Wisdom Worth Sharing

As 2009 winds down, I would like to share some wisdom with you from another writer. Frank Sonnenberg is not only a friend, but a marketing maven and strategic thinker. In my opinion, his post on “25 Thoughts for the New Year” has the rare quality of being pithy without being glib, and expresses insights that are wise and helpful, without being too sentimental.

• If you don’t pass your values onto your kids, someone else will.
• You’d think we’d learn something from watching a hamster run around on its wheel.
• Practice doesn’t make perfect if you’re doing it wrong.
• Paradise is not a place; it’s a state of mind.
• Fun shouldn’t be confused with happiness.
• A homeless person wasn’t at one time.
• If work isn’t fun, you’re not playing on the right team.
• Trying to be excellent at everything leads to mediocrity.
• Some people don’t communicate. They just take turns talking.
• Everyone was put on this earth for a good reason . . . what’s yours?
• When it comes to charity, some people stop at nothing.
• Trust takes a long times to develop, but can be destroyed in seconds.
• Anger is a loaded weapon . . . be careful where you point it.
• Lessons in life will be repeated until they are learned.
• Marrying for money is a high price to pay.
• A great start doesn’t always guarantee a great finish.
• It’s better to get called out swinging than called out on strikes.
• Just because it say’s “URGENT” doesn’t necessarily mean that it’s important.
• People often count their pennies yet squander their dollars.
• Half a sandwich shared with a hungry person is more nourishing than the whole.
• Helping people too much only makes them helpless.
• Those who serve arrogance as their main course will eat humble pie for dessert.
• Always give 110%. It’s the extra 10% that everyone remembers.
• We teach children to color inside the lines, and then expect adults to think outside the box.
• Live every day as if it were your last. One day it will be.

My plan for early 2010 is to begin a series of posts on lessons we all should have learned from the “Great Recession” and one of the biggest and sharpest stock market declines any of us have ever experienced. I hope to present these lessons in plain English, and with “real life” stories that you’ll be able to identify with. Ultimately, my goal is to help you to avoid the same mistakes again.

Oh, and if you’re wondering, my favorite thought on Frank Sonnenberg’s list is “Lessons in life will be repeated until they are learned.”

Health Care Reform, Part 2

In an earlier post, I highlighted a column discussing some details of proposed health care legislation.  As I said, it is a very complicated area.

One very important (and highly contentious) issue in health care reform is whether the health insurance industry needs more regulation and/or more competition, i.e. “a public option.”  For a special view of an insider, I recommend the July 10th episode of Bill Moyers Journal.  This TV program had an extended interview with Wendell Potter, who is the former head of Public Relations for CIGNA, one of the nation’s largest insurance companies.

In a change of heart, Potter decided to speak out against the insurance industry. Here is a salient quote from the program’s description.

Looking back over his long career, Potter sees an industry corrupted by Wall Street expectations and greed. According to Potter, insurers have every incentive to deny coverage — every dollar they don’t pay out to a claim is a dollar they can add to their profits, and Wall Street investors demand they pay out less every year.  Under these conditions, Potter says, “You don’t think about individual people.  You think about the numbers, and whether or not you’re going to meet Wall Street’s expectations.”

Conclusion

I am all in favor of corporations making a profit.  That judgment assumes that a competitive market exists and that consumers have real choice.  In general, if companies have an incentive to provide a better product or service, shareholders can prosper and consumers will benefit.

But there is very little competition in the health insurance marketplace.  If insurance companies have perverse incentives to deny coverage and to game the system, consumers are obviously harmed.  The insurance that you thought you had may be a costly illusion.

Watch the video or read the transcript, and decide for yourself.

Inspiration from Warren Buffett

There are many reasons why people listen to Warren Buffett.  Besides being the second richest American (right after Bill Gates of Microsoft), Buffett is widely considered the most respected (i.e. best) investor there has ever been.

But there are other compelling reasons for listening to him; simply put, he speaks in a way that anyone can understand.  It’s a Midwestern common sense, seasoned with well-earned and certainly, much deserved, confidence. He’s cheerful, loves what he does, and apparently cares very little about consumption.  He is extremely grateful for the opportunity he has had in the United States and the life that he has lived.  He has already given away billions and plans to give away still more to charitable foundations.

