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Joe is a former financial advisor and media representative for American Express and Ameriprise. He was the “Money Man” at Detroit television WXYZ-TV, appearing twice weekly. He’s also appeared in Bride, Best Life, and Child magazines, the Los Angeles Times, Chicago Sun-Times, Detroit News and Baltimore Sun newspapers and numerous other media outlets.  Joe holds B.A Degrees from The Citadel and Michigan State University. 

Life Insurance: What’s the Right Type of Life Insurance?

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I’m not a big television watcher, so I’m sorry to say that I don’t see much Dancing with the Stars. I know, you had such high hopes for me. My wife watches the show, so sometimes when I’m playing around on “the Twitter” I’ll sit with her on the sofa. On more than one occasion, I’ve half-witnessed a total breakdown by the “star” because the workouts were too hard. What’s interesting is that these “stars” end up achieving nothing on the show while the harder working pairs continue on. Even if they don’t win, those stars that worked hard talk about how rewarding it was to learn something new.

That’s what we’re going to do today: throw out rules of thumb and learn how insurance works. I am totally an analogy ninja.

He did so well last time, The Other Guy is back to write another scintillating post on insurance. If you missed his last one, you may want to start here: Find the Right Amount of Life Insurance in 10 Minutes.

Everyone wants to use rules of thumb, or “what I heard from my friend” to decide which insurance is best. Why throw a dart when it’s nearly as easy and far more profitable to just do the homework?

I hear experts tell us to always buy term insurance. Or they moan that universal life coverage is a rip-off. I agree that there is one type of insurance that’s best for everyone, but:

The best type depends on what you’re going to use the coverage for and how long you’ll need it.

Decisions …so before you believe someone telling you that one type of insurance is better than another, minions, know the available types and how they work! Last week I shared a quick formula to determine how much coverage you’ll need. Let’s use another quick method to understand your choices when it comes to life insurance.

Just as a carpenter needs to know the difference between a hammer and a drill, you’ll need to know all the types of insurance to pick the best kind. Don’t worry, I’ll keep it entertaining.

Term Insurance is probably that most well known type of coverage. Because it’s stripped down coverage, it’s often the only type available in workplace plans. Term insurance is nearly as easy to understand as first grade math: you pay for a specific amount of insurance which covers a set amout of time, called a ‘term’.

Helpful example: Barry Manilow purchases a $250,000 10-year term policy. If he dies during the term, Mandy, his beneficiary would receive $250,000 tax free simoleons. If Barry expires one minute after the term ends, the insurance company owes Mandy nothing.

Whole Life Insurance is equally well known. These plans began decades ago as an alternative to term coverage mainly because the coverage lasts…wait for it…your whole life. Awesome, huh? I know. Marketing and naming wizards, those insurance companies. Most whole life policies contain a “cash value” component that can be cashed in by the owner. Whole life policies require payment for their…drum roll please…whole life, unless you buy a policy that can be “paid up” early. Generally speaking, whole life = coverage for your whole life and premiums for your whole life.

What’s awesome about whole life insurance? Guarantees! If you continue to pay the premium to the insurance company and keep your account in good standing, it’s guaranteed to last. The cash value grows at a guaranteed rate, so you don’t need to worry about interest rate fluctuation much. It’s a wonderful policy type for the super-nervous people of the world.

Universal Life Insurance is a variation on whole life – at some point insurance people said, “Wouldn’t it be cool if the payments to the policy and death benefit could be partially flexible?” Maybe they didn’t ask that exact question, but it makes the point. People who own this insurance pay extra (just like with whole life coverage) to add money to a cash value portion of the policy.

Once enough cash value accumulates, you can sit back and let the cash cover the costs instead of paying more money from your wallet. Many policies allow you to raise or lower the amount of coverage without having to purchase another one.

What’s another key difference between universal life and whole life insurance? Okay, I’ll tell you: universal policy interest rates on cash often float with interest rates. Awesome during 1980 when CDs were paying over 10 percent. Now, though, with the value of savings through the floor, universal policy rates are Coyote Ugly. And no, that’s not code for awesome, like the model-bar.

Variable Universal Life is the newest of the 4 major types. Those crazy insurance companies were getting smoked because the average saver decided to invest money into the financial markets. Marketing people said, pulling their hair out, “what will we do to keep business coming in?” Once again, the phrasing is off, but VUL policies (as they’re known in insurance lingo) were a reaction to the widespread use of mutual funds and other investment tools.

Initially developed in the late 70’s and early 80’s, these types of contracts allow for investment in various stock/bond accounts (similar to mutual funds, but not the same). The major draw of VUL? Flexibility of investments became the name of the game – and the opportunity to have market-like returns right inside your very own life insurance policy. In the go-go 1990’s, this was awesome. Since then, many investors have had middling returns and unpredictable results.

Which is best for the salesman?

In the interest of fair disclosure, I’m going to let you in on a little secret. Life insurance is a BIG commission check…I mean GIGANTIC. You wouldn’t believe how much. Let me give you an example: If you’re a 40-year old man buying a term policy that costs $100/mo; your insurance sales person gets around $850-$900 cash for the first year of your premium payments. Yes, you read that right, you basically pay a year’s worth of premiums to cover the commission amount. I don’t mean to infer that this is bad…it’s just how things operate.

Just thought you’d like to know.

Whole Life, Universal Life, and Variable Universal Life are even bigger payers. I remember receiving a check for over $25,000 for a single $400,000 Variable policy I sold early in my career. I also remember a $70,000 commission check for a $2 million policy. Big money.

My goal isn’t to make you angry. It’s to help you know the broker’s game.

…which brings brings us to the “One Question You Should Ask Before You Buy Anything”:

“Mr. Broker, how much money are you going to make if I buy this insurance?”

