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Casey Smith is President of Wiser Wealth Management, Marietta, GA-based fee-only fiduciary wealth management firm offering asset management, tax preparation, estate planning and financial planning services. Wiser’s unique investing techniques has earned Casey speaking engagements at Inside... More
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Wiser Wealth Management, Inc
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Wiser Wealth Management Blog
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  • Why Dave Ramsey Is Wrong

    There is no denying that Dave Ramsey has done a commendable job of bringing back our grandparents' financial values into popular culture.

    Many Americans have been poor stewards of their finances and have been saddled with avoidable debt. Ramsey's advice has helped thousands get back on the right financial track. Even at my own company, Wiser® Wealth Management, we use the debt snowball of Financial Peace University to help right the finances of our pro-bono planning clients. Ramsey has become a multimillionaire by simply telling people to live within their means by creating and maintaining their household budget. Certainly, in today's society of zero interest and only three easy payments of $19.99, this is no simple task. However, once a person overcomes modern-day financial temptation and begins investing in his or her future, Ramsey drops the ball and becomes a spokesperson for one of the most confusing industries in America, financial product sales. Ramsey recommends his followers work with brokers who are paid high commissions for investing in mutual funds.

    Ramsey, as popular as he is - and no one disputes that - has missed the boat on one thing - dismissing the credibility and sensibility of a fiduciary and fee-only financial advisor. That may not sound like a big deal, until you understand that picking the right financial advisor can lead to an overall stronger financial foundation for your family, your future and your state of mind. Let's look at this a bit closer.

    The Fee-Only Advantage

    Fiduciary (your best interest) fee-only advisors take a different approach to investing. There are no selling products; fee-only advisors are not paid a commission from a product. This removes the conflict of interest that brokers carry in their relationships with their clients. This also causes the advisor to look differently at the product that he or she recommends to the client, which is why we see a much higher usage of index funds from the fee-only community. These highly diversified funds carry very low fees, because they don't pay any advisor any commission, and historically have beat actively managed, commission mutual funds over long periods of time. A well-diversified index fund portfolio should cost no more that 0.25% a year, with most of the funds trading at no charge.

    Fee-only advisors are compensated as a percentage of assets they manage, by a flat monthly retainer, or bill hourly for financial planning. Each of these options are free from any conflict that the advisor gives to the client. Most fee-only firms also include financial planning in their asset management fees. A financial plan sets how the portfolio should be allocated. Proper asset allocation is a large ingredient to successful long-term investing.

    A mutual mess

    Ramsey, on the other hand, encourages his followers to contact a broker within his referral network when they are ready to start investing. In the interest of full disclosure, his network rejected my firm telling me that being a fiduciary fee-only financial services firm we did not qualify because his network is made up of only commission brokers. Ramsey recommends that his flock work with a broker and invest in a mutual fund that has a long track record of good results vs. the S&P 500. He then adds that the investor should purchase and stay put, meaning don't sell when the market falls, be a buy and hold investor. The broker will collect a 5% +- commission from the sale and will receive a smaller percentage on a quarterly basis, assuming the investor does not sell the fund. Additional investments into the fund, whether it is annually or monthly, will also be charged the large upfront fee. Ramsey supports this model because he believes this to be the cheapest form of investing compared to fee-based firms that would be charging 1.2% a year to give advice and provide planning services.

    In the 80's and early 90's this may have been the correct advice, but unfortunately the US brokerage business has taken a turn for the worst, in that products are not built to benefit the client, they are built to make money for the firm and the broker. A retired executive from a large brokerage company recently told me he got out because his firm no longer focused on the client, they focused on what they could get away with selling to the client. Even if Ramey's referral network has the best intentions, history is against them. There have been very few mutual funds that actually beat the S&P 500 net of fees over long periods of time. Some get lucky over a 10 year stretch, but after 15 years the list is very short. Historically we see less than 1% of funds beat the S&P 500 (after fees) over 30 years. This might be a long time, but how long are you going to be invested? If you live to age 95 and are in your 40's or 50's, 30 years is not that long.

    Another issue is Ramsey's buy and hold philosophy. The idea is great on the surface, but when a year like 2008 strikes many individual investors, without a good financial support system, are going to sell. If you get burnt, you first want to stop the pain (sell low) and when you go back, if at all, it will be when you feel ready (buy high). Buy and hold is the correct advice, but when you call the broker for reassurance there is always the potential of him or her selling you another fund at 5% commission to help "make you feel better," while padding his or her pockets with more of your money. This is where a fee-only advisor earns their fee. By keeping the client focused long term, buy high and sell low tendencies can be eliminated, increasing the client's rate of return.

