If you are confused by the difference among these titles: Financial Planner, Stockbroker, and Registered Investment Advisor, you are not alone.  The “Name Game” in the financial services industry is downright confusing.  How does your financial advisor operate?  How does she get paid?  What are the advantages and disadvantages of each arrangement?

Many people believe that they are getting financial planning from a stockbroker, when in fact financial planning is usually only an incidental part of what a stockbroker does.  Similarly, many people are not aware that a stockbroker does not have to act in the client’s best interests.

A June 19th Wall Street Journal article Big Change in Store for Brokers in Obama’s Oversight Overhaul brings home this point.

According to the article, stockbrokers might have to change the way they do business; they might have to act in their client’s best interests, the way a Registered Investment Advisor already does.

Wow!  What a concept.

Here are the relevant quotes:

Buried in President Obama’s proposed regulatory overhaul is a change that could upend Wall Street: Brokers would be held to a higher “fiduciary” standard that would compel them to place their client’s interests ahead of their own.

Currently, brokers are only required to offer investments that are “suitable,” which means they can’t put clients in inappropriate investments, such as a highly risky stock for an 80-year-old grandmother. The move could change the way products are sold and marketed and even how brokers are compensated.

Many investors don’t even know the difference between the two standards, believing their brokers already are acting in their best interests.

But requiring brokers to operate under a fiduciary standard could force them to offer products that are less costly and more tax-efficient.  They will have to disclose any potential conflicts of interest, such as any fees they may get for favoring one product over another. That could mean clients will be offered fewer proprietary products if the broker can find a lower-cost option elsewhere.

For example, a broker couldn’t put you in a mutual fund with higher fees — or one he gets a bigger commission for selling — if he could get a comparable fund with lower fees elsewhere, says Tamar Frankel, an expert on fiduciary law at Boston University School of Law. (Emphasis added.)

The article implies that some stockbrokers sometimes put their interests above yours.  Hmm.   This might just be worth investigating.

Luckily, I’ve discussed this topic many times, and in fact I have a series called The Dark Side of Wall Street, which lists all of the relevant posts.  If you start with Choosing a Financial Advisor, Part 1 at the bottom of the page, you can read them in order by following the “To be continued” link at the end of each post.

Have we (i.e. mankind and womankind) developed in such a way that we are prone to making bad long-term decisions?  Is it a matter of evolution?  Is there any hope?

Last week, Nicholas Kristof wrote a column with the eye-catching title, When Our Brains Short-Circuit, that I read with interest.  I believe that the article provides lessons for all of us, as citizens and as investors.

A quick summary of Kristof’s thesis is that, because of the way we perceive risks, our brains are not suited to solving long-term problems.  His column addresses the issue of carbon emissions, global warming and how we are reacting to this threat.  It is not my place to assess the degree of the threat or the comparative advantages and disadvantages of suggested solutions such as a cap-and-trade system versus a tax on carbon, so I won’t even try.

What I would like to do, however, is to point out that our brains can sabotage our individual financial decisions, so the concepts are quite relevant for us as investors.

First, I’d like to recommend Nicholas Kristof’s columns, which are, for me at least, required reading, because he frequently writes about topics that are generally ignored by other columnists.  Sometimes the subjects are quite disturbing - the tragedy in Darfur, human trafficking, and the immense suffering caused by poverty in the developing world.  While it is upsetting to read about such things, he is not just about just gloom and doom.  He also writes inspiring stories about courageous and innovative people who are making significant improvements in the lives of others.  Overall, I find Kristof’s writing riveting.

Here are some quotes from his column.

Evidence is accumulating that the human brain systematically misjudges certain kinds of risks.  In effect, evolution has programmed us to be alert for snakes and enemies with clubs, but we aren’t well prepared to respond to dangers that require forethought.

“What’s important is the threats that were dominant in our evolutionary history,” notes Daniel Gilbert, a professor of psychology at Harvard University.  In contrast, he says, the kinds of dangers that are most serious today — such as climate change — sneak in under the brain’s radar.

