LISTEN: VOLATILITY UP, INVESTORS OUT (mp3audio) (4:54 min)

Here’s the lead sentence from a July 19, 2010 report on the stock market from BTN Research:

The S&P 500 stock index fell 2.9% last Friday 7/16/10

Losing almost 3% of value in one day is a pretty big decline; for investors, July 16, 2010 was not a good day. However, it is worth noting that the July 16, 2010 decline had been preceded by eight consecutive days of gains – in the language of investors, July 16 was a “pullback.” This is the nature of stock markets; they fluctuate.

But recently, the fluctuation, or volatility, has intensified. The BTN report noted that “in the last 50 years, a 1-day gain or loss of at least 2% for the S&P 500 has occurred every 21 trading days.  Since the beginning of September 2008 (i.e., the start of the global credit crisis), a gain or loss of at least 2% has occurred every 4 days.”

In other words, for 50 years, sharp one-day changes occurred about once a month. But in the last two years, the steep moves have been happening once a week. Certainly the struggling global economy plays a part in the jumpiness of the markets, but there may be other factors at work.

The Wall Street Journal’s July 12, 2010 front-page story carried this headline:

Small Investors Flee Stocks, Changing Market Dynamics.

Two days later (July 14, 2010) , the WSJ’s “Money & Investing” section led with this title

Letting the Machines Decide

Here’s the connection.
The July 12 article noted that the last three years have seen a steady defection of individual investors from the stock market – people have sold their stocks, liquidated their mutual funds, just cashed out. The principal reasons for leaving the market were losses and volatility. In the past, some individual investors may have been willing to ride out declines in the market, or get out slowly as they saw trends changing, but the recent volatility has been most unsettling. Several interviewees mentioned the “flash crash” of May 6, 2010 as an example of the type of extreme fluctuation that motivated them to leave the market. (In one of the largest one-day drops in history, several US indices plummeted almost 10% in 15 minutes before partially rebounding.)

As individual investors leave the market, large institutional investors exert a greater influence. And more often, institutional investors are relying on sophisticated computer models using artificial intelligence to make their investment decisions. These automated investing programs, controlling large blocks of investments, can potentially trigger strong movements up or down in markets, particularly when all the programs arrive at similar conclusions to buy or sell.

For the techno-geeks, the argument for using a complex algorithm to determine investment decisions is simple: “Human beings aren’t improving,” says Spencer Greenberg, founder of Rebellion Research in the July 14th article. But a side effect of removing the human factor from decision-making is the potential for increased volatility. When the computer model indicates “buy” or “sell,” there are no emotions involved – no caution, no anxiety, no fear. Decisions are made without hesitation. So whatever happens, the results will often be seen quickly.

These trends don’t necessarily preclude individual investors from participating in the stock market. Contrarians – those who believe in selling when everyone’s buying and vice versa – might even see great opportunities in this type of scenario. But just as automation has made other processes move faster, the more machines control investing, the greater the likelihood of spikes – both up and down – in the markets.

Like other changes brought about by increased complexity, the challenge will be how to profitably integrate this development for individual benefit.

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LISTEN: Whole Life Insurance: Complex, Ingenious (mp3audio) (11:47 min)

What is whole life insurance? A simple answer, one you might find on a financial information website, might describe whole life insurance as a combination of life insurance and cash value. But once you get past this basic definition, the details and workings of a whole life policy can be quite sophisticated, maybe even confusing. Writing in the January 11, 2009 Palm Beach Daily News, life insurance expert R. Marshall Jones said that:

“Until recently, permanent life insurance was arguably the financial industry’s most complex instrument…”

As with many other complex financial products, whole life insurance is the result of the integration of several basic financial ideas. The starting point for whole life is an understanding of some of the shortcomings with a simple financial instrument, term insurance.

Here’s the big issue with term insurance: As you get older, it gets more expensive. Because statistics show older people are more likely to die than younger people, insurance companies price the coverage accordingly. To illustrate, here are 50 years of scheduled premiums from a reputable life insurer for a healthy 35 year-old male non-smoker to secure $500,000 of life insurance on a yearly renewable basis.

This pricing, while accurately representing the risks assumed by insurance companies as people get older, creates a dilemma for consumers. As they live longer, and pay increasingly expensive premiums, the cost of insurance becomes prohibitive. Thus, when they are most likely to die, they may not be able to afford the insurance. From a financial perspective, the only way to “win” in this transaction is to die “young,” before the insurance gets too expensive. Given the aversion most of us have to dying, the most likely outcome of yearly term insurance is paying premiums for a period of time, then lapsing the coverage. Even though the consumer may have a real need to provide the financial protection of life insurance, the yearly renewable premium schedule creates a financial incentive to drop the protection as soon as possible – or simply forgo life insurance altogether. This is a lose-lose proposition, for the consumer and the insurance company.