I was never ashamed to admit to my clients how much money I’d earn…a good advisor has no reason to be deceptive. But, if he hems and haws…maybe this “complex insurance investment strategy” that sounded pretty cool benefits him more than you. In my opinion, the actual commission is irrelevant – it could be $2 or $20,000, I don’t care – it’s how he answers the question.

All Insurance Types Cost The Same

Sometimes insurance agents will mention that permanent policies, such as universal or whole life, are less expensive than term insurance. I’ll lay it out and let you decide:

Sure, like some margarines are saltier than others, some carriers offer better premiums for smokers, race-car drivers, or 45-year olds. That’s true. However, insurance ‘costs’ among competitors are far closer than you’d initially imagine.

In the above example you’ll see the differences between permanent and term. Notice additional fees (in the right chart, 5 percent is deducted as an additional charge—this fee can be higher or lower depending on the carrier).

Here’s how all insurance costs are similar:

Insurance is sold in $1,000 increments. Imagine pulling up to the insurance store drive thru and ordering 500 $1,000 units of insurance. The cashier calculates the cost based on two factors: your age and the number of $1,000 units you’re purchasing. I hate to disclose this secret: actuarially you’re more likely to die every year you age.

With permanent life insurance, your “cash value” grows over time, reducing the amount of life insurance you buy from the insurance company – which makes it seem like you’re paying less for coverage.

A second handy example: if Jeff Gordon races to buy $500,000 of coverage and he stuffs $50,000 of cash into the policy – his beneficiary would receive $450,000 of insurance and $50,000 OF JEFF’S OWN MONEY to total $500,000.

Permanent life insurance is only cheaper because you’re paying extra into cash when you’re young, which lowers the amount you’re buying later on when it’s expensive.

Whole life, UL and VUL insurances in many ways are forced savings accounts added to life insurance.

Which Should You Buy?

So…which one is best? Well, that’s a loaded question – but here’s what I think. Start by determining how long you’ll need coverage. For the vast majority of savers, maxing out a Roth IRA and 401(k) plan and buying term insurance is the right answer. If you have a long term need and have a maxed out Roth IRA, 401(k) and you still have money left over…well then maybe a permanent policy may be a better choice.

For this reason, using term insurance for succession planning needs at work or estate liquidity needs to cover estate taxes usually ends in disaster. These policies need to be in-force when you die, so permanent insurance works best.

If you’re a worrier about outliving your insurance and want forced savings, whole life, UL and VUL aren’t the enemy. I’ve had clients purchase permanent insurance only because they wanted security and were comfortable paying a lot of money for it. These policies work, but for a cost.

Because most families need life insurance for a fixed amount of time and have other ways to save money, term is often the best choice.

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Holiday Travel – Wins and Losses

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****note: our Boner of the Week! post won’t appear this week because I was so incredibly focused on consuming pumpkin pie that I neglected to scour the internet for that just-perfect financial misstep. We’ll have some …um….stiff competition for next week’s prize, I’m sure.

I’ve finally returned from the big Thanksgiving trip, 2011 edition. Although I’m always good for a few blunders–like spilling ketchup on my sweater within five minutes of reaching the restaurant—financial missteps aren’t usually AverageJoe’s style. For your viewing pleasure, I thought it’d be fun to lay out the list of savings from my trip. And, just so you don’t think I’d a total prude, let’s detail the areas where I really stepped in it, money-wise. I list of these savings as “potential” because I don’t know if, faced with full retail, I would have really followed through with the purchase. There are so many ways to find a good deal, I’m becoming a curmudgeon when it comes to full-price.

Okay, here we go:

Cha-chingGot it right:

1) Hotel—I scored gigantic deals, thank you. First, I tapped the letters “Hotwire” into Bing (which doles out Rewards if I use it to search) in order to secure an $85 hotel room for $52 while on the road. The hotel had free breakfast, including waffles–mandatory on an AverageJoe holiday–so we avoided the cost of breakfast for me and two hungry teenagers. While in “holiday town” we also had our choice between my in-law’s basement or a hotel. Thinking quickly, chose the basement, but Mrs. AverageJoe overrode my decision. That’s when I remembered that I’m lucky enough to have a relative who works for a big, expensive hotel chain. He was able to put us up for four days at $56 each at an Embassy Suites. The normal rate is $115 per day. Cha-ching! Potential savings: $21 breakfast + $33 on-the-road hotel = $54, plus four days at Embassy Suites totaled another $236 in hotel savings + free breakfast savings of $84, giving us a whopping total of $374 in potential savings over what I normally would have spent.

2) Auto—We drove our most fuel efficient car rather than the most comfortable one. My Trailblazer, although completely paid off, is apparently the 2005 GasSucker model (never heard of it? Stop by sometime and I’ll give you a test drive. It’s fun to watch the gas gauge lower in real time as we tool around the neighborhood). In prior trips, we’d usually shell out $450 in gasoline expenses alone. This time, we opted for the 2011 Equinox, and only spent $212. What an incredible difference. Potential savings: $338.

3) Black Friday—This year I had a list of items I already needed or that my children wanted for the holidays. I also knew my brother in law would love DVDs. Best Buy had XBox games half off, a Toshiba portable hard drive I was going to purchase anyway for a third off, and some good DVDs for $.99 and $2.99. Potential savings: $215.

Oops:

1) Gasoline—I could have saved even more money in auto expenses had I used one of the gazillion apps available to find the lowest price gas stations. On two occasions I was stuck paying over $3.15 per gallon when only a few miles later (or earlier) I flew by stations charging as little as $2.97 (but usually around $3.03).  Potential overpayment: $6.80.

2) Black Friday—I missed some specials only because of poor planning. By the team we reached Bed Bath and Beyond, my coupon had expired. I also decided not to wait in an ugly hour-long line to check out at KMart. By the way…I haven’t been in a KMart in forever. Does anyone else think it’s a total hole? It might have been just the Black Friday chaos, but the racks were a mess, there was no festive music playing and they seemed ill-prepared for the long check out lines. Hey, KMart, if you’re going to make us wait forever to pay you money, wouldn’t it make sense to make the wait bearable?  I ended up buying my KMart purchase at Radio Shack, but I spent $14 more on a comparable item. Potential overpayment: $17.60.

