The Four Corners of Your Financial House; Death of the Stretch IRA

Episode: 183
Guest: P.J. DiNuzzo
Originally Aired: December 14, 2016

The Lange Money Hour - Where Smart Money Talks

The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
Listen every other Wed. on KQV 1410 AM or at our radio show archives. Note: Some events referenced in our archives have already passed.

 

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TOPICS COVERED:

  1. Introduction of P.J. DiNuzzo of DiNuzzo Index Advisors, Inc.
  2. The Four Corners: Legal; Tax; Financial; Investment Planning
  3. A Deep Dive Into Cash-Flow Analysis Is Important
  4. Retirement Buckets: Cash Reserve; Needs; Wants; Dreams and Wishes
  5. Each Bucket Tied to the Client’s Cash-Flow Needs and Risk Tolerance
  6. Investments That Aren’t Diversified Can Underperform and Increase Risk
  7. Investment Decisions Often Aren’t Well Thought Out
  8. ‘Buy and Hold’ Pays Off in the Long Run

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Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.


1. Introduction of P.J. DiNuzzo of DiNuzzo Index Advisors, Inc.

Dan Weinberg: And welcome to The Lange Money Hour. I’m Dan Weinberg along with CPA and attorney Jim Lange. And tonight, we welcome back to the program, P.J. DiNuzzo. P.J. is a nationally recognized investment management expert and was approved as one of the first 100 Dimensional Fund Advisors. His Pittsburgh-area firm, DiNuzzo Index Advisors, Inc., was founded in 1989 as one of the first few hundred fiduciary, or fee only, advisors in the U.S., and it consistently ranks among the country’s top 500 investment companies. Tonight, Jim and P.J. will be talking about your financial house. Much like your physical house, your financial house has four corners: legal planning, tax planning, financial planning and investment planning. Now, if you take away one corner or build it the wrong way, your entire house could crumble around you. So we’ll talk about how your CPA, your estate attorney and money managers can all work together to make sure you’ve got the strongest possible foundation for your family’s financial success, and also tonight, we’ll be discussing a very timely topic, the potential death of the stretch IRA, which is covered in depth in Jim’s brand new book, so we’re going to talk about that. Our show is live this evening, so give us a call if you have questions. (412) 333-9385 is the number, and with that, let’s say good evening to Jim Lange and P.J. DiNuzzo.

Jim Lange: Welcome, P.J.

P.J. DiNuzzo: Good evening, thank you.

Jim Lange: Before we get into tonight’s program, I do feel honor-bound under full disclosure to say that I do have a professional relationship with P.J. DiNuzzo and his firm. Usually when I have a guest, whether it’s Jack Bogle at Vanguard or Ed Slott in the IRA world, if they have recently written a book that I like and recommend, I will usually put in a little plug for their book. By the way, that’s only if I have read the book and liked the book. But that’s fairly common, and very frankly, I don’t share in those royalties. There is no financial incentive for me to plug their book or to plug their service. Likewise, I do not pay them and never have paid any guest to appear on The Lange Money Hour, but with P.J. DiNuzzo, we are not independent. P.J. and I have a working arrangement and it works something like this: We believe that most clients have, let’s say … and we’re going to talk about the four corners, but I’m going to oversimplify for a moment and talk about two important needs. One is what I’ll call “strategic planning.” This might be in the area of Roth IRA conversions, how much should you convert, when should you convert, what’s the best Social Security strategy, how much money can you afford to spend, what’s the best way to educate your grandchildren, what should your estate plan look like, what is the best way to utilize everything that you have in terms of strategy. And that’s what our firm does, and that’s what we love to do. We use a process called running the numbers where we actually make projections given different scenarios. So, for example, what if you go ahead with the status quo? Let’s call that scenario 1. What if you do a series of Roth IRA conversions? That’s scenario 2. What if you do a series of Roth IRA conversions and you use the apply and suspend technique for Social Security? Well, that might be scenario number 3. What if you use a larger Roth IRA conversion in one particular year and smaller another? That might be scenario 4, et cetera, et cetera. And what we try to arrive at is what we think is the best retirement and estate plan, and we also take into account the most recent tax laws that we’re also going to be talking about.

But the other need that most clients have is actually managing the money itself. What should the asset allocation look like? Do you actually need to do a cash-flow projection in terms of how much you spend in order to arrive at the appropriate asset allocation? What if you don’t come in with all cash? What if you come in with an existing portfolio, some of which either must or you would like to be maintained? How does the money manager work around an existing portfolio? Well, these are all areas that are well beyond my area of expertise but well within the area of expertise of P.J. DiNuzzo and his firm, DiNuzzo Index Investors. So when I first became approved to represent Dimensional Fund Advisors, which we believe is the best set of index funds on the planet, and I knew that I had this limitation, I went to the people at Dimensional Fund Advisors and said, “Gee, our firm would love to do the strategic work, but we really don’t want to do the money management and we don’t think we could do a really good job, and rather than trying to hire somebody to do that, what we would rather do is we would rather find a firm that is just as good on the money management area as we are on the strategy area, and who do you recommend in western Pennsylvania?” And there was zero hesitation. They immediately said, “Oh, no, you need to work with P.J. DiNuzzo. He is by far the best guy in western Pennsylvania.”