Buffett was a guest on the November 13th episode of the Charlie Rose TV show.  Unfortunately, only excerpts of that show are available for online viewing. Go to the Charlie Rose website and search for Warren Buffett. What you’ll find are his ideas on financial regulation, his reasons why he bought the Burlington Northern Santa Fe Railroad, and his assessment of the global economy. There is also a “Web Exclusive” interview.

A full written transcript is available here.

I’d like to focus on his basic optimism about the future of the United States, because in my opinion, you need three things to be a successful long-term investor.

• Faith in the future.
• Patience.
• Discipline.

Here are some relevant quotes from the November 13th program.

(Regarding consumer demand)  Well, it will come back eventually. … Our system will still work. … We talked last year about the patient, you know, being on the floor with a cardiac arrest … and we’re not out of the hospital yet.   But we will come out of the hospital.  This — the things that made America what it is have not disappeared, and they will — they will assert themselves with time.

The American economy will come back.  It won’t be tomorrow, and, you know, it won’t be exactly the same.  But in the end, we have not — we’ve not changed the American people in their capacity to innovate or their excitement about — about becoming more prosperous, and coming up with new ideas.  Businesses will be formed.  Businesses will expand.  But not much tomorrow.

If you look back a couple of hundred years, we’ve gotten where we are not because we’ve gotten smarter or not because we work harder.  We’ve got it because we found ways to unleash more of the human potential.   And what does that?  Well, a rule of law helps.  A market system helps.   Equality of opportunity helps.  All of these things that are still a fundamental part of the American system. As a matter of fact, the American system is now better than it was a couple of hundred years ago, because until the 19th Amendment, you know, we’ve had half the talent in the United States that wasn’t entitled to do much. So we’ve got a great system.  (Emphasis added.)

Well, I have everything I want in life, so there’s nothing to spend it on.  I mean, I could have 10 houses instead of one, would I be happier?  No way.  I could have 10 cars instead of, you know, two in the house.   I wouldn’t be happier.  You know, it would drive me crazy.  I could have a 400-foot boat, you know, and then I’ve got to have a crew of 50 or 60, and some of them (inaudible), sleeping together — I mean, who knows what would be going on. So I don’t — if I wanted to be a ship’s captain, you know, I’d have gone into a different profession.  I have everything in life I want.

I love working — I love working with the people I work with.   I love just viewing the human scene, but I mean, I have an ideal life.  I get to do what I want to do every day.  So, you know, and money can’t — can’t buy any more than that.

As I said earlier, you need three things to be a successful investor:

Faith in the future. Optimism is the only realistic attitude; you cannot be fearful and succeed as an investor.

Patience. Moving in and out of the market or among various investments does not accomplish anything.

Discipline. Do not be driven by headlines or events.  Ask not, “What’s working now?”  Ask, “What always works?”

I believe Warren Buffett to be instructive and inspirational on all three counts.

Health Care Reform, Part 1

I have shied away from a discussion of health care reform, because I felt that the issue is too complicated.  And once I’ve started down the road to try to make some sense of the debate, I’d probably have to make a full-time job of it – it would suck me right in.

And, in truth, the topics that interest me most are quite contentious.  Why is the United States the only developed country that does not provide universal health care?  How can we change the incentives of citizens and medical care providers so that we reduce costs and improve outcomes?  Do we have a health care system now, or is it a “sick care” industry?  Why are we not paying more attention to prevention?

I’m sure that very smart people are thinking and writing about these issues, but I have just not taken the time to identify them and sort everything out.

However, there is one columnist who is readily available and discusses some practical issues that are worth mentioning, and that is David Leonhardt.  His weekly column, Economic Scene, appears on Wednesdays in the New York Times. He is also a contributor to the Times Magazine on Sundays.  I’ve been a fan of his for a long time, and in a previous post I discussed an article he wrote on President Obama’s Economic Agenda.

