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Investing Retirement Assets for Long-Term Success
James Lange, CPA/Attorney
Guest: Rod Kamps, CFP
Please note: Some of the events referenced in our audio archives have already passed. Please check www.retiresecure.com for an updated event schedule.
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- Guest Introduction: Rod Kamps, CFP
- Figuring Out How Much Money You Need to Retire
- Establishing a Reasonable Expected Rate of Return
- Tax Diversification
- Diversifying Income Sources
- Dimensional Fund Advisors and their part in Diversifying
- Managing Risk in Retirement
- Common Retirement Mistakes and How to Avoid Them
David Bear: Hello, and welcome to this edition of The Lange Money Hour, Where Smart Money Talks. I’m David Bear, here in the KQV studio with James Lange, CPA/Attorney and author of two best-selling books, Retire Secure! and The Roth Revolution: Pay Taxes Once and Never Again. Do you know the keys to investing your retirement assets for long-term success for you, your spouse and your heirs? For perspectives on the many issues involved in answering that question, we welcome Rod Kamps to this edition of The Lange Money Hour. Rod is founder of, and senior consultant for, Financial Advisors Network, which specializes in helping individuals during transitioning phases of their lives. A certified financial planner with over twenty years of experience, he’s helped with hundreds of estates during crisis and death, assisting them to pay only those taxes that they legally have to. And listeners, since today’s show is live, you can join the conversation with your questions and comments by calling the KQV studios at (412) 333-9385, and with that, I’ll say hello, Jim and welcome, Rod.
Jim Lange: Welcome, Rod.
Rod Kamps: Hey, welcome, Jim. Thank you very much. Appreciate it!
Jim Lange: It’s a pleasure to have you. Before we get into tonight’s show, I would like to share a Rod Kamps story that has had a huge impact on my career. Rod and I belong to a group that mainly consists of financial planners, and we try to learn how to improve our practices, and I was talking to Rod at one of these groups, and he said, “You know, Jim, my clients are doing so well with Dimensional Fund Advisors,” and he’s talking to me about the returns, and he’s talking to me about the low cost and the theory of indexing and everything else, and I had to admit, I was a little bit jealous because it sounded like his clients were getting such a good deal. Now, I wanted to become a DFA provider long before I had even met Rod, and I had applied, but I was turned down because I also had a deal with an active money management group, which I still do, by the way, which is still a very fine group, and they’re called Fort Pitt Capital Group, and I basically had an agreement with them that if I brought them business, and then our firm did, in effect, the planning like Roth IRA conversions, and Social Security, and the tax planning, and the estate planning, then Fort Pitt would actually do the actual money management, and we would split fees. Well, I went to Dimensional Fund Advisors, which is a no-load index fund, which I thought was excellent, and they said, “No. We’re not interested in letting you do that because you work with an active money manager.” So, they basically said, “You didn’t drink the Kool-Aid. You can’t work with us.”
So, anyway, Rod’s telling me about how wonderful Dimensional Fund Advisors are and how well his clients are doing, and he says, “Well, why don’t you become a DFA guy?” And I said, “Well, gee, Rod, it sounds like a great idea, but I already tried, and they said no because I work with an active money manager, and they said no, you have to drink the Kool-Aid if you’re going to represent our funds.” He said, “Are you kidding? You’re this national expert. You’ve written these best-selling books. Here, call my buddy.” And he gave me the name and telephone number of a particular person in Dimensional Fund Advisors. So, I called him and he said, “Well, I’ll tell you what. We’ll consider it. Send me your books.” So, I sent him the books, and then they do due diligence, and then, finally, they said, “Okay, guess what? We decided to let you represent Dimensional Fund Advisors,” which, I believe, is the finest set of index funds on the planet. And I was pretty excited about that, but then, frankly, I didn’t want to be a money manager, and then I ended up working with a firm called DiNuzzo Index Advisors, and I have more or less the same agreement with them that I do with Fort Pitt, which is that our firm does the tax planning, the Roth conversion work, the Social Security work, the estate planning, etc. DiNuzzo, using Dimensional Fund Advisor funds, is actually the money manager, and then rather than us charging on top of what P.J. does, P.J. and I split fees. So, Rod helping me get into DFA made a huge impact on my career, and I will publicly tell you, Rod, thank you so much because, man, you have changed my life, and you have also changed the lives of our clients, who are doing really well with DFA. So, a huge public thank you, Rod, for getting me involved.
Rod Kamps: Well, you’re very welcome, Jim. I think that you also have helped me quite a bit over the years, and you know, I think it’s difficult as we navigate in our industry, you know, through all the different tax laws, the legal rules and so forth. It’s hard to be a master in all areas, but I’ll tell you, it’s been good that we’ve been able to collaborate great ideas, and I was glad to help.
