Originally Aired: December 6, 2017
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
Listen to every episode at our radio show archives page. Please note: Some events referenced in our archives have already passed.
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- Introduction of P.J. DiNuzzo of DiNuzzo Index Advisors, Inc.
- International and Emerging Markets Rose More Than 30% in 2017
- Greed and Fear Pull Investors in Opposite Directions
- Miscalculating Monthly Spending Can Doom Retirement Plans
- Focus on Things You Can Control and You Won’t Outlive Retirement Funds
- Gamblers and Those Who Chase the Latest Thing Are Poor DIY Investors
- Dimensional Fund Advisors Rebalance Portfolios on a Daily Basis
- Consult a Qualified Fiduciary at Least Five Years Before Retirement
- DiNuzzo Index Advisors Regularly Meet With Prospective Clients
- Highly Efficient Bond Market Protects Against Drop in Stock Prices
Welcome to The Lange 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.
Dan Weinberg: And welcome to The Lange Money Hour. I’m Dan Weinberg along with CPA and Attorney Jim Lange, and this week, we welcome P.J. DiNuzzo back to the program. P.J. is a nationally recognized expert in investment management 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 United States, and it consistently ranks among the country’s top 500 investment companies. Now, this week, Jim and P.J. will be will be covering a wide variety of topics, including what’s happened so far in 2017, both in the U.S. and international markets, what these results might mean for investors, a look ahead to 2018 and how to deal with future unknowns by controlling what you can control, plus they’ll discuss things like active money management versus index investing, diversification and strategic versus tactical asset allocation. So, we obviously have a lot of great information for you this week, so let’s get right to it. Hi, Jim, and welcome back, P.J.
Jim Lange: Good evening, and welcome, P.J.
P.J. DiNuzzo: Good evening.
Jim Lange: So, this is a little bit of a unique show in that this is our second show that we actually videotaping, and we will let you know when and where that video will be available. But before we get into the meat of the program, I do feel honor bound to give a full disclosure. Usually when I have a guest, I try to get the top people in the country, and I think P.J. is one of them, but I usually have no financial interest in the guest. If they wrote a good book, which most of them have, I will typically pitch the book, but it’s not like I get a share of the royalties. So, I have no financial interest in the guest whatsoever. That is not true with P.J. DiNuzzo. P.J. and I actually have a joint venture, and the nature of it is that if a mutual client originates with me, our office does what I would call the strategic planning, the Roth IRA conversion planning, the estate planning, sometimes they utilize our law firm and actually draft wills and trusts, et cetera, and tax planning. So, we do that type of work, and then P.J. and his team actually do the investments, and they do a wonderful job. They use what we believe is the best set of low-cost index funds on the planet, and the way the fees work is we do our part and they do their part, we have one fee that covers both of us, and then P.J. and I split that fee. With that arrangement, we have roughly $320 million under management, and, perhaps more importantly for the listener’s purposes, we have a 96 percent retainage rate, so people have been pretty happy with that arrangement.
So, anyway, with that introduction, P.J., why don’t we start with what has happened in 2017. So, the S&P is up about 20 percent. What do you think is going on here?
P.J. DiNuzzo: Yeah, Jim, the interesting thing is, all the pundits make their predictions at the beginning of every year, and succinctly, I can answer what’s happened this year is pretty much 99 percent of the experts were incorrect, and everybody was talking about market correction, are we going to get on 10 percent or 20 percent after the presidential election last year, and coming into this year, as long as the bull market is, and I always enjoy doing these shows with you. I remember doing a review of the year and then a preview of the upcoming year, and I will tell the audience I think we’ll get back to basically “You’re my bread and butter” a number of times regarding having a plan. But to answer the question specifically, this year was a very strong year in the U.S. market. As you said, as we’re speaking today, U.S. large-cap stocks represented by the S&P 500 are up close to 20 percent as of the close of today. Small-cap stocks, not as good of a year, small and small value are up single digits, 7 percent, 8 percent, 9 percent, in that range. Large value up close to the market. Real estate having a decent year, but really, the outperformers this year have been on the other side of the pond, developed international companies, international large, large value, small, small value, on average up a little bit more than the U.S. market this year, and then especially emerging markets up in the, as of the close today, in the low 30 percent range.