3) Restaurants—I always check for specials before dining at home. In my rush to leave town, I totally forgot to research deals while out of town. That’s frustrating, because I ended up eating out a ton and paid full price for every meal. I have no idea how to calculate my potential overpayment, but based on 20 percent off, it was easily more than $50.

Final analysis: Man was my 2011 holiday travel was a blast! But it was also expensive, as are most vacations. All in all, my “potential” savings of $927 minus overpayments of roughly $74.40 totaled $852.60.

In the final analysis, considering that I stayed in comfort, drove a reliable automobile, and had the opportunity to beat my mother-in-law at Scrabble, I’ll take it!

How did you do during last week’s Thanksgiving holiday festivities?

Read More:

Fuel Up and Save Big: Costco’s Secrets to Slashing Your Gas Expenses!

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Find the Right Life Insurance Amount in 10 Minutes

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Another note from AverageJoe’s Thanksgiving visit to the in-laws:

Dear blog diary,

I’ve just trounced my mother-in-law at Scrabble again. It was absolute luck that the triple word score was open for my play of “austerity.” Of course, I had to hide a U and Y in my sleeve to place a nine-letter score. Luckily, we’ve both had enough “holiday cheer” that she didn’t notice. I know that to be a good son-in-law I should let her win, but not until I get a chance to play the word “bailout.”

Between all this winning and making Rice Krispies Turkey Pop Treats, I totally can’t be bothered to post anything today. Instead, I’ve opened the basement and let out The Other Guy, so named because he’s still a practicing financial advisor and doesn’t understand that being associated with me would totally be good for business. Whatever.

We’ll have a special piece tomorrow, but will completely understand if you don’t have time to read it. Safe travels, everyone!

Now, on to the Other Guy:

 

 

A couple of weeks ago, after being sick for about 10 days, I finally went to the doctor. Apparently, I have ‘walking pneumonia.’ I told the doctor that I don’t do any physical exercise, including walking, so I couldn’t possibly have “walking” anything.

In any event, I didn’t feel well. I began to contemplate my own mortality and then an idea popped in my mind: let’s spend a couple of days talking about life insurance! It’s obviously everyone’s favorite topic…and as a financial advisor who doesn’t like to be sold some insurance, I make the perfect teacher. As AverageJoe did with the “evaluate a mutual fund in 10 minutes” post, I’m going to break it down nice and easy for ya’.

Here goes:

Before anything, let’s not waste time evaluating coverages if we don’t have to. All too often, insurance sales professionals and financial advisors will just make the assumption that you need it and proceed to sell it to you. Here’s an easy way to determine if you need life insurance at all:

Questions to ask:

Does anyone rely on you for financial support, either right this moment or if you got hit by lightning?

If you’re single and/or have no dependents, there’s almost a zero point zero percent chance that you need life insurance. I might be convinced that a small group policy so that someone can bury you is adequate. If you have charitable intentions, there are insurance strategies that work really well….but that’s all. Nothing more.

Don’t let an insurance salesman tell you otherwise.

For those of you who have people relying on you for financial support here’s an easy way to calculate how much you need. Is this the best way? Nope. However, once we walk through these steps you’ll be on your way to making a good insurance decision.

Every life insurance discussion contains assumptions. You’ll need to make some to decide what amount is right for you. At the least, you’ll need to know where assumptions have been made, so you’re able to change directions if you need to.

Here are a few assumptions:

If married, I usually assume with clients that they’ll want the mortgage paid off when they die. Even if both spouses have a full time job and can still afford the house, I’ve seen too many people “go off the deep end” when their spouse dies to determine whether everything will remain stable at work and home. I can understand leaving this out, but at the least I’d evaluate your insurance cost with and without this cost before deciding to drop it.

You may find the additional cost is worth the pain.

If you have children, I assume you’ll want them to go to college, and you’ll want it paid for . Maybe not Harvard or Yale, but you want them to have some level of in-state public university education. Since college costs increase 8-10 percent per year on average, this is one of the most expensive budget items a family can face.

Let’s have the discussion here that we’ll have in client meetings: Maybe you paid for your own college expenses. Evaluate your children and savings and not your personal situation when you went to school. With costs rising quickly, do you want them to have this burden?

Here’s how much life insurance you’ll need…plus or minus the assumptions above plus a few more below.

Add together all of your debts, including your mortgage: $__________________

I’ve done the math on an average in-state tuition in the chart below. Add in these costs: $__________________

Next, we’re going to give your family basic income to live on. Here are where we need to make some large assumptions. Take your annual post tax (take home) income and multiply by 80%. This assumes that your family will live on 80 percent of your current salary if you’ve died. There are better ways to do this. Instead, determine what percent your family would need in the event of your death and use that percentage.

Divide this amount by .05. This means that you’ll need to peel off 5 percent to live on. This single number creates (again) huge assumptions. The biggest? It’s that you’ll continue to live on this income stream even as inflation skyrockets. Once again, we’re trying to get in the ballpark, so if you’re trying to do this the “quick and dirty” way, we’ll be close, but there are better ways.

Place your answer here: $__________________

Add up these 3 lines, that’s how much you need.
$__________________

Now, often, I’ve seen insurance salespeople stop at this point. Not good. Remember, you have some current savings! The goal of insurance in most situations is to replace income that you don’t yet have.

Subtract the amount of money you already have saved from the final number.

$__________________
Buy the difference.