Jim Lange: And Rod, one of the things before we get into the meat of the show that, frankly, I thought was really impressive is you had kind of a life-altering event that gives you a little bit of a different perspective on life, and actually a different perspective on how you treat clients and your mission in life. So, I thought if you could start by telling people a little bit about that life-altering event and how that has changed you, then we’ll get into the meat of the show, if that’s okay with you?
Rod Kamps: You got it. That sounds great. Well, I think that, as we spoke, Jim, about two-and-a-half years ago, it was actually Thanksgiving day, I was on a great Thanksgiving cruise, a Disney cruise, with my family down in Cabo San Lucas, Mexico, and unfortunately, during one of the shore excursions, I had a major ATV accident that resulted in the breaking of seven ribs, my shoulder, and the result of my ribs going through my lungs, which was extremely, extremely painful, and made it to a hospital in Mexico in life-threatening condition, and I had, according to the doctor, somewhere in the neighborhood of about thirty minutes until my lungs had completely filled up with blood, and I was going to be in a spot where I wasn’t going to make it. But I was able to get to the hospital in time, they were able to do immediate surgery, and I woke up roughly twelve days later being in an induced coma, coming down with a lung disorder called ‘ARDS,’ and, you know, from that point on, I looked at life in a very different way. I was able to come through. My recovery was in excess of about six months, but through that process, one thing I realized was that life can be really short, and you never know when your last day and your last breath is going to be. So, I realized that hey, wait a minute, I’ve been saved for a reason, and my job and my role is to help others. And so, I have kind of taken my gift that has been given to me, which is in the financial planning industry, and I’ve kind of taken a different approach that just says hey, how can I give back to the world as a gift, and I truly look at every day as a blessing. So, to be part of your show, and to be part of some of the groups that we’re involved in together is just very, very exciting to me, and I’m glad to be able to depart my years of experience to help others, and hopefully, as we go through the show, that we’ll be able to guide some of the listeners to a wonderful changing impacts on some of the decisions they make going forward.
Jim Lange: All right. Well, you know, I know that you are a teacher and you teach a lot of courses at local universities that are well attended, and you had mentioned a couple things that I thought would be a terrific thing that you normally teach…
Rod Kamps: Umm-hmm.
Jim Lange: …and what I’d like to do, if it’s okay with you, is ask you some of the things that you talk about, and I might have a slightly different view of the world or of some of the things you say, but that’s fine. But why don’t we get to one of the most important issues, which is how much money does somebody need to retire?
Rod Kamps: Well, Jim, I think that’s a great question, and obviously, one of the…probably the most commonly asked questions during my classes. I really look at it as seven main factors that an individual must consider when answering that question. First off, I find that it’s an extremely important part to identify what their budget is or what we call ‘the lifestyle need.’ That lifestyle need is different for everybody, and sometimes in California, people are living quite lavishly. So, what I think we need to do is identify what is that lifestyle need or budget?
Jim Lange: Yeah, I did forget to mention to the audience that you are a California planner. So, while we’re here with zero degree wind chill weather, you’re out in sunny California.
Rod Kamps: Yes. I just recently laid out in the sun at the beach the other day in about 82 degree weather, so I…
Jim Lange: Yeah, you have a tough life, Rod. I feel for ya!
Rod Kamps: Thanks, Jim! Well, you know, I think in regards to answering that question, too, of how much money does somebody need, I think number two, we need to identify what the expected rate of return is that an individual anticipates to be reasonable for assumption purposes. Number three, which I think could get out of control in the not-to-distant future, is inflation. You know, Jim, in the last twenty years, inflation has been just slightly above two-and-a-half percent, but I think, in these calculations now, we should probably consider higher numbers for inflation calculations, probably in excess of about four percent on a go forward basis.
David Bear: And why do you say that?
Rod Kamps: Well, I think that with a $17 trillion deficit, at some point in time, there’s a high probability that we’re going to need to…interest rates are going to rise and inflation, the borrowing cost is going to get to us, and we’re going to have inflation that’s going to come out of control.
Jim Lange: Is it fair to say that one of the things that you fear is one very easy way to pay off debt is to pay it off with cheaper dollars? So, if you have $17 trillion (or whatever the debt is), and the value of the money goes down and you pay it off in reduced value, that’s one way of solving the deficit. On the other hand, for those of us who are, you know, buying groceries and milk and rent and mortgage payments and things like that, we’re going to get less for our dollar.
Rod Kamps: I think that’s a very fair assumption, Jim. I think that, you know, at some point, we’ll see it, and I think that’s absolutely one way to look at it.
Jim Lange: I actually think it’s wise to assume that inflation really is a major danger. Jane Bryant Quinn calls it, you know, ‘Harvey the Rabbit,’ the danger that you don’t see.