Integrated Solution, Step One
One response to increasing yearly renewable premiums is leveling the premium. Instead of increasing the cost every year, the insurer determines a flat rate for a specified number of years, i.e., for a term. A typical term may be 10, 15, 20 or 30 years. The level term arrangement results in a policyowner overpaying (relative to the true annual cost of insurance) during the early years of the term, then underpaying at the end. For the 35-year-old in the above example, the 30-year level term premium is $490/yr. Compared to yearly renewable term, the level premium is more expensive for the first 10 years, then less expensive for the next 20.

To accurately price level term insurance, the insurance company must make some assumptions about the time value of money, because the “additional” premiums they collect in the first 10 years will be invested to subsidize the cost of insurance for the following two decades.

A level term premium schedule significantly resolves the problem of the cost of insurance becoming progressively more expensive in later years – at least during the term. But when the term expires, the problem returns. In our example, the cost to renew $500,000 of life insurance at age 65 is $5,025/yr. – providing the individual can prove excellent health by passing a new physical examination. Even if he is healthy, the new term is limited to 20 years (age 85). And what happens if this man lives to age 86? The scheduled renewal premium is now $207, 990! For one year!

While level term premiums help consumers afford life insurance longer, the same end-of-life problem remains: Just when you are most likely to collect on the life insurance, you may not be able to pay for it. Level term insurance is certainly a win for the insurance company because policyholders pay more premiums longer, but the financial outcome is less clear for most consumers using term insurance – they still are not likely to have an insurance benefit in force at death.

Integrated Solution, Step Two
A lifetime term policy with level premiums would solve the problem. But fairly pricing term for one’s entire lifespan creates a new problem: As illustrated by the yearly renewable table, the cost of insurance rises steeply after age 60. So even with a long time to “overpay” at the beginning, a policy guaranteed to be in-force at age 100 requires a sizable annual premium. In the case of our healthy 35-year-old non-smoker, the lifetime annual premium is $6,165/yr., more than 12 times the annual premium for the 30-year term policy. Unless the consumer has money to burn, the idea of overpaying $5,600 each year (the difference between the whole life and level term premium) for the next 30 years just to keep the premiums affordable in old age probably won’t set well. There’s just too much overpayment for too long to convince most consumers to set aside that much money for an event that may be 50 years in the future.

Enter the concept of cash value. The overpayment of premium in a whole life policy represents reserve capital the insurance company will use to cover the cost of insurance as the policyholder ages. In the meantime, this reserve capital will be invested to generate more capital. A portion of this excess cash value, and the earnings from it, is credited to a cash account tied directly to the policy. While the policy is in-force, the policyowner has the right to access this cash value, through a variety of transactions (loans, partial surrenders, dividends, etc.).

In a typical whole life policy, this cash value can eventually exceed the total premiums paid, i.e, the policyholder not only owns the insurance benefit, but has received a positive return on the premiums.

This blending of cash value and life insurance is a brilliant example of integrated thinking. A whole life policy with a level premium provides economic certainty for consumers – they know how much insurance they will have, they know how much it will cost, and (as long as premiums are paid) they know the insurance will be in-force at the end of their lives. At the same time, the larger premiums give the insurance company greater financial stability. It has greater resources to meet its contractual obligations. And during the lifetime of the policy, the owner also has access to this stable source of cash value (and its growth) as well.

Complexity begets more complexity – and more opportunities
Besides turning the life insurance benefit into an asset instead of an expense, the cash value component opens the door to other possibilities. Dividends* can be received as income, or used to pay premiums. Additional paid-up insurance may be purchased. Depending on the performance of the cash value account, additional premium requirements may change or be eliminated.

Because the benefit paid at death is now certain, life insurance can do more than provide income replacement protection in the event of a premature death. Among other things, the proceeds can be vital in estate and inheritance planning, serve as a supplement to long-term care, pay creditors and fund charities.

Some might argue that it is hypothetically possible to project similar or greater financial results by choosing to use term insurance alongside other accumulation vehicles. On paper, this is possible. But while two simple stand-alone financial products might appear to out-perform whole life in a narrow set of criteria (such as pre-tax accumulation in a 20-year period), they cannot equal the combination of benefits, guarantees and flexibility that result from using a whole life policy. The integration of level premiums and cash value, and the resulting opportunities make life insurance a win-win for all parties.

Just as whole life is a multi-faceted complex financial instrument, there are many ways to position whole life in one’s financial program. Contact us to find out how whole life might best fit your current circumstances.

*Dividends are not guaranteed, and are generally declared annually by the company’s Board of Directors.

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LISTEN: Should a Second Home Be The Only One You Own? (mp3audio) (10:24 min)

It’s too early to make a definitive statement, but the fallout from the real-estate bubble may result in some fundamental long-lasting changes in Americans’ perspectives on home ownership. Not only is there the chance that fewer Americans will be able to own a house, but even those who are prime candidates for home ownership may find other options more attractive and financially profitable.

A little background:
Before 1940, slightly less than half of all American households owned a home, a percentage that had remained unchanged for more than four decades. Following World War II, the Baby Boom, coupled with government tax breaks and subsidies, rapidly increased the percentage of Americans who owned their house¹. By 1960, more than 60% of Americans were homeowners, and for a period in the late 1990s and early 2000s, the number approached 70%.² Homeownership became a standard fixture in the American Dream.