Education Chart

Age$ needed todayAge$ needed today
0$78,855.8711$64,200.32
1$77,395.5712$63,011.43
2$75,962.3213$61,844.55
3$74,555.6114$60,699.28
4$73,174.9515$59,575.22
5$71,819.8616$58,471.98
6$70,489.8617$57,389.16
7$69,184.5018$56,326.40
8$67,903.3019$34,071.75
9$66,645.8320$23,139.91
10$65,411.6521$11,792.45

Later, we’ll have a discussion on the various types of insurance you should consider and the #1 question you should ask before you buy anything from any insurance sales person.

As always, this exercise is more about understanding the variables that go into making a good decision as much as it is about the final product. Plug in your own unique situation and evaluate many types of coverage thoroughly before buying life insurance.

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It’s A Bad Day When A Munchkin Dies

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I had to tear myself away from the petition to kick the Kardashians off the air long enough to write about a horrible event I just came across online.

This morning I read with much sorrow that Karl Slover, one of the last living munchkins from the The Wizard of Oz, has died at age 93. It says in the article that Mr. Slover enjoyed late-life acclaim at events celebrating the classic film. It’s inspiring that he was nearly as famous at 93 as he’d been when the film was made. He played three different roles and was one of the shortest munchkins at 4-foot 5 inches short. I’m sorry to say that my knowledge of all things “munchkin” is also short. I’ve only been an expert on the awesome round variety down at Dunkin’ Doughnuts (where’s my endorsement, DD…I plug you nearly every $#!@ post).

I DO know a little about their cousins, Oompa Loompas, from the 1971 film Willy Wonka and the Chocolate Factory (NOT that awful Charlie and the Chocolate Factory remake, thank you). Like Mr. Slover changed Dorothy’s life as he and his friends led the girl and her dog down the yellow brick road, Oompa Loompas helped change my world view. I’m not sure I wanted to get close to those creepy monkeys in the Wizard of Oz, but a golden ticket tour of a bad-ass chocolate factory? Sign me up, brother! That’s a world I would have loved to experience,

and some say that I still live in.

Regardless, as I said before: with apologies to Mr. Slover, I’m not an expert on munchkins, but I think Oompa Loompas have a lot to teach us about living.

 Let me count the ways:

1) They’re original. Oompa Loompas don’t worry about acting like “ordinary” people. They wear goofy outfits and have horrible hair. Most important: you’ve never seen an Oompa Loompa trying to keep up with the Jones’.

2) They sing all day. How awesome would it be to spend your day singing? Wouldn’t that wipe away your @#$! horrible mood? In my case, people around me would absolutely hate me, but crooning always makes me feel great, even though my vocal cords don’t know a note from a full-on letter. I don’t sing enough. I don’t celebrate enough. It’s time to start singing.

oompa_loompa3) They work in an awesome job. We’ve all read the statistics. Most people who are lucky enough to still have a job dislike their work. Baby, if I was making chocolate all day I know two things:  I’d weigh seven-hundred and fifty six pounds AND I’d be giggling every moment I wasn’t singing.

4) They stick close to the visionary. Willie Wonka wouldn’t be the easiest boss to work for, but I’m fairly certain his brain wasn’t focused on charging thirty cents more so they can meet Q2 earnings. He didn’t have time for cover sheets on TPS reports. Nope. Willie was designing a flippin’ elevator into the sky and was intent on finding the right person to carry out his legacy. That’s a guy to have as a friend. 

What does this have to do with you? With money?

Money is a fuel for your life. The passing of a munchkin should remind us that we’re only here for a finite amount of time before we’re all off to see the wizard. Forget the dead end job and your next four percent raise. Chuck social climbing and start mountain climbing. See the world. Celebrate. Set goals and use good money habits to claim your own chocolate-fueled adventure.

….and most of all: remember to sing.

-Facts in story: Us Weekly story, 16 Nov. 2011

-YouTube video: Warner Brothers pictures

-Willy Wonka pic: Warner Brothers pictures

Here’s a sales pitch, but it’s for awesome stuff:

Don’t have any of these three classic films? Why not make holiday shopping easy AND support your favorite blog at the same time?

Exchange Traded Fund: A Low Cost Tool to Reach Your Goals

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If you’ve been living under a rock and haven’t heard of exchange traded funds (ETFs), today’s lesson is for you (though I still can’t figure out how you managed to get a wi-fi signal under there). An exchange traded fund is:

– often referred to as a “basket” of investments. This means a single ETF includes a collection of investments, so to some degree, you’re already diversified.

– investments that share a similar quality, such as all large companies, all oil companies, or all value-oriented firms. Sometimes they’re really quirky: all water companies, for example.

– usually aligned with an index, which is an unmanaged benchmark set of investments that people use to gauge the economy or success of their own investments. Some popular indexes are the Dow Jones Industrial Average, the S&P 500 and the NASDAQ 100. Some unpopular indexes are the Joe’s Favorite Boardgame Index and Best Doughnuts Ever Index, though I tried diligently to gain support for both products.

– unmanaged OR managed on “autopilot” based on predetermined criteria, not based on the whims of a manager.

According to Clark Howard, exchange traded funds are the fastest growing investment type, and with good reason. Although they compare favorably with mutual funds, they’re more attractive in many portfolios for a few reasons:

– Lower fees. Some investors believe that lower fees equal better results. I’m not that guy. But I do think that if I’m going to get middling results, why not pay less money for it? The average mutual fund fee is around 1.4 percent, while the average ETF fee is only 0.32. That’s a HUGE difference in fees. Think it isn’t a big deal? Check out this:

Story Problem!

Sally just sold her illegal street-rod and wants to invest the $10,000 profit. Over one year, an exchange traded fund will add an additional $108 more to her account than that average mutual fund her friend Jimmy uses. That $108 cost savings, invested for 30 years at 7 percent nets Sally an extra $11,738.01 for free, which she plans to invest in new headers and purple undercarriage lighting when she’s 65 years old. ….stuff Jimmy won’t be able to afford. HAHAHAHA

– Many investment options. A few years ago there were limited choices. Now if you can dream it, someone has probably created an ETF to emulate that investment idea.