Wednesday’s column, Falling Far Short of Reform, discusses some very practical issues reflected in the two different health-care bills currently working their way through the House of Representatives and the Senate.

If you’ve been following the health care debate and are interested in a sensible discussion, I can recommend this column.  And if you’ve not been following the debate, but would like to catch up on what all the hoopla has been about, I can still recommend this column.

Request

I would love to hear from others on recommendations of articles that appeal to them.  I’m specifically not interested in articles that rail against “a government takeover of health care” or call efforts at reform “socialized medicine.”  I am interested in articles that discuss what works in improving health care and/or in reducing costs – priorities, both, for the majority of Americans, I should think.

More About Ric Edelman

When in my last post, I criticized some of Ric Edelman’s practices and fees, I felt a bit queasy.  Was I being unfair?

I reached my conclusions by reading the handout material and by what he said in a seminar.  I also studied his web site, which disclosed his fees.  But I did not have direct access to a client’s portfolio, so I felt somewhat tentative in my judgments.  But today’s post by Allan Roth An Interview with Ric Edelman – Is High Cost Indexing an Oxymoron? confirmed my suspicions.

Roth analyzed an Edeleman client’s portfolio, and he also spoke to Edeleman. Roth reached the same conclusions I had about the high fees, and he also questioned Edelman’s recommendation of not paying off a mortgage.  Finally he confirmed my belief that Edelman was not paying attention to asset location, since he found the same allocations in the IRA accounts as in the client’s taxable accounts.

But enough criticism.  The rest of this post is about Edelman’s book The Lies About Money, which I can recommend.  In the first two chapters he persuasively lays out the case for diversification and for not trying to time the market.  This is a very important message which many investors still do not get.  Then he explains the advantages of mutual funds.

But it in his fourth chapter, The Demise of the Retail Mutual Fund Industry, that he shines.  He essentially demolishes (active) retail mutual funds.  For starters, he discusses the frequent manager changes, the costs of active management, and the dangers of style drift.  And this is just the beginning; he discusses 25 reasons why you should not use a typical (active) retail mutual fund.

Not satisfied with that, Edelman actually put together A Mutual Fund Scandal Timeline outlining the abuses that have been alleged or proven from 2003 to 2007.  It takes him a “mere” 40 pages to summarize the questionnable practices and allegations of abuse.  If that is not enough to make you question whether your mutual fund or stockbroker is actually your friend, then nothing will.  So buy the book or get it out of the library simply for Chapter 4.

Conclusion

The financial services business is fraught with conflicts of interest, high fees, misleading ads, and general confusion for the typical investor.  Sorting through this mess is not easy.  As William Bernstein says, “Both mutual fund companies and brokerage houses know more ways than you can count of fleecing you without your knowing it.”

To be continued.

Edelman Financial: Bigger Isn’t Necessarily Better

Because Edelman Financial Services is opening six offices in the New York/ New Jersey area, I accepted an invitation to attend a seminar by Ric Edelman, the well-known author, radio host and investment manager.  The talk was held at the luxurious Hilton Hotel in nearby Short Hills last week.

Here is my review.  As a public speaker, I gave him an A+.  He was entertaining and informative, and offered a very clear piece of advice: Buy-and-hold a diversified portfolio of low-cost institutional mutual funds. Certainly, I would recommend his firm over a broker from Ameriprise, Smith Barney, Merrill Lynch, etc.

Still, I would only give him a B to a B+ as an investment manager.  I realize that it takes a certain amount of chutzpah (nerve) for a solo practitioner like me to judge someone whose firm manages approximately $4 billion and has thousands of clients – my goodness, Barron’s rated him the No. 1 independent financial advisor in 2009 – but I believe it is my responsibility to give you my opinion.  Read on, and see if you agree with my assessment.

Points of Agreement

First of all, let me state the areas of agreement.  I think his basic message is absolutely correct.  Most individual investors have so many misconceptions and make so many mistakes that their results are generally terrible.  Edelman provides a useful service in summarizing the theory, evidence, and his personal experience to educate the public on what really works.  He correctly points out that investing in safe instruments such as CDs is just about guaranteed to cause penury in retirement, because the “safe” investments don’t keep up with inflation, especially after taxes are considered.