However, the allure of homeownership has lost much of its luster in the recent financial melt-down, both for homeowners and the financial institutions who initiated the mortgages to make the purchases possible. Where once only a few financial commentators questioned the financial value of owning a home, a tide of commentary is asking if the US economy would be better off with fewer homeowners and more renters. But maybe the problem isn’t how many people own a home, but what type of home they own.

When the housing market was booming through the past two decades, it was assumed that almost every homeowner could expect to cash out with relative ease, either by selling the house or taking a home equity loan. Home equity was seen as a liquid real asset, one that could be accessed at almost any time.

However, as banks have tightened their lending standards to potential homeowners, the market of potential buyers has shrunk, driving prices down. At the same time, more homes are being liquidated at discount in foreclosures and short sales, further depressing the market. In the course of the past three years, current homeowners find their home equity has substantially diminished – and isn’t very liquid.

These changes in the real estate market increasingly make homeownership a much longer term proposition. A decision to buy a home today isn’t easily undone. For those who currently own a home, it may take awhile for values to rebound, and selling the home in the future is no longer a foregone conclusion, even at reduced prices. This fundamental change in perspective regarding homeownership should compel individuals to consider questions like:

• Is there a profitable exit strategy for this house, or should I plan to live here for the rest of my life?
• What happens if an employment change requires a relocation?
• What is the projected market for my property in the future?
• What is the legacy value of my home? Is this an asset my heirs will want to inherit?

In the past half-century, the largest increase in American residential housing has been in suburban communities, and the bulk of the middle-class homeowners own single-residence dwellings in subdivisions. If you are one of these suburban home-owners, how would you answer the questions above? Can you see yourself staying in this house for the next 20 or 30 years, or into retirement? Would someone else want to live in your subdivision? And if your children or other heirs inherit this property, will they see it as a valued asset or a financial albatross?

When you consider the changing demographics of an aging population, a post-Baby Boom contraction in housing demand for single-family homes, and fewer financially-qualified home buyers, it is reasonable to think the long-term prospects for suburban housing won’t be what they have been for the past 50 years. If this is true, a different approach to homeownership might have some appeal.

A different approach.
Instead of a single-family house as the default option for real estate, look at other options. For example, think about renting a primary residence and buying a “second home” – such as a cottage, a vacation or resort property, or a even an income property in a thriving community. Under the right conditions, this strategy could have several advantages.

First, many buyers of a “second home” property could still receive tax advantages that would closely approximate those that come from owning a primary residence. Second, income from rentals (seasonally on resort properties, or year-round in residential locales) may offset many of the costs of ownership. Third, resort and vacation properties can be enjoyed by owners and their families for their recreation and destination value, both now and in the future. Fourth, renting may offer greater flexibility in adjusting to fluctuating living conditions, such as changes in employment or children leaving the nest. Fifth, if it is desirable to make this property a home in retirement, the transition is simple; you stop renting and move into the house. Sixth, a profitable rental or desirable vacation home would likely have ongoing value for heirs; a sale would not be required for them to receive value from the inheritance.

This strategy of buying a “leisure home,” while living in a rental is not a new idea. This pattern was typical of many wealthy individuals during the late 19^th and early 20^th century. They owned an “estate” in the country, and rented a workplace residence. American steel magnate and finance giant Andrew Carnegie (1835-1919) was one of the richest men in history, and he established his fortune quite early in life. When he was in his twenties, Carnegie erected a large estate home on property in Homewood, PA, near his hometown of Pittsburgh. Yet for much of the next 25 years, Carnegie resided in luxury hotels in New York City, returning to his estate during the summers or as a stop on his travels. At various times, other members of Carnegie’s family also lived at the estate, but it was never Carnegie’s exclusive residence. In later life, Carnegie established additional large estates in Massachusetts, Georgia and Scotland.

In several ways, the “titans of industry” during the Industrial Revolution mimic some of the work circumstances of people in the 21^st century Information Age. Carnegie and other businesspeople of his era were establishing continent-spanning businesses that required them to be mobile. Even though some employers may offer telecommuting options, today’s workforce opportunities often require a high level of transience. Today’s worker expects to change jobs more often, and to change their places of residence as well. While any relocation is stressful, it could be argued that renting makes moving easier from a financial perspective – there is no home to sell, no monthly mortgage payment on an empty home, and there is no equity loss to worry about.

At the same time, buying an “estate property” offers several tangible and financial benefits, both now and in the future. A well-managed income property has the potential to add revenue to your financial program. A vacation home can be a welcome getaway and a gathering place for families as they grow up and expand. In both instances, the need to sell will be lessened, which allows more time for equity appreciation, and gives owners the upper hand in deciding when and if a sale should take place. If this property stays in the family for several generations, the long-term benefit of buying estate property could be incalculable.As the turmoil from the Great Recession recedes, the fallout is revealing changes in the financial landscape. Those changes may affect the role of homeownership in the American dream. While single-family residences may still occupy a prominent place in the financial lives of many Americans, it doesn’t hurt to consider (and prepare) for other options.