– Downside protection. As a side benefit, exchange traded funds trade like a stock, meaning that you can use protection measures such as stop losses on an ETF. Stop losses can’t be used with mutual funds, because they only trade once daily.

Exchange traded funds aren’t the end-all, be-all. There are downsides:

– You’ll pay trading costs when you buy and sell exchange traded funds. This will take some of the $822 back out of your pocket.

– You won’t beat the index you’re competing against. Because your investment is tied to the performance of the applicable index, your returns will most often be slightly lower than that index (because of fees).

– In fact, your results will be pretty ordinary. The only way to beat the index is to invest in the hottest investments only. By capturing the returns of the entire index, you’re getting the best and worst picks of the crowd.

There are other downsides, but they’re more technical (such as dividends and volatility due to stop-losses). For the beginner, this is what you should know.

When is an exchange traded fund in order?

Just like you don’t bring your own hot dogs to a wedding reception (lesson learned), there is a time and place for exchange traded funds. Here’s where they really shine:

– ETFs are a great “hull” of a portfolio. Think of a ship’s hull. It holds the rest of the ship above water and cuts a straight path. Any position that you need in the portfolio to mimic market conditions AND you aren’t going to trade often is perfect for an ETF for two reasons: 1) trading fees won’t kick your butt (you don’t trade in and out of the “hull” of your ship) and 2) you’ll get the same diversification as a mutual fund at a lower cost.

– You want market-like results but fear volatility. I love psychology. Everyone wants two things from their portfolio (what’s with the two things today?): 1) Big returns and 2) no risk. Am I right? Of course I am. The market doesn’t give you Burger King (have it your way), but you can limit volatility. As I explained earlier, exchange traded funds trade all day long, while mutual funds only trade once per day. Why’s this a big deal? Mutual fund investors can’t limit volatility during a trading session. ETF investors can use instruments like stop losses to curb losses. Sure, you’ll pay trading fees, but if the market tanks, your nest egg will only have dropped to your stop loss point.

– You want to take a risk, but don’t want to bet on a single company. Because some ETFs emulate sectors of the market, you can gain exposure to precious metals, commodities and other risky asset classes without betting the farm on a single stock, bond or commodity. Sure, you can do this with mutual funds also, but with the ability to buy and sell all day long (as described above), ETF investors enjoy a greater degree of flexibility.

– Wrap and low cost trading accounts. If you have an account where you don’t pay for individual trades or pay a minimal amount, trading fees on ETFs are no longer a bridle on your results.

So, minions, that’s our Exchange Traded Fund lesson for the day.  Here’s my question to you: If you use exchange traded funds in your portfolio, how do you deploy them? Why do you like them? If you don’t use ETFs, it may be a marvelous idea to read the comments and see if some of our brilliant readers have additional ideas. Enjoy!

There’s Something Wrong With The Car

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There are good days and then there are bad days. Neither of those descriptions fit last Saturday morning.

I woke up to my son running in the door.

Nick: Dad, there’s something wrong with the car. You have to come outside.

me: Where did Kim Kardashian run off to?

Nick: Dad, wake up. Come outside.

me: What time is it?

Nick: 7 o’clock. Come outside. There’s something wrong with the car.

me: (suddenly realizing Kim isn’t coming back, I’m not drunk in a Beverly Hills swimming pool and I’m a happily married parent of twin 16 year olds) What’s wrong with the car?

Nick: Just come outside

Cheryl: Go, Joe

me: (I’m thinking to myself: why don’t you go?) I’m saying out loud: Okay

(18 years! Why do you ask?)

Cheryl (to Nick): What’s wrong with the car, honey.

Nick: I hit a mailbox.

me: Okay. (out of bed, throw on jeans and a tee-shirt, follow Nick outside)

I shouldn’t interrupt the story here, but it’s time for a little op/ed piece.

Who the F$%# decided that mailboxes should go in brick structures? My mailbox looks like this:

Our Mailbox

Awesome dent in the side, huh? I was going to actually change this mailbox until some kids late at night kept driving down our street with a kid out the car window slamming a baseball bat into everyone’s property. Where before, I saw a rotten looking mailbox, now I saw less cost when it’s finally destroyed.

So, back to our story…..

I’m following Nick through the house, expecting to see my mailbox on its side, with maybe a little dent in the car fender. My son has been driving for six weeks. We’ll have a talk about it and he’ll go to his swim meet. We’ll laugh about it when he’s 35 years old.

Heading up the stairs, I realize that many of my neighbor’s mailboxes look like this:

random neighborhood mailbox

Holy brick-house, Batman! The front end of the car might be crumpled around that thing. Now I’m worried. By the time we hit the front door my pace is almost as fast as a cop headed for Dunkin’ Donuts.

me: Whose mailbox did you hit?

Nick: Huh? (he’s 16. I omitted most of the 16-isms for brevity, but had to leave one “huh?” in here.)

me: Whose mailbox?

Nick: Bill’s

me: Oh sh$#.

Bill lives across the street and has a mailbox similar to the one above. The front of our Saturn Aura is probably crushed in. Being a Saturn, it’s a collector’s item (that’s a joke, by the way. Some are apparent, others I’ll point out as we go.).

me: How did it happen?

Nick: I was trying to change a CD.

me: Nick! Don’t try to change a CD while driving. Keep your hands on the wheel. (I think I’m giving good parenting advice here, but I’m not. It turns out that my daughter–remember I said I had two driving? My insurance company remembers….and giggles out loud.–My daughter had a GLEE CD playing LOUD. I know because, when I turned on the car, it was still playing. My poor son. A Glee CD. The Horror.  Forget the mailbox, I would have hit Bill’s house hard enough to end it all.)