Rod Kamps: I very much agree with that. So, I think when answering the person’s question of how much money they need, I think it’s fair to use what we call ‘conservative assumptions.’ So, maybe inflation has only been two-and-a-half, but let’s use conservative assumptions, raise the inflation rate, consider receiving lower growth rates. I always feel that being more conservative in your assumptions and then being pleasantly surprised is much better than wishing for a dream and then falling short. So, I think that using that four percent is probably reasonable and fair. Others may even say it’s higher, but that’s what we use in our practice.
Jim Lange: Wait, you mean a four percent safe withdrawal rate, or four percent inflation?
Rod Kamps: No, a four percent inflation rate.
Jim Lange: Okay, all right, fair enough.
Rod Kamps: Absolutely. I think the next thing that we need to assume is number four, which would be what are the expected sources of income? Does an individual have, or are they eligible for, Social Security? Do they have a pension? Or do they also have rental properties that are going to be creating cash flow? Because that nest egg is going to be determined on the difference between those reliable sources of income and what the portfolio must generate to make up the deficit. Another thing that I think we need to consider, which would be number five, would be something that I also fear that we’ve already seen an increase in, which is taxes, which kind of goes to a lot of the books that you’ve written, in your Roth conversion. It’s probable the tax rates are going to continue to rise as an effort to pay down the deficit.
Jim Lange: It’s pretty scary what I think is coming. We’ve actually had shows on what I call the ‘death of the stretch IRA,’ which can really hurt your heirs, and just some of the tax changes that we’re seeing, even this year, we’re paying a much higher tax rate with the surtax of the 3.8%, or the so-called ‘Obama tax.’ So, knowing that we already have higher tax rates, and certainly, I think it’s fair to assume that the rates are going to go up. So, I’m agreeing with you on all these.
Rod Kamps: Yeah. I do think it’s important to consider. And then, next, number six would be the age that you desire to retire. Now, why is that so important? Because we need to identify the starting point of how long retirement is going to last. And then, number seven is, well, what’s the length of retirement, or how long do we want to project our life expectancy? And for most of our calculations, in answering that question of how much money does one need to retire, I like to use a number typically not less than ninety, but preferably ninety-five or one hundred, just to anticipate that if we do live that long, make sure that the money has been planned for to last for that period of time. So, Jim, it’s a long-winded answer, but those seven points are factors that should go into the calculation of determining how much one is going to need in order to retire.
Jim Lange: Well, I like those seven factors. Why don’t we nail down one or two of them? So, for the expected rate of return, you know, I know that many of the country’s pension plans are using an eight percent assumption, even though they’re paying out every year. So, let’s say, for discussion’s sake, probably the biggest pension plan in the world is probably the California Employee…
David Bear: CalPERS, yeah.
Jim Lange: CalPERS. So, they pretty much know how many people are going to be retiring, how much money they’re going to have to pay each person per month or per year, they have some idea from their actuaries how long those people are going to live, and in order to fund it, they have to say, “Okay, what do we think that our investments are going to earn?” And because they have to pay out on a regular basis, they can’t certainly have anything in stock. So, they’re going to have to have some kind of well-diversified portfolio of stocks and bonds, and do you know what CalPERS is using right now for their assumptions?
Rod Kamps: You know, my assumption…I believe, I don’t know the exact answer to that, Jim, but I do believe it is eight percent.
Jim Lange: A lot of the states are.
Rod Kamps: Yeah.
Jim Lange: And I think they’re in dreamland…
Rod Kamps: I do too.
Jim Lange: …because, you know, who knows, maybe, if you’re lucky, the market will give you eight percent. Even that’s maybe a little bit aggressive. You know, the interest rates these days, you’re lucky if you get one or two percent, so let’s add the two of them together so you have a blended rate of about five percent, and then that’s without fees, and you’re obviously going to have to pay somebody something to do all this. So, there’s a huge difference between using something like eight percent or five percent, and…
Rod Kamps: Absolutely.
Jim Lange: …and so, hopefully, some of the individuals will be a little bit more responsible than some of the pension companies.
Rod Kamps: Well, I agree with that. I believe we use, in our practice, the number between five-and-a-quarter and seven-and-a-quarter, seven-and-a-quarter being tops, and again, Jim, we like to over-deliver and under-promise, and we believe that seven-and-a-quarter is something that’s doable, but I would say, on average, most of our plans are using right at about six-and-a-half percent in that calculation. So, we’re using a six-and-a-half percent growth rate in our assumptions, and we’re using a four percent inflation rate. So, the deltas of 2.5% is what we’re using.
Jim Lange: Right, and that seems, to me, much more reasonable. Now, I might come to a similar conclusion using the safe withdrawal rate…
Rod Kamps: Yes.
Jim Lange: …which is a little bit of a different assumption. There, the idea is you’re not trying to, in effect, maintain your portfolio. You’re just making sure that you have enough money for your life. So, let’s say, using your idea of a ninety-five year old wanting to provide until age ninety-five, a sixty-five year old client who needs, let’s just say, for discussion’s sake, $40,000 from their portfolio, we would probably want them to have a million dollars, and if they didn’t, and the Social Security and other areas of income weren’t sufficient to make up the difference, we would either say keep working, or spend less.