He convincingly explains in great detail the necessity for wide diversification, proper asset allocation and rebalancing.  He also shows that listening to the media is bad for your investment results.  Good for him!

Like so many good investment managers, Edelman recommends having a long-term strategy and the importance of being invested at all times.  He was quite convincing in explaining how past performance is no guarantee of future results.  His down-to-earth “toaster” comparison was so good that I plan to use it myself when the occasion arrives.

He also explained in detail why retail mutual funds are just way too expensive.  These are not just opinions, but are based on facts.

He graphically illustrated the high cost of being “out of the market” for even a short time.  According to the data, provided by Standard & Poor’s, the average yearly return of the S&P 500 from 1994 to 2008 was 6.5% per year, if you were invested all 3,827 days.  If you missed the 10 best days, that’s right only 10 days, your return was actually 0%.  What a convincing comparison for a buy-and-hold all-the-time strategy.

So in general, I applaud Ric Edelman for being on the right track.

Where we disagree

My first criticism is that, although Edelman emphasized the long term cost that inflation inflicts on client portfolios, pointing out that over the long term inflation has been 3.2%, he says that it is “too early” to be concerned about inflation. He is “monitoring the situation” and will change his strategy when he thinks it is appropriate. In my opinion, this is a very strange approach for someone who believes that you cannot forecast the future.

Since markets react very quickly to new information, I worry that Edelman will not be able to change his strategy at just the right time. Why try to “time the market” by saying that inflation is not a concern now? To paraphrase an old Wall Street saying, “No one rings a bell to let you know when you should be worried about inflation.”

The question and answer portion of the seminar revealed a position that I take exception to.  Edelman suggests that paying off a mortgage quickly is a mistake, because clients can invest the money for a higher return.  While this is a controversial area, I believe that it is comparing apples to oranges, because mortgage debt is a certain obligation, while investment gains are variable.  As with many personal financial issues, the right answer is “it depends.”  There are too many variables in one individual’s life to hand out one-size-fits-all investment advice.  For some people, paying off a mortgage is the right thing to do, depending on their tax situation and their risk tolerance.  The peace of mind a debt-free retirement provides is valuable to some people who are no longer trying to maximize returns.

And, frankly, I am concerned that he is recommending something that will give him more assets to manage and therefore increase his fees, without mentioning the conflict of interest.

When I decided to look up Ric Edelman’s previous books, including The Truth About Money and The Lies About Money, I was surprised to see reviewers on Amazon.com chastising him for his previous rejection of index funds.  While Edelman now (appropriately) denounces actively managed retail mutual funds (because they are a rip off to investors with their high fees and hidden expenses), it’s unconscionable that it took him such a long time to realize that. 

It appears that Edelman had been attacking the notion of index funds for years.  Interestingly, he now follows a correct passive approach to investing, which is very similar to index investing.  He just isn’t willing to admit his conversion (or his past mistakes, for that matter).

In addition, I have read that Edelman doesn’t require that his advisors be Certified Financial Planners.  If true, this is a very serious shortcoming. Real financial planners address more than just investments, and while the CFP certification is not a panacea, it does indicate the seriousness to master your craft. More than passing a 10-hour test, the continuing education requirements are invaluable.

Fees and Value

Edelman Financial Services uses low-cost institutional mutual funds and ETFs, as do I.  The firm charges annual management fees of 2% on the first $150,000, 1.65% on the next $250,000, 1.25% on the next $350,000, 1% on the next $250,000, etc.  There is no additional cost for buying and selling mutual funds, which is a plus.  Another good thing is that they are willing to take on clients with modest amounts to invest, as low as $50,000.

However, while all-in costs are less than you might pay a typical stockbroker, I believe that for individuals with as little as $250,000 or $300,000 to invest, his fees are higher than those of a typical independent fee-only financial planner.

