Income, Longevity & Client behavior

Even Smart People Make Strange Decisions

Or how to stop loaning the Government your money and start earning more

by Herbert K. Daroff, J.D., CFP, AEP

Mr. Daroff is affiliated with Baystate Financial Planning, Wellesley, Ma. Visit

Would you race to the store to save 6.25%? Sale, 6.25% off everything in the store! Probably not. Yet, people flock to the store for a sales-tax holiday. Do you like getting an income tax refund? Do you like making an interest free loan to the government? Do you realize that’s what you are doing when you get a tax refund? You over-paid your taxes. Now, you are getting YOUR money back without interest. If you owe the government too much money, they charge you interest. But, regardless of how much you over-paid in withholdings and/or estimated tax payments, you get your money back without interest.

The Federal Reserve in the 3rd quarter of 2018 raised the borrowing rate 25 basis points, just a quarter of a point. No big deal! Right? But, raising the rate from 2.00% to 2.25% was a 12.5% increase (0.25 / 2.00 = 0.125). Markets reacted poorly to this seemingly “aggressive” increase. So, the Fed said that the next increase would be smaller. What did they do? For the 4th quarter 2018, they raised the borrowing rate another quarter of a point, from 2.25% to 2.50%. That is smaller. Only 11.11% increase. The DJIA which was UP 300 at noon, before the annoucement ended the day DOWN 300 after the announcement. For consumers who have seen interest rates credited to their accounts in the low single digits (1%, 2%, 3%, 4%), double-digit increases in the borrowing rate are enormous.

By comparison, an increase from 2.00% to 2.05% would have been a 2.5% increase. Increasing by another 2.5% would bring the Fed rate to 2.10125%, instead of 2.50%. And yet, these smart people on the Fed don’t seem to understand why the stock markets dive for cover with ONLY a “quarter of a point” increase. They don’t seem to understand that they are increasing the Fed rate way too fast for this economy.

The DJIA being down creates an opportunity, right?

When is the best time to buy a snow-blower? July. Right? When do most people buy their snow-blowers? After the first blizzard. When the stock markets go down, many investors sell. But, when the stock market goes down, the price you pay for stocks is lower. They are ON SALE!

Why do smart people run out of the store, instead of taking advantage of the sale and buying great companies at a lower price? They fear that the prices will go down further. They might be right. But, the prices may go back up, too.

Years ago, there was a mutual fund that returned over 90% for just one year. Yet, most investors in that fund LOST MONEY that year. How is that possible? The media starting reporting on that fund’s performance in the 3rd quarter. That’s when many investors bought. At that point, the fund was up 95%. So, they bought high.

All too many investors buy high and then sell low. They buy out of greed. And, then they SELL out of fear.

Chasing Fees

Investors are also chasing low fees. Advisor “A” charges 30 basis points = 0.30%, and Advisor “B” charges 100 basis points = 1%,. So, which advisor do you pick? That decision makes sense only when coupled with performance.
Advisor “A” charges 30 basis points = 0.30% but your portfolio grows at 5% even with benchmarks matching your investment portfolio are generating double-digit returns. Advisor “B” charges 100 basis points = 1%, but your portfolio grows at just above the double-digit returns measured by the benchmarks matching your investment portfolio.

Now, which advisor do you choose?

Shouldn’t your goal be to grow your money net after taxes, and inflation, and fees at a rate commensurate with your risk tolerance and risk capacity? Isn’t the goal to maintain purchasing power?

One advisor advertises, “Just don’t lose the money!” Is that the “right” goal for you? You could put all of your money in a safe deposit box and not lose the money. Shouldn’t your goal be to grow your money net after taxes, and inflation, and fees at a rate commensurate with your risk tolerance and risk capacity? Isn’t the goal to maintain purchasing power?

I met with a prospective client many years ago. The couple told me that I was the third of five financial planners they were interviewing. They would hire the advisor that could show them how to pay the least amount of income taxes on their retirement account. I told them that their search was over. There was no need to see the last two. I said, “If we lose 20-30% every year, even in up markets, your retirement accounts will dwindle to next to nothing when you are ready to retire. You will pay almost nothing in income taxes.” Is that really what they wanted? I continued, “If we grow your account by 20-30% every year, even in down markets, you will pay much more in taxes, because you have a much larger value.” Would that be a bad thing? We went on to discuss a series of Roth Conversions every year to fill up their tax bracket. We discussed life insurance to fund a Roth Conversion by the surviving spouse. We got hired because we showed the client that they were chasing the wrong objective.

I have told other clients that just want to minimize their income taxes and estate taxes that they can do so by just giving away more to charities during lifetime and at death. So, is the right objective to minimize taxes?

Isn’t the “right” investment objective to maximize my return net after taxes, and inflation, and fees? Isn’t the “right” estate planning objective to maximize what I leave to my heirs, net after taxes and my own standard of living expenses during lifetime? And, to protect those assets from the heirs’ creditors. In other words, a strategy that provides Multi-Generational Tax Planning and Multi-Generational Creditor Protection.

Define & Design

What we get paid for is helping our clients properly state their measurable objectives and then design the most cost effective and tax efficient method of attaining those goals. We get paid to help our clients make decisions that they think are counter-intuitive. Like re-balancing an asset allocation portfolio.

If my client’s risk tolerance, time horizon, and objectives say allocate his or her $30,000
$10,000 to “A”
$10,000 to “B”
$10,000 to “C”

Then, after some period in time, the account is up 10% to $33,000.
$15,000 to “A”
$ 8,000 to “B”
$10,000 to “C”

We advise
$11,000 to “A”
$11,000 to “B”
$11,000 to “C”

They say, “Are you crazy? You want me to sellL $4,000 of the winner (“A” that is up 50%) and BUY $3,000 of the loser (“B” that is down 20%) and $1,000 to “C” that didn’t move at all? And we answer, “Yes!”

If the previous asset allocation was consistent with their risk tolerance, time horizon, and objectives, then re-balancing should return them to the same allocation.

What does the client want to do? sell the losers and BUY the winner. Put it all into “A”.
$33,000 to “A”
$ 0 to “B”
$ 0 to “C”

That may work out for this investor. But, the odds are that since “A” went up 50% it could just as easily go down by a similar amount. All in “A” is too risky for this client. We are paid to help them sell some of their winners and buy some of their losers in order to “hedge” their future performance.

We are paid to help our clients avoid making strange decisions. ◊