And I had known P.J., but I hadn’t known him well, and I got in touch and I said, “P.J., so I’ve been in business for over 30 years and I have a lot of clients that trust me, and I’m continuing to get new clients and new prospects, and our firm wants to do the strategies, the estate plan, the Roth, et cetera” — what I had mentioned earlier — “and what we don’t want to do is actually manage the money and do the asset allocation, and then I know that you have all these wonderful, let’s call it, extras in the form of balance sheets and income statements, et cetera. What if we do our part for a client, you do your part, but part of the idea of index investing and part of the way that we can stay competitive, is if rather than us charging a fee and you charging a fee, what if we combine our services, charge one fee, which would be anywhere between 50 basis points if you’re investing a lot of money, or 1 percent if you’re investing a minimum? What if we do that and then you and I split the fee?” Which, by the way, would be the same fee structure if you just went to P.J. on his own, which is a very fair fee given the level of service. So he’s taking a little haircut in that he’s not getting a full fee on his clients, and we are, too. On the other hand, we think it’s a win-win-win, meaning our firm gets to do what we like and what we’re good at, P.J. gets introduced to people he would otherwise not meet, and he doesn’t have to worry about the things that we like and we’re good at. He can do the things that he likes and he’s good at, and the real winner, frankly, is the client who gets the best of both worlds all for one fee. So P.J. and I have been doing this for a number of years. We are now growing at … I think we’re going to hit about an additional $60 million, and we topped the $250 million of assets under management in our, let’s say, joint arrangement, and it continues to grow, but perhaps more importantly than how fast we are growing for the consumer is that we have a 97 percent retention rate, meaning that the people who come with us stay with us, and frankly, that’s what we are looking for. So, anyway, with that full disclosure, I’ll say thank you for agreeing to be a guest, P.J.

One of the things that you like to talk about with some of the prospects that we share is the four corners. Can you tell us what the four corners are and how they work?


2. The Four Corners: Legal; Tax; Financial; Investment Planning

P.J. DiNuzzo: Yes, thank you, Jim. I think it’s always helpful to sort of paint a picture for folks, and if you can think of a single-floor ranch dwelling, no basement, no second-floor ranch house, and if you’re looking at it from the bird’s-eye view and you lifted the roof off, we’d refer to this as your personal financial house. And there really are four large rooms in your personal financial house that you need to manage. And as Jim did a great job mentioning earlier, describing rather, the estate-planning corner is mission critical. You don’t go into that room every year, but when you do, it arguably is the most important room in your house. Jim has a law firm. He has specialized in estate planning for decades and decades and does a great job, and that’s an integral part of our value proposition. So Jim will review that corner with our clients. Really, the great part about the entire relationship that we have is how we’re able to add value for our clients that one of our nine wealth advisors is in communication with one of Jim’s multitude of CPAs and estate-planning attorneys on a daily basis, and being able to get that quick turnaround to our clients, as you all know, you’ve got something that you need to take care of. It sneaks up on you. You’re under the gun. You need a great answer, and we’ve been able to historically provide a great level of service to our clients, and that’s a testament to Jim and his team and attorney Matt Schwartz on the estate-planning side. The tax planning, of course, Jim handles that as well, and you had mentioned a number. It’s sort of a shame, Jim, how quickly you mentioned a lot of those as far as the Roth conversions, the capital-gain harvesting, and I see you and your CPAs, I mean, I’d almost refer to it as coming up with a formula or a recipe to really get that exact … you know, Jim’s CPAs will give us things along the lines of, “Hey guys, this year, we need to do a Roth conversion for this household for $27,000, and we need to harvest $35,000 in capital gains.” You’re just not going to find that basically anywhere else that I know of, certainly in the southwestern-PA area. Now that, coupled with us on our side, on the planning corner, and also the investment-management corner. The planning corner that we specialize in, financial planning, more specifically retirement planning and retirement-income planning, is probably the most important to us but the least sexy, so to speak. It’s really what gives us all the answers. When can I retire? How much do I need to retire? How much can I afford to withdraw? How much can I afford to spend on my multitude of goals and objectives? Each household has its own unique spending habits. It’s our job as advisors, we pride ourselves, and I’ve seen Jim perform successfully for decades and decades is what we refer to as making it happen. Clients come in. They have a goal. It means everything in the world to them. That’s what our job is, and I don’t know of anyone who applies themselves more and has been able to accomplish that than us with our joint value proposition.