An investor with $500,000 will have to pay Edelman $8,375 per year as compared to a typical $5,000 fee to a smaller financial planning firm. An investor with $1,000,000 will pay Edelman $14,000 per year as compared to $10,000 for most boutique firms.  And many of the fee-only planning firms use the same low-cost institutional mutual funds and ETFs that Edelman does.

Conclusion

I have received mixed reviews from other financial planners regarding Edelman Financial Services.  Some call his portfolios cookie-cutter, which may or may not be a fair description.  Others have pointed out that there is very little attention paid to asset location, as compared to asset allocation. One financial planner told me that there was no effort to do tax loss harvesting, but another one said “it depends” on the client.  These are issues that many investors will not even be aware of, but the answers can influence after-tax returns.

Certainly Edelman’s services are better than working with a typical stockbroker, who might put you into a bunch of expensive retail mutual funds or sell you a variable annuity.

However, investors should understand that they are paying a premium for a celebrity’s name on the door.  And something a potential client should definitely ask is how much financial planning will be done, in addition to investment management.  The answer to that may also be “it depends.”

For a second opinion, and to help do a cost comparison, use “Find an Advisor” at the National Association of Personal Financial Advisors’ (NAPFA) web site and interview other financial advisors.

Evidence-based Investing, Part Two

“When you look at the results on an after-tax, after-fee basis over reasonably long periods of time, there’s almost no chance that you end up beating an index fund. The odds…are 100 to 1.” – David Swensen.

Passive investing, sometimes called index investing, is, as the name suggests, the exact opposite of active management of a portfolio.  The latter attempts to “beat the market” by various means, including selecting securities that are (hopefully) underpriced, trading holdings, and sometimes, by getting out of (and eventually back into) the market entirely.  Passive investing, on the other hand, employs a consistent strategy of buy and hold.  The $64 billion (adjusted for inflation) question is which approach is better?

The evidence proves that active fund managers actually under-perform their relevant benchmarks.  Specifically, over a 10-year period, approximately 75% to 80% of all mutual funds fail to “beat the market.” Attempting to be one of the 20% to 25% who succeed is known as “playing the loser’s game.”

And the longer the period under consideration, the worse the odds become. A study published in 2008 found that from 1975 to 2006 only one in 166 mutual funds outperformed the stock market.  That was 0.6% of the total. 99.4% failed to outperform the market.

Keep in mind that mutual funds that use active management charge more in management fees.  First of all, they have higher operating expenses, because they spend more money on research and on active trading.  And by claiming that they can outperform their peers, they can charge more, so they do.  But as an investor, you start with a handicap if the mutual fund you are using has higher expenses.

I don’t doubt that some of the active managers sincerely believe that they can deliver on their promises.  But logically, and statistics proves this out, they can’t all be above average.  So buyer beware.

Another consideration is that active management generates short-term profits, which are more highly taxed than long-term capital gains.  So, even some investment managers who think they can add value by actively managing a portfolio decline to manage a taxable account.  They believe that, after taxes, an actively managed portfolio will always underperform a passively managed portfolio.

Given the stakes in determining whether you can ever “beat the market” it’s not surprising that so much has been written on the subject.  And since we are talking about 50 years of research, it isn’t easy to summarize the evidence.  So I’ve chosen one (somewhat facetiously titled) article, How to Beat the Market in Three Easy Steps, which I think is well-written and which will give you a flavor for the logic and practical implications of passive investing.

Here are some quotes from the article by Karl N. Huish, Esq., CFP®

To be an active investor, you must say, ‘I am right, and most of you are wrong.’

One huge challenge is separating talent from luck.  Wall Street is filled (and overflowing) with bright, capable fund managers, with gold-plated MBAs and Ph.Ds in economics, mathematics, computer science and physics.  IQ tests and education resumes will not be enough to distinguish the true geniuses from the merely intelligent.  Most of these funds are advertised by top-flight marketing companies.  How do we dis­tinguish the sheep from the goats?

Can past performance help us?  This is the miscon­ception upon which many investors stumble.  It turns out that [surprise!] past performance is not indicative of future performance. A recent large study (3,700 public and corporate plans, representing $737 bil­lion invested) found that manager hiring and firing decisions made by retirement plans, endowments and foundations was a complete waste of money and time: the fund managers performed better than the market before being hired, but underperformed the market af­ter hiring.  In other words, their market-beating per­formance was luck, not skill.