Rod Kamps: I would agree with that. I think…actually, there’s a study. The gentleman that kind of wrote the four percent number was a gentleman by the…
Jim Lange: Bill Bergen.
Rod Kamps: Yes, and then there was another one who also tested it and did another theory to it, and it was called ‘The Geiten Report.’ So, I do like that four percent. So, we use both the four percent assumption rate, or what we call the ‘four percent distribution rate rule,’ and we also use the statistics, or the seven rules, or seven (I guess) factors to develop the plan.
Jim Lange: Yeah. By the way, I’ll just throw in a quick plug: Bill Bengen actually was a guest on this show, because when I wanted to do a show just dedicated to safe withdrawal rate, I said, “Okay. Who’s the modern Bill Bengen?” And I went looking, and I couldn’t find anybody because I remember fifteen years ago reading Bill Bengen, so I just thought, “Well, okay, I’ll get Bill Bengen!” He’s a little bit older, but he’s still pretty sharp, and he still sticks by his original analysis, although he shaves it a little bit, saying you have to be a little bit more conservative today just because in today’s low interest rates, he’s thinking it’s a little high.
Rod Kamps: Absolutely.
Jim Lange: All right. So, anyway, I think some of that is really good information for people. The other thing that I know that you like to teach is diversification, and for the moment, I’m actually not talking about, you know, large cap and small cap and mid cap, etc., but you actually talk about tax diversification. So, what are some of the things that people should be thinking about in terms of tax diversification?
Rod Kamps: Well, Jim, I think that…one of the things I’ve recognized is that over the years, many individuals have been taught to defer, defer, defer, defer. Well, they’ve been taught that under the assumption that they’re going to be in a lower tax bracket when they retire. Now, most of my clients have built a lifestyle, and that lifestyle is going to be very, very challenging to give up. So, they want to have a very similar income to what they’re currently making. So, we have taught, and, for several years now, for the last fourteen years, we’ve been teaching tax diversification. What I mean by that, Jim, is that tax-deferred is one of the methods, but taxable is another. So, we have preferential tax treatment, whether it’s municipal bonds or dividends from stocks or anything like that. And then, the last one is the tax-free element, which you’re the expert in that area, Jim. You’ve written, you know, several books on it and discussed the importance of the tax-free element of a Roth, and I believe that that is just a very, very commonly overlooked piece that you’ve done a great job and explanation over your career.
Jim Lange: Well, interestingly enough, one of the things that you have pointed out, I tend to be a by-the-numbers type guy…
Rod Kamps: Yep!
Jim Lange: …so we kind of tend to run the numbers, and we often recommend which one works out purely on a quantitative base, and one of the things that I got from that discussion a little bit is uh, don’t necessarily do it purely by the numbers. You want to diversify. So, even if the numbers might be a little bit shaded towards more Roth or no Roth or whatever it might be, I think the advice of having some of all is probably very sound, and David, I think, is going to…
David Bear: I’m making that noise!
Jim Lange: Yeah.
David Bear: Let’s take that quick break. If you have questions or comments for Rod or Jim, call the KQV studios at (412) 333-9385.
David Bear: And welcome back to The Lange Money Hour, with Jim Lange and Rod Kamps, founder and senior consultant of Financial Advisors Network.
Jim Lange: Well, a minute ago, we were talking about diversification in taxes. Another way that I know that you like to teach, Rod, is diversifying in income sources. So, can you tell us a little bit about somebody who is about to, or is already, retired, and what you call your ‘income tax stool’ for diversifying regarding income sources?
Rod Kamps: Absolutely. Well, I think earlier, Jim, one of the things that we spoke about was how much money does an individual need to retire, and in my classes, we teach a phrase normally known as ROI, meaning return on investment, but I have actually changed that philosophy a little bit for the retiree. I’ve actually changed it to the words ‘reliability of income.’ And now, what I have found is that the four legs to the stool consist of…of course, one of them, Social Security, pension, rental properties, and then, finally, the gap, or what we call ‘bridging the gap,’ is the investment portfolio. Many individuals don’t have rental properties, and rental properties are a wonderful way to be able to have a certain element of your cash flow that does have preferential tax treatment. And that’s basically through the utilization of depreciation on your rental properties. So, we find that these four, what we call, legs to the stool are a very important part, and most individuals that retire only have two of them. They typically only have Social Security and an investment portfolio. So, at that point in time, the two that are typically lagging, or are not part of the stool, are pension and rental properties. So, there are different ways in order to create those types of benefits or income streams to secure cash flow for a lifetime.
Jim Lange: Well, let’s nail down a few of them.