So the retirement-income planning process, we can get into in a second. I’ll just give the big overview now. Retirement-income planning process (is a) very deep, very broad dive, and then the last corner room, investment planning, investment management, as Jim had mentioned, we’re the largest, oldest pure index-management firm in the city of Pittsburgh. We’re currently a little bit over $550 million in assets under management. We’ve been at it since 1989, and again, as Jim had said, we’ve been efficient-market-theory believers since our inception. We were using Vanguard indexes for the first few years. Whenever DFA became available, we applied to them. As Jim said, we got accepted as one of the first 100 advisors. But I think we don’t throw the word “expert” around, but I think we know an awful lot about indexing, how to couple that with your goals and objectives for retirement planning, and again, working with Jim and his team in the tax- and estate-planning side hand-in-hand to provide the best and most comprehensive results for our clients.

Jim Lange: P.J., let’s say that I’m normally on the estate planning and the tax planning, although I think there might be a little bit of overlap, and we sometimes talk about that, but on the planning corner, and specifically the retirement-income planning, what is your approach to retirement-income planning, and what do you do differently that you believe would be an important ingredient for clients to follow?

P.J. DiNuzzo: Yeah, Jim, what I would say, I’d sum it up as attention to detail. As anyone in the audience can imagine, I mean, the harder you’ve worked on something and doing your homework, doing your research, whether it be you bought a refrigerator, a new automobile, the legwork you put into your son or daughter what college they were going to go to, I mean, there’s no substitute for good-quality hard effort and work, and we get to know each prospective client — of course, the first two, or even three, meetings, someone’s just a prospective client — as well as humanly possible. Each household is completely different. I don’t know, Jim. I used my snowflake thing for decades and decades, but now that’s got a political connotation. I hear all these people in the political circles talking about snowflakes. But each household is completely different, and we get to know them intimately regarding their unique assets, liabilities, income and expenses. That takes a long time, but I would juxtapose that against our observations. When we look at national firms who we run into and they’ve got advice that’s quite distinctly different from what our advice is to our prospective clients on retirement planning or retirement-income planning. And almost without fail, it’s the devil’s in the details. These national firms are using just broad averages, regional composites, “professional” guesstimates. We get to know each individual household pretty much down to the last penny. It’s a little bit of a cumbersome process. Of course, the nice part is there’s no cost and no obligation. I mean, all of our time is pro bono. We’re financial planners. We’re not salespeople. Our goal, and what we’ve succeeded at and what Jim has succeeded at for decades and decades is showing people what we do, having them intimately understand what we do and how we do it, and then, on their side, it’s just very obvious to them, “Yes, that’s what I need. I understand what you do. I think you guys are great at it. I want to hire you.” So the retirement planning process, looking at you and your household as your own organization, Jim & Jane Jones, Inc., Mary & Sue Smith Organization, everyone listening has unique assets and liabilities, income and expenses, goals and objectives unlike anyone we’ve ever met before. It’s very, very important to get that unique, customized plan calculated for you. So I’m a CPA from way back the same as Jim is. Again, we look at you as your own organization. We gather that information. That takes the bulk of the first meeting. But again, as Jim mentioned earlier, or Dan did, rather, on the intro, and it was quite appropriate. It sounds, you know, an overused metaphor sometimes, but you know, literally building a solid footer and foundation, and with the national firms you run into, they’re off on annual cash-flow estimates for folks in retirement by $20,000, $30,000, $40,000, $50,000 a year or more, and this isn’t just a rare occurrence. We see this on a regular basis, and you don’t want someone guessing at your retirement. You want someone who treats you as the unique individuals that you are who appreciates the decades and decades that your household has worked hard to save that money in your 401(k) or your 403(b) and giving it the highest-level objective advice possible. So you go through a deep data dive, so to speak, from a lot of fronts. So the initial consultation usually lasts about two or 2½ hours, and that’s the discovery consultation, get to know you personally, as well as the data gathering. Then we’ll come back to the office, do our homework for two or three weeks, and then we present to you at the second meeting our best ideas, advice, recommendations and guidance, which I could describe if you would like.

Jim Lange: Yeah, I would, but by the way, that is following two meetings that I have typically had. So, typically, if I get a referral, or if somebody goes to a workshop, I like to provide them with a lot of information. I meet with them. If it looks like it might be a good fit, then we actually do an analysis of where they are using Morningstar. Then we present an idea of where perhaps they could be. So it’s kind of like a danger/opportunity analysis, and if it continues to look like a good fit, then they go to P.J. And what P.J. had alluded to, but P.J., I’m going to ask you to be a little bit more specific, because I don’t know any firm that does this, and certainly, even if any firm did do this, they would never do it at the level that you do. To quote yourself, “We delve down to the last cable bill.” So you do this cash-flow analysis, and why don’t you tell our listeners why you do this cash-flow analysis and what you do with it after you’re done with it and why you bother?