David Swensen is the manager of the Yale University Endowment, which is the highest performing endowment fund over the past 20 years.  To many he is considered the greatest current institutional investor – a modern mastermind. … He stated the fol­lowing:

‘When you look at the results on an after-tax, after-fee basis over reasonably long periods of time, there’s al­most no chance that you end up beating an index fund. The odds…are 100 to 1.’

Mr. Swensen – the best in the business – isn’t very con­fident about beating the market rate of return, as re­flected in an index fund.  How confident are you that you or your advisor can identify those active funds that will – taking all costs into consideration – outperform the passive alternatives?

What Does the Research Say?

Well, what about the data?  It turns out that David Sw­ensen is just about right.  In a 2008 published study, Professors Laurent Barras, Olivier Scaillet, and Russ Wermers used the most advanced statistical testing in science (using tests from computational biology and astronomy), to drill down into the performance of active mutual funds for a 32-year period, from 1975- 2006.  The researchers found that, on a pre-expense basis, 9.6% of mutual fund managers showed genuine market-beating ability. But after expenses were de­ducted only 0.6% of fund managers outperformed the market.”

Conclusion

My Investment Philosophy is based on the belief that a passive approach is the best way to invest my clients’ money.  I follow that same strategy for my own portfolio, as well.   I am not convinced, however, that using simple index funds is the best strategy, largely because of their trading inefficiencies.

But that’s the topic of another post.

Evidence-based Investing, Part One

Just as evidence-based medical care utilizes fact-based best practices in treating illness and disease, it is possible to use research from the academic community in making investment decisions.  Evidence-based investing is really a bridge between academic finance research and practical portfolio management. That’s a mouthful, but what it comes down to is attempting to maximize potential returns, while limiting risks and avoiding common mistakes.

It all started in 1952 when Harry Markowitz published a seminal paper called Portfolio Selection.  He wrote about risk and return and the value of diversification. It may seem commonplace now, but at the time it was groundbreaking.

Markowitz simply said that investors should be more concerned with the characteristics of their portfolio than in choosing individual investments.  He concluded that while investors cannot control the “risk” of individual stocks, they can control the variability (risk) of an entire portfolio with proper diversification.  Of course he proved his point with a lot of mathematics and statistical analysis.  But underneath it was an elegant exposition of a simple concept that your grandmother not only understood, but probably often quoted – don’t put all your eggs in one basket.

Academic research has ballooned since the 1950s.  There have been thousands of studies trying to explain how investors do (and should) behave. The old rule of “publish or perish” certainly applies to professors of Economics and Finance, yet many of the papers were published in journals that very few investors even know existed, such as the Journal of Finance, The Journal of Financial Economics, and the Journal of Portfolio Management.

Harry Markowitz earned a Nobel Prize in 1990 along with Merton Miller, and William F. Sharpe for their work in “Financial Economics.”   The body of work developed by them and others has become known as Modern Portfolio Theory (MPT).  This approach is not foolproof, and the advice is based on models, not truth written in stone.  And, of course, MPT can be misinterpreted and used incorrectly, sometimes (unfortunately) to sell questionable investment products.  Nevertheless, the practical implications of MPT – focusing on risk and return – are extremely valuable for investors.

You really don’t have to understand all of the details of terms such as the Capital Asset Pricing Model, Alpha, Beta, the Sharpe Ratio, and Portfolio Optimization; there’s no test, after all.  But you should be aware of the major conclusions and practical applications.

One major topic previously discussed in this blog is the difference between active and passive management of investments.  This dichotomy comes straight out of the research that academic economists have performed.

Similarly, you don’t have to read the research of Eugene Fama and Ken French, nor do you need to understand the Fama-French three-factor model, but it would certainly be helpful if your investment manager did.

Actually, Fama and French are quite accessible on their blog.  If you check out the Fama/French Forum, which I highly recommend, you will notice a logo that says “hosted by Dimensional.”