Rod Kamps: Sure.
Jim Lange: First, with Social Security, and I don’t know what you have been doing. We’ve actually been doing a lot of work in Social Security, and right now, I’m actually writing a book (that doesn’t sound all that unusual), but it’s actually for a relatively new market for me, although I’ve been in it, let’s say, on the side, if you will, not in a big way, for over ten years, and that’s the same-sex couple market, and in order to do the analysis of what same-sex couples should be doing, I’ve really taken a very hard look at Social Security. And, by the way, I will tell you some of the advice that I have come up with for a lot of couples is to run to a state like New York or California, where your marriage is recognized, get married, and then return to the state where you live, and for federal tax purposes (and we’re hoping very soon for Social Security purposes), your marriage will be recognized and you’ll be able to get spousal benefits. So, I’ve been doing a lot of number crunching on Social Security, and to summarize my results (and I don’t know if you’ve come up with something similar), I tend to like to hold off on Social Security. Let’s say, for a married couple who are both in their early sixties and, say, retired, I like to hold off until the stronger earner is 66. Then, we do a technique called apply and suspend, where the stronger earner applies for Social Security, suspends collection, and then their spouse applies for a spousal benefit. That pattern continues until they’re 70, and then the stronger earner returns to their own record, but they get the exact same amount as if they had never collected a nickel, and then the spouse returns to their own record. And we are seeing enormous differences, and literally hundreds of thousands of dollars, if you do this over time, and particularly if the stronger person dies. So, Social Security I don’t think can just be kind of taken advantage of. There are real strategies involved, and I don’t know if you use some of these same type strategies, but I do not think that it is just a given to just say, “Oh yeah, I’ll get Social Security, and I’ll go apply at 62, or even 66.”
Rod Kamps: I would tend to agree with you, Jim. I think that what we’ve done in our practice is we’ve continued to, on a regular basis, have the public affairs specialist of Social Security actually come out and educate our clients on the specifics of the pros and the cons of drawing early. One of the conclusions that we’ve definitely drawn is that many people think, “Oh my gosh, you know, I have been told that I should draw it because the system is going to go broke, and I’d better draw it right away.” Well, what we find is that that individual who decides to draw it at 62 goes and continues to work, and, unfortunately, because of being over certain wage limits, they have to give back, for every two dollars over the wage limit, one dollar of benefits back to Social Security, and then it catches them off guard and they become very disappointed in that advice that that, we’ll call it neighbor or friend, gave them. So, I do think, Jim, that it’s important that they do have the facts to make a good decision because it’s quite frequent that people do draw early and find out that there are negative ramifications to that.
Jim Lange: You know, one of the great things about having this show is I get to talk to national experts such as yourself, and another national expert that I spoke with was a guy named Larry Kotlikoff, and we were talking about Social Security, and I had established that, in effect, the break-even number as to whether it makes sense to apply early or not was age 84, and he told me, “Jim, quit thinking like an actuary. Start thinking like an economist. If you die early, you’re dead! You don’t have any more financial problems. You don’t fear dying early for financial purposes. What you fear is living a long time and not having sufficient income.” And one of the strategies that I like to do, whether we’re deferring Social Security or doing the apply and suspend, is to, in effect, wait and get a higher amount in the event that you do live a long time, and that same kind of analysis probably can go to the pension because even in the pension area, there’re often a lot of choices.
Rod Kamps: Sure, absolutely. Well, and I tend to agree. I think that one of the things that we have considered in the distribution of a pension is obviously, you know, one of the key pieces is should I draw it now? Should I wait a little bit? Well, I don’t typically like my clients to draw from their portfolios in a rising market. So, at that point in time, meaning other than just the dividends if they were to be retired. So, we like to, in most cases, suspend the pension in a rising market, and then if the markets become weaker, at that point in time, assuming that they’re eligible and the benefit is reasonable, that we’ll draw the pension, and then that will take less draw against a dropping portfolio. So, again, our clients predominantly draw the income from their portfolio, meaning the dividends and the interest. So, just another factor in the big scheme of things, kind of going back to that question of how much money do I need? These all are very important topics that we need to consider when building and creating a plan and making final decisions.
Jim Lange: Well, the other thing that we should at least mention with a pension is that some of the advice that I like to give is typically…and by the way, people don’t like this. A) They don’t like to hear holding off on Social Security, and B) they don’t like the advice that I give on pension, which is, in general, assuming that it’s a husband and wife, I like to do a two-life pension, meaning that if the pension owner dies, that their spouse will continue to get the same benefit. And one of the things I don’t like is, I don’t like the stronger earner collecting Social Security at 62, taking a one-life pension, and then if something happens to them, then their surviving spouse is really in trouble financially. So, I think that making sure that both people have enough money for the rest of their lives is important.
