in order to drive up prices and combat deflationary pressures. As a result of the same ability, the risk of inflation has perhaps increased.

While stocks in the local market may suffer, at least initially from either inflation or deflation, a globally diversified stock portfolio actually provides some of the best long-term protection to both scenarios. In the more likely inflationary scenario, a portfolio that is tilted toward value stocks would be expected to perform even better as these companies tend to be more leveraged and benefit from the real value of their fixed-rate liabilities declining.

Bonds, particularly those with long durations, tend to get decimated by unexpected inflation. Conversely, long-term bonds perform quite well during deflationary environments. Given the belief that inflation is the more likely risk, the deflationary benefits of long-term bonds do not outweigh their inflationary risk. Most investors would be well-served to maintain a short to intermediate duration in their bond portfolio. An attractive alternative to longer-term nominal bonds is Treasury Inflation-Protected Securities (TIPS). TIPS are bonds issued by the US Treasury and backed by the full faith and credit of the US Government but pay a fixed real interest rate plus an adjustment for actual inflation. They allow investors to avoid the short-term volatility risks of stocks without assuming the purchasing power risk that comes with nominal bonds. Those in or approaching retirement should probably consider having a healthy allocation to TIPS.

Gold, often thought to be a natural inflation hedge, doesn’t actually perform that spectacularly during periods of prolonged inflation, and in fact does better during periods of deflation. When inflation is high, it appears that gold is just another commodity to measure inflation against so there’s little reason to assume it would perform better than other metals, grain, or oil. Conversely, when the public loses faith in the financial system, which is often associated with deflation, panic ensues and people flock to tangible gold bullion.

The takeaways for investors are relatively straight-forward. In the long-run a globally diversified stock portfolio, which represents ownership of thousands of companies around the world is one of the best hedges against macroeconomic events such as inflation and deflation. Still, most investors do not have time horizons long enough or risk tolerances high enough to be fully invested in stocks and therefore should invest a reasonable portion of their portfolio in bonds. As the proportion of bonds to stocks increase, the portfolio becomes more susceptible to unexpected inflation and this risk should be hedged by allocating at least the longer portion of the bond portfolio to TIPS. In all but a deflationary environment, gold is probably not going to be a productive investment in the long run. If deflation or geopolitical instability is of particular concern, then owning gold bullion may provide some protection, but it’s best to think of it as insurance rather than an investment.

Temporal Investment Risk

Temporal Investment Risk

From November 2007 through February 2009, the world stock market (represented by the MSCI All County World Index, net) lost 55% of its value. Every investor and financial advisor lost sleep during this period. However, the outcomes of investors varied widely, depending on their level of discipline and adherence to their long-term plan.

Some investors, spooked by the downturn and fearful for the future, bailed on their plan, swore off stocks, and put whatever money they had left into FDIC-insured bank accounts. Several years later, many of these same investors, after watching the market recover and then hit new highs while their cash earned almost nothing on the sidelines, plunged back into the stock market.

This extremely common investor behavior is a classic example of “buying high” and “selling low,” something we all know is a terrible investment strategy.

Mistiming the market, whether out of fear or speculation, is likely the most frequent and severe form of permanent capital loss investors experience. Even though most investors will eventually re-enter the market, they will have forever missed out on the outsized positive returns that typically follow bear markets.

Imagine a hypothetical investor who had $1 Million invested in the world stock market at the beginning of November 2007, but who sold near the bottom of the last financial crisis at the end of February 2009. At that point, his once $1 Million investment would be worth only $450,770. Five years later (end of February 2014), feeling confident that the markets have recovered and watching other people get rich while his money is earning nothing on the sidelines, he decides to reinvest his $450,770 back into the world stock market. At the end of 2015, his investment would be worth only $455,521.

Let’s imagine another hypothetical investor who also had $1 Million invested in the world stock market at the beginning of November 2007. Her investment would have also declined to $450,770 by the end of February 2009, but unlike the first investor, she had the fortitude to stay the course and remain invested even though it was very uncomfortable. At the end of 2015, her investment would be worth $1,113,640.

While the bear market in stocks was temporary, the first investor experienced a permanent loss of over $650,000 compared to the disciplined investor who stayed the course. Both investors experienced risk and both investors saw their investment fall by 55%, but only the investor who mistimed the market experienced a permanent capital loss.

The lesson here is not that every investor should be 100% invested in stocks, in fact, that is surely not the case. Instead, the lesson is that investors who need cash in the near-term or who have a very low tolerance for volatility should not invest in a stock-heavy portfolio in the first place. Conversely, an investor who doesn't need cash in the near-term should build a balanced portfolio, containing both global stocks and high-quality bonds, and then ignore market gyrations, stay the course, and not allow what are most likely temporary losses to become permanent losses.