3. A Deep Dive Into Cash-Flow Analysis Is Important

P.J. DiNuzzo: Yeah, Jim. As you had said, you know, we joke around and tell folks that we’re going to pretty much get it down to how much toothpaste they’re using per month, and the way we’re able to do that, of course, we’ve done thousands and thousands of these iterations over decades, but we’ve basically got every category that you possibly could spend money on, and again, we’ve got tons of experience. So when we work through this with individuals, they’re constantly amazed that they have no idea, they’ve never done a budget before, and we go out of our way not to mention the word “budget;” it’s sort of like a four-letter word. So we don’t want to say “budget,” but to get our arms around your spending and get this intense level of detail, and I could think of a couple cases just within the last couple of weeks. Folks had never done a budget, been together for 30, close to 40 years, and we got their monthly spending down. We always get it down within 1(00), 2(00), 300 dollars of their actual spending.

Jim Lange: And the other thing that you have, which is relatively new, is you have some software that, frankly, I’m a little bit jealous of because this software does some projections, and it looks to me like it has enormous flexibility and capabilities, and you are doing that now with new clients and some reviews. Can you tell our listeners a little bit about that new software and the experience that they receive when you work with the combination of the cash-flow analysis that you just mentioned and the software?

P.J. DiNuzzo: Yeah, we refer to that as our unique process. So what’s happened is, I guess, you know, the harder you work, the luckier you get, so to speak, but we would never, ever really find, like, the missing piece in our unique process for retirement planning and retirement-income planning. We’ve had our DiNuzzo Money Bucket Stack Analysis for our cash-reserve bucket, our needs bucket, our wants bucket and our dreams and wishes. We’ve had our deep dive that we do on a financial statements tied into customized asset allocations. We’re typically using on average three different asset-allocation recommendations for clients in retirement, again, very highly customized, and been able to customize software within that unique process that we have that allows us to run a lot of stress tests on the portfolio, so to speak. I mean, some things may not be intuitive. If an individual comes in and someone’s very conservative, they can be so conservative to the point that if inflation were to kick up 1 or 2 percent higher, with them taking the withdrawals that they need out of their portfolio for required minimum distribution, and them being in an all bond portfolio and a lot of money in the money-market fund in the bank, it’s surprising how quickly that plan can come into jeopardy much earlier before their life expectancy.

Jim Lange: So, P.J., you had mentioned when you were talking about building an income statement, if you will, to really understand how much money people are spending per year, and then sometimes people might have some income source other than their portfolio, perhaps a pension, perhaps Social Security, which, by the way, is usually determined after we have run the numbers, if you will, and that is part of our unique process. But you also mentioned something quickly that I wanted to delve into a little bit, which is what you call the DiNuzzo Stack Analysis, or Bucket Analysis. Can you tell us a little bit about the Stack or Bucket Analysis?