Rod Kamps: I absolutely agree with that. I think, at the end of the day, as a team, whether it’s husband and wife, or whether it’s same-sex marriage, I think, at the end of the day, it’s very important that we plan for both individuals, and sometimes it’s that age gap, too. We’ve got, you know, a ten-year age gap, it’s not uncommon to see that, and in many cases, the higher wage earner has married somebody that might be ten years younger, and we’ve got to plan for that and make sure that the income will last for that younger person for the rest of their life.
Jim Lange: The other, you know, leg of the stool that you mentioned was rental property, and I know that you yourself personally have done very well with rental property…
Rod Kamps: Yes.
Jim Lange: …both for your business and other places. Do you kind of consider that a business as opposed to a passive investment? I mean, don’t you have to know something, or do you even recommend clients who are not terribly real estate savvy get involved with rental property?
Rod Kamps: No, I think it’s important to have a knowledge based on any type of an investment that you do. I think that real estate overall is one of these investments that you don’t care if the property goes up and down in value, as long as you get your rent check. And so, what I have found is that we went through about a thirty to forty percent correction in the real estate market out here in California, but each of my clients that owned the rental property said, “But Rod, this really doesn’t matter. You know, the fact that my real estate has gone down three, four, five hundred thousand dollars, Rod, it only matters if I’m going to sell. As long as I get my rent check, I’m okay.” So, we find that, you know, it’s important that when you get to retirement, we like to have our clients own their rental properties free and clear. We don’t want them to have mortgages. We want their cash flow to be strong, reliable and fixed, and we like to be able to see, usually, whether it’s fourplexes, whether it’s commercial property, we want multiple tenants, and the reason we like that is, again, it just diversifies under the same principles of some of the management, and whether it’s a mutual fund, an index, whether it’s DFA, we want that diversification. And tenant diversification is just as important as asset allocations, stock selection, all of that, so very similar principles apply. So, I think it is important that you have a knowledge base, and if you need help, very similar to having a financial advisor, an attorney, a CPA, hire a professional that’s going to help guide you through that process. Just make sure that your leverage isn’t too much, especially going into retirement, and get a good property manager, one that you can trust, count on, and that will send you regular reports so that you can monitor your progress.
Jim Lange: Well, it seems that your mantra, kind of, is diversify, diversify, diversify, and you mentioned Dimensional Fund Advisors, and that is the index fund for the index investors that we work with. That is our investment set of index funds as choice, and one of the things that I like about DFA (Dimensional Fund Advisors) is that if somebody owns a well-diversified set of index funds within Dimensional Fund Advisors, they actually have over 13,000 stocks. Is that also consistent with your idea of diversify, diversify, diversify?
Rod Kamps: Absolutely. You know, I think that what we have found over the years is that concentration creates wealth, and diversification preserves wealth. So, I think it’s an important factor that when building a portfolio, especially a retiree, that the broad diversification, I don’t think many people saw the debacle of Enron coming. Some of you might have been able to see the Bear Stearns or the Smith Barney, but it’s hard to have been able to predict some of the companies that have gone through bankruptcy. So, I believe that the concept of diversification simply says that if you happen to own one of the ones that does wrong things, that does declare bankruptcy, we don’t want that to be an extremely detrimental element to your portfolio. So, that extra diversification that DFA offers is such a great, great way to spread out the risk, and Dimensional has done a great job in their performance over the years.
Jim Lange: Well, I know, very frankly, you were instrumental in getting me hooked up with Dimensional Fund Advisors, and I know they’re pretty fussy about which advisors they will even accept. So, I don’t know, there’s roughly, maybe, a million financial types in the United States alone, and I think that, because of their record, you know, practically everybody wants to represent Dimensional Funds, or, at least, they should…
Rod Kamps: Sure.
Jim Lange: …and they only accept, what is it? Like 1,200 or 1,300 representatives right now. Is it something like that?
Rod Kamps: Yeah. I think that that’s pretty accurate. I think that one of the philosophies that they maintain is, they don’t want the investor to be a buy-sell-buy-sell. They want you to be able to have certain assets held outside of your equity investments that are going to allow you to get through the rainy days, or the bad markets, the turbulence, whatever we want to call it, and I think that Dimensional has selected individuals that maintain a focus on that asset selection, meaning picking the exact stock in an efficient market, is very, very difficult to do. And so, some of the trading philosophies that they use are simply just about how do we get the costs down? When somebody’s selling, let’s call it Exxon Mobil, (which Warren Buffett picked up a heavy position, I guess, earlier in the year), but let’s just assume that there’s a seller of Exxon Mobil. Well, if the bid-ask spread is very, very attractive, DFA will simply say to one of those institutional sellers, “Hey, we’ll take that off of your hands.” So, they have found a great way to keep trading cost at a very low price, and then they continue to actually take those securities that are held over the long haul and they lend them to other firms and receive what we call ‘margin interest,’ and they re-beep that back to the investors, which is just a great way to keep that cost down that your traditional loaded fund, or 12b-1 fee fund, wouldn’t consider that. They’ll keep that revenue themselves, and DFA actually sends that right back to the investors to help keep the internal costs down.
