Medical ID Theft and Medicare Fraud
From the Denver District Attorney’s Office:
As if worrying about frauds in later life isn’t enough, Medicare beneficiaries must also be concerned about medical ID theft and Medicare fraud. According to recent complaints received by the Colorado Division of Insurance, this phone number,1- 866-234-2255 is implicated in a national scam presently operating in Colorado. In this scam, the caller requests the bank account and Medicare ID numbers of the Medicare beneficiary. If the beneficiary doesn’t comply, the caller threatens to withhold the beneficiary’s Medicare card.
Typically, medical “identities” are stolen by thieves for the purpose of receiving medical care, or obtaining medications to feed a drug addiction. As is true in many cases of identity theft, victims can end up with damaged credit ratings if they are unaware their medical ID has been stolen. Medical ID theft may also result in medical misinformation being placed in the victim’s medical file, which could be life threatening.
In the case of Medicare fraud, a caller may try to scam Medicare by billing for allowable expenses, such as Durable Medical Equipment (DME). Under Medicare policies, DME suppliers are not allowed to “cold call” consumers for such orders.
Protect Yourself
- If you receive a suspicious call, check the number on your caller ID, and call the Office of Inspector General at 1-800-447-8477, or http://oig.hhs.gov/fraud/hotline
- Never give out Medicare, credit card, bank account or SS Numbers to strangers
- Save Medicare Summary Notices and Part D Explanation of Benefits
- ALWAYS review your Medicare Summary Notice (MSN) for accuracy
- If your Medicare card is lost or stolen, call Social Security at 1-800-772-1213
Door-to-Door Con Artists Making the Rounds
From the Denver District Attorney:
As reliable as hot July weather, fraudulent door-to-door scams are on the increase in Denver and the surrounding area. Particular scams that have been reported include charitable book sells, and tree-trimming services. Perpetrators in these scams have been reported acting alone, or with another person, and their preferred target is the elderly.
The first step of prevention is to be aware of how con artists select their victims, and the ploys they use to carry out their scams, as follows:
- Select older neighborhoods where older adults are most likely to reside
- Commonly solicit victims outside in their lawns, or at the door
- Perform quick, shoddy, or bogus work
- Tell “down on their luck” stories to gain sympathy (e.g., book sale scams)
- Pressure victims for “unanticipated”, or inflated costs once work is done
The following is information from the Denver District Attorney’s Office on how consumers can protect themselves:
- Don’t do business with door-to-door contractors or solicitors
- Keep doors, including garage doors locked at all times, especially when working in the yard.
- Install security doors with metal grillwork and key locks
- Don’t hide keys under the doormat or rocks.
- Secure sliding glass doors with anti-slide blocks or a slide bolt.
When selecting a contractor, always get three bids, insist on a written contract detailing what will be done, and don’t pay in full until the job is done. For more information on choosing a contractor, contact the Better Business Bureau at www.denverbbb.org/consumer-tips/
Denver DA’s Fraud Line: 720-913-9179
Can I freeze a child’s credit report?
From the Office of Denver District Attorney Mitch Morrissey
With the rise in identity theft, many parents are wondering if they can place the same type of “security freeze” on their child’s credit file as they can on their own. Good question. The answer is – Sometimes.
A parent or legal guardian can, in fact, freeze a child’s file – if a file exists. But hopefully, a child doesn’t have a credit file to freeze. A credit file is only created when there is a request for a new credit relationship, such as a credit card. One way to make sure a child has not been the victim of identity theft is to make frequent requests for free credit reports under the child’s name and SSN from www.annualcreditreport.com. If the credit agencies are unable to process the request – most likely, no file exists. Good News!
If a credit report exists for a child, it is almost certainly an indication of fraud. In that case, the parent or legal guardian can place a security freeze on the child’s credit file. The individual will have to provide proof that they are the parent or legal guardian and that fraud has occurred. Also, a police report should be filed with a local law enforcement agency.
A credit bureau cannot create a file for a child if a file does not already exist.
Diversifying a Portfolio with Real Estate
Real estate as a wealth generator is hardly a new idea. People owned property long before the advent of stock exchanges and other capital markets. In more recent times, large corporations and institutions have held commercial real estate in their portfolios.
