Ric Edelman radio show recap 12-8-07

Ric opened by sharing some statistics that demonstrate not all Real Estate values are dropping across the Nation. For example according to Forbes magazine in Salt Lake City prices have climbed over the past year by 22%. Redding PA up 11%, Glen Falls NY up 11%, Cumberland MD up 9%, Binghampton NY up 20%, Spokane WA up 10%, Salem OR up 17%. Ric wonders if the angst is affecting as many people as the media suggests. Unless you are buying or selling a house you really don’t need to worry about any of the headlines.

Caller 51 years old makes $40,000 per year and has yet to beginning investing in mutual funds for retirement. He owns three real estate properties valued at $1.2 Million, one he lives in. The other two are worth about 500K and the 250K they have mortgages of 100K and 125K respectively. Both have positive cash flow and he has owned them for 12 years and 2 years. Both have appreciated in value since purchase. Edelman says this shows there are lots of ways to build wealth. However Ric is worried about liquidity. The lack of liquidity is one of the things that makes real estate risky compared to stocks or bonds. Also his asset allocation is not diverse. He is 100% in local residential real estate. Ric prefers a plan to sell one of the properties and use the proceeds to diversify into other asset classes. The liquidity and diversification would help lower risks without lowering the rates of return. In fact in the long haul it may improve the returns. Over the last fifty years returns in the stock market average twice that of real estate.

Caller would like to know the differences between Index Funds and ETFs. In some cases an Index Fund and ETF are pretty much the same. The big difference is the ETFs in general are much cheaper to own. Vanguard for example built a reputation on low cost Index funds and Ric doesn’t use any of them, he does use some of their ETFs due to the lower expense ratio. Other advantages to ETFs are better management. Many Indexes are constructed in a poor fashion for investors. For example the S&P 500 was built as a means to gauge the U.S. economy not as an investment vehicle. Ric goes into detail in this in many of his books. ETFs also allow for intra day current pricing.

Caller in the Army phoned from Iraq. He is seeking advice on where to put his money now. While deployed all his income is excluded from taxes. He is contributing to the Thrift savings plan to the maximum. Is that worth continuing since he is not paying taxes this year? Edelman says to continue contributing to maintain the tax deferral of those funds after he returns home. Since he is in a tax free situation this year it would be a great time to start a Roth IRA. In addition the caller has no expenses and wonders what to do with of the remainder of his income while he is in this unique position. Ric says to invest what ever is available into ordinary investments using mutual funds and ETFs. As always do so in a highly diverse way to balance return with risk. The best way to reduce risk is to reduce the percentages of money in any one investment.

Caller asked for a definition of stock options. Ric said there are two types of stock options. The kind you buy on your own and those obtained from the company you work for. Furthermore the kind you can get from work can be either non qualified or ISO (incentive stock options). Edelman’s book “The Truth about Money” goes into greater detail on how to handle stock options at work. All options are the same regardless of if you buy them or get them as a result of employment. If you buy a stock you need all the cost to buy each share and have all that money at risk. With options you normally buy the right to buy or sell the stock at some point in the future at a specific price. This costs much less than the share price. You then decide to buy it or “exercise” your option. This can get complex, there are eight types of options. You can buy the right to buy or sell a stock, you sell the right to buy it or sell the right to sell it. All of these can be done while owning or not owning the stock. Six out of eight of these are very speculative. And frequently end up as a 100% loss. Some are defensive in nature. Around 50% of people that invest in options lose money before commissions. Factoring in commissions around 80% lose money. However if you are given stock options at work this can be a valuable benefit.

Caller asked if renting is a terrible idea. Not everyone is a good candidate for home ownership. You don’t need to worry about budgeting for maintenance and taxes. It is a lifestyle choice keeping in mind unless you plan to stay 7 years it is probably a good idea to rent from a financial perspective.

Caller was reassigned a new advisor after his old one left the firm. The new one has suggested and implemented a 10% stop loss orders on all his stock holdings. So far this has resulted in selling low in the recent market environment. To make matters worse in most cases the stock price has recovered. Ric explained briefly how a stop loss works and went on to say he is not a fan of that strategy. In some circumstances after a nice gain or a stock hits a price target you may use a stop lose to protect that gain. Edelman says the best way to avoid this whole problem is get out of individual stocks and into mutual funds. Perhaps this new advisor is churning the account. Ric said the caller chose his original advisor, don’t let the firm choose the successor.

Caller has been nervous about his equity investments the last couple years and is now in money market funds. His long term plans are retirement in ten years plus. Ric asked the caller for a prediction on if the stock market will be higher in ten years. He thought he would be and so did Edelman. If this is the case invest today and not worry about current market volatility, this will be irrelevant ten years from now. If watching the daily gyrations bothers you stop looking instead of stop investing. Ignore the short term volatility and stay focused on the long term trend. Be sure to invest in a highly diverse manor. Diversification breeds the safety of a competitive return without taking the big risks. Often the problem is not so much the investments but the attitude about those investments and being unwilling to hold onto them over a long time frame.

Caller has 401(k) money form a previous job and would like to know where to move it or if he should keep it in the plan it is currently in. He is getting a pitch to move it into an AXA “accumulator” proprietary product with a 6% guarantee. Ric said it sounds like an annuity and if that is what it is Edelman says not to go that way. You don’t need the tax deferral since it is a retirement account or the annuity expense. Get a second opinion from a fee based advisor versus a commissioned sales person to get objective advice.

Caller has a 529 plan for grandchildren ages 9 and 11 with about $55,000 in each account. All the money is in one fund. Ric said there are other choices available in the plan she is in. The good news is they can stop contributing new money to the plans unless they can be very confident they will be going on to advanced degrees. If there is money left after the kids graduate the remainder withdrawn will have to pay taxes plus a 10% penalty. Unused money can also be transferred to 529 account for a child related to the one it was set up for. One could set up an additional trust account for the retirement of the children using a Retirement InCome for Everyone Trust. http://www.ricetrust.com/q.asp

Caller has been investing for around ten years and thinks he may be to diversified. In that time his account has gained one percent. Ric said it is possible to have to much diversity, it can get to the point of redundancy. The idea is to have a proper asset allocation model that you receive competitive returns. The goal of diversity is not to lose the ability to generate positive results but to reduce volatility. On a risk adjusted basis diversification should allow you earn competitive returns without suffering much downside. Edelman suggested either his allocation is not proper or he is using sub-standard investments. To identify the problem and find a solution Ric suggested running it by a financial advisor. Ric and his staff routinely do this for clients and invited anyone to get any questions answered by calling his office at 1-888-752-6742 during the week.

I’ve used the tool on Ric’s site called “Guide to Portfolio Selection” and find it helpful.

https://www.advisorlynx.com/secure/edelman/