Professor Gilbert argues that the threats that get our attention tend to have four features.  First, they are personalized and intentional.  The human brain is highly evolved for social behavior (“that’s why we see faces in clouds, not clouds in faces,” says Mr. Gilbert), and, like gazelles, we are instinctively and obsessively on the lookout for predators and enemies.

Second, we respond to threats that we deem disgusting or immoral — characteristics more associated with sex, betrayal or spoiled food than with atmospheric chemistry.

Third, threats get our attention when they are imminent, while our brain circuitry is often cavalier about the future.  That’s why we are so bad at saving for retirement.

Fourth, we’re far more sensitive to changes that are instantaneous than those that are gradual. We yawn at a slow melting of the glaciers, while if they shrank overnight we might take to the streets.

In short, we’re brilliantly programmed to act on the risks that confronted us in the Pleistocene Age.  We’re less adept with 21st-century challenges.

This short-circuitry in our brains explains many of our policy priorities.  We Americans spend nearly $700 billion a year on the military and less than $3 billion on the F.D.A., even though food-poisoning kills more Americans than foreign armies and terrorists.

Risk Perceptions

All four of Gilbert’s “features” affect people’s perceptions of many aspects of finance, but let’s focus on this one – “we’re far more sensitive to changes that are instantaneous than those that are gradual.”  How does this affect a comparison of risk perception regarding stocks versus bonds?  Remember that all investments have risk. 

Consider the word “bond.”  It sounds substantial, even reassuring; “My word is my bond.”  We believe bonds to be something sturdy and steadfast. Stocks prices, on the other hand, we know to be variable, fluctuating for no apparent reason.

Encouraged by the media, we are all riveted by substantial stock market declines, especially if they occur over a short period of time.  From all media accounts, it seems as though the sky must be falling; certainly the adjectives bandied about by TV broadcasters don’t help: meltdown, disaster, crash. 

Even something as simple as the phrase, “stocks are declining today” is misleading.  It would be more accurate to say “stocks have declined.”  To say they “are declining” implies that they will continue to go down, which may or may not be true.

Market volatility can be sharp, sudden and terrifying.  And yet we know that the long-term trend of stock market prices is up.  In fact, on a yearly basis, stock market returns are positive in seven out of ten years.  Of course, we cannot know which years will be positive and which will be negative, but we do know that investors expect to be rewarded for taking risks, and they are rewarded, over the long term.

The Real Risk

Consider, on the other hand, what I think is the real risk for investors – the long-term erosion of the purchasing power of the U.S. Dollar. You never see a large increase in prices on any given day, but over time, inflation has been slow, constant and nearly invisible.

In truth, we vastly overestimate the probability that a stock market decline will cause us to suffer catastrophic losses, but we also vastly underestimate the probability that, over the decades of retirement, erosion of purchasing power will grind down our lifestyle.

Wise investors will constantly remember that markets can and do go down suddenly and significantly, but they have never stayed down.  For the long-term investor, the effect of declines has been negligible.

By the same token, prices very rarely go up much in any one year, but they virtually never stop going up. You can observe the cumulative effect by comparing a 15-cent first-class U.S. postage stamp issued to celebrate the 1980 summer Olympics with a brand new 44-cent stamp today.

And yes, I know that currently inflation is not a concern.  But my prediction is that it will be; I just do not know when.

Conclusion

I believe that investors should have both stocks and bonds in their long-term portfolio, and for reasons discussed in earlier posts, I favor mutual funds, not individual securities.  My advice is don’t be so concerned with short-term fluctuations in stock prices.  Remember, the real long-term risk is the erosion of your purchasing power.

For a longer discussion of the real risk of the loss of purchasing power over time, read Nick Murray’s book Simple Wealth, Inevitable Wealth, which also provided the postage stamp example.

A great documentary

Some of the most memorable evenings in my life have nothing to do with money and numbers, and everything to do with music and theater.  As a child, my mother took me to Broadway plays.  Later, in my twenties, I saw Fiddler on the Roof and A Funny Thing Happened on the Way to the Forum, both with the late great Zero Mostel, and The Apple Tree with a very young Alan Alda, who went on to fame in the television series M*A*S*H.