    Ramsey also recommends that you not own bonds. He states "bonds are mistakenly believed to be safe." While it is true - not all bonds are safe - there is a good case to be made for adding the right bonds to a portfolio to lower volatility. Bonds in a portfolio help keep you from hitting the panic button when it feels like the stock market is falling into oblivion. A fee-only advisor can help choose the right bonds for the portfolio.

    Ramsey also wants his followers to stay away from Exchange Traded Funds (ETFs). ETFs, if used properly are more tax efficient than any mutual fund, held outside retirement accounts, are more liquid and offer cheaper fees. There are good ETFs and bad ETFs, and I think Ramsey has thrown the baby out with the bath water with this advice. Perhaps it is because his network of advisors would not receive a commission or trailing fee if ETFs were used.

    What should Ramsey do?

    If Ramsey and his network of brokers wanted to truly work in the best interest of his radio and print flock, I propose that he endorse a network of fee-only advisors, simply being paid by the hour. These advisors would help create portfolios for the Ramsey following at a fraction of the cost of his commission advisors, all while giving unbiased investment advice. In the end, Ramsey's math does not add up and the investor loses. Ramsey, who tweeted that he was the "big dog on the porch" in a recent tweet with fee-only advisor Carl Richards, could use his status to help make all advisors work in the best interest of their clients, as is being discussed at the SEC in 2015. Instead, he sits in the pockets or every big insurance company on Wall Street who wants to maintain the current system of taking from Main Street to pad the profits of Wall Street.

    Casey Smith is owner and president of Wiser® Wealth Management, a wealth management firm based in Marietta, GA. Wiser® Wealth Management helps clients identify, understand, and commit to a long-term planning and investment objective that is realistic and appropriate. The investment and planning solutions are based on putting the client first by operating as a fee-only firm and accepting fiduciary responsibility. For more information, visit wiserinvestor.com.

    Jan 24 7:34 AM | Link | Comment!
  • Global Real Estate In Your Portfoio

    With the impact that the European debt crisis is having on portfolios, many people are looking for ways to diversify from this impact. Adding real estate to your portfolio is one way to do this. This decision could make sense if you are looking to diversify your portfolio's revenue stream.

    Historically, REITs have been structured to include investments mostly here in the US. However, over the last decade the structure has expanded to include REITs in a total of 21 countries, making a global REIT allocation possible in your portfolio. According to Cohen and Steers, from 1990 to 2010 the number of global publicly traded REITs increased from 33 to 250 companies.

    There are currently 18 domestic, seven foreign and three global REIT Exchange Traded Funds (ETFs) to choose from. During our search for real estate ETFs, we found it interesting that the highest Morningstar rankings went to the global REIT category. While four and five star rankings are only indicators of good past performance and reflect nothing into the future, it still sparked a bit of curiosity on our part as to the inner workings within the three global ETF choices.

    To understand the difference, a domestic REIT will invest in real estate companies within the US. A foreign REIT will invest in real estate companies outside the US; these funds often have ex-US in their title. A global REIT will invest in companies all over the world, including the US.

    The three choices for a global REIT ETF are as follows:

    • First Trust FTSE EN Developed Markets Real Estate (NYSEARCA:FFR)
    • Cohen and Steers Global Realty Majors (NYSEARCA:GRI)
    • SPDR Dow Jones Global Real Estate (NYSEARCA:RWO)

    METHODOLOGY

    The most important research into any ETF is knowing the methodology of the index that the ETF tracks. The methodology will explain the fund's performance, turnover and allocation.

    First Trust FTSE EN Developed Markets Real Estate (FFR) tracks the FTSE EPRA NAREIT Global Real Estate Index. This index is managed by committee and reviewed quarterly. The index is made up of developed and emerging market real estate holdings. The real estate companies represented within this index will get 75% of earnings (before interest, taxes, depreciation and amortization) from real estate activities. Companies that finance real estate, construct homes or hold infrastructure assets are excluded from the index. Companies that sell residential homes are only considered within emerging markets. The index holdings are tested for liquidity on an annual basis.

    Cohen and Steers Global Realty Majors (GRI) tracks the Cohen and Steers Global Reality Index. The index is managed by a committee and tracks the top 75 companies that in the committee's analysis are leading the securitization of real estate globally. Companies must meet minimum size and liquidity requirements, as well as final determining factors such as market position, financial strength and asset quality. Positions are limited to 4% of the index while also trying to maintain geographical proportional representation. The index is reviewed and rebalanced quarterly.

    SPDR Dow Jones Global Real Estate (RWO) tracks the same index as its name. To be included in this index, a company must be both an equity owner and an operator of commercial or residential real estate, as well as have its revenue derived from the ownership and operation of these assets. The company must have a minimum market cap of USD 200 million. Some companies, such as real estate finance companies and home builders, are excluded from the index. The index is float adjusted based on market capitalization. Index daily pricing data is available back to December 31, 2004. This index is reviewed and rebalanced quarterly.