4. Retirement Buckets: Cash Reserve; Needs; Wants; Dreams and Wishes

P.J. DiNuzzo: Yeah, Jim. What we do is, you know, I’ve had the good fortune of dealing with Dimensional Fund Advisors for decades and run into a lot of Nobel Prize winners who’ve been associated with the University of Chicago Graduate Booth Business School and DFA, and that’s great, the concept they have come up with, but what our job as advisors is, you and your team do a great job and I think our advisors do a great job as well taking these very large complex strategies, philosophies, and distilling them down to something that the everyday person can understand. So we came up with, sort of right after our inception back in 1989, we just refer to it as the DiNuzzo Money Bucket Stack Analysis, and in fact, there’s buckets involved, the average person gets their mind around that pretty well. We want to have a cash-reserve bucket. That will be our amount of money which would provide us with our sleep-at-night capability. Next one is our needs bucket for food, clothing, shelter, health care and transportation. The third one is our wants. That covers all of our discretionary spending. And our last bucket is for dreams and wishes. That would be dreams until while there’s at least one partner or spouse that is living, and then the wishes after the last partner or spouse would be deceased. So, really, coming up with specific numbers for that, taking a look at stacking our client’s money from the floor to the ceiling, and how are we going to allocate it into those buckets. The next part that comes into play is with those buckets, you do not want to have your needs bucket, the money paying for food, clothing, shelter, health care and transportation, overly aggressively invested, or else the individual is going to get scared out of that portfolio. They’re going to make bad decisions. So we typically come up with three unique customized strategies, something in the conservative to moderate range for the needs bucket, something in the moderate to balanced range for the wants, and something in the growth to aggressive growth (for the dreams and wishes bucket). Oftentimes, we even have two strategies in the dreams and wishes bucket. We’ll have a growth strategy and then we’ll have a very aggressive growth strategy usually tied into the next generation. That’s where your Roth IRAs come in. Oftentimes, that money’s going directly to children or grandchildren. If that now has a 50- or 60- or 70-year time horizon, even 40 or 50 years, we’d love to place that in 100-percent all index-stock portfolio, let that grow, and the miracle of compounding, if I could just grow 1 or 2 percent, or even 3 percent more per year, the children or grandchildren are going to be pretty much eternally grateful for that additional growth in the portfolio. Then, what we’re able to do is take those buckets in very specific numbers, and that’s what really gets the buy-in from our prospective clients and our clients as we’re working through it, they recognize the numbers as we’re starting to work through them. “Yeah, that is my cable bill.” “That’s my electric bill.” “That is the property taxes on my second residence,” et cetera, into their financial statements, and then we’re able to stress-test these various portfolios. So we want to have a 99 percent probability, even after we’ve stress-tested the needs bucket, that that is the footer and foundation for our house, that that is absolutely as rock solid as possible. Then we’ll go onto the wants bucket, and then, of course, the dreams and wishes is the extra money for extra cash flow. Whenever we’re doing this, this is really what dovetailed us into the indexing strategy decades ago. If the audience could just think, for example, if you did know that you wanted to have 60 percent in stocks in your portfolio and 40 percent in bonds, then what’s the best way to ensure that you’ll do the best over time with 60 percent in stocks and 40 percent in bonds? And that’s where the research led me decades ago to indexing efficient-market theory, Professor Fama of the University of Chicago. So we want to place all 60 (percent) of that in indexes. We want to be two-thirds U.S., one-third international on average. Two-thirds large, one-third small. We know we want the lowest possible fees and expenses, and again, there’s never any guarantee in the investment world, but just with how efficient the stock market is, if you can keep your fees and expenses very low in the indexing side, and you have great managers like Dimensional Fund Advisors, DFA, which is now the sixth-largest mutual-fund manager in the United States, you know, watching over that portfolio, maintaining that coverage for that specific asset class, for that specific index, it can work out very well over time, achieving your desired rate of return close to the band that you would like to be in, maintaining a commensurately low risk for that portfolio, not taking on any excessive risk, and having low fees and expenses, all within a strategy that is custom fit for you and dovetails very well into your customized retirement plan.

Jim Lange: Can I ask a question about the stack analysis? And this really actually is partly for me because you had alluded to a time horizon, you know, meaning that if you’re not going to need the money and it’s really money that’s more likely going to be for your children and grandchildren, that that can be invested 100 percent stock, and you even mentioned more likely a Roth IRA, and perhaps even not just U.S. stock, but maybe international stock or small company or small value that tends to maybe have a little bit more fluctuation, but in the long term, has a greater reward. Do you also take time horizons into those buckets? In other words, if somebody needs money next year from their portfolio, is it fair to say that that’s going to be money that’s going to be invested differently than, say, money that their grandchildren are likely to inherit and have a very long, let’s say, investment life? So are you not only looking at the purpose, but also looking at the projected time horizon for the investment?


