The Independent Investor: Time to Check Your Risk Tolerance
It is a good time to take a reality check on how aggressively you are invested. The 6.9 percent decline in the S&P 500 Index over October was gut-wrenching. But entirely within the realm of probability given the historical data. Here are some questions to ask.
Did you find yourself checking your investment portfolios every day? How about every hour? Did you have trouble focusing on other, possibly more important, things like your job, or your family and friends? Was it more difficult to sleep at night, or did you lay awake worrying about the markets?
How much time did you spend checking the averages and listening to the talking heads on television or in the print media? Did you call your broker or investment advisor and, if so, how many times? Did you want to blame someone for the market's decline? Did you need that money for something immediate?
If you answered yes to any of the above questions, you have probably invested too aggressively. That's not to say that a sell-off is in any way pleasant. Everyone feels the disappointment, the pain of losing money, and the fear that tomorrow will bring more of the same. And even though your losses are only on paper, you still feel some anxiety. The question is how you handle it.
By now, most of my readers understand that the stock market is not a one-way street. Investors should expect at least three declines of around 5 percent and one decline of 10 percent per year in the stock market. That's on average. There have been plenty of times when the averages have declined more than that. Over the course of the last several years that has occurred consistently, and it will continue to do so for the next several decades into the future.
And one's risk tolerance is both personal and financial. Only you can tell yourself what it is or should be. And the risk is not static. It changes over time. How much risk you are willing to take depends on many things; some, such as your health or your job are different than when you will need the money in your investment accounts.
Geopolitical events such as Brexit, the Trump election, North Korean conflict, stock market valuations, and the next recession will also impact your attitude about risk. None of the above remain static. What was a negative development last year (like the Trump vs. Kim double dog dare) may be a positive this year, such as North Korean nuclear disarmament.
We can try to break risk down into two concepts: risk tolerance and your capacity for risks. Capacity for risk is how much you can afford to lose. That is measurable and involves time and finances. If you are saving for retirement, which is decades away, you can afford to lose more in the short-term, because you won't need the money anytime soon. Over time, the stock market has been shown to be a good investment and will make up your losses and then some if you remain patient and don't panic.
For example, the pain and fear are real for someone in their forties or fifties, who holds a $5 million portfolio, which loses $500,000 in a 10 percent correction, over the course of two months. Yet, if that person plans to retire 20 years from now and has a good paying job that is secure, then they have the capacity to hang in there, even buy more, because they won't be needing to tap those funds for decades.
On the other hand, if that money were needed to pay next month's mortgage or car payment, the purchase of a house in two weeks, the first semester's payment on their kid's college education, then that capacity for risk is far lower.
Risk tolerance is far more connected with your emotions; fear and greed among the most prevalent. It is greed that drives an investor's desire to "beat the market," something that is as hopeless as winning consistently at the slot machines. Fear is what drives you to sell at the top (fairly easy) but also destroys your ability to buy at the bottom (almost impossible).
So how do you determine these risks and when they change? It's not easy. Start with the questions I asked, and if you answered yes to any of them, review your risk appetite, preferably with someone like an advisor or financial planner. I found that it is far easier to examine your risk tolerance after a market sell-off when the pain is still fresh than when the markets are roaring.
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The Independent Investor: Textbooks Worth Their Weight in Gold
Forget the stock market, internet, and whatever you might think is worth investing in. The good old college textbook beats them all.
That boring first-semester hardcover and similar books have risen over 1,000 percent in price since 1977. Textbooks are a big business. Estimates for the total value of the textbook industry range from $7 billion to $9 billion. And just a handful of companies sell them. The five largest publishers are: Pearson Education, McGraw-Hill Education, Scholastic, Cengage Learning and Houghton Mifflin Harcourt. They have been around a long time, carry deep pockets and usually acquire any startups or smaller competitors in quick order. Some analysts compare them to drug companies because they have similar economics.
In the pharmaceutical sales model, for example, drugs are marketed to the decision makers — doctors, hospital pharmacies and the like. The patient, at least those with health insurance, end up paying the price, but much of those costs are paid for by the insurance company or Medicare. Medical decision makers' criteria are usually not how cheap or expensive a drug might be; instead, they select those drugs that are the most efficacious with the least number of side effects for their patients.
In the textbook industry, teachers (mostly professors), are the decision makers at colleges, and like doctors, could care less about the costs of a textbook to the student. They demand the most up-to-date educational information possible since they strive for academic excellence in the classroom.
It doesn’t help that today the information advances occur at such a rapid pace that most books are out of date by the time they are printed and in the hands of students.
There is another wrinkle that boosts the price of textbooks. Today, one in four colleges bundle their textbooks with an access code, which expires at the end of each semester. All the materials that a given student needs to participate in the classroom are put behind this access code paywall. Once you pay for the access code, you get your login ID. In return, the student gains access to workbooks and tests, in addition to the new textbook. It becomes essential to have this access in order to pass the course.