But individual investors have not traditionally had ready access to a professionally managed, diversified real estate portfolio. This has changed in the last few decades with the development and growth of real estate investment trusts, or REITs. Now individuals can add a real estate component to their portfolio to improve overall diversification.
What is a REIT?
A REIT is a company that owns, operates, and/or finances real estate property.1 Most of this discussion will address equity REITs, which manage different types of income-producing properties, such as hotels, office buildings, industrial facilities, apartments, and shopping centers. As commercial landlords, equity REITs typically generate dividend income from the rent paid by tenants. Many REITs in the US are traded on the public stock exchanges.
Publicly traded REITs offer investors several potential benefits:
- Real estate exposure. While publicly traded REITs account for only a small portion of the real estate investment universe and the equity market, academic evidence suggests that REITs have similar returns to the overall real estate market .2
- Low correlations with financial assets. Over longer periods of time, historical correlations of REITs and stocks have been generally low. (Correlation refers to the co-movement of asset returns. When two assets are positively correlated, their returns tend to move together; when negatively correlated, their returns are dissimilar.)
- Diversification. A REIT holds a portfolio of properties, which may specialize by property type and industry, or be broadly diversified according to industry and region. With the more recent advent of real estate securities overseas, investors can further diversify their exposure among foreign developed markets.
- Higher yield, regular income, capital appreciation. Since REITs have to pay out a large fraction of earnings as dividends, they tend to offer higher-dividend income than equities, and this may benefit certain income-oriented investors. Total return of the shares is tied to income and change in market value.
- Distinct asset class. While REITs are considered equity vehicles and can have significant exposure to the size and value risk factors, they are generally considered to be a separate asset class, due to their low long-term correlations with stocks.
- Liquidity and transparency. Publicly traded REITs can be bought or sold whenever the stock market is open for business. The availability of market-determined share prices can reveal information about the market’s assessment of the company’s prospects, including the ability of the firm’s management team.
- Tax treatment. REITs operate as “pass-through” corporations in which most income goes directly to shareholders. They typically pay little or no taxes on corporate income.3
Investing in REITS
A REIT mutual fund that manages a portfolio of REITs typically offers more diversification than owning a single REIT. Most REIT funds are either actively managed or indexed. An active fund manager seeks to pick securities that appear undervalued—an approach that often results in over-concentration in a single category, which may raise risks and potential costs, including transaction costs and management fees. On the other hand, an index fund tries to replicate a benchmark, such as the FTSE NAREIT Equity REIT Index or the Dow Jones US Select REIT Index. Although index funds may have lower fees, securities held in the portfolios may experience buying and selling pressure when indexes are reconstituted.
Our preferred approach is a structured strategy. Rather than trying to replicate an index, a manager may choose securities based on risk-return characteristics, diversification benefit, and favorable price negotiation. By keeping costs low and trading efficiently, a structured REIT strategy seeks to generate improved returns over time. Advantages of this approach include broader, more systematic exposure to the REIT universe at a lower cost.
Adding a real estate component to a portfolio may be a good diversification move. But strategy and implementation are crucial, and before investing, you should consider how a real estate strategy and the REIT you select may affect your portfolio. Some factors that may come into play:
- Asset coverage. Most actively managed stock funds and indexes include REITs in their equity holdings. This creates the potential for overlapping asset class exposure for investors who add a REIT component in their portfolio. Treating REITs as a separate and distinct strategy helps you achieve more precise risk exposure in the asset class weights. For example, investors with significant direct ownership in real estate may want to exclude REITs from the equity component in their portfolio to better control their overall exposure.
- REIT category. Equity REITs may operate property in a specific area of expertise, such as retail, office and industrial, hotels, or health care facilities. Residential REITs own and operate apartment buildings and multi-family commercial dwellings, rather than single-family homes. Mortgage REITs, which lend money directly to real estate owners or invest in existing mortgages or mortgage-backed securities, are generally excluded from the equity REIT universe because they perform more like fixed income instruments, with income based on interest payments. Hybrid REITs combine the strategies of equity and mortgage REITs.
- Diversification. As with financial assets, owning a broad mix of REITs can help reduce specific risk in a portfolio. This diversification eliminates exposure to a single REIT category, manager style, or geographic region. Also, adding international real estate can further enhance the potential diversification benefit.4 Correlations among international REITs are low across countries, regions, and equity markets, making them a useful complement to equities in developed and emerging markets.