Dimensional Fund Advisors (DFA) is a company best known for applying academic research to portfolio management.  DFA has been referred to as “the best mutual fund company you’ve never heard of.”

To be continued.

Estate Planning for Procrastinators, Part 2

“The most common excuse parents give for putting off writing a will is trying to decide who will raise the children.” – Ric Edelman.

An earlier post discussed some of the psychological and practical reasons why people put off writing a will.  For young parents, the biggest challenge, and the main reason for procrastinating and not writing a will, may be the task of choosing a guardian or guardians for their children.

Since it is such a prevalent challenge, you can find many articles on the Internet addressing the issue of choosing a guardian.  Actually if you enter “choosing a guardian” in Google, your search will yield 4.7 million hits.  One article I found particularly useful is Why Parents Procrastinate in Writing Their Will . . . and Nine Questions to Help You Overcome It  from Ric Edelman’s newsletter Inside Personal Finance.

The bottom line is that since “deciding on a guardian and how to provide for their kids’ financial needs is difficult …a lot of parents do the worst thing of all: nothing. This means the decision, if one becomes necessary, will be made by a judge or county official.”

To avoid this outcome, that article sets out a procedure for young parents to follow.

“Sit down with pen and paper and answer the following questions, providing as much detail as possible.   If you’re deciding as a couple, answer the questions separately and then compare your answers.  Some of the questions will take some thought, so you might not be able to answer them right away.  That’s okay.  Answer what you can at the first sitting and set a deadline to finish the rest.”

There is not space to repeat the 9 questions, which are quite good, so please read the entire article.  I hope that mulling over this issue will empower you to move forward.  Consulting an experienced estate planning attorney should be high on your agenda of things to do before the end of the year, if not sooner.

Although the article is recommended as a good place to start, here are some additional thoughts from two other articles.

From Guardianship for Your Children 

If you’re having a hard time choosing someone, take some time to talk with the person you’re considering. One or more of your candidates may not be willing or able to accept the responsibility, or their feelings about acting as guardian may help you decide.

If You and the Other Parent Can’t Agree

When you and your child’s other parent make your wills, you should name the same person as personal guardian. If you don’t agree on whom to name, there could be a court fight if both of you die while the child is still a minor. Faced with conflicting wishes, a judge would have to make a choice based on the evidence of what’s in the best interests of your child.

Writing a Letter of Explanation

Leaving a written explanation may be important if you think that a judge could have reason to question your choice for personal guardian.

Judges are required to act in the child’s best interests, so in your letter explain why your choice is best for your child.

If Your Child’s Other Parent Is Your Same-Sex Partner

If you coparent your children with a same-sex partner, you will probably want to name your partner as the personal guardian of your children.  Because some courts will be unfamiliar with your family structure, consider writing a letter to fully explain to the court why it’s important for your partner to be your children’s personal guardian.

From The Importance of Writing a Will

After you’ve made the decision, choose an alternate guardian to include in your will.  He or she will take care of your child in the event that your primary choice is unable to do the job.

If you have a life insurance policy, 401k, or IRA account, be aware that … the beneficiary forms accompanying these documents overrule wills.  The funds in these accounts will be distributed to whomever you name—regardless of whom you specify in your will.  You’ll need to double check the names on these accounts and make changes to match the names with those you dictate in your will.

Conclusion

Why Parents Procrastinate in Writing Their Will . . . and Nine Questions to Help You Overcome It concludes with

“Above all, remember: If you fail to make a choice, you are leaving the decision up to the probate court, where all of the people you considered above (and possibly others) will fight over the decision, with the judge acting as referee.  It’s a difficult task for a judge, since he or she has never met you and will have no idea what you would have wanted.

If the thought of making a choice sends you into a panic, remember that you can always change your mind.  I’ve seen clients change their minds every other year, as their family circumstances change.  If your parents seem the best option today, pick them.  In a few years, when they’re older or have become ill, you can change your mind. Or maybe your choice marries someone you don’t like, or suffers a setback of some kind.  No problem.  Just base your decision on the facts as they are today, and rest assured that as times change and people change, your mind can change, as well.”