Fast forward to the next semester. For a new student beginning that same course, all the materials will have changed again, along with a new access code. The student looking to resell their old course material is out of luck. There is no re-sale market. It is simply useless. Many of the introductory courses that are part of the general education requirements for all students function in this way. These codes force students to buy books at retail prices at campus bookstores while walling off any chance to recoup part of the costs through resale.
Textbook prices have increased four times faster than the rate of inflation since 2006. At least 30 percent of post-secondary students buy their textbooks with financial aid money. Community college students are twice as likely to buy textbooks in the same manner.
Today, the average costs of textbooks per year, per student is $1,168. It is a pinch shared by public, primary and secondary education as well. Books have begun to be a major expense for every grade level. The costs are even worse for low-income school districts since standardized test requirements are based on these private-label, high-priced textbooks.
How does that work? It is a vicious circle: the school can’t afford the newest books, so students don’t get the information needed to pass standardized tests. As a result, the school gets lower funding because of poor test scores, keeping the new textbooks unaffordable. And on goes the cycle. It would be hilarious if we, the taxpayers, were not paying the bills.
Some say the system needs to be changed. As it is, the end user remains the student who bears the brunt of the cost. But since the buyer is the institution or instructor, all the book publishers need to do is maintain a good reputation, a cozy relationship with the teacher, and comparatively up-to-date new textbook editions.
Textbook companies, therefore, can continue to act as a quasi-cartel, if the formula of higher textbook prices is based on expanding college attendance and thus increasing demand for textbooks. Price really doesn’t come into it.
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The Independent Investor: The Student Loan Crisis
Student loans have now become the second-largest pile of consumer borrowing, after home mortgages. What's worse, it is the fastest growing slice of American household debt and shows no sign of slowing down.
Young Americans are going to college in droves. At the same time, the costs of higher education are at historical highs. That combination has become a lethal cocktail that could hamstring young workers over their entire life and along the way damage the overall economy.
Since the financial crisis and Great Recession over a decade ago, student loans have grown by almost 157 percent. Compare that to auto loans, which have risen 52 percent. In the case of mortgage and credit card debt, we have seen a decrease by about 1 percent.
At this point, the total loans outstanding amounts to $1.5 trillion, almost the same as this year's tax cut. If students graduate and land a good-paying job, so the theory goes, they should be able to service that debt and ultimately pay it off, even if it takes half their lifetime to do so. But, if you ask the 44 million Americans with student debt, that is not what's happening.
Many graduating students can only blame themselves for their predicament. During the financial crisis and its aftermath, many students figured going to college would provide the skills that have now become the minimum requirement to land a well-paying job. What's worse, their parents -- who should have known better -- allowed their kids to pick and choose what they wanted to study. It turned out that many of those degrees (in liberal arts, for example), failed to provide enough money to even service their student debt load. Degrees that did, like post-graduate law and medicine, required much more study, money and effort to attain.
More alarming still is the rate of loan delinquencies. It is higher than all other household debt, if we measure it by failure to pay. Over 10 percent of student borrowers have now failed to make their payments in the last 90 days or more. To put that in perspective, the delinquency rate on home mortgages stands at 1.1 percent.
Another problem with student debt is rising interest rates, which makes the cost of borrowing increase. Since the Fed started raising interest rates two years ago, undergrads have seen loan interest rates rise to 5 percent. It is even more (6.6 percent) for those who are working on graduate degrees.
Even the Fed is worried about the problem. Jerome Powell, the Chairman of The Federal Reserve Bank, explained it back in March when he testified before Congress. He pointed out that failing to pay your bills under the student loan program damages your credit. As a young person starting out, your credit rating is already shaky. Delinquencies could put you in a credit hole for a large part of your working life.
As it is, 85 percent of college students work at paying jobs just to afford what their student loans don't cover. Many of them need to live with their parents because the costs of college are simply too high to manage on their own. As this debt mounts (and it will), it ultimately starts to crimp the overall economy.
Homeownership, for example, has declined because of student debt. "Household formations," as economists like to call it, among workers between 25 and 35 years old is stagnant, thanks to overwhelming debt payments. The entire generation of Millennials and beyond are loaded down with student debt, and it is limiting how much they can spend on goods and services.
The only good news is that, unlike the mortgage debt crisis, student loans do not present a risk to the entire financial system. However, that may be small comfort to those who face a mountain of student debt repayments. My advice to parents, as well as their children, is to think long and hard before making a college decision.
If, for example, your child is not willing or capable of graduating with a degree in the hard sciences that have great job prospects (triple digit salaries), it may be much better to attend a vocational school. At least that way, the costs and debt load will be much lower and prospects for a good-paying job are somewhat brighter.
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The Independent Investor: Estate Planning Is for All of Us
Here is a trick question. What did Aretha Franklin, Tupac Shakur, Martin Luther King, Jr. and Abraham Lincoln have in common? They are all famous people who died without a will.
In the case of the "Queen of Soul," she died in August leaving $80 million and according to Michigan state law, those assets should eventually be divided up among her four children. In the meantime, the entire estate must go through the probate process, which is both expensive and time-consuming.
