Wealth Clarity Blog

This  may sound sacrilegious coming from the president of a company that provides wealth management services.

However, it may ring true for you, for any number or reasons:

1. Everyone seems to be a wealth manager. The term “wealth manager” has been terribly overused, causing confusion about what it means and what it doesn’t–and who one is and who isn’t.
2. Financial advice = Investment advice. Your experience working with financial advisors may have been primarily through a retail brokerage, which offers purely financial advice. It may be unclear what value is offered by the broadened portfolio of advice and service that wealth management provides.
3. Too many cooks in the kitchen. You enjoy coordinating your various advisory relationships and investments. Why add another?
4. Lack of Need: There is a perceived–or real–lack of need for wealth advisory services at this time of your life.

Recently, I was having a discussion with a wealth creator who was struggling with these issues.  He was frustrated with the brokerage model of advice but he was having a hard time determining whether he needed a wealth management-style solution.

Here’s what he wanted:

• an “a la carte” advisory solution, one where he could choose the services he wanted and opt out of others
• an investment-only orientation and the freedom to handle other financial advisory services himself
• the benefits of wealth management–e.g. objectivity, customized solutions, integrated advice and reduced conflicts of interest, etc.–but without the relationship
• to receive custom services but pay based on a discount brokerage fee structure.

Those are not uncommon preferences for wealth creators, especially those new to wealth. If this sounds familiar to you, I am going to let you off the hook:

Just because you’re a wealth creator doesn’t mean you need a wealth manager.

Locking into a relationship with a wealth manager isn’t always the right solution. And it could come at the wrong time. Like a personal relationship, it’s better to stay single if you feel the relationship or timing isn’t right. Better to do that than get married and have it end in divorce several years later.

The same is true for wealth management: If you don’t seek a more substantial relationship, you shouldn’t get into one. Trying to covert an a la carte advisory relationship into something it wasn’t designed for can be a dead-end proposition. It can end up in “divorce.”

One thing I haven’t mentioned yet is this:  You undoubtedly receive regular messages from the financial services industry telling why you need their help and their model. They send these messages out broadly, without accounting for whether their model is really right for you. Financial services firms make their case constantly, without knowing anything about yours.

So some people believe they don’t need a wealth manager because they’re not familiar with the value. Others truly don’t need, or aren’t well matched, with the wealth management model.

But my point is this: Just because you have wealth doesn’t mean you need a wealth manager.

No matter who you are and what your situation is, it’s important that you get clear on your needs first before entering into an advisory relationship with anybody. And that includes a wealth manager.

I am a fan of country music.

The big draw for me is that country songs generally tell a story.  In fact, I believe this is the reason why country music is so popular, crossing over into mainstream pop and other music genres.  And let’s face it, everyone likes a good story.

The problem is that too many real-life stories don’t get told–or,  maybe better stated, stop being told.

I am finding more frequently that many wealth creators are quick to limit their life story, those specific desires and dreams, until some future event occurs that will magically free them to continue on.

One particular country song by Jamey Johnson, titled “In Color,” touches on this idea.  It tells the story of how life is lived in color, and not in shades of gray, or black and white.

Using snapshots as the example, the song attempts to express that there are really two stories for each life experience:  the static one we see in a black and white photo, and the vivid, colorful, passion-filled one that really embodies the story behind the picture.

Your Life Story

Put in the context of wealth creators, there are very specific, in-living-color plans, dreams, and hopes for your life.  They are things you think about; maybe not often, and maybe only in those quiet moments on the plane, driving home from work or in the solitude of a family trip with the kids asleep in the backseat.  But they are there and they are in color.

This was true of a woman I met in Oregon recently, who shared with me the clear five-year vision for her life.  Unfortunately, she owned three real estate properties that didn’t fit into that vision, and in fact, they were blocking her from pursuing the life she wanted.

I asked her, “What are you doing today to have confidence that your five-year vision will become a reality?”  (This process was discussed in a previous entry.)

Answer: She was going to wait for the real estate market to recover, potentially 2 – 3 years, before pursuing her dreams.

What if the real estate market doesn’t come back?

What if this is the new normal for the real estate market?

What if prices continue to decline?

And, isn’t everyone else thinking the same thing i.e. let’s plan to sell our real estate when prices move higher?

She was faced with several choices:

• Sell the properties at a loss and move quickly towards her future vision
• Sell one of the properties now and set a timetable for selling the others during the next eighteen months
• Delay her dream while waiting for the markets to recover

Getting a nudge to start seeking information from a local real estate broker allowed for new alternatives and opportunities to surface, and gave her a sense of excitement.