Risk Considerations
REITs carry stock market risk, as well as risks specific to individual real estate properties, sectors, regional markets, and the operating firm. The securities are also subject to market pressures that may push share prices above or below the value of the underlying real estate. However, identifying a market premium or discount in a REIT is difficult since the underlying asset value reported by a REIT is based on an appraisal, which may be several months old. REIT returns also depend on the buying, selling, and operating decisions of management.
A manager may adopt risky strategies, such as heavy leveraging or lack of diversification. They may pay too much for properties, acquire poorly performing properties, change strategies regarding property mix, or make other business decisions that compromise performance. Investors holding foreign REITs or REIT funds are also exposed to risks specific to the country, such as legal structure, investment restrictions, ownership rules, tax treatment, and currency risk.
All of this underscores the importance of knowing your risk tolerance, carefully analyzing REIT fund managers, and diversifying to eliminate exposure to a single REIT manager or category.
Endnotes
1. Equity REITs make up about 91% of the REIT market. Mortgage REITs, which compose about 7% of the market, loan money to real estate owners or invest in existing mortgage-backed securities. Hybrid REITs combine the strategies of equity and mortgage REITs and make up about 1% of the market. Source: National Association of Real Estate Investment Trusts, Inc. (NAREIT).
2. Joseph Gyourko and Donald B. Keim, “Risk and Return in Real Estate: Evidence from a Real Estate Stock Index,” Financial Analysts Journal 49, no. 5 (September-October 1993): 39-46.
3. A US REIT must invest at least 75% of its assets in real estate and derive at least 75% of its income from real estate property or interest on real estate financing. It must also distribute at least 90% of its income to shareholders to maintain tax-advantaged status. This pass-through provision allows REIT investors to have access to the same cash flows as investors in private real estate equity. REIT shareholders, however, generally must pay taxes on income they receive from a REIT.
4. Over the 20-year period from 1990 to 2009, the annual return correlation between US REITs and the US stock market was 0.498 (1.0 denotes exact positive correlation in returns).
Disclosures
The information presented above was prepared by Dimensional Fund Advisors, a non-affiliated third party. Diversification neither assures a profit nor guarantees against loss in a declining market.
REITs vs. US Stocks
Annual Returns: 2000-2009
| Year | Dow Jones US Select
REIT Index |
CRSP 1-10 Index (US Market) |
| 2000 | 31.04% | -11.41% |
| 2001 | 12.35% | -11.15% |
| 2002 | 3.58% | -21.15% |
| 2003 | 36.18% | 31.61% |
| 2004 | 33.16% | 11.97% |
| 2005 | 13.82% | 6.16% |
| 2006 | 35.97% | 15.47% |
| 2007 | -17.55% | 5.83% |
| 2008 | -39.20% | -36.70% |
| 2009 | 28.46% | 28.82% |
US Equity REITs are represented by the Dow Jones US Select REIT Index.
The US equity market is represented by the CRSP 1-10 Index.
Average Annualized Returns: 1990-2009
| Data Series | 1 Yr | 3 Yr | 5 Yr | 10 Yr | 20 Yr | Std Dev
(20 Yr) |
| Dow Jones US Select REIT Index | 28.46% | -13.65% | -0.07% | 10.67% | 8.69% | 20.41% |
| CRSP Deciles 1-10 Index (US Market) | 28.82% | -4.79% | 1.13% | -0.33% | 8.46% | 15.38% |
Returns in USD. Inception dates for Dow Jones US Select REIT Index is January 1978; CRSP Deciles 1-10
Index inception date is January 1926.
Indices are not available for direct investment, and performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results.
The Center for Research in Security Prices (CRSP), at the University of Chicago Booth School of Business (Chicago GSB), is a nonprofit center that also functions as a vendor of historical data. CRSP end-of-day historical data covers roughly 26,500 stocks—active and inactive—listed on the NYSE, Alternext, Amex (formerly AMEX), NASDAQ, and ARCA exchanges. OTC bulletin board stocks are not included.
Does Gold belong in your Portfolio?
Fama and French answer the question here:
http://www.dimensional.com/famafrench/2010/04/qa-does-gold-belong-in-my-portfolio.html
What to Do if Your Identity is Stolen
From the Office of Denver District Attorney Mitch Morrissey:
Resolving the consequences of identity theft is left largely to victims. Act quickly and assertively, and keep records/copies of all contacts and reports.