Over time, I discovered folk music in Greenwich Village, then classical music and jazz, and finally cabaret music.  I am certainly not a connoisseur, by any stretch of the imagination, but I know what I like.

I remember when a friend suggested going to hear Van Cliburn play Gershwin’s works at Lewisohn Stadium, located in what is now the City College campus in Harlem.  Since Gary was always coming up with interesting things to do, I agreed.  And was I glad I did.  What an amazing night!  As I remember it, the audience was so enthusiastic that Cliburn performed three encores.

It was in Rochester where I saw the Alvin Ailey dance troupe for the first time, and I was blown away by the energy, the muscularity, and the joy of the performances.

Some very memorable life cycle events have been marked by equally memorable musical plays.  When my wife Joan was pregnant with our first child, we went to see the original A Chorus Line, which had just opened on Broadway.  It took about eight seconds for me to be totally captivated by the play.  It’s still my favorite musical.  When it finally closed, after the then-longest run in Broadway history, we took our two daughters to see it.

Last week we used Netflix to get an Academy Award winning documentary: From Mao to Mozart: Isaac Stern in China about the famous musician’s 1979 trip to China.  I thought it was a great film, and it captured the impact that a single person can have.  You can witness Stern’s musical genius not only in performing but also in teaching.  And you can see the hunger and enthusiasm that the Chinese performers and audiences had to learn more about Western music, which had been brutally suppressed.  Little did anyone know, at the time, that China was about to change dramatically.

Check out the film and see for yourself. I think you’ll enjoy it, and the DVD extra, Musical Encounters, which tracks Stern as he returns to China, 20 years later. Some of the young musicians in the original film return and reminisce, most of them in fluent English. They are now adults and are successful musicians and teachers.

My brother-in-law likes to say that “there are no coincidences,” but I find it striking that Sunday’s New York Times had a very long article about the effect of Stern’s 1979 visit to China.  After all, we had just seen the documentary a few days ago, and here is this very detailed analysis celebrating the 30th anniversary of Stern’s trip.  You can read the entire article here.

And by all means, rent the DVD documentary from Netflix, Blockbuster or your local store.  You won’t be disappointed.

On June 10th in the first part of this series, I wrote about the dangers of buying stocks in companies you think you know well, and I extolled the virtues of diversification.  One reader posted a comment saying that he believed that owning 30 to 35 individual stocks was “sufficient” diversification.   I’m not so sure.

Today’s Hot Tip: Don’t Buy Stocks! an article by Howard Gold, written in 2008, reinforces my arguments.  He interviewed several professionals to make his point.  Here is a summary of his article.

William Bernstein, a money manager and the author “estimates that because of close correlations between markets, even 100 carefully chosen stocks can’t match the diversification of holding just a couple of index funds and ETFs that cover the global market.”

If you’re still not convinced, just how much work are you willing to put into picking stocks?

According to Gold, “even individuals who have good stock-picking skills rarely can do the necessary research to post consistently good results over time.”

He quotes a study by the Schwab Center that “tracked the portfolios of Schwab clients who had $5,000 in household equity and whose accounts were either at least 95% individual stocks (including foreign shares and ETFs) or 95% open-end equity mutual funds.

The survey, taken over 2005-2006, produced stunning results:

The fund investors substantially outperformed the stock pickers, with less than half the risk and after all expenses.

Though it covered only two years—and the investors may have held other assets at other financial institutions—it did take in a huge number of the 3.5 million clients of Charles Schwab, about as good a sample of the US investing public as you can find.”

Doing Your Homework

“You have to have tremendous energy to devote to the stock-picking process,” says David Swensen, chief investment officer of Yale University. “Individuals don’t have the time or the resources.”

In his book “Unconventional Success: A Fundamental Approach to Personal Investment,” Swensen advises individuals to stick to a set of broadly diversified index funds.

“If you try to manage your own money and invest in your own stocks, and you don’t…do every single piece of homework necessary, you won’t beat the market, and you’ll probably lose money,” says one well-known investing guru.  “If you don’t have the time or the inclination to do this work, then I’m begging you, please don’t try to invest in individual stocks.”  (Emphais added.)