Here’s what I see. Remember that as a recovering advisor for 200 families, it’s difficult to amaze me. I’ve pretty much seen it all.

Except this:

Wheelie!

We call it “Wheelie!” or “Full-Sized Car Statue on an attractive brick base.”

My car is on two wheels (the left two if we want to be technical about it), and is TETTERING ON THE TOP OF my neighbor’s brick mailbox).

me: How the hell did you get the car all the way on top of it?

Nick: I don’t know.

Me: What did you tell me inside? Something’s wrong with the car?

Nick: Yeah.

Me: Understated. In social circles, that’s classy.

It took TWO wreckers to get the mailbox out from under the car. One to pick up the front end and another to drag out the mailbox.

Do you know that whole thing about people getting their 15 minutes of fame? The wrecker drivers all took pictures with their cameras “for the record.” I’m sure my car claimed its 15 minutes and more that night. You may have already seen this picture on Facebook.

So, in closing: please read my blog. Click on every advertising link. Next week I’ll have advice on how to deal with your car insurance company, and how to write big $%#!ing checks without shaking (much).

Evaluate a Mutual Fund in 10 Minutes

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Part II of our thrilling series, Evaluating Mutual Funds (or How to Cure Insomnia)

I think whatever intern created yesterday’s headline inferring that my mutual fund post would put you to sleep REALLY messed up. Both of our other readers told me it was scintillating discourse. Mom especially liked it. Looks like an intern’s head is going to roll at Average Joe, Inc.

MOST ways to evaluate mutual funds are snorers AND take too much time. THIS method (using Morningstar) is like have a hamburger for dinner and then your spouse surprises the whole family with ice cream for dessert. All in 10 minutes. This saves you time for a beer and pizza. It’s exciting and time-saving without the Tums.

If you haven’t read yesterday’s post, I’ll implore you to start there, because iin that magical discussion I showed you how to get to the page we’re going to explore today. If you don’t want to read yesterday’s piece, just click this link to open a Mutual Shares page on Morningstar.com and follow along.

This lesson will be oh-so-awesome with that little bit ‘o background.

So….when we last left our hero, he’d pulled up ING Franklin Mutual Shares, Portfolio I and was staring at the page. You should be doing the same now. Today I’m going to show you my secret 5 point program to quickly decide if this fund is worthy of your money or not. Before we start, I’ll remind you, this isn’t the place to start! You should be already hunting for a specific type of fund based on your financial plan. Once you know what you’re shopping for, Morningstar will help weed out ugly ducklings. In investing the ugly ones don’t turn out to be pretty swans. They just become ugly ducks.

1) Purchase Info.

I don’t like to go into the store until I’m ready to buy. It’s the same concept here. We don’t want to waste our time evaluating a fund if we can’t buy it. Click the tab that says “Purchase” just below the name of the fund.

– First’, we’ll find out the minimum investment. Across the left column are statistics about how much it’ll take to buy this fund. Thankfully, it’s zero. I can afford that.

– Second, let’s make sure it’s open to new investors. The last two lines of this same column tell me that, no, it isn’t closed. Bonus.

– Third, I’ll see if it’s available where I have my money. I’m in luck. I do all of my investing through Matrix Financial Solutions. If I had used a bigger, more well-known firm like E*Trade, TDAmeritrade or another, I wouldn’t be able to use this fund. (No, this isn’t an advertisement for Matrix, and no, my funds really aren’t there….sometimes my readers are so very literal….).

So what, Joe? – We probably can’t buy this fund. That saves us a ton of work. We’re going to keep going for the sake of comparison, but there’s a reason I started here. Over the years I’ve wasted a ton of time evaluating funds that I can’t invest in….only to find out a half-hour into the exercise. There is good news if you like Mutual Shares. This fund has other classes available for purchase if you have money and like it. Search “Mutual Shares” and you’ll find several other versions of this same fund with a different cost structure.

…which brings us to the last point. Costs. The Morningstar front page on this fund listed the costs as “below average.” Click the “expenses” page to get a better idea. Expenses are such a big deal, that we’ll do a more in-depth look another day.

2) Management

I don’t want to evaluate a fund and find out there’s a new captain at the helm. So, quickly, we’ll click on the Management tab and take a look. Yup, all three managers have been there from the beginning. I may do more in-depth research on these people later, but for now, I’m satisfied.

3) Category

To compare a fund against it’s true competitors, let’s begin by verifying exactly what  type of fund this is. To the right of NAV (the share price), you’ll find the header “Category”. It lists this fund as a “large value” fund. Further right, the header “Investment Style” shows a graphic Morningstar calls a “style box.” This box, which resembles a Rubic’s Cube, represents nine possible types of investment (This particular box is for stock-based funds. Bond based funds have a different style box.).

As you can see, the stock style box has nine sections. The top row of boxes represent large company investments, while the bottom depicts small companies. Guess what the middle is? You’re so smart! You’re right. It’s mid-sized investments. You’ll see that Mutual Shares is a large company fund. It invests in large firms.

The three columns represent value investing on the left, considered more conservative by many investors, a blend in the middle, and growth-oriented funds on the right. This fund trades in the value column.

Put these two criteria together and you’ll find that Mutual Shares is a fund which invests in large, value oriented stocks.

So what, Joe? – There’s a BIG “so what” here. Funds sometimes drift from what they say they’re going to do. Some analysts call it “cheating.” If I’m starting with my goal in mind and I think that a large, value oriented fund is the way to go, I may look toward Mutual Shares. But what if I looked at the style box and it showed up in the blend or growth column? – or the fund really bought more mid-sized companies? It might be a good fund, but not right for my goals.

4) Risk

Evaluating risk is something I love to do, especially since we had that fireworks fight in 6th grade and I nearly had my eye blown out. risk Long story….but let’s just say two things: I’ve never been particularly excited about looking like a pirate and I’ve become passionate about weighing risk before participating in any activity.