- File a report with local law enforcement and get a copy of the report for the credit agencies, banks and credit card companies. You can also request and complete the ID Theft Affidavit from the Federal Trade Commission.
- Notify your credit card companies as soon as possible and follow their advice. If you report the loss you will most likely not bet responsible for any unauthorized charges. As always, carefully monitor your credit card statements for evidence of fraudulent activity.
- If your checking account is compromised, notify your financial institution, close affected accounts and complete “affidavits of forgery” on unauthorized checks.
- Report the theft to one of the fraud units of the credit reporting agencies. That agency will notify the other two of possible fraud. Request the credit reporting agencies to flag your credit file for fraud. Add a victim’s statement to your report, such as: “My identification has been used to apply for fraudulent credit. Contact me at (your telephone number or address) to verify ALL applications.”
- Consider putting Security Freezes on your credit files at the 3 credit agencies. See information at Denverda.org/Fraud Alerts or call 720-913-9179.
- Ask utility companies (especially cellular service) to watch for anyone ordering services in your name. If you have trouble with falsified accounts, contact the Public Utility Commission.
Think Before You Pump
From the Office of Denver District Attorney Mitch Morrissey
Be aware of your surroundings when filling your tank. There is an increase in break-ins while individuals are at the gas pump. Thieves pull up on the opposite side of vehicles from where drivers are pumping gas. While drivers are occupied, thieves take purses, wallets, and other valuables from unattended vehicles. In most cases, stolen credit cards are used immediately before owners realize the theft has occurred.
Be cautious:
- Don’t leave purses or other valuables on the front seat of vehicles.
- Lock car doors – even when remaining in close proximity to the vehicle.
- Always be aware of your surroundings.
These quick “snatch and run” crimes can be prevented if we just take a moment to think before we pump.
Here are a few additional safety tips related to driving:
- Travel on well-lighted, busy streets.
- Keep doors locked and windows up.
- Do not leave purses on the seat and keep packages in the trunk.
- Avoid stopping to aid disabled motorists. Report it to the police instead.
- If you have car trouble, use a cell phone to call for assistance. Raise the hood and stay in the car with the doors locked. If someone tries to enter the car, sound the horn.
- Be aware of surroundings when entering a garage. Close the garage door before getting out of your car. Have your keys ready to enter your home before exiting the garage.
Denver DA’s Fraud Line: 720-913-9179
Rebalancing Act
Global diversification gives investors a valuable tool for managing risk and volatility in a portfolio. But smart diversification has an important side effect. It requires maintenance.
In a given period, asset classes experience divergent performance. This is inevitable and, in fact, desirable. A portfolio that holds assets that do not perform similarly (i.e., with low return correlation) will experience less overall volatility. That results in a smoother ride over time. However, dissimilar performance also changes the integrity of your asset mix, or allocation—a condition known as “asset drift.” As some assets appreciate in value and others lose value, your portfolio’s allocation changes, which affects its risk and return qualities. If you let the allocation drift far enough away from your original target, you end up with a different portfolio.
Once you form a portfolio to match your current investment goals and risk tolerance, you should preserve its structural integrity since asset allocation accounts for most of a portfolio’s return.1 This is a strategic priority, like portfolio design or investment manager selection. To efficiently pursue investment goals, you must manage asset drift.
Rebalancing is the remedy. To rebalance, you sell assets that have risen in value and buy more assets that have dropped in value. The purpose of rebalancing is to move a portfolio back to its original target allocation. This restores strategic structure in the portfolio and puts you back on track to pursue long-term goals.
Why rebalance?
At first glance, rebalancing seems counter-productive. Why sell a portion of outperforming asset groups and acquire a larger share of underperforming ones? Intuition might suggest that selling previous winners may hinder returns in the future. This logic is flawed, however, since past performance may not continue in the future—and there’s no reliable way to predict future returns.
Equally important, remember that you chose your original asset allocation to reflect your risk and return preferences. Rebalancing realigns your portfolio to these priorities by using structure, not recent performance, to drive investment decisions. Periodic rebalancing also encourages dispassionate decision making—an essential quality during times of market volatility. Moreover, if and when your overall financial goals or risk tolerance change, you have a foundation for making adjustments. In the absence of a plan, adjustments are a matter of guesswork.