Who said that?  Vanguard founder John Bogle?  No, it’s Jim Cramer, who pounds the table for individual stocks amid the booyahs and silly hats on his weekday Mad Money show on CNBC.

“Investing is fun for a lot of people, and if they want to try their hands [at stock picking], they should go for it,” says Peterson. “Just make sure that the majority of your portfolio is diversified.”

Gold’s observation is that the rest of us should “get our thrills and chills elsewhere.”

Conclusion

You can only achieve real diversification by investing in both stocks and bonds.  Moreover, within each category, you need to have many individual securities to be truly diversified.

Suppose you believe that your portfolio should include the following asset classes: large-cap U.S. stocks, small-cap U.S. stocks, large-cap international stocks, small-cap international stocks, stocks from emerging markets, and Real Estate Investment Trusts.  How can you possibly achieve this diversification without hundreds of individual securities?  In my opinion, you can’t, which is why you need mutual funds.

The portfolios I construct for my clients typically have mutual funds with thousands of securities.  That is diversification.

Roth Basics

If saving for your retirement is one of your financial goals (and it should be), you might want to consider investing in a Roth IRA.  You should know that some people earn too much to qualify; here are the limitations:

In general, if you file as a single, you can make the full contribution provided that you earn no more than $105,000; if you’re married and file a joint return, that maximum is $166,000.  It’s actually a bit more complicated than that, but if you’re interested in learning the nitty gritty, here is a link explaining how to calculate the amount you can earn and still contribute to a Roth IRA.

Investment Choices

As with a traditional IRA, you can invest in a number of things: Certificates of Deposit, stocks, bonds, mutual funds, etc.

Advantages

With a Roth, all earnings on your investments escape taxation completely. This is unique.  All other investment vehicles are either taxed currently or tax-deferred.  By tax-deferred, I mean that you don’t pay any taxes until you take the money out.  Examples of tax-deferred investments are 401(k)s and 403(b)s, as well as traditional IRAs.

Other benefits of a Roth IRA include avoiding the early distribution penalty on certain withdrawals and eliminating the requirement to take minimum distributions after age 70½.

Disadvantages

So what’s the catch?  The primary disadvantage of a Roth IRA is that you don’t get a tax deduction when you contribute to it, as you do with other retirement options.  Your personal situation will drive what is more important, tax-free growth or a current tax deduction.  But that decision to go with a Roth will also depend on the assumptions you make about what your tax bracket may be when you retire.

Another disadvantage of a Roth, albeit a minor one, is that you have to go out of your way to use it.  What I mean by that is you have to actually open an account with a bank, brokerage firm or mutual fund.  With a 401(k) or 403(b), you just pen your John Hancock to some forms at work and you’re good to go.

Aside from the (in)convenience aspect, psychologically it is easier to save though an employer sponsored plan, simply because you never see the money; it comes right out of your paycheck.  And, of course, many employers match your contribution either in full or in part, which you ordinarily wouldn’t want to miss out on.  That is, after all, found money.

Limits

What’s the maximum you can contribute to a Roth IRA?  The same amount as the traditional IRA.  For 2009, it’s $5,000 if you’re younger than 50 years old; otherwise, it’s $6,000, and both spouses can make contributions to a Roth.  You should be aware that contributions are a “use it or lose it” proposition; in other words, if you fail to take advantage of this year’s contribution, you can’t do it retroactively.

Summary

For a quick summary of your choices, Understanding the Roth IRA has a useful table comparing the various options.

Conclusion

In general, a Roth IRA is a very smart choice in saving for retirement for many people.  To make the right decision for you, discuss the question with your financial planner or accountant.

Despite the title, this post is not about nostalgia, about the simpler times of pillow fights, water balloons, and The Lone Ranger.

It is about the education of an investor: me.

My last post discussed the risks of investing using individual stocks.  My point was that you simply cannot get enough diversification that way; therefore, you have unnecessarily increased your risk.