DO YOUR LONG TERM FINANCIAL PLANS INCLUDE “ESTATE PROPERTY?

IF YOU FOUND AN ESTATE PROPERTY OPPORTUNITY, HOW WOULD YOU EXECUTE THE TRANSACTION?

WOULD YOU LIKE TO EXPLORE THESE, OR OTHER IDEAS WITH US?

U.S. Census Bureau:
11989 report, Historical Statistics: Colonial Times to 1970.
2 US Census Report, Homeownership by Area (focusing on homeownership from 1960-2008)

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LISTEN Disability Insurance: A Case Study in Illusions? (mp3audio) (5:36 min)

“Even if I get disabled, I’ll still work.”

Huh? How is that possible?

Ask any insurance agent who’s been in the business for awhile, and chances are, he/she has heard this statement, or a variation of it. That’s because disability is one financial topic where illusions often prevail over the facts.

For most non-retirees, their ability to earn an income is their greatest financial asset. Compensation from work puts food on the table, pays the mortgage, sends kids to college, and builds the retirement nest egg. Without an income, none of that happens. It should be easy to recognize the desirability of good risk management strategies for disability, right?

Wrong. Just like the findings in The Invisible Gorilla, people underestimate the risk of disability and overestimate the abilities and resources available to handle it. Consider these statistics:

• The government’s Social Security Administration (SSA), which provides disability benefits for most Americans, says that three in 10 people entering the workforce today will become disabled before retiring.*
• SSA also reports that the overall rate of disability is increasing among both men and women workers. In 1999, 3.6% of covered workers were receiving Social Security Disability Income payments, while in 2009, 5.1% were receiving SSDI payments. Factors behind this dramatic rise include the aging of the U.S. workforce and the recent poor economic conditions.**

When 5% of Americans are on disability claim and 30% are likely to experience a period of disability before retirement, this sounds like a situation that should be addressed. And in some ways, it is: Social Security offers some insurance, as does Workers’ Compensation, which provides benefits for disabilities occurring in the workplace. But do these programs really provide adequate risk management for disability? Again, look at the numbers:

• The Council for Disability Awareness** (CDA), an association of 16 insurance companies that comprise 75% of the commercial disability insurance marketplace, reports that 95% of all CDA Member Company disability claims are not work-related. For the SSA, 90% of all disabilities are not work-related.
• 31.2% of individuals who received long-term disability benefits from CDA Member Companies** in 2009 did not qualify for disability benefits from Social Security. While the number of workers receiving Social Security benefits has increased, only 35% of workers applying for SSDI disability claim payments in 2009 were approved; 10 years ago, the approval rate for workers applying for disability was 52%.
• In spite of the limited protection afforded by Social Security and Workers’ Compensation, the US Bureau of Labor Statistics reported in an April 29, 2010 press release* that 46% of full-time workers had short-term disability benefits and only 39% had signed up for long-term disability.

The conclusion: Many of the disabling incidents that could keep you from earning an income are not going to result in payments from either SSA or Worker’s Compensation. And half of all workers don’t have any other coverage. How does this happen?

“Many people recognize the emotional and financial impact of becoming disabled, but they tend to underestimate the consequences of not having adequate income protection,” according to insurance company vice president Kevin Farley***. Instead of insurance, they think they can rely on their savings, make adjustments in lifestyle, and get help from family members.

But mostly, people think they can define the terms of their disability. They will say…

“If that happened to me, I could still go to work.”
or…
“I wouldn’t be out that long. I’m a fast healer.”
and…
“I’m not one of those people who would milk an insurance claim.”

Hmmm. It sounds like these people are operating under some illusions. They minimize the impact of a disability, often because they underestimate the likelihood of it occurring while overestimating their ability to withstand the financial consequences.

*April 29, 2010 Press Release from Business Wire, “Most Americans Live to Work But Don’t Prepare for Illness or Injury That Could Put Their Income at Risk.”
**www.disabilitycanhappen.org
***Business Wire from Principal Financial “Despite Fears, Americans aren’t Protecting Themselves,” May 14, 2010.

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LISTEN Bugged by Gold (mp3audio) (10:32 min)

It’s baaaack!

The foundation of monetary systems for centuries, gold has been considered an anachronism in modern financial philosophy, something that computers and sophisticated monetary models had made irrelevant. With the exception of a few contrarian “goldbugs” who market a doomsday view of the financial future, gold is now seen as a precious industrial metal, and its value depends on how it is used – in jewelry, dentistry, electronics, glass-making, etc. But as the shake-outs continue from the global financial crisis that began two years ago, gold has resurfaced in the financial arena. Two news items during the same week in May highlighted a return to prominence for an ancient financial asset.