Jim Lange: And is that one of the ways that they have such a strong performance for looking at performance on an after-fee basis?
Rod Kamps: Absolutely. In fact, they have a philosophy that says that you should only focus on the things that you can control, and one of the things you can control is cost. So, if we can keep the cost down (and DFA is one of the most cost-effective investment firms), that’s a great way to do it. So, they have got this rebating of the securities lending. They also have low turnover, which means you don’t have to pay a lot of institutional traders to actually go out and buy and sell and buy and sell, because those institutional traders are making great money. They’re not doing it for two dollars, five dollars a trade. They’re doing it at significantly higher blocks. So, DFA has found a great way to be able to keep those trading costs down by keeping lower turnover. And then, one of the things you and I love is tax benefits. It’s always better to have a long-term capital gain than a short-term capital gain. So, they focus on making sure that those types of distributions focus more on the long-term versus the short-term to keep it more tax efficient.
David Bear: All right. At this point, why don’t we take one more break?
David Bear: And welcome back to The Lange Money Hour, with Rod Kamps and Jim Lange.
Jim Lange: Rod, another thing that you like to talk about in diversifying and managing risk is some of the things that people can do to manage risk in retirement. I was wondering if you could tell our listeners some of the things that you like to teach your clients and prospects, and even just people who are trying to get some information on how they can manage risk in retirement?
Rod Kamps: Well, I think, first off, there’re a few different ways that we do it. First off, making sure you’ve got the proper asset allocation. I think you’ve got to be very comfortable before putting your money into any investment portfolio that you know what we call the ‘volatility,’ in advance. So, we like to explain to our clients that you should understand, kind of, what the longer-term averages are, and what are the highs and lows, and a great comparison is to look at what a portfolio has done on a worst one-year basis, and see how you would feel during that uncomfortable time of a down market, or what we call ‘an extreme bear market,’ and if you can accept the risk of what the worst has happened, there’s a high probability that that portfolio is okay for you. If you can’t, you may want to taper down the risk. So, I think the return on investment and the volatility is very, very important in the first stage of managing risk and retirement.
Jim Lange: Yeah, and by the way, I agree with that, although mechanically, one of the things that I like about DiNuzzo Index Investors is what they actually do is, they actually have several portfolios. So, even one client, instead of having one portfolio like 50/50 or 60/40 or 70/30 or whatever it might be, they would have, let’s say, a portfolio for, you know, their absolute needs for the short-term that would probably be mainly invested in cash and CDs, etc., and then a different portfolio for maybe a more intermediate, or a longer-term, that would still have a lot of cash and bonds and CDs, but it would have some exposure to stocks, and then even longer-term money that would be much more heavily invested in terms of a higher yield that would be equities, and then, very long-term, maybe even money that you’re going to leave behind in your estate, which we often put in Roth IRAs. It might even be ninety or a hundred percent equities. But I have a feeling that if you kind of mushed all ours together and we compared it to some of the ones that you’ve come up with, it would be pretty similar. We just do it that way because people can psychologically say, “Oh, okay. Well, the market went down, but my next two or three years are taken care of with fixed income, so I don’t have to worry. So, I’m just going to wait for the market to come back for the longer-term money.”
Rod Kamps: You know, I think that one of the professionals in our industry that a lot of people have heard over the years is David Ramsey, and the theory of buckets of money.
Jim Lange: Umm-hmm.
Rod Kamps: I think that that theory is great, and I believe that it actually works, and I think it is good to consider the short-term, medium-term and long-term investment pieces for aspects of your portfolio. And then, when you look at financial planning software and technology, there is what we call ‘integration’ software, that allows you to look at that big picture. So, what you’re saying, Jim, I completely agree that it’s okay to stage it in various areas, but again, I think it’s important to know at each one of those buckets what the expectation is upfront, understand the volatility, and then, if it meets your comfort, or your volatility comfort zone, then proceed.
Jim Lange: You know, Rod, there’re so many things that you teach that I would love to talk about, and I’ve cut out a lot of things that I know that you have a lot of expertise in, but in the remaining few minutes, I think what I’d like to do is talk about some of the mistakes that people make in retirement, and I know that you are really…you know, you get up on the bully pulpit and say, “Hey, don’t do these things!” So, what are some things that our listeners should not do in retirement?
Rod Kamps: All right. Well, I’ve got a series of things that we’ve experienced over our twenty-two year career. One of the first, and probably most important, things is that we need to make sure that before making decisions, that all the facts are there. So, we call it ‘creating a written plan’ and we’ve heard this from all of the different motivational speakers that if you don’t write it down, it doesn’t exist. And most people actually spend more time planning a vacation than they do planning for retirement. So, we believe that a written plan is one of the biggest and most important things that you need to do, and the absence of doing it is a major, major mistake.