If you’ve been reading my posts, for example here and here, you have probably noticed that an underlying theme of this blog is my conviction that the right way to invest is to use mutual funds, specifically those that follow a “passive” approach.  I have believed this for 40 years.

How did I come to this belief?  Forgive my stroll down “memory lane,” but I actually went through something of a conversion process.  You see, back when I was in school I decided that I wanted to become a securities analyst.

Being a securities analyst meant that I would become a specialist within a particular industry and, through rigorous and comprehensive analysis, I would choose the “good” companies to invest in within that industry.  By the way, when I said “school” I meant high school; even at the tender age of 17, I had already set my path to fame and fortune (at least, in my own mind).

My plan, all those years ago, was to attend a liberal arts school and study Economics, because I thought that was the discipline that would be most useful to me.  I figured that I would major in Economics and then go on and get my MBA in Finance. Was I a precocious, or merely delusional, 17 year old?

Well, I graduated with an undergraduate degree in Economics from Lafayette College, and in an exit interview with a career counselor, I was asked what my future plans were.  I was steadfast in my conviction that I was going to get an MBA in Finance and then work on Wall Street.  Even four years of studying Economics and Accounting had not changed my plan.

But a funny thing happened on the way to Wall Street.  What I learned in graduate school changed my mind and also my career path.

Perhaps my professors were that convincing or the theory and evidence were just too persuasive.  For I learned that, because of competitive markets, it was nearly impossible to identify undervalued stocks and therefore “beat the market.”   I recall one professor, George Benston, remarked that you could beat it (the market) with a stick but not as an investor.

Who believed such things in the 1960s?  Followers of the Chicago School of Economics; in my case, at the University of Rochester.  This is not the time to discuss the relative merits of the Chicago School, but suffice it to say that such economists as George Stigler and Milton Friedman were held in very high esteem at the U of R.  In particular, Friedman was considered a “minor” deity (and I’m not so sure about the “minor” part).  To diminish the hero worship I remember that Benston irreverently but still affectionately referred to Friedman as “Uncle Miltie.”

The Finance I studied in the 1960s was so new that it was not covered in any textbook.  Instead, we read primary documents (journal articles) by such pioneers as Harry Markowitz, William Sharpe, and the team of Modigliani and Miller, known as M&M.  These were the people who would later win Nobel prizes in economics.

One professor, Michael Jensen, had just written his groundbreaking Ph.D. dissertation on the performance of mutual funds.  Eugene Fama was his thesis adviser.  Jensen actually coined the term “Alpha,” which is a measure of excess returns achieved by investment managers.  More formally it is a statistical estimate of “how much a manager’s forecasting ability contributes to the fund’s returns.”  When you hear someone on TV talking about “creating Alpha” you now know where that term came from.  I’d bet that 90% of investors don’t know that.

But the punch line is that Jensen learned that mutual fund managers could NOT create Alpha, i.e. they could not “beat the market.”

His research was published in the Journal of Finance in 1967 and here are his conclusions:

The evidence on mutual fund performance indicates not only that these 115 mutual funds were on average not able to predict security prices well enough to outperform a buy-the-market-and-hold policy, but also that there is very little evidence that any individual fund was able to do significantly better than that which we expected from mere random chance.  It is also important to note that these conclusions hold even when we measure the fund returns gross of management expenses (that is assume their bookkeeping, research, and other expenses except brokerage commissions were obtained free).  Thus on average the funds apparently were not quite successful enough in their trading activities to recoup even their brokerage expenses.  (Emphasis added.)

Since 1967, there have been many, many follow-up studies and, they have confirmed his basic finding that active investment managers cannot “beat the market.”  Neither can stockbrokers or “experts” on TV.  And reading articles about hot mutual funds or “10 Stocks to Buy Now” is a waste of time.

If mutual fund managers and pension fund managers– some of the so-called experts – cannot use securities analysis or trading strategies to “beat the market” why would you, an individual investor, even want to try?

Now there’s the real lesson that 90% of investors do not know.

What I want to do is save you from the potential losses caused by buying individual stocks.  Sadly, this is not merely an academic discussion, since I have known many people who have been crushed by losses in individual stocks.  It upsets me to know that the devastation could have been avoided.