5. Each Bucket Tied to the Client’s Cash-Flow Needs and Risk Tolerance

P.J. DiNuzzo: Yeah, Jim, I’d say that’s an associated benefit. So each of the buckets are designed first and foremost for unique cash-flow solutions. … Second, and equally important, they’re all tied into each household and each client’s unique risk tolerance. Each household has their own unique risk capacity for food, clothing and shelter, risk tolerance for the wants bucket. So it has to be matched up. There can’t be excessive volatility in a portfolio. One individual may be able to handle a stock portfolio with only a maximum of 40 percent in stocks, whereas another individual would be upset because that 40 percent stock portfolio would seem to them like they’re driving 25 miles an hour in a 55-mile-an-hour speed limit. So some individuals, if it’s customized, we could do it for 70 percent in stocks, but it gives us the customization addition to the initial solution, which is providing the daily, monthly, annual cash-flow solution. Then we tie it into something that they can live with through their risk tolerance, and then also, the third benefit is what you just mentioned, that time horizon. So the needs bucket is the shortest time horizon. That’s the month-to-month, that is paying electric bill, gas bill, property taxes, grocery, et cetera. The wants bucket, although a lot of expenses are monthly, there is a degree of flexibility that that can be looked at from an intermediate term because the wants expenses are discretionary by nature. They’re non-essential. And any time we go back, if we take a look at the forensic economists, when they go back and take a look at 2000, ’01 and ’02, they take a look at ’07, ’08, ’09, any time the market goes through a recession or a severe recession, those are the expenses that the average household is able to cut back on. “Yes, we would like to spend $12,000 a year on vacation, but we’re going through a bad bear market. This year, we’re just going to spend $6,000 so there’s some flexibility.” When we get into that top bucket, really the Number 1 sensitivity that we have in that dreams and wishes bucket, a lot of individuals are what we would refer to as self-insured when it comes to long-term care. Long-term care is really one of the largest curve balls, or almost knuckle balls, that someone could get thrown at them in retirement, and we have to have a solution for that if they don’t have a reasonable funding or even hopefully, if they did have a full-funding estimate regarding long-term care policy. So we would not want to have 100 percent in stock invested in that dreams and wishes bucket if someone was self-insured for long-term care purposes. So a lot of times, we’ll have that money earmarked at 60 percent to 70 percent in stocks would be typical. So if the audience can think again, we get back to that money-bucket stack analysis, one of the images we show people is we show them their money stacked up from the floor to the ceiling, and if you could imagine, let’s just say you have an 8-foot ceiling, if we can account for every dollar that you have, and that would be from the floor up to, let’s say, 7 feet, and that top 1 foot of money, there’s no need, let’s say, for example, that we can come up with within the next 10 years or even maybe 20 years, that you would need any withdrawals from that money. That now gives us that long time horizon going into 20-plus years, 30 years, and then again, even going into the children or grandchildren. So that’s what gives us that very long time horizon, and I always make it a point because sometimes, individuals may have, a lot of cases we have, and again, Jim, like I said, the Roth IRAs that you do are a favorite account type to perform this in. They’ll have $80,000, maybe $150,000, $200,000 in Roths, and they’ll say, “Yeah, P.J., I understand, but that doesn’t seem like that much.” You show someone the compounding benefits of something growing at 2 or 3 percent better per year for 20 or 30 years, even on $100,000 or $200,000, it’s quite an eye-opener. They’re quite impressed with what the projections are that they’re going to leave to their children and grandchildren.

Jim Lange: Well, P.J., you just alluded to something that I wanted to talk about, because this is something that, frankly, you do much differently than most money managers. So most of what you have been talking about, I would call “asset allocation.” That is, percentages of stocks, bonds, cash, but what I want to talk about now, because I think that this is where you really excel, is in the area of diversification. So let’s assume, for discussion’s sake, and I know that you don’t like to think of portfolios as just percentages of stock and percentages of bonds, but let’s just say, for the simple discussion, that somebody is comfortable with a 60 percent stock and 40 percent bond portfolio, and let’s even assume that you’re going to integrate that into the stack analysis. How would you typically diversify, let’s say, the 60 percent in stocks? In other words, what I have found is that a lot of times, people coming into your process typically have what I would consider an overweight in large U.S. companies, and when they are done with your process, they tend to have a much broader diversified portfolio of index funds, maybe spread over literally 13,000 companies in 40 countries, but different classes. So for example, small value and international large and international small and international value. Can you talk a little bit about those different asset classes that you use as part of your diversification process?


6. Investments That Aren’t Diversified Can Underperform and Increase Risk

P.J. DiNuzzo: Yeah, Jim, one thing I was thinking about before that, if I could just mention, you just reminded me of a great point, because one thing we get complimented on continually is that most money managers, when you said about what’s different about us and our process and working together, most money managers are only concerned about what they’re managing. In our process, when we get compliments constantly from the individuals that we’re working with across the table from us is that they’re impressed with how sensitive we are to every dollar that they have. So the folks in the audience have to think that when we’re working with you on a retirement plan, the money that you have in the local bank in CDs or money-market funds, the money that’s in your 401(k), the money that’s in your spouse or partner’s 403(b), maybe some IRA you have in the bank, some that you maybe had inherited and still have another custodian for a certain reason. We’re just as sensitive to every dollar that you have, pulling that into the plan, so we want to know what the asset allocations are in these individual portfolios. But at the end of the day, we have to have also a target allocation for the aggregate portfolio of everything being pulled together. So we want every dollar that you have working as hard as possible whether we’re managing it or not. So people really like that because they’re doing some, usually like a lot of things where it’s out of sight, out of mind, to haven’t looked at an account for five or 10 years or even longer, heaven forbid, for 20 years, that they’ve got concentrated positions. But as you mentioned, Jim, you typically unearth this in your first or second meeting, and I hate to digress again, but that was a great point, if you think about it, Jim, that you made earlier, is we typically have, on average, four meetings with an individual without charging them a penny. I mean, they’ve got two full meetings with you of a couple hours each. I mean, depending on, you know, you customize it however long it takes to meet with them, then we’re typically meeting for two meetings, sometimes three, and that basically, what gives you, you would wonder, you know, that’s a very high retention rate of 97 percent, but, you know, we’re spending so much quality time with individuals, being able to get to know them as well as possible, provide them with world-class recommendations and ideas.