The decision about what to do would become clearer once she started moving toward her goal.

It’s easy to think about all the reasons why we shouldn’t do something; I believe most people are wired to think about things this way.  I surely don’t want to minimize the benefits of waiting, patience, and timing—all key attributes to a successful strategy.

However, in many cases, action is the missing ingredient in achieving the life you desire.

Is it time to take action?

In my last entry, “Home Mortgage or No Mortgage,” I discussed some of the common strategies for using mortgage financing, and the four keys to smart debt decision-making.

There is one additional key that makes sense to add: 

            Run the numbers before you refinance.

This was important to a recent client case that involved a 5/1 adjustable rate mortgage (ARM).  This type of loan structure has been very popular over the past decade because of the generally low entry level interest rate (fixed for the first 5 years), which converts to a variable interest rate based on an index (e.g. one-year Treasury bills), for the remaining term of the loan. 

One of the risks of this product is the following: Depending on when the initial fixed rate period ends, you might face variable interest rates that are substantially higher than when you started.  With the real possibility of higher interest rates in the future, partially caused by fiscal and monetary stimulus, refinancing now seemed to make sense for my client. 

Fixed-Rate Term Ends

My client (call him Steve) had reached the five-year mark back in April, which stopped the fixed rate of 4.5 percent (historically a wonderful interest rate).  Interestingly, because rates had dropped significantly the past several years, the first-year adjustment reduced the rate even further to 3.5 percent, and locked that in for another year.    

Further, he was a quick payer, and wanted to pay-down or pay-off the principal balance quickly, possibly in 10 – 15 years. 

Dilemma:  Refinance or Not?

The choice was to either (1) refinance to a new mortgage with an interest rate of roughly 5 percent, or (2) keep the low one-year rate (3.5 percent) and take his chances on interest rates rising in the future.

Surprisingly, the standard loan document (i.e. Fannie Mae) held some clues to the outcome:  namely the common provisions related to ARM’s.

• There is a ceiling on how high the rate can rise.  In Steve’s case it was 9.5 percent. 
• There is a cap on how much the rate can adjust each year.  Steve’s loan document said two percent. 
• At each adjustment date the loan is recast.  (Note:  Recasting a loan means that you calculate the new payment by using the remaining balance and years to maturity (in this case 25 years), and the new interest rate, and solve for the payment.  It is somewhat akin to refinancing but without the cost and associated paperwork.)

15-Year Mortgage Alternative

This type of loan structure matched Steve’s objective of paying off the mortgage in about 15 years and suggested a monthly payment of about $3,000.

When comparing the 15-year mortgage to the ARM Steve currently had, and considering the maximum interest rate on the ARM of 9.5 percent, the calculated monthly payments of both alternatives were about the same.  

The benefits of running the numbers:

• Steve was able to avoid the cost and hassle of going through a refinance but still meet his objectives of shortening the loan term and defusing the perceived interest rate risk.
• He was able to create his own 15-year mortgage by making an increased payment on his ARM equal to the difference between his current ARM and the 15-year mortgage payment.    
• Because the ARM loan is recast (see note above) each year, these higher monthly ARM payments actually have the affect of paying off the mortgage faster than 15 years. 
• Steve can make additional larger principal payments throughout the year, reducing the outstanding balance even faster, and will still be reflected in the payment calculation at the time of loan recasting.
• If interest rates stay lower and don’t rise, the rate on the ARM is lower than the 15-year mortgage alternative, saving Steve money.

Having mortgage debt on a personal residence is an interesting paradox for many wealth creators.  No matter how much risk you might currently be exposed to via business or investments, the home, and mortgage financing, create a tension that is caused by: 

• The family home is a naturally supercharged emotional topic
• The differences in how each person was raised and what role money, and specifically debt, played in your history
• Your investment experience and comfort with debt 

3 common strategies for debt 

In general, wealth creators fall into three camps as it relates to having a home mortgage.  

1. Debt free:  These individuals want to pay cash for their home—and generally other major purchases as well. 
2. Quick payers:  They will use financing to purchase a home but will make large principal payments to shorten the life of the mortgage. They also tend to choose shorter-term mortgage products like 15 year mortgages. Note:  these people tend to struggle when an expensive home purchase or home development project is funded with debt, even if only for a short period of time.  The size of the debt balance fosters increased stress levels, ultimately becoming the impetus to rapidly reducing the outstanding balance.
3. Debt analyzer:  These people view home mortgage debt as a choice, in essence, an investment decision.  Because they have ability to be debt free (as is the case with most wealth creators), it really comes down to whether they believe their other investment assets will return more than the after-tax cost of the mortgage.   