So, again, having a globally diversified portfolio, we never know which one of these asset classes is going to outperform from year to year, but this year, again, very strong year, and propelling the market, it’s always about earnings and everyone has a different perspective on earnings, but again, we’ve been having really strong earnings across the U.S., strong projected growth, and again, with a number of things that are on the conveyor belt in Congress regarding the tax cut, et cetera, the market is pricing those into the new highs we’ve been achieving. One emotional thing I have to mention, Jim, I just saw the data from last week. We’ve hit a new high a number of weeks in a row, including last week, and there were hundreds of millions of dollars last week switched out of U.S. stock mutual funds into U.S. bond mutual funds and money market funds. So, we talk about that all the time, the emotions of investing and individual investors zigging instead of zagging.
Jim Lange: You did say something that caught my attention. You said that the emerging markets were up 30 percent? And I’ll tell you one of the reasons why I really want to point that out is because part of our process, if we like the prospect and the prospect likes us, is we take their entire portfolio, we run it through Morningstar, which is an objective reporting service, and we find out where people are, and then we typically say, “Well, if you go with us, this is what it will look like,” and one of the very common recommendations, in fact, I would say almost universal, is to significantly increase the percentage of their portfolio in emerging markets. Now, if the emerging markets significantly outperform the S&P 500, would it follow that people who, let’s say, actually listened to that advice, everything else being equal, would have had a good year?
P.J. DiNuzzo: Yes, a very good year. The diversification has truly paid off this year, again, with international and emerging markets in aggregate doing better than the U.S. market, which has had a very, very good year.
Jim Lange: Well, Burton Malkiel, when he was on the show, he said everything is … or maybe not everything, but he said that price-earnings ratios are very, very important, and he was even saying, and this was more than a year ago, that the price-earnings ratios of emerging markets were very attractive. So he was encouraging people to get into emerging markets. That might just be what you would call standard asset allocations. But many lay investors feel that the market is overheated and that we are headed for a crash. Some of the more traditional analysts look at price-earnings ratios and say, “Well, they’re a little bit high, but probably within reason.” Who do you think is right? Or is that just one of those questions that there’s really no certain answer, and some of the, let’s say, conclusions what people should be doing will be the right answer?
P.J. DiNuzzo: Yeah, well, what I think, Jim, you know, another thing to flesh this out is the fact of how prevalent behavioral science of the emotions of investing play, and you really have people at both ends of the continuum right now. You’ve got folks that think the market’s overheated, and the one thing that you’ll see the longer a bull market goes on, you’ll see more people getting funneled into more and more stocks. You’ll see people, if you’d met them a few years ago, maybe they’d had 60 percent in stocks, now they’ve got 80 percent or 90 percent. I don’t have any problem mentioning this, we just got terminated from a relationship here about two months ago, and we had done a tremendous amount of work, had the plan laid out, it was a perfect plan, looked at it over and over, and the household was at 60 percent in stocks and 40 percent in bonds, and it was an out-of-state client, and they didn’t feel that they were participating in the market as much as they should because they were looking at 100 percent in stocks, and they’re going to be retiring in about a year-and-a-half or two, and they wanted to achieve what the market was and they wanted to go 100 percent in stocks, and I told them, of course, we’re not going to do that. We have you on a glide path. Actually, we wanted them to be 50 percent in stocks in a couple years when they start to take their withdrawals for their RMDs, and that’s just an example of Dalbar.