Now we get down to the allocations you were referring to, Jim. As you said, most people come in more heavily weighted with U.S. large-cap stocks, and as I always say, tongue in cheek, whatever’s done the best recently. So if gold’s done good the last two or three years, you’ll see a lot of gold in a portfolio. If international’s done good, you’ll see a lot more. But there’s always that home bias typically of U.S. large-cap stocks, but typically, very underdiversified, and what individuals are doing is for the level of exposure they’ve got to the stock market, they’re typically not allowing themselves to achieve as much in return as they can while also taking on materially more risk than would be necessary, as well. So at the end of the day, as you mentioned Jim, if you sort of take a look at Dimensional Fund Advisors, DFA, University of Chicago graduate business school research, what our core beliefs are, you know, we believe that there are identifiable premiums in the stock market. We call it the equity premium for stocks. That’s stocks versus bonds. That’s been around for a hundred years. We believe that will continue. Value stocks versus growth stocks, value doing better over time. Small stocks versus large stocks, and then the newest premium, DFA and a couple of the other firms that identified is the profitability premium about two or three years ago. So taking a portfolio and basically, as we’ve referred to index to planet Earth, in all the areas that have done the best, and that’s all we have to work with, and we’ll take that track record any day of the week, we got a 88-year track record on the Dimensional Fama/French U.S. indexes that we track. So U.S. large, large value, small, small value and real estate. So we’ve got the U.S. market covered from five asset classes, five, as you mentioned, Jim, completely different areas of the market. You see a lot of portfolios, a lot of people come in with three or four mutual funds that are the biggest holdings and are all U.S. large-core holdings. Even though they’re four different mutual-fund family names, they’re buying the same stocks, basically. Then internationally, we’ve got large and large value, small and small value, and then in the emerging markets, we have the emerging markets, core emerging markets, small and emerging market value, and as you mentioned, Jim, we typically average at least 14,000 stocks in the portfolio. Of course, these are purchased through the indexes, underlying ownership in over 14,000 stocks in over 40 countries on Earth. So great diversification, indexing the planet Earth in all the areas that we want to be indexed in, which we feel is the commensurate index manager in the United States or on the Earth, for that matter, DFA Dimensional, with very low fees, very low expenses.


7. Investment Decisions Often Aren’t Well Thought Out

Jim Lange: And before we go to break, I just want to highlight one thing that you said, because I think that you just do an outstanding job. You said that you actually look at every asset somebody has, or every financial component, whether there’s a pension, whether there’s a one-life pension, or a survivorship pension, or Social Security, et cetera. Because most people, when they come to see us at the beginning, where they are tends to be a function of a whole bunch of individual decisions, each one that seemed to make sense at the time. So they read an article and they bought a mutual fund. They went to a dinner and they buy an annuity. They realize they need a will, so somebody refers them, they get an attorney and the attorney does a will. Then they get a hot tip and then they buy something else, and then they go to their 401(k) plan administrator and the plan administrator recommends a certain allocation. So even smart people end up where they are not as a result of a well thought-out plan involving Roth analysis, Social Security analysis, portfolio analysis and even, let’s say, juggling several different sources of money like a 401(k), for example, and I think what the combination of our process does is say, “Hey, wait. We’re just going to take a fresh look at the whole thing, including some of the strategies that we do and the investments that you do, and even if we’re not managing all the money, or if we’re not preparing the tax return, or we’re not preparing the will, we’re still going to look at all those so that your entire house will be in order.”