Although it’s always possible that the global market won’t ever recover after a downturn, such a case resembles an Armageddon scenario where most assets (stocks or otherwise) might be worthless. Remember, stocks represent ownership in companies and as long as those companies have a future, the owners have a right to those future profits. As a result, I believe it’s best to be an optimist in this case, diversify your portfolio across the entire global market, and have faith that capitalism will continue to work in the long run. Although I believe it will all work out, I also believe it’ll be a bumpy ride so it’s important to maintain sufficient liquidity in “safe” assets for short and intermediate term needs and to build flexibility into your financial plan so that you’re still around for the long term. If you cannot get comfortable with this outlook and have faith in the long-term prospects of the global market, then you should seriously consider whether you have any business investing in stocks in the first place.

I often think of the temporal risk of stock market volatility as being akin to turbulence on an airplane. Some passengers find it uncomfortable, some will close their eyes and breathe deeply in order to stay calm, and some find it so terrifying they assume a plane crash is imminent and would prefer to jump out of the plane before it gets worse. On the other hand, the pilots and well-educated frequent fliers know that turbulence is just a normal part of flying through the air at 500 miles per hour and does not indicate that the plane is going to crash. For those who nevertheless find it too unnerving, the alternative option is ground transportation. While you won’t experience any turbulence, you’re far more likely to get in an accident and unless your destination is nearby, the journey will take 10 times longer, assuming your time horizon is even long enough to make it there at all.

The Risk of Incorrect Return Assumptions

The Risk of Incorrect Return Assumptions

"It is better to be roughly right than precisely wrong."
-John Maynard Keynes

Historically, the S&P 500, a common benchmark for the US stock market has returned approximately 10% annualized (1926-2015). After accounting for inflation (CPI) over the same period, the real return of the S&P 500 was ~7%. Over the same time period, US bonds (represented by Five-Year US Treasury Notes) returned approximately 5% before inflation and ~2% after.

Determining the correct return assumptions to use in a forward-looking financial plan is impossible. Without knowing the future, we’re required to make a [hopefully educated] guess. One of the easiest ways to do this is to use historical returns, such as those noted above, which is precisely what many online calculators and financial advisors do. After all, it’s simple and defensible. Unfortunately, it may also be overly optimistic and could result in running out of money long before your financial plan projected. This is only truer when you realize that simply using historical market returns doesn't account for the costs of actually implementing an investment plan, such as the advisor’s own fee.

Some might argue that the investments they choose will outperform, thus making up for any fees, and that by performing a Monte Carlo Analysis (a stress test that models thousands of random scenarios) they can properly simulate the uncertainty of future returns. Both arguments are faulty. First, study after study has illustrated the difficulty and unlikelihood or persistently outperforming appropriate benchmarks. Second, while a Monte Carlo simulation is incredibly useful for modeling sequence of return risk and the probability of unfavorable outcomes, one of the primary assumptions driving the simulation is the average annual return. If the average return assumption is inappropriately optimistic, all the results will be upwardly biased.

If it’s dangerously optimistic to use historical return assumptions in forward-looking financial plans, what are we to do? Most importantly, we need to give up our desire for precision. The world of finance is filled with mathematics and vast data sets, which often gives the false impression that we can engineer plans and portfolios with the same level of precision that goes into designing bridges. However, unlike gravity, market assumptions are not a constant. As a result, we should formulate reasonable but conservative assumptions, build flexibility into our plans, and be willing to adapt along the way.

Models that attempt to calculate the expected return of stock markets are very noisy and imprecise as there are so many factors to account for, but many indicate that future stock returns are expected to be lower than they have been historically. How much lower is up for debate and also depends on the time period considered. The important takeaway is simply that the historical figure of 10% (7% after inflation) seems too high by almost all accounts.

Models that predict future returns for high-quality bonds tend to be less noisy than stocks as the future interest payments are known (barring any default). As a result, a relatively simple and historically accurate measure for high-quality bonds has simply been to look at the current yield-to-maturity. As of 12/31/2015, the yield of Five-Year US Treasuries was 1.76% and the yield for Thirty-Year US Treasuries was 3.01%. While it may be reasonable to assume that bond yields will eventually increase toward historical levels, the reality, at least for the short and intermediate term, appears to be that bonds also have an expected return several percentage points lower than the historical figure of 5%.

Any financial plan that uses historical returns as a direct proxy for future returns (which based on discussions with colleagues appears to be many) has significant hidden risks. While your assumptions will have no effect on the actual returns delivered by the market, they will impact many other aspects of your financial plan including how much you need to save and how much you can spend. Using more conservative "expected” returns instead of optimistic historical returns reduces the likelihood that you’ll need to work longer or spend less than you planned for. If it turns out that you estimated too low then you’ll end up with more money than you expected and have greater flexibility in the future.