We sort of joke about the numbers and about people making the wrong decision two out of three or three out of four times, but there’s a huge gravitational pull for individual investor’s investment DNA towards greed and fear, and you see really people being pulled in both of those directions right now. We’re meeting people who’ve been out of the market for a year, two, three years or longer because they thought the top of this market was, again, going to be one or two or three years ago, and on the other end, we see people who are leveraging up more and more. Again, you really should be in a 60 percent stock portfolio and want to go to 100 percent in stocks and just coming in too heavy and too late to the party. So, the emotions just play a huge part. Again, have a plan. As we’ve talked before on your show numerous times, our average joint client has three strategies in their portfolios. Of course, their cash reserve in the bank has nothing in stocks, but their needs bucket, food, clothing, shelter, health care and transportation, you want a conservative to moderate strategy. On your wants and your discretionary spending, your non-essential spending, you want a good solid growth strategy, but not too aggressive. It’s something that has to be able to handle the withdrawals coming out that you’re living on for the next 30 years of retirement, and also has to be able to offset inflation, and then the top bucket we talk about all the time that we just have hundreds of clients literally who have, you know, you especially, the Roth IRAs and Roth IRA conversions, at the very top of that bucket, and those typically are 100 percent in stocks. But you have to have a plan, you have to have a reason for what you’re doing, not just being pulled back and forth by the whims of the market and letting your emotions tell you what to do on an annual basis or on a monthly basis.
Jim Lange: All right, let’s think about this for a minute. So, what you’re, in effect, doing is creating multiple buckets, and literally having different portfolios. So let’s just say, for discussion’s sake, that we had a client who is relatively good shape, not a huge spender, concerned about leaving some money to his family, and let’s say that through our office, that is Lange Financial Group’s office, we ran the numbers and we determined that they should be making a series of Roth IRA conversions, or maybe they came to us with Roth IRA conversions. So, let’s say that they have some Roth money. Let’s say that they have some other money, maybe some IRA money or some other funds, and then let’s say something even more liquid, like cash and CDs and maturing bond ladders. So, what you’re saying is, if I’m hearing you right, that you’re going to invest the Roth money that has a very long time horizon that is more for dreams and actually even legacy. That’s going to be invested completely differently than some of the money that they’re going to need in the short term, and then some bucket in between, if you will.
P.J. DiNuzzo: Yes, typically three different strategies, and it’s customized for every individual household, but I tell folks at the first meeting, and I think it bears, because some of the audience is maybe listening for the first time, maybe the second time, you know, one thing that I always have a high degree of comfort in is that the typical individual or household that meets us has typically attended one of your workshops, and they come in, sometimes three or four or five, you’ve got a big following, but they’ve attended one of your workshops in which they’ve heard you go through a wide range of tax planning, estate planning, talking about investment planning, then they come into the office and meet with you for an initial consultation, they come in and meet with you for a second consultation, and again, everything’s no cost, no obligation, and then if you think they’re a good fit, you introduce them to us, and then again, we, in turn, were having an initial discovery meeting and then a second meeting, a planned presentation. So again, for no cost, no obligation, the average individual who comes to us is averaging four face-to-face meetings and extremely high-quality meetings, and we like to feel that even if someone’s not a good fit, we provide them with great advice and point them in the right direction, but, you know, as you said, our retention rate’s very, very high.
We have a large client base that’s very attractive, and it’s not a coincidence that you’ve been in business for four decades as well as we have, you know, just very steady. We’re both under a fiduciary standard, but if you just take a look at that versus a lot of people that come to us, and I think the main point of differentiation I’m trying to make here, Jim, is the average household that comes to us has one strategy with a firm, everything just sort of lumped into one basket, and it’s easier for a firm to run one strategy, maybe two. We just met with a joint prospect of ours just two days ago earlier this week, and they had the three account types. They had the tax-free Roth IRAs, the tax-deferred IRAs and the taxable accounts, individual and joint, and the allocations were all completely wrong. They had a number of Roths that were in CDs, money-market funds, bond funds, it was just everything completely upside down. So, the value that’s added from your process that we continue to add value at every meeting, and again, if the listeners think initially four meetings, and then to fast forward, we don’t forget about our clients. Our typical service model for our joint clients is we prefer a semi-annual progress meeting where their lead advisor is meeting with them twice per year, and then one of your senior CPAs typically is having a one-time per year tax planning, et cetera, review with them. So just take a look at that versus other models out there. One of our senior advisors is meeting with our clients on average once every four months.