• Beginning May 13, 2010, CBS News and the Wall Street Journal were among several news outlets to report on an ATM in Abu Dhabi that dispenses gold in exchange for paper money. The ATM provides updates of gold prices every 10 minutes, and dispenses both coins and bars of gold in exchange for paper money.
• Later that week, on May 17, a high-profile television stock market guru (known for his loud and animated opinions) weighed in that now was the time for investors to consider gold as an investment. Citing “Six Reasons to Buy Gold Now,” this investment expert was enthusiastically recommending gold as a “buy.”

At the same time, there is a proliferation of commercials on radio and television urging consumers to exchange their “unwanted gold” (usually jewelry) for money. So…there’s a group that says “now is the time to buy gold”, and another that says “now is the time to sell”. What to think?

Because of its chameleon-like characteristics and long history, gold holds a unique place in the financial world. It is truly a one-of-a-kind financial asset. And there are numerous ways to view gold in a financial program.

Gold as Money
One of the most common uses for gold through history has been as money. In coins or bars, gold has been a preferred medium of exchange. Historically, several characteristics have made gold well-suited as money. First, gold itself, in any form, has an almost-universal appeal. It is attractive, durable, and malleable. This means gold can be converted from its function as money into another type of asset without an exchange taking place. A person with five gold coins can melt them and recast the metal into a bracelet, or gold thread or a crown for a tooth. Second, gold is a fungible commodity, i.e., one ounce of gold is considered interchangeable with another. Possessing these two traits, almost every society was more than willing to accept gold as payment for any type of transaction. The face or national symbol stamped on the coin might vary, as would the measures of weight, but for most of the past twenty-five centuries, gold has been the universal currency. (In the early years of the United States, all sorts of gold coins circulated as money, from Spanish doubloons to American double eagles.)

While other items (such as shells or animal pelts) have also served as money, the proponents of gold argue that no other item, including all types of paper currency, is a better medium for financial exchange. Because gold is relatively rare (it is hard to extract and hard to refine), and has real value besides serving as money, there’s not enough in circulation for governments, institutions, or individuals to manipulate its value. In contrast, governments and central banks can “re-price” their money in a variety of ways, typically by increasing or decreasing the amount of paper money in circulation.

Currency manipulation is a primary cause of inflation. In the past, countries and banks have so drastically manipulated either their currency or notes of credit that they became worthless. In the 20th century Germany, Argentina and several African countries experienced periods of hyper-inflation such that their paper money systems collapsed. Instead of serving as units of value, the “money” was nothing more than small pieces of printed paper. Because of the possible dangers of paper money, some economists advocate that all paper money be backed by gold, i.e., you can always exchange a paper note for a corresponding amount of gold. Today, no countries operate on this gold standard, but in times of financial unease, gold may become “money” for people who don’t feel secure making transactions with the paper currency of a particular nation.

Gold as an Investment
Since gold has a long history as real money, it is possible to use gold as a gauge of the value of other forms of money, and to make bets as to which forms of money may fluctuate in value. For example, the market price of an ounce of gold in US dollars on May 21, 2005 was $416.27. Five years later, on May 21, 2010, the price was $1,187.80. An individual who bought 100 ounces of gold five years ago for $41,657 and sold it on May 21, would have realized a gain – in US dollars – of $76,889, which equates to an annual rate of return of slightly more than 23.3%. That sounds like a pretty good investment decision. However… If you bought 100 ounces of gold 15 years ago, in May 1995, the price was just under $400/ounce. During the 10-year period, from May 1995 to May 2005, the rate of return on a gold investment – in US dollars – was close to 0 percent. From an even longer perspective, the price of gold compared to US dollars dropped from a high of $850/ounce in January, 1980 to $481.50 two months later, then stayed in a range between $500 and $300/ounce for the next 15 years. This isn’t the type of long-term performance that most investors are seeking.

From an investor’s perspective, gold usually delivers returns when the bet is against the economy. As the TV stock guru put it, gold is for “when the mentality toward the market becomes negative.” But the trend of a nation’s economy, and human activity in general, is not downward. Down cycles are corrections, followed by new growth. This makes investing in gold primarily a timing strategy. You have to believe you know when to get in, and when to get out.
Statistically, most of us, even the experts, are poor market timers, whether the investment is gold or something else. A cynical observation is that the only people who consistently profit from market timing are those who market the idea.

A “Classic” Idea: Gold as “Insurance”
Besides the use of gold as money and as a speculative investment, there is a long financial tradition of gold as a small, permanent fixture in a financial portfolio. In the form of jewelry, coins and other physical forms from works of art to bars, gold has been viewed as another real asset, like real estate, equipment or art. These gold items were not intended to be bought and sold – they were purchased for collections, for artistic and personal reasons, and were intended to be passed on as family heirlooms.
But just in case…there was always the security in knowing that as a last resort, these items could be liquidated in the event of an extreme financial emergency. This was not an investment strategy, like a collector who buys in order to sell later. This was financial “insurance”, because regardless of whatever might happen to the collectible value of coins or jewelry or other gold objects, there was the assurance that the gold gave it some underlying value. In this context, many individuals would routinely acquire some gold or similar precious metals, primarily as things to enjoy, but with a perception of “financial security.”