Number two that we find is a major problem is people let greed get in the way of sound judgment. And I think that we can’t turn on CNBC without seeing the TV show American Greed and realize that the individuals that are on those shows have touted how great and wonderful that they are, and they never really seem to talk about the downside. So, people get lured in by extravagant returns and they just turn a blind eye to what’s being said. And I think the next is, investors frequently take on more risk than they truly understand. You know, I think it’s important, again (and I said this earlier, but I have to repeat it), to know your downside up front, when it happens, if somebody’s already kind of told you expect a fifteen percent, expect a twenty-five percent return, when it happens, it’s not as painful because you’ve kind of been pre-warned. I guess the favorite analogy I use in my class is it’s always nice when you’re flying maybe from here to Pittsburgh…I don’t know why we’d go to Pittsburgh, Jim. It’s a little cold out there! But I do think that if the pilot tells you in advance that, “Please go ahead and buckle up. We’re going to have some turbulence,” and you actually know it up front, when the turbulence happens, it’s not as scary. But, all of a sudden, if you’re kind of walking around and the plane jerks around and goes up and down, you start to get a little bit uncomfortable. So, I like to know, like a pilot, I’m here to tell you that there’s going to be turbulence, and I’m going to tell you in advance. So, buckle up your seatbelt. Sit down, relax, and we’re going to get you here to Pittsburgh safely. So, I think it’s important. The other thing…
David Bear: Unless you stop in Chicago!
Rod Kamps: Oh, yeah, yeah, exactly! Chicago’s low, right? The other thing is that many people actually might even create a financial plan, but they don’t update it and manage the progress of it. So, Jim, I know that you meet frequently with your clients and make sure that their tax and estate planning needs, their life events, you constantly are updating it. I think, in the investment community, in the financial planning community, it’s just crucial to know life change events and how they impact it, and make the necessary changes to the plan and let the client know how is this going to effect you and how’s it going to affect your livelihood. Again, it’s their money. They get to make the decision. We just want them to make an informed decision. The other thing, too, is we believe that in the creation of a financial plan, that many people use too aggressive assumptions. So, we think that it’s better to use more conservative assumptions, and we kind of alluded to this earlier, that the pension funds have been using eight percent for long periods of time, and unfortunately, we hear the crazy news that many pensions are under-funded. And I think they’ve done two miscalculations: one, they underestimated how long people are going to live, and number two, they used a higher rate of return than was achievable. So, again, I think if we’re going to make sure we use assumptions, put in a more reasonable number.
Jim Lange: And Rod, could you just do one more, because then we’re going to run out of time?
Rod Kamps: You got it!
Jim Lange: So, what’s the last big mistake that people shouldn’t make?
Rod Kamps: Well, I think that…here’s the last one, is that don’t think that there’s any one individual that has all of the answers. You and I have come and worked together and go into groups specifically because we realize that we want to surround ourselves with professionals that can provide expert advice in some of the areas that we might not be as strong in. But by developing a strong team, and it sounds like you’ve done that with your firm, that you’ve surrounded yourself with good wealth managers and you’ve got yourself covered on the tax and the legal side, to have a firm that represents a balance of all of the areas that are essential in creating a successful retirement and estate plan, I think, is of the utmost importance.
Jim Lange: And David’s going to kill me, but could you give us your contact information…
David Bear: I have it right here!
Jim Lange: …for people who want to go to your website, or want to go to see you personally, because this is a national show? And I’m sure that we have people in southern California listening.
Rod Kamps: David, would you like to give that?
David Bear: I would! It’s www.financialadvisorsnetwork.net.
Jim Lange: And telephone number is?
David Bear: Well…
Rod Kamps: Is…
David Bear: Go ahead.
Rod Kamps: (866) 526-7726.
David Bear: Well, thanks to Rod, and thanks to Dan Weinberg, our in-studio producer, and Lange Financial Group program coordinator, Amanda Cassady-Schweinsberg. As always, you can hear an encore broadcast of this show at 9:05 this Sunday morning, here on KQV, and you can access the audio archive of past shows, including written transcripts, on the Lange Financial Group website, www.paytaxeslater.com, or call Lange directly at (412) 521-2732. Finally, please join us on Wednesday, February 5th at 7:05 for the next new edition of The Lange Money Hour, when Jim’s guest will be Maxine Horn, information and referral specialist for AgeWell Pittsburgh.
James Lange, CPA
Jim is a nationally-recognized tax, retirement and estate planning CPA with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania. He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again. He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans. His plans include tax-savvy advice, and intricate beneficiary designations for IRAs and other retirement plans. Jim’s advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger’s Retirement Reports and The Tax Adviser (AICPA). Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.