    To see how the index methodology is applied, we looked at the top holdings for each REIT ETF.

    (click to enlarge)

    The listing shows that the funds' top five stocks are very similar; only the weight in each security seems to be the differentiating factor. Looking deeper into this, we find that this is also the case for the top twenty-five holdings of the three ETFs. RWO and FFR have a similar number of holdings, at 213 and 286 respectively. GRI holds 75 securities and caps the weight at 4% as defined in the index methodology.

    We can also break down the ETF holdings by market cap. The chart below shows that FFR and RWO hold more weight in mid caps while GRI holds more large/giant caps.

    (click to enlarge)

    Breaking down the ETFs into their respective country weights, we see that for each ETF the top five weights are the same: USA, Australia, Japan, Hong Kong and the UK (highlighted in yellow below). The slight variation in weight from one ETF to another can be explained by index methodology.

    (click to enlarge)

    We can look to correlation to help show us how REITs have reacted to each other and major indices over the last few years. As you can see in the chart below, all three ETFs are highly correlated to each other, as expected given what we have observed in holdings and country exposure. We also note that we should expect the REIT ETFs to closely move with the S&P 500 and MSCI EAFE (developed Europe) indexes. The ETFs are negatively correlated with the US Dollar. The chart below shows correlation from 7/1/07 to 6/30/2012.

    Many investors deploy the use of REITs for the income that they generate. FFR has a 12-month yield of 2.35%, GRI's yield is 2.31%, and RWO's is 3.03%.

    The fees associated with ETFs are usually much less than mutual funds. The expense fee for FFR is 60bps, GRI is 55bps, and RWO is 50bps. Unlike mutual funds, however, this is not the only expense. How you trade ETFs is also related to your expense. ETFs trade with a bid and ask just like stocks. Your purchase price if at a premium to the funds net asset value (NYSE:NAV) would in theory add an "expense" to your investment. Of course, if you also sell the fund at a premium then you would recapture that cost.

    Contrary to many articles on the internet, low trading volume or low fund assets do not mean that you cannot trade the ETF at or near NAV, you just have to have the right tools to make it work efficiently for you. Any ETF can be shut down, but a fund with less than 100 million in assets has a higher risk of being closed due to lack of interest. Fund closings have historically been done in an orderly fashion.

    Currently FFR has 87 million in assets and an daily average trading volume of 18,800 shares. GRI has 64 million in assets and a 9,700 average daily trading volume. RWO has 461 million in assets with a 91,000 average daily trading volume. The tradability ranking would go to RWO in this analysis, based on its relative high volume and assets under management. We also note that RWO trades free of transaction charges at TD Ameritrade.

    The historical performance of these funds differ greatly, however volatility looks to be very similar. The unique strategy of GRI does not appear to have much of a performance difference between these funds. Because the ETFs have not been around for 10 years we note that the below chart uses the index data where ETF data is not available. The index for FFR is not available for 10 years.

    (click to enlarge)

    (click to enlarge)

    FFR, GRI and RWO represent many of the same global REIT stocks but with different weightings. RWO looks to be the the leader in assets and ease of trading. In the end, each of these ETFs are going to give you the global REIT exposure you are looking for. As to which one is best for you depends on which index methodology makes you more comfortable.

    Notes:

    Mitchell Williams, Wiser Research Intern, contributed to this article

    Index Methodology

    GRI http://etf.capitallink.com/files/global0911.pdf

    FFR http://www.ftse.com/Indices/FTSE_EPRA_NAREIT_Global_Real_Estate_Index_Series/Downloads/EPRA_NAREIT_Index_Rules.pdf

    RWO http://www.djindexes.com/mdsidx/downloads/fact_info/Dow_Jones_Global_Select_Real_Estate_Indexes_Fact_Sheet.pdf

    Disclosure: I am long RWO.

    Jul 24 9:11 PM | Link | Comment!
  • 401k Plans Need ETFs

    There has been a lot of discussion concerning the use of exchange traded funds (ETFs) as the primary investment vehicle within 401k plans. The barriers that once stood in the way are being removed by innovative record keeping and the growing use of ETFs in private and institutional accounts. There are some compelling reasons as to why ETFs can force the door open into 401k plans across America.

    PASSIVE vs. ACTIVE

    We all believe, or want to believe, that we are winners. This mindset can take us far in life, but it is not necessarily how we should approach portfolio management. Of course we want to win in investing, but investors should focus long term, not on the hot stock, sector or asset class of the year. There is a growing realization that actively trading stocks and bonds for short-term gain is a losing bet. We see this in a University of Maryland Study that shows, adjusted for risk, only 0.06% of fund managers beat their index from 1975 to 2007. 1975 is an important year as this is the conception of the Vanguard S&P 500 Index fund.