What is the after-tax cost of a mortgage?  

This is most critical to the debt analyzer.  Because the interest paid on a home mortgage can potentially be an income tax deduction, the after-tax cost of the mortgage is generally a rate lower than the stated mortgage interest rate.       

For example, an individual with a 5% mortgage, in the 35% federal marginal income tax bracket, and able to utilize all of the mortgage deduction, would have roughly a 3.25% after-tax mortgage rate. 

 mortgage rate X (multiplied by) 1 minus the marginal income tax rate

This becomes the bogie or hurdle rate you could use to assess your mortgage decision. In other words, if you have investments that are returning more than the hurdle rate (3.25% in our example) you might decide to place a mortgage on the property. 

To the contrary, and applicable in this environment of very low cash returns, you might choose to take low yielding cash—essentially zero—and pay down the higher cost mortgage debt. 

            In both cases, it boils down to an investment allocation decision.

Four keys to smart mortgage decision-making 

1. Find a mortgage broker that is able to review various options, not just sell product.  This will require running scenarios and alternatives to make sure the debt solution is customized to your needs.  (I will be writing more about this shortly.) 
2. Understand what your emotional tolerance is for debt, and how it might differ from your spouse.  What you learned about money from your parents (your money history) will have a huge impact on your debt strategy.   
3. Know your payback plan.  If you are going to use debt financing for your home, explore the various strategies that will optimize your payback needs.  This may require the combination of various strategies, for example margin debt, line of credit, and traditional mortgage.  It will also require an understanding of what assets will be used for the planned principal payments. 
4. Be cognizant of the many specific tax considerations regarding mortgage financing; tax deduction phase-outs and debt balance limits to name a few. Make sure to review any mortgage with your CPA before you sign loan documents or take action. 

In my last entry, “Welcome to the New Normal”, I wrote about a teleconference featuring Bill Gross and Mohamed El-Erian of PIMCO, a leading global asset management firm. Their thesis is that, following 25 years of steady bull-market growth and a set of familiar assumptions, we are currently in transition to a “New Normal.”

Gross and El-Erian see the new economic norm as being characterized by:

• de-risking and de-leveraging
• re-regulation
• potential slight de-globalization
• a decrease in investment returns
• slower economic growth (possibly one half of what we have seen in the past 25 years)

All of this raises challenges for anyone with assets to protect and grow—to say nothing of maintaining successful businesses and steady employment.

I believe there are 5 key insights from this discussion that need to be considered as we look to the future: 

1. Government balance sheets can get over-leveraged just like individuals’ can.  More and more fiscal and monetary stimulus will be required to get the same result.  Mohamed El-Erian proposed that this was akin to a “sugar high.”  If that occurs, it is unclear what the source of economic growth will be going forward. It is a real possibility that the growing economies (i.e. China, Brazil, India) will over time replace the U.S. as the largest engine of global growth. This is very important for investors to consider.
2. Cost cutting has created much of the current profit growth, and with a few industry exceptions, revenues aren’t growing yet.  Companies need to re-address their business models and strategies in this new environment. They will need to change. This has major implications for all business owners.
3. With consumption historically accounting for roughly 70% of our economic growth, it is unclear whether consumer demand will return and in what form.  Unemployment is rising and unlikely to reverse quickly, which adds to the consumer relevance question. The implications are clear for businesses that depend on domestic consumer spending.
4. There remains a volatile journey ahead. There is widespread uneasiness about whether we will experience inflation or deflation; significant reduction in risk-taking; additional corporate defaults; a continuing unstable commercial real estate loan situation; and the impact of de-leveraging on banks.  Note: It is human nature during times of uncertainty to revert to what we know about the past versus asking what is needed and required in the future. It’s also true that this thinking can have profoundly negative consequences.  
5. The reserve currency status of the U.S. dollar is unclear.  Non-dollar denominated assets and other dollar hedge investments could gain in importance over time. All investors need to be aware of this.

This list is not exhaustive, but captures a few key issues investors will face in the near future.  As I have suggested before, the need for a trusted guide (or a “transformer,” as we like to call it) in your life will be critical to the type of journey you have and the outcomes you achieve. Now more than ever.

My entire career as a financial advisor has played out in the shadow of a bull market.  Take a look at the chart below. (Dow Jones Industrial Average 1982-2007)

The Dow rose from roughly 1000 at the start of my career in the 80’s to over 14,000 two years ago.  Sure, there were recessions and corrections along the way, but it is clear that wealth creation was consistently propelled forward by a very strong and unique set of financial and economic factors.  Those of you in your 40’s and early 50’s have experienced the same economic circumstances.