Challenges and decision factors
In the real world, portfolio allocations are usually complex, incorporating not only fixed income and equity, but also the multiple asset groups within equity investing. The more complex a portfolio’s allocation, the greater is the need for maintenance.
Determining when and how to effectively rebalance requires careful monitoring of performance and awareness of your tax status, cash flow, financial goals, and risk tolerance. Rebalancing also incurs transaction fees and potential capital gains in taxable accounts. Thus, while there are good reasons to rebalance, the benefits must outweigh the costs.
Given these challenges, a practical rebalancing approach will establish asset drift triggering points while leaving enough flexibility to manage costs effectively.
Defining triggering points helps investors decide when to rebalance. Most experts recommend rebalancing when asset group weightings move outside a specified range of their target allocations. This may be widely defined according to stock-bond mix, or more appropriately, according to a percentage drift away from target weightings for categories like small cap stocks, international stocks, and the like.
While rebalancing costs are unavoidable, several strategies can help minimize the impact:
- Rebalance with new cash. Rather than selling over-weighted assets that have appreciated, use new cash to buy more under-weighted assets. This reduces transaction costs and the tax consequences of selling assets.
- Whenever possible, rebalance in the tax-deferred or tax-exempt accounts where capital gains are not realized.
- Incorporate tax management within taxable accounts, such as cost basis management, strategic loss harvesting, dividend management, gain/loss matching, and similar considerations.
- Implement an integrated portfolio strategy. Rather than maintaining rigid barriers between component asset classes and accounts, manage the portfolio as a whole.
Rebalancing incurs real costs that can detract from returns. We can help investors define ranges within which investment components can acceptably drift, and adopt cost-saving strategies during rebalancing, paying particular attention to tax-sensitive transactions. In helping our clients rebalance, we strive to develop a structured plan that remains flexible to each individual’s unique blend of goals, risk tolerances, cash flow, and tax status.
No one knows where the capital markets will go—and that’s the point. In an uncertain world, investors should have a well-defined, globally diversified strategy and manage their portfolio to implement it over time. Rebalancing is a crucial tool in this effort.
Endnotes
1 Gilbert L. Beebower , Gary P. Brinson, and L. Randolph Hood, “Determinants of Portfolio Performance ,” Financial Analysts Journal 42, no. 4 (July/August 1986): 15-29. Gilbert L. Beebower, Gary P. Brinson, and Brian D. Singer, “Determinants of Portfolio Performance II: An Update,” Financial Analysts Journal 47, no. 3 (May/June 1991): 40
The information presented above was prepared by Dimensional Fund Advisors, a non-affiliated third party.
Disclosures
Although investors may form their expectations from the past, there is no assurance that future investment results will model historical performance. Indexes are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Stocks offer a higher potential return as compensation for bearing higher risk. However, this premium is not a certainty, and investors should not expect to consistently receive higher returns from stocks. In fact, market history shows extended periods when stocks did not outperform bonds. Diversification neither assures a profit nor guarantees against loss in a declining market. A bond portfolio designed for income also carries significant risks, including default and term risk, call risk, and purchasing power (inflation) risk. Foreign securities also are exposed to currency movements.
Global diversification gives investors a valuable tool for managing risk and volatility in a portfolio. But smart diversification has an important side effect. It requires maintenance.
In a given period, asset classes experience divergent performance. This is inevitable and, in fact, desirable. A portfolio that holds assets that do not perform similarly (i.e., with low return correlation) will experience less overall volatility. That results in a smoother ride over time. However, dissimilar performance also changes the integrity of your asset mix, or allocation—a condition known as “asset drift.” As some assets appreciate in value and others lose value, your portfolio’s allocation changes, which affects its risk and return qualities. If you let the allocation drift far enough away from your original target, you end up with a different portfolio.
Once you form a portfolio to match your current investment goals and risk tolerance, you should preserve its structural integrity since asset allocation accounts for most of a portfolio’s return.1 This is a strategic priority, like portfolio design or investment manager selection. To efficiently pursue investment goals, you must manage asset drift.
Rebalancing is the remedy. To rebalance, you sell assets that have risen in value and buy more assets that have dropped in value. The purpose of rebalancing is to move a portfolio back to its original target allocation. This restores strategic structure in the portfolio and puts you back on track to pursue long-term goals.
Why rebalance?