To find out how risky this fund is, let’s maneuver over to the “Risk” tab and click to that page.

You’ve seen how “those damned kids” know all the right buttons to press with their video games and whatnot. (That was a poor imitation of my dad, btw.) If you’re going to play the mutual fund game, it’s important to know the right buttons to press. These risk statistics look difficult, but it’s important to gain a basic understanding if you’re going to be a skilled investor.

A note to financial gurus reading this page….remember our audience. This is the 101 version. I won’t be covering all the stats and I’m probably going to do a quick fly-over only. Put your protractors away and let’s begin.

The area we’re going to focus on is the MPT statistics box in the center of the page. It isn’t important for our discussion what MPT means (although, to fill you with the soothing knowledge that your teacher has mad fly skillz, I’ll tell you that it’s Modern Portfolio Theory. Happy?)

Notice that you can tab between 3-year, 5-year and 10-year statistics. That should be the first clue that it’s impossible to know what risks the fund is going to take tomorrow. We can only evaluate the historical track record over time. There are two basic measures: against the S&P 500 and against the “best fit” index. Without getting into another diatribe, we don’t care about the S&P 500 here. We want to know how this fund compares with others it competes against in the “Large Value” sector we identified above.

On the 3-year record, you’ll see that Mutual Shares has a beta of 0.87 and an alpha of – 2.68. What the heck do these numbers mean?

It isn’t easy, and I didn’t learn it in a day, so you won’t either. But here’s the training-wheels version:

A beta below 1.0 means the fund has had a history of producing less volatility than the index it’s compared against. A fund above 1.0 takes more risk. So, if funds have betas of .5, .8, 1.1 and 1.6, the one with a beta of 1.6 is the hot tamale while the one with a .5 takes the least risk. A beta of 1.0, by the way, would mean that the fund takes the same amount of risk as the comparison index. Got it? So, with a beta of .87, this fund has taken less risk than it’s competitors.

So what, Joe? – If you’re looking for a large company value fund that takes big risks, this ain’t it.

The alpha number rates the manager of the fund. If the fund has a positive alpha, that means that the manager’s picks have added value to the fund. If the alpha is negative, the manager is taking away value. With a low beta, I’d expect this manager to also have a negative alpha when compared to the index. Why? A fund that’s geared to take less risk is going to make more conservative plays, resulting usually in correspondingly low results.

…and what do you know? The alpha IS negative….

So what, Joe? – We’re finding that this management team takes less risk and provides less value than some competitors. A fund with a low beta and high alpha (obviously) is my favorite type of fund. You’ll find those, unicorns and four leaf clovers in the same place.

5) Performance

Left of the Ratings & Risk tab, you’ll find the “Performance” tab. Click that.

This page opens onto a chart which shows the growth of $10,000 over time. Let’s look at the data below the chart. I want to focus on one line: “% Rank in Category.” This measurement tells us how well the fund has performed competitively against others during that year. in 2008, it’s rank was 61, meaning that 61 percent of all funds in it’s class beat it’s performance. It wasn’t much better in later years. Although in 2009 the fund was in the top 30 percent, it declined to be only top 72 percent in ‘10.

Let’s play a little Sherlock Holmes here. I’d bet that in 2009 the market was lower and in ‘08 and ‘10 the market was a little better. Why? This fund, according to the beta we evaluated above, should hold onto money better during poor years. True in this case?

Not at all.

Surprisingly, the fund actually beat the market in 2009 and was trounced in 2008 when the market was horrible and in 2010 when the market had a pretty average year.

So what, Joe? – You can see what we’re getting at here. This fund has been a mixed bag in terms of results, but on a daily basis takes less risk.  This means there is still more for me to know. This fund is apparently doing something else with money to keep the beta low. It seems to be a fund that walks to it’s own drum. This could be good or bad. All it really means is that I need to know more. The good news? I know roughly what I’m looking for.

In 10 Money-Making Minutes we’ve learned:

10-minutes – The costs of the fund are low, and I can only get it at one firm.

– The current management is responsible for the results I’m evaluating.

– Mutual Shares bills itself as a Large Value fund and it’s investment style reflects the same.

– The fund takes less risk and produces lower results than the average fund it competes against.

– The fund doesn’t seem to uniformly win in an up or down market.

– It might pay to dig into the management philosophy more so I’ll have a better idea of what to expect.

Clients used to pay me to show them how to quickly evaluate a fund. Today you got the same treatment for free. Yes, I am a heck of a guy.

– Joe

Okay, minions. Here’s a question for us to play with: What other criteria make your “10 Minute Fund Evaluation” list?

Researching Mutual Funds (or How to Cure Insomnia)

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Part I – Introduction to an Investment Analysis Tool: Morningstar

 I’ve become a tool deviant. I feel like Tool Man Tim when I walk into Home Depot. My wife had to nudge me to stop grunting in the paint aisle last week; Cheryl is convinced I’m thinking about leaving her for a Wagner Paint Sprayer.

Unfair, unfounded and not true. I just grunted. It could happen to anybody.

My tool obsession began with financial planning tools. The good news is, if you like to carry a tax table in your pocket and wear tape around your glasses like I do, financial calculators are every bit as hot as any U joint in aisle 7 at Lowes. Financial geeks like me drool over an HP 12-C calculating 30 year mortgage payments at six percent interest.

Morningstar

In one of my favorite recurring dreams, I’m on a deserted island with an investment analysis web tool called Morningstar. This website, found at www.morningstar.com, is the single best place to find third-party mutual fund advice. Period. There aren’t any others nearly as robust available to the general public for free.

That doesn’t mean Morningstar is perfect, but I’ll show you what to avoid.

Morningstar is to mutual funds what Consumer Reports is to toasters. If you’re pretty anal about your toaster (and really, who isn’t?), Consumer Reports will point you to the absolutely best model at the lowest cost. Similarly, Morningstar divides funds into categories and then ranks competing funds against each other. Each fund has it’s own pages, displaying the inner-workings and past performance of the product.