    The buy and hold indexing approach is being fueled by two things: disenchantment with high-cost, under-performing active mutual fund managers; and the migration of brokers from commission firms to fee-only platforms where a fiduciary responsibility forces a better look at active mutual fund management. These issues have increased the use of index funds, specifically exchange traded funds. As plan participants want their 401k accounts to look like their private accounts, ETFs are building momentum to fill this void, especially in small to mid size 401k plans. Plan fiduciaries also realize that adding indexing to active management plan options reduces their liability.

    LOW COST INVESTING

    If a plan participant can save 1% a year in investment costs on a $20,000 portfolio, over a 20 year period that participant would have 17% more money, not accounting for any performance differences. The benefit of cost savings are more apparent over the last market decade where portfolio rates of return have been nearly flat after the 2000 tech crash, September 11th and the 2008 financial crisis. The average mutual fund costs 1.15%, where the average iShares ETF costs 0.45%. Core ETFs would be much less.

    DIVERSIFICATION

    Index funds offer great diversification. IVV or SPY hold all 500 stocks within the S&P 500, where as a similarly styled actively managed mutual fund may hold only 40 - 60 equities, some not even listed on the S&P 500.

    ETFs can also provide plan participants access to harder-to-reach asset classes such as emerging market bonds, frontier markets, international bonds or commodities. All of these asset classes can be held at a cost of less than 0.50%.

    TRANSPARENCY

    Ask any plan participant, or in some cases the plan sponsor, how much their plan costs. This includes the administration and investment fees. Very few will be able to tell you. In 2012 there is new regulation that will help change this, but up until this point transparency has been about as clear as a muddy river. Exchange traded funds provide a daily look into what is held within the portfolio, and management fees are fully disclosed. Add a report showing the participant plan administration fee and you will have a very transparent 401k.

    WHO NEEDS ETFs TODAY?

    One can argue that large plans have the negotiation power to lower plan participant investment costs. This is true to a certain extent. In some cases a Vanguard Index Tier may be more beneficial to plan participants versus exchange traded funds. The Vanguard Index Tier can drop investments costs below 0.05% if the plan is large enough. Indexing as an option if desired in these plans, whether it is an index mutual fund or exchange traded fund.

    The real benefit for ETFs falls in plans with less than $100 million in assets. These 401k plans are currently being serviced by industry leaches such as the Hartford, VALIC, and other annuity-based 401k/403b plans. Participants in these plans can pay nearly 3% annually in fees. Lowering their costs by 2% would be huge.

    For some plans that do not offer any form of indexing, often the plan sponsor has allowed the plan provider to offer a brokerage link account. This is where a participant is allowed to move all or a portion of their 401k balance into a brokerage account under the 401k umbrella. Within this account a plan participant can purchase most equities and bonds including index mutual funds and Exchange Traded Funds.

    THE BARRIER

    An exchange traded fund trades just like a stock, which means that they can be traded intraday with a bid and an ask spread. A net asset value (NYSE:NAV) is also calculated; NAV is the value of the underlying securities. Mutual funds, on the other hand, trade at day end on NAV. There is a good probability that an intraday purchase of an ETF could be made at a value greater than the NAV, which is not a good thing for 401k plans. This issue has been solved by not allowing intraday trading of ETFs inside a 401k. Transactions will take place at the end of the day, just as mutual funds are currently traded. There has been noise that mutual funds have the same NAV issue but at a different level. There is debate that ETFs could, in the end, be traded more efficiently than mutual funds. This is actually good news for proponents of ETFs within 401ks, as just a short time ago this was a case-closed win for mutual funds.

    Another barrier for ETFs has been record keeping. Up until recently, accounting systems would only handle mutual funds. Participants can hold fractional shares of a mutual fund. ETFs trade in whole shares. This has changed; through new techniques fractional ETF ownership is possible.

    THE PLAYERS

    Several companies are offering ETFs within 401k plans. The larger players are ING's Sharebuilder 401k, Charles Schwab, Invest N Retire, WisdomTree, iShares and TD Ameritrade. All of these companies have invested into architecture that allows for the efficient use of ETFs within a 401k plan.

    USERS

    Plan sponsors that use ETFs within their plans are innovators, and the organizations understand investing at a level higher than the average sponsor. As CFOs and HR directors learn about indexing and the use of exchange traded funds, the ultimate winners will be plan participants.

    Jul 24 5:29 PM | Link | 1 Comment
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