At first glance, rebalancing seems counter-productive. Why sell a portion of outperforming asset groups and acquire a larger share of underperforming ones? Intuition might suggest that selling previous winners may hinder returns in the future. This logic is flawed, however, since past performance may not continue in the future—and there’s no reliable way to predict future returns.
Equally important, remember that you chose your original asset allocation to reflect your risk and return preferences. Rebalancing realigns your portfolio to these priorities by using structure, not recent performance, to drive investment decisions. Periodic rebalancing also encourages dispassionate decision making—an essential quality during times of market volatility. Moreover, if and when your overall financial goals or risk tolerance change, you have a foundation for making adjustments. In the absence of a plan, adjustments are a matter of guesswork.
Challenges and decision factors
In the real world, portfolio allocations are usually complex, incorporating not only fixed income and equity, but also the multiple asset groups within equity investing. The more complex a portfolio’s allocation, the greater is the need for maintenance.
Determining when and how to effectively rebalance requires careful monitoring of performance and awareness of your tax status, cash flow, financial goals, and risk tolerance. Rebalancing also incurs transaction fees and potential capital gains in taxable accounts. Thus, while there are good reasons to rebalance, the benefits must outweigh the costs.
Given these challenges, a practical rebalancing approach will establish asset drift triggering points while leaving enough flexibility to manage costs effectively.
Defining triggering points helps investors decide when to rebalance. Most experts recommend rebalancing when asset group weightings move outside a specified range of their target allocations. This may be widely defined according to stock-bond mix, or more appropriately, according to a percentage drift away from target weightings for categories like small cap stocks, international stocks, and the like.
While rebalancing costs are unavoidable, several strategies can help minimize the impact:
· Rebalance with new cash. Rather than selling over-weighted assets that have appreciated, use new cash to buy more under-weighted assets. This reduces transaction costs and the tax consequences of selling assets.
· Whenever possible, rebalance in the tax-deferred or tax-exempt accounts where capital gains are not realized.
· Incorporate tax management within taxable accounts, such as cost basis management, strategic loss harvesting, dividend management, gain/loss matching, and similar considerations.
· Implement an integrated portfolio strategy. Rather than maintaining rigid barriers between component asset classes and accounts, manage the portfolio as a whole.
Rebalancing incurs real costs that can detract from returns. We can help investors define ranges within which investment components can acceptably drift, and adopt cost-saving strategies during rebalancing, paying particular attention to tax-sensitive transactions. In helping our clients rebalance, we strive to develop a structured plan that remains flexible to each individual’s unique blend of goals, risk tolerances, cash flow, and tax status.
No one knows where the capital markets will go—and that’s the point. In an uncertain world, investors should have a well-defined, globally diversified strategy and manage their portfolio to implement it over time. Rebalancing is a crucial tool in this effort.
Endnotes
1 Gilbert L. Beebower , Gary P. Brinson, and L. Randolph Hood, “Determinants of Portfolio Performance ,” Financial Analysts Journal 42, no. 4 (July/August 1986): 15-29. Gilbert L. Beebower, Gary P. Brinson, and Brian D. Singer, “Determinants of Portfolio Performance II: An Update,” Financial Analysts Journal 47, no. 3 (May/June 1991): 40.
The information presented above was prepared by Dimensional Fund Advisors, a non-affiliated third party.
Disclosures
Although investors may form their expectations from the past, there is no assurance that future investment results will model historical performance.
Indexes are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results.
Stocks offer a higher potential return as compensation for bearing higher risk. However, this premium is not a certainty, and investors should not expect to consistently receive higher returns from stocks. In fact, market history shows extended periods when stocks did not outperform bonds.
Diversification neither assures a profit nor guarantees against loss in a declining market.
A bond portfolio designed for income also carries significant risks, including default and term risk, call risk, and purchasing power (inflation) risk. Foreign securities also are exposed to currency movements.
Till Money Do Us Part
As we think of the season of love, thoughts of candlelit dinners, romance and saying “I do” may pop into your head. When they do, it is wise to envision more than love, and mention a topic that often gets neglected: money. The topic of money may be an unromantic thought for some. But,but all things considered, it is what many couples fight about most often.
Big issues or small, money has an impact on all areas of a relationship. Examples range from balancing and overdrawing a checkbook, investments that have crashed, and out-of-control spending habits to overuse of credit and debit cards. These arguments are rarely about the money itself, but instead about power, control, security, beliefs, and communication.