In financial geek circles, it’s awesome.

Different than Consumer Reports, Morningstar can’t predict the future of the fund. This is an important distinction. People think a fund that’s highly rated is going to perform in the future. Don’t make this mistake. It’s become a cliché in the money management industry, but it’s true: past performance is no indicator of future results. Where your highly-rated toaster should rock-n-roll all over your bagels, a top-rated mutual fund could lose significant money tomorrow.

Using the Site: Front Page

Before you reach the front page, you’ll be presented with an advertisement. You may click “direct to Morningstar.com” to leave the ad at any time. This is the price you pay for solid advice. Morningstar is littered with advertising and not every link will work (some force you to sign up and others are only for paying members). Although you don’t need to ever register to use Morningstar, significant benefits are available for people who choose the free membership option. As a recovering money manager, I’ll recommend that you avoid the premium sections. These are generally sections that give you Morningstar’s feelings and advice about investments (there are some nifty tools also, but none that you can’t live without). I’d rather you learned how to evaluate funds on your own before paying for someone’s advice.

Morningstar’s front page covers many types of investments. The Chicago-based company has expanded over the years to also deliver ratings and advice on stocks, bonds, exchange traded funds, and closed-end funds. Although I’ll use this site as a secondary place to review my investments in these other areas, there are many competitors who offer similar services. In my opinion, Morningstar still shines brightest in the area where they began: mutual fund research.

From the front page, click on the “funds” tab to see the mutual fund front page. You’ll notice top stories in the middle, analysis tools on the left, and Morningstar favorites on the right. Only paid members can access most of the buttons on the right and several on the left.

Using the Site: Search Function

If you know the name or ticker symbol of the fund you’re hoping to evaluate, there is no reason to click the mutual fund tab. Nearly every page of the site allows you to type either the name or ticker symbol into the “Search” box at the top of the page. Find your fund on a drop-down menu that appears. Click on the link to bring up a page about your fund.

About Star RankingsSea_Star

On the fund page, next to the fund’s name is most user’s favorite tool: the Morningstar star ranking. Morningstar ranks funds the way Zagat’s categorizes top restaurants.  They use a five star system with five stars being the highest rank and one star being a near-sure sign to stay away.

A word of warning: don’t pick a fund based solely on the star ranking. Do you often disagree with movie critics? You’ll find that, much as critics pick top films based on criteria different from your own, it’s better to know how to review the fund on your own. Choose a fund for your money based on goals and evaluation of the fund management. A fund with a five-star ranking is likely to become bloated with lots of cash over the near future because dollars rush in when funds achieve a high score ranking. A fund managing lots of cash often has trouble investing it all, creating mediocre returns.

Tomorrow we’ll continue the tour of Morningstar. For our purposes, we’ll evaluate ticker symbol IFMIX, ING Franklin Mutual Shares Portfolio I. If you want to practice, find this fund page for tomorrow’s exercise.

I’d love to stay and chat longer, but I’m headed out to oogle alternative minimum tax criteria. Sexy!

How to Date Your Bank

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Before I begin my joyous rant, I must comment that I’m sure there’s no correlation between the massive amount of chocolate I consumed last night and the sleepies I’m feeling today.

None at all.

monkey_dancing But, even a bad case of sugar-low can’t stop me from doin’ my monkey dance after I saw the news that Bank of America is dropping their $5 debit card fee.  Much like Netflix recently was forced to step back from plans to split their service, Bank of America miraculously realized that screwing their customers might not be in their best interest.

Better late than never.

Choosing a bank is a little like choosing a spouse. It’s a tough decision. You don’t just walk in one day and say, “Hey, bank, wanna tie the knot?” You’re going to be together in some capacity nearly every day, so it might be better to date for awhile.

My favorite banks are much like my spouse: intelligent and low maintenance.

But you don’t know that at first. I used to be a Bank of America customer. Bank of America was the pretty girlfriend who said all the right things until I found the cap off the toothpaste. Then she became the wicked Bank of the West. When I wanted to talk about the toothpaste, she disappeared behind a phone bank of polite service people who “didn’t do it.”

To get the best bank possible, you have to date. Play the field a little. Sew your wild oats. Introduce a few of your friends over to see how the New Bank acts around the family.

Here are a few of the qualities I look for when deciding on the perfect bank:

1) Fees. Banks have, among others, checkwriting fees, teller fees, debit card fees, wire transfer fees and overdraft fees. I want a complete fee schedule before deciding on a bank.

2) Convenience. Is it easy to deposit and withdraw money? How responsive is the bank if I have questions? I mentioned that Fidelity will allow me to use my smart phone to deposit checks. How much more sexy can it get than that?

3) Range of services. I want to know what online tools are available. I love online banking, so I’m going to wine and dine these features before settling on a mate. Budget tools are also important to me. I need to be able to easily track my expenses. Banks with robust budget tools are going to get a second look from me.

4) Statements. This might not be important to you. My spouse doesn’t care for online banking, and wants a statement mailed to us. It must be easy to read. I know what you’re thinking. We also have an abacus at home to help the children with their math homework. Call us the Flintstones.

5) Interest rates. Is there a fairly high interest rate money market? I don’t use CDs often, but are their rates competitive? Use resources such as www.bankrate.com to decide if this bank is in the ballpark.

Those are the four most important areas to me. Maybe you have others. Much like dating, to some degree the mix of qualities one looks for in a bank boils down to personal preference. But also like finding a mate, it’s vitally important to become comfortable with the wide range of online and local banks to see what’s available. It’s better to be surprised about how lovely your bank still is many years later, holding your hand at age 80, rather than finding out too late that she’s been in your wallet again, stealing your cash or your breath mints.

Or leaving the cap off the toothpaste.  I’m looking at you, Bank of America.