Well, this is some really bad news, particularly for those of you who have significant IRAs, and I have been talking about it. I wrote two peer-review articles in 2016. I did a big presentation in San Diego and the second most prestigious estate-planning conference, and for those of you who get my newsletters, you know I’ve been talking about this for years, and for some reason that I can’t quite understand, it’s really not very well-covered in the literature at all. So what is the death of the stretch IRA, what is the stretch IRA, what is the status of it, and what will happen? So normally, and I’m going to have to make this quick because of time limitations, but we’re actually going to do two one-hour shows just on this topic. But typically, right now, if you die with an IRA and you leave it to a non-spouse, typically children or grandchildren, they are allowed to get what’s called a stretch IRA. So to simplify, let’s say that, for discussion’s sake, you leave a million dollars to one child or a combination of children, and let’s say, for discussion’s sake, that that child has a 40-year life expectancy. Well, that ends up being 2½ percent. So that child would be required to take out 2½ percent, or $25,000, of the inherited IRA and pay income taxes on it. The following year, it (life expectancy) would be one over 39, which would be a little bit higher. The next year, it would be one over 38, et cetera. But the idea is you can continue to defer income taxes after your death based on the life expectancy of the beneficiary, and we’ve literally prepared 2,400 estate plans that incorporated the stretch IRA, and it has been a wonderful benefit, and most of the time, by the way, it’s botched. Either the CPA botches it, the attorney botches it, the client botches it, but we make sure it gets done right. So that’s been very, very important for us and we think very important for any IRA owner. Well, I have known for a while that this law was not safe, and there was legislation that almost passed in 2013 that we call “death of the stretch,” and what would happen under that proposed regulations is that when you die with your million dollars in your IRA, that your non-spouse beneficiary, instead of being able to stretch it or defer it over their lifetime, they would have to pay income tax on the entire amount within five years of your death, which would be an income-tax disaster, and I kept saying, “It’s coming! It’s coming!” And I even wrote a book that basically is saying, “It’s coming!” The book is The Ultimate Retirement & Estate Plan for Your Million Dollar IRA, which you can get, by the way, for free by going to our website, www.paytaxeslater.com, where I warn, “Hey, this is coming, and here’s some of the strategies that you can use to avoid it.” Then I wrote that book, got it, then we published the book, literally hard-copy publishing the book, and then on September 11th, the Senate Finance Committee meets and votes 26 to nothing to kill the stretch IRA. Now, is that law today? No, but it is virtually certain that when the Senate Finance Committee, on a bipartisan basis, votes 26 to nothing to kill the stretch, that it’s going to be killed. It’s probably going to be effective by January 1, 2017. There will come a vote. It will be the first major tax bill. It will be attached to any tax bill, so any tax bill that is going to pass, it is going to be part of that tax bill. So then what we did is we said, “OK, what’s the difference between what was proposed and what we had anticipated?” And we actually nailed it pretty well, with one major exception, and that is the proposed law is going to offer a $450,000 exclusion to the death of the stretch IRA, meaning that if you only have a $450,000 IRA and you’re leaving it to a non-spouse beneficiary, you can still use the old law. But for people who have more than a $450,000 exclusion, there’s all types of interesting strategies that we didn’t even mention in the first book. So we wrote an addendum, and that addendum is also available for free at www.paytaxeslater.com. Again, I’d love to go on and on about this. We are going to do two one-hour individual shows on this, but P.J., I did want to go back in our closing moments to talk about behavioral science of investing and what you guys do differently and how you keep your clients on track.


8. ‘Buy and Hold’ Pays Off in the Long Run

P.J. DiNuzzo: Yeah, Jim. Everybody’s heard of buy and hold, and that’s been our bread and butter and our core belief for 28 years, and it is very challenging at times to stay in your seat. You know, Dalbar that we talk about, they do the audits of the portfolios and you see the average individual doing about one-half of what the stock market does over the average 20-year period of time, or maybe 60 percent or 70 percent, but it’s a huge discount off of the returns that they should actually be achieving being invested in the market, 100 percent in stock mutual funds. And I think we just had a great example over the last two years. In 2015, U.S. small stocks and U.S. small value were both down. They were in the red. Emerging markets was down materially in the red, and you always see a direct correlation between the performance of an area of the stock market, be it U.S. or international, and the cash flows going into or out of those types of mutual funds. Long story short, you couldn’t give away U.S. small or small-value stock, mutual funds last year or the indexes. You couldn’t give away emerging-market positions either in those funds, and this year, and again, we’re never talking specifically about performance, but this is just the asset classes, to make a point, and again, we’re about halfway through December. U.S. small is up a little bit over 20 percent, and U.S. small value is up a little bit over 24 percent. So, again, the typical individual’s going to miss that run, huge benefit of having an asset class up that much this year. Emerging market’s up anywhere from 10 percent to 12 percent to 14 percent. So, you know, you have to have a philosophy. You have to be able to stick with it, to be able to stay in your seat, have one that’s going to dovetail into your portfolio and is going to be able to achieve your goals and your objectives in what makes the most sense for you and your family.

Jim Lange: And that’s a tough one because you’re doing exactly the opposite of human nature. Human nature wants to buy more of what just did well and sell what just did badly. Your advice is doing the opposite, and people following your advice are mechanically forced to buy low and sell high.

Dan Weinberg: All of The Lange Money Hour episodes are archived soon after they air on the Lange Financial Group’s website. That is www.paytaxeslater.com. Just click on “Radio Show.” Special thanks to the Lange Financial Group’s marketing director, Amanda Cassady-Schweinsberg, and to KQV’s Alexandria Chaklose handling the controls for us. I’m Dan Weinberg. For Jim Lange and P.J. DiNuzzo, thanks so much for listening and we’ll see you next time for another edition of The Lange Money Hour, Where Smart Money Talks.

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