But, over the past eighteen to twenty-four months the world changed, arguably forever. 

Essentially, capitalism overdid it.

The greed of several large financial institutions, the increasing appetite by individual and institutional investors for more and more return without properly considering the risks involved, the lack of oversight mechanisms that could stop or even foresee the ultimate disaster at hand, and an economy built on consumer spending beyond our means.  These issues weren’t limited to the U.S., but instead impacted the world.  

This isn’t to suggest we’ll never wealth create again. But it does mean the rules have changed.  Wealth creation will require new thinking and a new skill set. We won’t be able to use the same assumptions we relied on the past twenty five years:  stable appreciation, double digit returns, and what many have referred to as the “Goldilocks Economy”–not too cold, not too hot, but just right.

So where do we stand now? 

That, of course, is the big question.  And there is a lot of confusion and uncertainty.  I recently got some insight into the current economic environment I’d like to pass along.

I was invited to join a teleconference hosted by PIMCO, a leading global asset management firm, and their well-known Co-CIO’s Bill Gross and Mohamed El-Erian. They may not be familiar names, but the financial community listens to them closely. 

Old Normal → Transitional Period → New Normal

The basic ideas of the PIMCO presentation were the following:

1) The economic world has changed.

2) There is a growing level of uncertainty about the direction of the global economy and the direction we are heading.

3) We are shifting to a period where returns will likely be lower and long term assumptions about portfolio allocations will continue to be challenged.

4) We have left the old world, but have not reached the new world.  We are in transition. 

The Old Normal was the period we’ve all experienced for the past 25 years:  The world’s economic growth as measured by nominal GDP (Gross Domestic Product without taking into consideration inflation) grew in the 6-8% range.  As Gross and El-Erian laid it out, this growth was possible because of:

• Declining interest rates (since 1982)
• Low inflation (since late 70’s)
• Increasing financial leverage
• Increasing financial innovation
• Decreasing regulation
• Increasing globalization

But now, Gross and El-Erian say, all of that is changing.  We are transitioning to a New Normal. 

What is the New Normal?

This current moment is a time when we’ll be seeing, and in some cases are seeing:

• De-risking and de-leveraging
• Re-regulation
• Possibly slight de-globalization
• Decreasing investment returns
• Slower economic growth (possibly one half of what we have seen in the past)

As Gross and El-Erian see it, several forces are driving this New Normal:

• Housing market:  Cheap financing and speculation are gone; home ownership is declining from a high of 70%; and unemployment in associated industries could linger for a while. 
• Savings rate:  We are moving from a period of high consumption and zero or negative savings to positive savings, and moving higher.
• Global forces:  The world’s growing concern about accepting our Treasury securities and currency in exchange for goods and services, and other parts of the world replacing the U.S. as the engine of consumption growth.

So what does all of this mean for any one of us individually – especially to people with assets to protect and grow?

There’s a lot to say.  I’ll take it on in my next blog post, “Adjusting to the New Normal.”

Your time is limited, so don’t waste it living someone else’s life. Don’t be trapped by dogma—which is living with the results of other people’s thinking. Don’t let the noise of other’s opinions drown out your own inner voice. And most important, have the courage to follow your heart and intuition. They somehow already know what you truly want to become. Everything else is secondary.  ~Steve Jobs

Whether you like Steve Jobs (or Apple Computer) isn’t the point. 

Jobs’s quote reminds me how often I let my inner voice get drowned out, or at least watered down, by the opinions and thinking of other people. 

Learning how to trust myself —really trust—myself is hard. 

Why?  Because it takes courage and self expression.  It requires a willingness to share a slice of who I am, to live my dream and not someone else’s, to not let fear get in the way.

Even writing this blog requires a new level of courage and transparency for me.  On the one hand, I am opening myself up to critique, but I also feel an incredible sense of fulfillment in following my intuition and inner voice and sharing my voice with friends, clients, and strangers.   

Whether you are creating wealth or pursuing other passions in your life, I hope you will do them in a way that expresses you and who you are. 

We can all take a lesson from artists who do this all the time. 

In fact, this past weekend I was strolling through an art fair on the streets of Santa Barbara.  I was drawn to some of the art, but more importantly, I caught myself observing the artists sitting in their booths, letting others see and experience their work, proud and confident in what they had created. 

Moving in a new direction, creating something new, or following the lead of your heart isn’t always easy or comfortable.

But, I believe that trusting in you is a skill that can be learned and honed with practice. 

After his much publicized liver transplant, I can’t help but suspect this quote now rings even truer for Steve Jobs.