Buying individual stocks certainly gives you something to talk about over drinks with your friends.  But I don’t believe that the cocktail chatter advantage means you should actually buy individual stocks.  I don’t invest in individual stocks for myself, and I don’t recommend it for my clients.

People always have their reasons as to why their favorite stock is just “great.”  Some have done their research and have created a model that predicts that the stock that they are going to buy will double in the next four years.  Others have been following the same company for decades and are convinced that now is the time to buy.

Usually they’re talking about well known companies, such as General Electric, Johnson & Johnson or General Motors.  Did I get you?  I made that last one up.  In actuality, no one has ever told me that he was planning to buy General Motors.  That’s good, because looking back, we now know that GM, even though it was once considered a solid “blue chip” stock, was not in fact such a smart investment .

And there’s the rub. Looking back, it is crystal clear that we should’ve bought Microsoft when it first went public.  We should’ve bought Google.  Anyone with the time and inclination can do the research and figure out which stocks they should’ve bought.  But it’s not so easy going forward.

For one thing, there’s an excellent chance that whatever you have learned that convinced you that a particular stock is a good buy is already known by everyone else.  Therefore, the current price already reflects the brilliant insights you so cherish.  But another reason is that stocks are inherently risky.  If you are not using mutual funds to achieve diversification, but only buying a few stocks, you’re adding to your risk, unnecessarily.

Chances are you’re buying the stock of a company that you know quite well. If you live in Seattle there’s a good chance that Microsoft and Starbucks are in your portfolio.  Great.  And if you live in Rochester, New York there’s an excellent chance that you had Eastman Kodak and Xerox in your portfolio. Not so great, we now know.

In Atlanta, many people have invested in Coca-Cola.  By the same token, people in Houston had invested in Enron.  Where you live, and what you are familiar with, are not good reasons for investing.

Neither is loyalty.  Maybe your grandfather gave you some stock before he died and told you never to sell it.  I’m sorry, and I mean no disrespect, but don’t listen.  That stock with a family pedigree could be the next General Motors.

Or maybe you used to work for a great company and you have accumulated a lot of stock in your former employer.  But were you lucky enough to have worked for Exxon or unlucky enough to have worked for Citigroup or Bear Stearns?  Why let luck play such an important factor in your investment success?

By now you get the idea.  I’ve probably been way too repetitive.  But this is a really important concept.

As Nick Murray, author of Simple Wealth, Inevitable Wealth, says “Diversification is the conscious decision never to be able to make a killing, in return for the priceless blessing of never getting killed.”

To be continued.

A great documentary

I really, really like Netflix.  It can’t be beat for its convenience and economy, and I have watched many very good movies that I easily would have missed.  With over 100,000 DVDs in their library, there are certainly more than enough to choose from, no matter what your preference.

Netflix started out several years ago by touting its no late fees arrangement. I suppose from a marketing point of view, it’s a brilliant concept.  They must have figured out that a great many consumers were unhappy paying a late fee to a local video rental store; in the grand scheme of things, returning borrowed movies is low on the agenda, and these fees can really add up.  With Netflix, though, there are no due dates or late fees, ever.  When you’re done with a movie, you simply drop it in any mailbox using a prepaid return envelope.  As I said, the convenience can’t be beat.

I also like that you can create a wish list of films that you would like to watch, and as you return one DVD by mail, another one from your list is shipped out to you.  I usually receive the new one in 3 days.  It’s that easy.

But for me the best part is that Netflix uses technology to become a wonderful referral source for movies I might like.  How this works is that, after you’ve watched a movie you grade it from one to five stars; in this way, Netflix “learns” what you like and don’t like.  That facilitates recommendations.  For example, if I click on Little Miss Sunshine, a 2006 comedy, and ask for “Movies Like This,” Netflix will recommend Sideways and Juno.  If I click on Amelie, Netflix will recommend Priceless, another Audrey Tautou movie.