So before you agree to “I do” and merge your finances, it is important to consider having The Money Talk.
My husband says, “This makes the hair on the back of my neck stand up.” And, in fact, many couples find it easier to discuss most all other topics, but delay covering their finances. Many people find it easier to talk about sex than money, regardless of their age. However, getting on the same page can prevent a lot of stress down the road; better to have “the talk” now rather than later.
Here are some questions which should open up the communication on finances whether you become a couple at 25 or 55.
- What is your credit score? It sounds rather unromantic, but a good place to start for an idea on how you handle your finances. Your credit score will indicate how well you handle borrowing (debt) from mortgage, credit cards, and car loans. The credit score will determine the financial building blocks and your access to credit and interest rates.
- Where are you going financially? As a couple you will map out what is important to you financially, and where you want to go. This could mean how much you save for a house, vacation, or retirement. Do you have other financial responsibilities, such as from a first marriage? For some, this question may revolve around how you handle debt or how much you are comfortable borrowing.
- What is your experience with money? What are your beliefs about money? Your family attitude towards money will shape how your attitudes are formed. Did your family hide money issues or “yell” about money? Were you taught to save or live day to day? Emotionally charged arguments about money arise because couples don’t always see money from the same perspective. Discussing this early on will help you understand each other’s financial habits and how you can find compromise on a middle ground further preventing arguments.
- Who handles which financial duty? Couples need to find a way to divide up these responsibilities and play to their strengths. One partner may balance the checkbook and pay the bills, while the other partner handles the investing and insurance. Unfortunately, what occurs with many couples is that one partner chooses to handle all the financial decisions and thus becomes a source of power and control over the other partner. You may also have a partner who completely ignores all the money matters. Neither situation is desirable. Both partners should be aware of what is happening with their finances, even if not involved with the daily activities. This will prevent surprises later on!
- How do you handle the checking accounts and credit cards? This question comes up a lot. Many couples find it easier to each have a checking account, with one being the household account. You may have a savings account for emergencies, vacations, and big purchases. Each partner can spend an agreed amount, say $250.00 without the approval of the other partner. Each of you should have a credit card in your own name to maintain a separate credit history.
When all is said and done, The Money Talk, like marriage, is about communication and compromise. You can live happily ever after, at least financially speaking.
The Stock-Bond Decision
Choosing a basic stock-bond mix is an important first step in portfolio design. Although the decision may appear simple, it can have a profound impact on your wealth.
Portfolio theory explains the value of making a deliberate, strategic decision about the proportion of stocks versus bonds to hold in a portfolio. This decision has roots in the “separation theorem,” which was proposed by Nobel laureate James Tobin in the late 1950s.1 The separation theorem proposes that all investors face two important decisions: (1) deciding how much risk to take, and then (2) forming a portfolio of “risky” assets (equities) and “less risky” assets (fixed income) to achieve this risk exposure.
Your stock-bond decision implements this risk position.
The Rationale
The theorem proposes that all investors who are willing to take stock risk should begin with a diversified market portfolio. Each investor then can dial down total risk in the portfolio by adding fixed income to the mix. The greater the bond allocation relative to stocks, the less risky the portfolio and the lower the total expected return; the greater the stock allocation relative to bonds, the higher the portfolio’s expected return and risk.
Investors who want to take even more risk than the market can increase exposure through borrowing on margin and/or tilting the stock portfolio toward asset groups that offer higher expected returns for higher risk.
So, how does one confidently allocate between stocks and bonds? A common method is to evaluate model portfolios along the risk-return spectrum. A riskier portfolio holds 100% stocks, and the least volatile portfolio holds 100% bonds. Between these extremes lie standard stock-bond allocations, such as 80%-20%, 60%-40%, 40%-60%, and 20%-80%.2 Then you compare the average annualized return and volatility (standard deviation) of each model portfolio for different periods, such as one, three, five, ten, and twenty years. Volatility is one of several risk measures investors may want to consider. With this in mind, the analysis should feature average returns, as well as best- and worst-case returns for the various periods.
While this technique relies on historical performance that may not repeat in the future, and does not consider various investment costs, it may help you think about the risk-return tradeoff and visualize the range of potential outcomes based on the aggressiveness of your strategy.