Estate Planning Terms You Should Know

As I discussed in the last post, individuals tend to delay estate planning for many reasons; no doubt one of those is the daunting lingo and complicated jargon.  Truthfully, it is confusing the first time you hear these words and concepts explained. While it’s not quite a foreign language, it sure feels like it. 

But don’t be intimidated; don’t be deterred.  A basic understanding of a few estate planning concepts and terms will help you feel less reluctant to move forward and complete an important aspect of financial planning.

1. Will.  A will directs where and how you want your estate property distributed when you die, and appoints the individual(s) who will take care of your children.  Without a will, the state will decide, according to statute. A will does not control those properties with specific beneficiary designations such as life insurance benefits, retirement accounts, and trust assets.

2. Probate.  The court process that ensures that the portion of an estate passed by a will is properly settled. The court establishes the authenticity of the will (if any), appoints a personal representative or administrator, identifies heirs and creditors, directs payment of debts and taxes, and oversees distributions of the assets according to the will, or according to state law in the absence of a will.

3. Executor/ Executrix.  The person (male or female) who administers your final estate, as appointed by you in your will.  The politically correct, modern terminology is a “personal representative,” which removes any reference to the sex of the person.

4. Guardian.  A person designated by court appointment and given the responsibility of managing the personal affairs of a minor child or a person who is legally incompetent to manage his or her own affairs.

5. Advanced directives.  The two key advanced directives are a living will and a medical power of attorney.  In the event you become permanently incapacitated and unable to communicate, a living will is your expression of what life-sustaining medical treatment you want or don’t want employed on your behalf.  Though not always honored, with a medical power of attorney you give a third party, such as a spouse or an adult child, the power to make medical decisions on your behalf in the event you are incapacitated and unable to communicate them.

6. Power of attorney.  This gives another person, such as your spouse or an adult child, the legal power to act financially on your behalf should you become incapacitated.  This can be as restrictive (bill paying only, for example) or as comprehensive (able to sell property, file tax return) as you wish to make it.  It can be amended or rescinded at any time.

7. Title.  Document proving ownership of property.  Improperly titled assets could mean property being transferred contrary to your wishes or could result in higher estate taxes or probate costs.

8. Trust.  A legal entity created for holding property for the benefit of the creator of the trust or other beneficiaries.  Trusts are used for everything from avoiding probate and helping heirs manage assets, to saving estate taxes and ensuring that certain assets go to certain heirs.

9. Trustee.  The person or institution appointed that manages the trust property under the terms of the trust agreement.

10. Revocable and irrevocable trusts.  A revocable trust means the creator of the trust can change fundamental aspects of the trust or even dissolve it.  An irrevocable trust severely limits what changes the creator can make in the trust document.  Irrevocable trusts typically are used to reduce estate taxes.

11. Testamentary trust.  A trust created by a will.  A testamentary trust is established upon the creator’s death and an inter vivos trust is established during the creator’s lifetime.

12. Estate tax and gift exemption amounts.  The amount of an estate’s value passed on to heirs and subject to estate tax depends on the size of the estate.  By federal law, in 2009, the maximum amount of estate that is exempt from taxation is $3.5 million.  The law is repealed completely in 2010, but in 2011 it returns with a $1 million exemption cap or limit.  These exempt estate tax amounts are reduced by any gift-tax exemption amounts taken during lifetime.  The maximum in gifts you can exempt from gift taxes during a lifetime is $1 million.

13. Annual gift exclusion.  Each person can donate tax free up to $13,000 (indexed for inflation) a year to as many people as he or she chooses.  For example, you could give away a total of $39,000 a year to your three children or three friends ($78,000 a year if your spouse joins you).  The annual exclusion does not count against the lifetime gift-tax exemption amount.

14. Codicil.  A written change or amendment to a will.

15. Disclaimer.  The refusal of a beneficiary to accept property willed to him.  When a disclaimer is made, the property is generally transferred to the person next in line under the will.

Read the next post.

Next Page »