Ultimately, gold is a real asset. While it is fungible and accepted by almost everyone as being valuable, its value depends on all sorts of other variables. While it can function as money, and be used to speculate on the relative value of other types of money, a case can be made that the classical perspective on gold – small amounts purchased for enjoyment, inheritance and rare financial emergencies – is one that can be most applicable to everyone.

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LISTEN (mp3audio) (5:45 min)

Right before the 2010 Super Bowl, a page 1 article in the February 5, 2010 Wall Street Journal opened with this sentence:

“Investors are sometimes accused of treating the stock market like a casino. Now, one Wall Street firm wants to treat casinos like the stock market.”

The article details the decision of a Wall Street bond-trading company to take over the management of sports betting at a new Las Vegas casino. Lee Amaitis, the company executive who runs the betting operation, says the firm got into sports gambling because “we wanted to turn gamblers into traders.” Using sophisticated financial-markets software, bettors can not only bet on the final outcome, but also make wagers on events during the game, such as whether the next pass might be completed, or who kicks next field goal.

On several occasions, the article noted similarities between investing and gambling. The article even featured a bond trader-turned-professional gambler who said “Wall Street is just a form of legalized gambling.”

Is investing just a form of gambling? For many investors, the answer may be “yes.” But it doesn’t have to be. And it probably shouldn’t be.

In July 2000, Tom Murkco, the CEO of Investor-Guide.com, published an essay titled “What is the difference between gambling and investing?” While Murkco noted that many aspects of gambling and investing might appear similar, there were several distinct and easily defined differences.

For either investing or gambling, the beginning of Murkco’s definition is the same: An activity in which money is put at risk for the purpose of making a profit.

But while the purpose of gambling and investing is identical, the methods by which the purposes are achieved are drastically different.
Here are Murkco’s distinctions:

When someone invests…

• sufficient research has been conducted;
• the odds are favorable;
• the behavior is risk-averse;
• a systematic approach is being taken;
• emotions such as greed and fear play no role;
• the activity is ongoing and done as part of a
• long-term plan;
• the activity is not motivated solely by entertainment or compulsion;
• ownership of something tangible is involved;
• a net positive economic effect results.”

When someone gambles…

• little or no research has been conducted;
• the odds are unfavorable;
• the behavior is risk-seeking;
• an unsystematic approach is being taken;
• emotions such as greed and fear play a role;
• the activity is a discrete event or series of discrete events not done as part of a long-term plan;
• the activity is significantly motivated by entertainment or compulsion;
• ownership of something tangible is not involved;
• no net economic effect results.

When defined this way, it’s easy to see the differences between investing and gambling. It’s also easy to see that because of the methods some people use to invest, their behavior may more closely resemble gambling.

For example, industry studies have repeatedly shown that the behavior of mutual fund investors often accounts for poor investment performance. Because they don’t approach investing systematically, emotions like greed and fear may cause people to make impulsive decisions, with little or no research. Not surprisingly, the results from these methods more often resemble the returns from lottery tickets.

Not Gambling with Your Investments: Easier said than done?
In his book, Snap Judgment: When to Trust Your Instincts, When to Ignore Them, and How to Avoid Making Big Mistakes With Your Money, author David Adler says it’s the psychological component of investing that is the most difficult to manage. Adler contends that behavioral research shows many individuals have an almost over-whelming set of hard-wired dispositions to take gambles rather than make investments. Adler quotes Andrew Lo, an MIT professor of finance:

“The same neural circuitry that responds to cocaine, food, and sex has been shown to be activated by monetary gain as well.”

For some people, the thrill of investing/gambling can be addictive. But when the stakes are one’s financial future or retirement, or your children’s college education, the need for a thrill shouldn’t come by jeopardizing one’s investments.

This imperative to not compromise investing by gambling highlights one of the greatest benefits of working with a team of financial professionals: Besides receiving informed advice, a financial professional can often serve as a protection against gambling with your investments, by encouraging you to make sound decisions based on good research that have a high likelihood of success.

Take a moment to consider the last few major financial decisions you’ve made in the past year. Then look at the list above. Did you make an investment or take a gamble?

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In terms of financial value, has a college degree reached its “tipping point?”

Since the end of World War II, obtaining a higher education has been touted as one of the surest paths to a higher income and better financial life. Supporting this idea, various government programs have been established to make it possible for more people to afford a college education. Included in these programs are grants, scholarships and work-study options, but the most widely-used assistance plans are student loans, which allow individuals to borrow money in order to finance their education on very favorable terms. (Not only are government-approved student loans generally issued at lower interest rates, but most do not become due until after several months after graduation.)

President Ronald Reagan was not an economist, but he was fond of repeating several economic adages that succinctly expressed his views. Among those most frequently recited: “If you want more of something, subsidize it.” This statement has proven true in higher education; more Americans are attending college – and more Americans are using government assistance to do it. But subsidies, government or otherwise, have other consequences as well.

When the demand for something increases, the price usually goes up as well. A 2008 report from the National Center for Public Policy and Higher Education found that “published college tuition and fees increased 439% from 1982 to 2007 while median family income rose 147%.” In other words, the cost of a college education over those 25 years had tripled in relation to family income.