In addition, Netflix has a section called “Movies You’ll Love” which are suggestions based on your ratings.  In any case, Netflix will predict how well you will like any given movie, based on your previous ratings.  There are also brief descriptions of the movie plot and you can also read reviews by several film critics.

They have a very large selection of just about everything: hit movies, musicals, international flicks, documentaries, silent movies, and TV series.  If you don’t get HBO, you can still watch In Treatment with Gabriel Byrne. Don’t get Showtime?  You can still watch old episodes of Weeds.

Do I sound like a commercial? Only telling you the good stuff?  Okay, there is one glitch that I’ve occasionally encountered; from my experience, about 5% of the DVDs are damaged.  If you run across a problem like this, you can request a replacement disk, which will be sent out immediately.  So for me, it is an occasional annoyance, but not a deal killer.

I recently received an e-mail saying that if I forwarded it to friends, they could try Netflix for free for one month.  I’m not going to willy nilly send an email to everyone in my contacts list, but if you’re interested in trying Netflix out, send an e-mail to me at rstreit@keyfeeonly.com, and I’ll be happy to forward the message to you.  Their offer expires June 15th.

FYI, the cost of a monthly plan depends on how many DVDs you have out at one time, but vary from $4.99 (2 movies per month) to $16.99 for 3 DVDs at a time with unlimited renting.

As I mentioned, there are some really good movies that I would have missed or even bypassed without their recommendation.  This is only a partial list, because there really are too many to post:
Antonia’s Line, Ballets Russes, Billy Elliot, Elsa & Fred, The Girl in the Café, My Mother’s Castle, Miss Pettigrew Lives for a Day, Raise the Red Lantern, Smiles of a Summer Night, and Together.

And, no, in case you were wondering, I’m not getting a commission from Netflix for referring this great service.  So, why am I doing this?  For two simple reasons: first, because we all need a little less stress in our lives and second, because I really like Netflix.

I think it is imperative that you confront your fears and put something in writing, especially if you have minor children.  Having a will and naming a guardian is nothing short of mandatory.  My experience is that many people, who definitely know better, have not taken care of this responsibility.  That’s quite sad.  Parents spend so much time and energy in ensuring the successful viability of their children’s (long term) future in terms of education and comfort, but fairly little in considering who will care for them (in the short term) if the worst thing that could ever happen happens.

Whether you should take a step beyond just a simple last will and testament and also use a trust is the subject of a June 3rd article in The Wall Street Journal, Deciding if Your Kid Is Trust-Worthy, by Stacey L. Bradford. She raises several pertinent considerations in estate planning.

The subject of trusts can be intimidating, but it is well worth your time to become acquainted with the issues. Fortunately, Bradford explains in plain English “why parents may want to consider estate-planning tools beyond a will.” Here are some relevant quotes.

Even middle-class folks can benefit from trusts when it comes to estate planning. That’s because children under the age of 18 can’t directly inherit more than a small amount of money. If you have more than that to leave to your minor child and make no provisions in your will, a court will appoint a property guardian to manage your child’s assets until he reaches 18 or 21, depending on the state.

That property guardian may be a complete stranger who won’t understand your values. Perhaps more important, the guardian could add one more layer of bureaucracy to an already complicated situation. When your child needs money, the guardian may have to make a formal request that then goes through the court system. It can be a real headache for your kids to get funds when they need it, and it’s not an arrangement that’s always in their best interests.

One way around the court system is to set up a custodial account for your kids through your will. In that case, you get to name the custodian, and he decides how the money is spent. Once your son or daughter is legally considered an adult, he or she inherits the money outright. The problem with this setup is that your kid might blow through the money and have nothing left over for college or grad school.

For many parents, setting up a trust is a better alternative that allows them more control over how their money is spent once they’re gone. If you have the means and want your child to go to private school, for example, include that in the trust document. A trust can also delay the age at which your kids get their hands on the money.

While setting up a trust is a bit more complicated than a custodial account — it requires a lawyer’s assistance, for one thing — it also provides more financial security for your children and is therefore worth considering. Ideally, you should set up a trust when you draft your will. But you can always add a trust later as your estate gets more complicated or your assets grow.