Refining Your Stock Allocation
After establishing the basic stock-bond mix, investors turn their attention to refining the stock allocation, which is where the best opportunities to refine the risk-return tradeoff are found. Investors who are comfortable with higher doses of equity risk can overweight or “tilt” their allocation toward riskier asset classes that have a history of offering average returns above the market. Research published by Eugene Fama and Kenneth French found that small cap stocks have had higher average returns than large cap stocks, and value stocks have had higher average returns than growth stocks. By holding a larger portion of small cap and value stocks in a portfolio, an investor increases the potential to earn higher returns for the additional risk taken.
The final step in refining the stock component is to diversify globally. By holding an array of equity asset classes across domestic and international markets, investors can reduce the impact of underperformance in a single market or region of the world. Although the markets may experience varying levels of return correlation, this diversification can further reduce volatility in a portfolio, which translates into higher compounded returns over time.
Fixed Income Strategies
Research shows that two risk factors—maturity and credit quality—account for most of the average return differences in diversified bond portfolios. Long-term bonds and lower-quality corporate bonds typically offer higher average yields to compensate investors for taking more risk. But keep in mind that these premiums are considerably lower than the market, size, and value premiums documented in the equity world.
Investors generally hold fixed income to either (1) reduce overall portfolio volatility, or (2) generate a reliable income stream. These objectives typically lead to different investment decisions. The first approach, volatility reduction, is an application of separation theorem (i.e., hold equities for higher return and use fixed income to temper portfolio volatility). Rather than increasing risk to maximize yield, these investors want to hold fixed income securities that are lower risk. Certain fixed income asset groups are better suited for this strategy.
With this in mind, some long-term investors may seek to earn higher expected returns by shifting risk to the equity side of their portfolio. With an eye to minimize maturity and credit risk, they hold short-term, high-quality debt instruments that have historically offered lower yields with much lower volatility.
The second purpose for holding bonds is to generate reliable cash flow. Income-oriented investors, including retirees, pension plans, and endowments, may not worry as much about short-term volatility in their bond portfolio. Their priority is to meet a specific funding obligation in the future. Consequently, they design a portfolio around bonds and accept more volatility in hope of earning higher yields, which they pursue by holding bonds with longer maturities and/or lower credit quality.
Whether investing for total long-term return or for income, a portfolio should be diversified across issues and global markets to avoid uncompensated risk from specific issuers and to capture differences in yield curves around the world.
Summary
The stock-bond decision drives a large part of your portfolio’s long-term performance. During portfolio design, evaluating different stock-bond combinations can help you visualize the risk-return tradeoff as you consider the range of potential outcomes over time. Once you determine a mix, it can guide more detailed choices of asset classes to hold in the portfolio. And as your appetite for risk shifts over time, you can revisit the mix to estimate how shifting your portfolio mix may impact your wealth accumulation goals in the future.
Endnotes- James Tobin, “Liquidity Preference as Behavior Towards Risk,” The Review of Economic Studies 25, no. 2 (February 1958): 65-86.
- The basic stock component may be reflected by the S&P 500 Index, or preferably, by a broader market proxy, such as the CRSP 1-10 Index. The CRSP 1-10 Index is a market capitalization weighted index of all stocks listed on the NYSE, Amex, NASDAQ, and NYSE Arca exchanges. The S&P 500 Index offers a proxy of the large cap US equities market. The fixed income component may be represented by an index of short-term US government securities or government and corporate bonds.
Disclosures
- Stock is the capital raised by a corporation through the issue of shares entitling holders to an ownership interest of the corporation. A bond is a loan that an investor makes to a corporation, government, federal agency, or other organization. Also known as debt or fixed income securities, most types of bonds pay interest based on a regular, predetermined coupon rate that is set when the bond is issued.
- Although investors may form their expectations from the past, there is no assurance that future investment results will model historical performance.
- Indexes are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results.
- Stocks offer a higher potential return as compensation for bearing higher risk. However, this premium is not a certainty and investors should not expect to consistently receive higher returns from stocks. In fact, market history shows extended periods when stocks did not outperform bonds.
- Diversification neither assures a profit nor guarantees against loss in a declining market.
- A bond portfolio designed for income also carries significant risks, including default and term risk, call risk, and purchasing power (inflation) risk. Foreign securities also are exposed to currency movements.