Because higher education costs more money, the Center’s report adds that “student borrowing has more than doubled in the last decade.” The public service web site www.finaid.org acknowledges borrowing is now almost inevitable: “Few students can afford to pay for college without some form of education financing. Two-thirds (65.6%) of 4-year undergraduate students graduated with a Bachelor’s degree and some debt in 2007-08, and the average student loan debt among graduating seniors was $23,186.”

As the cost of education and the amount of borrowing necessary to finance it both increase, the financial value of a higher education begins to decrease relative to its cost. A February 2, 2010 Wall Street Journal article titled “What’s a Degree Really Worth?” presented some calculations that the financial advantage of a college education had diminished by almost 60% in the past decade.

Various data collected from 1999 through 2002 and used in publications by the Census Bureau and the nonprofit College Board showed a college education paid off in an average lifetime earning advantage of $800,000 to $1 million, compared to those without degrees. However, using current numbers reflecting the disproportionate increase in costs compared to incomes, the American Institutes for Research, another non-profit, found the lifetime advantage had diminished to $280,000.

Beyond the possibly diminished advantage in lifetime earnings, the increase in student loan indebtedness may present greater financial dilemmas for college graduates. Student loans are unique financial obligations, and their negative financial impact can last a lifetime.

Particularly in a tight job market, repaying student loans can be a financial hardship when one is just beginning a career. In response, lenders may offer options to postpone or modify payments, but forbearance on large sums can make future payments positively overwhelming. In a February 13, 2010, Wall Street Journal article (“The $550,000 Student-Loan Burden”), Mary Pilon detailed how the student loan debt of a family practitioner ballooned from $250,000 to $550,000 in the eight years after her graduation because of deferrals and charges.

Since most student loan debt is secured debt borrowed from the federal government, it can almost never be erased, even by filing bankruptcy. As www.collegescholarships.org says on its website: “Student loans are rarely forgiven since they are guaranteed government funds dispersed with low interest to all kinds of people with no credit history. You don’t epect the IRS to forgive you on all taxes that are owed, so expect the same treatment with your student loan.”

Jeffrey J. Williams, a professor at Carnegie-Mellon University, writes that student loans “stipulate severe penalties and are virtually unbreakable, forgiven only in death, not bankruptcy, and enforced by severe measures, such as garnishes and other legal sanctions, with little recourse. (In one recent case, the Social Security payment to a person on disability was garnished.)”

Even if you can make regular payments following graduation, the terms are heavy. “Student debt is a long-term commitment — fifteen years for standard Stafford guaranteed federal loans,” says Williams, author of The Post-Welfare State University. “With consolidation or refinancing, the length of term frequently extends to thirty years—in other words, for many returning students or graduate students, until retirement age.” Having student loan payments at age 55 or 65 is a sobering thought.

Because of these sizable long-term obligations, “College student loan debt has revived the spirit of indenture for a sizable proportion of contemporary Americans,” says Williams. “Because of its unprecedented and escalating amounts, it is a major constraint that looms over the lives of those so contracted, binding individuals for a significant part of their future work lives.” Pilon agrees, saying “in practice, student loans are one of the most toxic debts, requiring extreme consumer caution.”

Conclusion: Education Good; Debt Bad; Preparation Essential
In almost every instance, more knowledge and greater skills are valuable, even if the financial calculations seem to indicate the benefits aren’t as great as they used to be. The critical financial questions about a higher education are whether it’s worth mortgaging a significant portion of one’s future to acquire a higher education, and whether using student loans is a preferred method of financing.

In addressing these questions, there is another dynamic. The person who will be most affected by this decision is often financially inexperienced and possesses limited resources. Bruce Necker, writing a “President’s Page” opinion piece in the March, 2002, issue of the Michigan Bar Journal, related that

“One of my friends, a successful obstetrician in Grand Rapids, told me that if she had to do it all over again, she would forgo her medical school education rather than strap herself for her entire life, to decisions she made as a 22-year-old before entering the profession. I hear the same tale from young lawyers. Borrowing is the easy part. Repayment proves to be more difficult.”

In reality, these hard financial decisions about college education are greatly determined by earlier financial decisions made by a student’s parents or guardians. If they haven’t made preparations for college funding, the choices for their children are limited: athletic or academic scholarships, need-based financial aid, or loans. Scholarships are available to a uniquely gifted portion of the population, and need-based funding has decreased with the economic decline. That leaves either loans – or forgoing college.

IS COLLEGE EDUCATION ON YOUR LIST (OR YOUR CHILDRENS’)?  IF SO, NOW IS THE TIME TO EXPLORE FUNDING ALTERNATIVES TO STUDENT LOANS.

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The potential for financial devastation from disability is substantial. For most Americans, the ability to earn an income is their primary financial engine. If something stops the engine, everything else comes to a halt as well.