Here are a few questions to ask yourself to determine if a trust is right for your family:

Do you anticipate leaving your children more than a modest sum of money?

Do you want to have some say in how your children’s money is spent?

Would you prefer that your children not inherit the money when they turn 18 or 21?

Do you want the money to be used for a college education?

Bradford also discusses choosing a trustee and how your guardian and trustee will work together.

Even after reading just these excerpts that I posted here, you will know enough to ask the right questions of your attorney. Reading the article in its entirety or the book on which the article is based, The Wall Street Journal Financial Guidebook for New Parents, couldn’t hurt either. By the way, in my opinion this book will be valuable for parents who are not so new and even grandparents.

And, of course, it is absolutely imperative to work with a knowledgeable lawyer who specializes in estate planning issues. Trusts are highly complicated and simply not a do-it-yourself project.

What you spend upfront on the lawyer fees will be saved many times over, if the need ever arises.

My last post discussed a recent Wall Street Journal article, Laws Take On Financial Scams against Seniors, which stated, “financial scams that target seniors are on the rise, and states are cracking down.”  According to the article, “The recession has spurred more scams that play off people’s fear of stocks. Some investments pitched as low-risk could instead be quite complex.”

The sidebar included advice on what questions to ask when you’re presented with an investment “opportunity.”

What are the risks of this investment?

How much does it cost initially to purchase this investment and what, if any, additional or ongoing costs will I have to pay?

How liquid is this investment?  If I need to sell or cash in the investment, how little he can I do so?

Will my investment be tied up? If so, for how long?

What happens if I decide to sell or cash in my investment?  Are there surrender charges or other fees?

For what type of person is this investment a good idea?  For what type of investor is this a bad idea?

Is this investment registered?  If so, with which regulator?

If the speaker can’t or won’t answer your questions to your satisfaction, and in writing, the investment is not right for you.

Understand Risks and Costs

All of these are good questions and arguably they apply to any type of investment.  Understanding the risk of your investment is very important.  My advice is to shy away from any advisor who does not take the time to explain the risks of a particular investment.  If the presentation makes you feel extremely “lucky” that you have attended the session in the first place, it’s time to slow down.  And if all you hear in a presentation are the glorious benefits of an investment, and nothing about the risks, head straight for the door.

In my opinion, the questions above particularly apply to deferred annuities and mutual funds.  It’s important to understand what the costs and fees are of any investment you may make.  Keep in mind that Wall Street is very good at obfuscating, hiding fees, and using doublespeak to confuse consumers.

Regarding deferred annuities and mutual funds, under no circumstance should you accept the answer that “you do not pay any fees, because the insurance company or mutual fund firm pays me.”  This is an example of the “doublespeak” that I referred to in the previous paragraph.  To put it simply, it’s a lie.  Obviously, any fees that are paid out come from somewhere; in fact, they come from the returns that you could get in an investment product.

Beware of B sharers of mutual funds.

Mutual fund B shares are not a scam, but I have met prospective investors who assumed that they were not paying anything to buy their mutual funds.  Actually, they had been sold B shares of mutual funds.  To be kind, the investors were “misinformed,” and the advisor was paid handsomely for this “misunderstanding.”  You decide if this akin to a scam or not.

According to the Securities and Exchange Commission:

Class B shares might not have any front-end sales load, but might have a contingent deferred sales load (CDSL) (a type of fee that investors pay only when they redeem fund shares, and that typically decreases to zero if the investors hold their shares long enough) and a 12b-1 fee (an annual fee paid by the fund for distribution and/or shareholder services).  Class B shares also might convert automatically to a class of shares with a lower 12b-1 fee if held by investors long enough.

In other words, unless you wait for years to sell these shares, you will pay a contingent deferred sales load – in plain English, a commission – to get your money back.  In addition, that quote does not make clear that B shares typically have much higher annual expenses than true no-load funds.

If you read through the prospectus carefully and know enough to ask your “advisor” the “right” questions, you will reach the proper conclusion – that there are better investment alternatives for you.  Actually, there are plenty of better investment alternatives available.