Some other famous people who failed to prepare their heirs and beneficiaries for their eventual death are: Jimi Hendrix, Bob Marley, Howard Hughes Sonny Bono, James Brown, Prince, and Michael Jackson. Some of these unclaimed estates are still going through the probate process and could remain there for years to come.
One might assume that those with a great deal of money would make sure that their estate was protected. After all, they have the money and the opportunity to hire the expertise they needed to put things in order. Obviously, in the above cases, that wasn't true.
Therefore, it should come as no surprise that roughly 64 percent of Americans don't have a will. That number is even higher for younger people (over 70 percent for those 45-54 years old). The most common answer for those questioned is that they simply have not gotten around to it. About 25 percent just don't feel that it is urgent.
Some other reasons people procrastinate are that it is depressing to face the eventuality of your own death. Others believe that lawyers are expensive and wills and such are costly. The same people usually underestimate the worth of their assets, believing they don't have much to distribute. In my experience, for example, many of my clients fail to include their largest asset, their home, when computing how much they are worth.
Typically, a will spells out who will serve as the executor, who will receive your assets, and under what terms. If you die without one, you are considered intestate. Under intestacy laws, who gets your assets is pre-determined, according to the degree of your relationships. You are also at the mercy of whatever state and/or Federal income and inheritance taxes may be due as well as the legal expenses in settling the estate through a probate court.
At our shop, most clients go through the estate planning process as a matter of course. We make sure that every investment account that we manage has an updated beneficiary listed but there is much more to it than just that. I asked Zack Marcotte, our financial planner, how he handles new clients without an estate plan.
"For most people, I like to see they have their basics covered — a will, a power of attorney, health care proxy, and don't forget to list of beneficiaries on every account that allows it, specifically your retirement accounts and insurance policies," he explained.
"One of the biggest issues I tend to see is neglecting to update beneficiaries after a divorce, death, or other change in circumstances; so make sure you look them over once a year. These are the basics that will cover most of the gaps people are exposed to; however, you should always seek legal counsel to provide personalized advice."
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The Independent Investor: Credit Freeze for Free
It just got cheaper to freeze your credit files, thanks to the Economic Growth, Regulatory Relief and Consumer Protection Act. But should you do it?
The law, signed by President Trump back in May, only took effect this month. It requires the three major credit reporting bureaus — Equifax, Trans Union and Experian — to drop the fees to freeze your credit. Those fees ranged from $3 to $10 per person, times three credit bureaus, plus more charges to "thaw" your credit. Consumers can now also un-freeze their files, either temporarily or permanently, free of charge.
Thanks to a recent spate of credit breaches, Congress felt it needed to do something about the problem. Readers may recall last year's credit breach at Equifax and its aftermath. Hackers stole personal data, including Social Security numbers, birth dates, addresses and even some driver's licenses from an estimated 143 million people in the U.S. Another 210,000 credit card accounts were also at risk. To make matters worse, the company knew about it, but kept quiet for some time before revealing it to the public. There had been a flurry of hearings, investigations and demands from both sides of the aisle to do something about it. Then there was the Yahoo breach in 2016, where over one billion users were impacted. Several banks, including Citibank as well as countless department stores, have reported hacking of information for millions more users. Thus, the new legislation.
So, what exactly is a credit freeze? It is a way to protect personal information from credit fraud and identity theft. Once you freeze your account, no one can get access to your credit files to open a new fraudulent account in your name. The downside is that you can't apply for new credit, either, unless you lift the freeze using a special PIN number.
But if you have ever had the misfortune of dealing with these credit bureaus, you know how time-consuming and complicated it is to change anything at all in your files. First, you need to be able to contact them. Sometimes the robo-answering service can keep you on the line for hours. You are required to repeat this excruciating task at all three agencies and you better have all your account numbers, credit card numbers and everything else handy and documented.
Remember, too, that if you need to apply for a loan, a credit card, set up electricity or phone service, rent an apartment, buy a house, obtain insurance, even apply for a new job, you can't — until you thaw your credit file. That will mean calling back all three companies, waiting in line, unlocking your credit, conducting your business, and then re-establishing the credit freeze. Putting up with these monumental delays may well be insurmountable for many.
You could, instead, take advantage of a credit lock, which works like a freeze and is offered by the credit bureaus. The companies market it as being more convenient since consumers can lock and unlock their credit files simply by using a smartphone application. Of course, they charge you a fee for it, as much as $20 a month, and that fee can be increased (and probably will be) in the future.
Fraud alerts could be the way to go. If you believe that your information may be in jeopardy, you can notify all three credit bureaus and they will then have to verify your identity before releasing information. Fraud alerts had expired after 90 days, but the new law requires them to remain in place for a full year.
Bottom line: if you are an actual victim of ID theft, a security freeze is critical. If you think you might become a victim of ID theft (your wallet was stolen or lost, as an example) a freeze might be worth considering. If so, do not lose your PIN number. If you do, it will cost money and mountains of your time to get a new one. And finally, if you are paranoid about identity theft, consider a fraud alert. Your credit information will still be available, but creditors must take reasonable steps to verify your identity before granting you credit.
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