In spite of the critical need for ongoing income in most people’s financial program, relatively few Americans obtain personal disability income insurance from an insurance company. Some may pick up group disability coverage from an employer, but for most Americans, their primary disability insurance is through the Social Security Administration (SSA).

According to the SSA website (www.ssa.gov), Social Security provides disability benefits for all workers who qualify, i.e., they have “worked long enough and paid Social Security taxes.”

Like other private forms of disability insurance, SSA benefits can only be paid if your disability fulfills or meets a pre-established criteria. SSA considers you disabled* if:

• You cannot do work that you did before;
• SSA decides that you cannot adjust to other work because of your medical condition(s); and
• Your disability has lasted or is expected to last for at least one year or to result in death.

* Please contact the Social Security Administration for complete eligibility criteria. The text above is a summary of those requirements.

SSA explicitly states “This is a strict definition of disability. Social Security program rules assume that working families have access to other resources to provide support during periods of short-term disabilities, including workers’ compensation, insurance, savings and investments.”

Under the law, your payments cannot begin until you have been disabled for at least five full months. Payments usually start with your sixth month of disability, providing your disability is approved (more on this later).

The amount of benefit paid will depend on several factors, including your earnings and family size. In some situations, additional benefits through the Supplemental Security Income (SSI) program may be available. Benefits may be paid until you return to work or reach retirement age, at which time your payments will be disbursed from your Social Security retirement.

In summary, the SSA disability insurance is minimal when compared to coverage available through insurance companies, but certainly is better than no coverage.

But beyond the strict definition of disability, lengthy waiting period and limited benefits, disabled workers face a significant hurdle when applying to receive SSA benefits: The claims process itself.

According to the SSA, the average processing time for an individual awaiting a decision from Social Security with regard to a disability claim is 442 days.

That’s almost 15 months!

And that’s just to get a decision. Approval is another matter altogether, because according to the Social Security and Disability Resource Center (www.ssdrc.com), only about 40 percent of all claims are approved from the initial submission.

If you are denied benefits, SSA offers two appeals. The first is called Reconsideration (in which another 20 percent are approved to receive benefits), and the final appeal is a hearing before an Administrative Law Judge.

How quickly a SSA disability claim is resolved depends on a number of factors, many impossible to determine in advance. As the SSDRC says:

“Social Security Disability and SSI cases can be won in as little as 30 days, or take as long as two years for benefits to be awarded. There is simply no way to predict how long a case will take because unlike other programs (Dept of Social Services, for instance), the federal disability program does not have deadlines for applications or appeals.”

The bureaucracy and legal procedures involved in receiving SSA benefits has made professional assistance almost a necessity. SSA claims have become a specialized niche for some law firms.

Participation in Social Security is mandatory for almost all Americans who earn an income. And if you are entitled to benefits from SSA as a result of a disability, you should by all means make a claim. But honestly…

Is this the only insurance protection you want in place in the event of a disability?

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Demographic trends, i.e., the analysis of population statistics to identify markets, can uncover significant, large-scale, long-term economic movements that are already in place. Once in place, demographic trends may take a long time to play out, so understanding these trends may be valuable in shaping future financial plans.

Among the most significant trends currently affecting the industrialized world: Depopulation of developed countries, particularly in Europe and East Asia, coupled with more people living to the limits of extended life expectancies. The result: decreasing populations with an increased percentage of older people, a format that will be unable to sustain social and economic models started in the post-World War II era.

As a consequence of these changing demographic trends, many of the paradigms and products related to personal finance may need to be adjusted. This includes length and type of employment, retirement and accumulation planning, self-employment and insurance programs (both public and private).

In light of these conclusions, think of your own financial programs. The following questions might be relevant:

• Are your retirement plans designed to provide income and security to age 100 and beyond?

• Does your career path include working, in some capacity, well into your 70s (or 80s)?

• Are your savings and retirement programs structured to accommodate self-employment or phased retirement?

On reflection, a lot of financial information is just trivia that takes up space and is quickly forgotten. But historically, economic demographics seem to have staying power. The last great demographic trend began after World War II. More than sixty years later, the Post-War demographics are finally winding down, and in developed countries, the rising demographics of depopulation and rectangular longevity are already in place. Do your financial programs account for the possibilities – and perils – of these new trends? Remember, the impact of demographics can span decades, even centuries.

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IDEAS THAT ENDURE

Ideas matter. The value of every statistic, every calculation, is determined by the ideas and philosophies to which the numbers are applied.

In the past several years, several trade publications have republished a short commentary on the essential elements of life insurance. Originally titled “Just a Life Insurance Policy,” this is a brief yet powerful statement of the timeless ideals that make life insurance a financially relevant product.

The article, probably written at least 50 years ago, was resurrected by Marvin Feldman, a prominent Ohio insurance agent and industry authority, in 2006. Feldman notes in an accompanying commentary that he was unable to identify the original author, and while the article can be found in a number of publications and websites, none of these sources cites an author either. Feldman also acknowledges he had to reword some of the article because the original syntax reflected a different era. Still, the financial and social concepts at the heart of life insurance remain relevant to the challenges and aspiration of today’s world.

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