Jim Lange: Yeah, and to clarify, what our office does is we do what we call a master plan, which includes, again, things like Roth IRA conversions, Social Security, how much money you can afford to spend, should you have a gifting program, what’s the best way to educate your grandchildren, et cetera. And then what we try to do is then update that plan every year. But one of the things that you said, I think, is important, and it’s probably the opposite of what a lot of firms try to do, which is maybe they have, like, three or four standard boxes and they try to put everybody into one of those boxes. You either said now or you’ve certainly said many times in the past, everybody’s a snowflake, which sounds like more work for you because the other thing is, people don’t come in with a million, two million, three million or whatever it is, in cash; they come in with different stuff. They come in with some highly appreciated assets that shouldn’t be sold, or at least you have to think about it because it’s going to trigger a capital gain. They come in with some load funds. They come in with some annuities. And I’ve seen your firm go to great lengths to try to work on that, and the other thing that you guys do, which I don’t think anybody does as well or as in great detail, is you actually really go into the nitty-gritty of how much people spend. Why is that important in the bucket analysis? Let’s say a guy has $1.5 million or $2 million. What’s the difference if he spends $70,000 or $120,000? How would that make a difference in your investment world?
P.J. DiNuzzo: Yeah, one thing, I guess, Jim, you and I are pretty good at numbers. You’re a lot longer-time CPA than I am, but being a CPA, we look at every household as its own entity, and the assets and liabilities and income and expenses, that’s the footer and foundation for every individual’s personal financial house that we talk about, and if we’re off by $1,000 per month, and again, we’ve had numerous even engineers over the years who come to us as the most prepared prospective client when they walk in the office. We’ve had them be off by $1,000 a month, $1,500 a month. So, if an individual’s off by $1,000 a month, if they think when they prepare for retirement, they think the retirement expense is going to be $7,000 per month of retirement, if their expenses are $8,000 a month, it seems like just $1,000 a month they drop, but it represents about one-third of a million-dollar portfolio. So if someone were to go to one of the major insurance companies in the United States, go to New York Life and say, “Here I am, Mr. and Mrs., or partner and partner. Here goes our ages. We’re just getting ready to enter retirement. We need you to send us $1,000 a month for the rest of our life.” That major insurance company would say, “Yeah, give us about $333,000 and we’ll guarantee that.” Most Pittsburghers don’t have an extra $333,000 lying around, so that’s how it’s critical to really get that down. We never make any value decisions, but again, being under a fiduciary standard, we want to do the best homework we can and provide you with the same advice that I would provide to my mother or my children.
Jim Lange: Well, it does sound like this asset-allocation idea diversification is pretty darn important. How do you achieve the appropriate amount? Is this strategy? Is it tactics? Is it a little bit of both?
P.J. DiNuzzo: Yeah, it’s a large strategy and executed tactically, but on the asset allocation, if the audience wants to think of that as your strategy, as we refer to it, you’ve got an aggressive growth strategy or growth or balance, et cetera, and that’s what really dovetails into the indexes, the Fama/French indexes. We’ve got an 89-year track record for U.S. large, U.S. large value, U.S. small, U.S. small value, 50-couple-year track record for international developed markets, over a quarter century for emerging markets, and I would just challenge the listeners to go and take a look at the individual managing … the male or female lead manager managing your mutual fund, how long have they been sitting in their seat, and the national averages are, the average active mutual-fund manager is in his or her seat for eight years, that’s the tenure. We have, again, an 89-year track record in U.S. indexes, and a lot more confidence when we’re meeting with clients and explaining to them how we’re coming up with an expected rate of return and an expected level of risk for each of those portfolios.
Jim Lange: Well, P.J., you’re talking about the importance of getting the spending right, and that the spending has a critical impact on what your asset allocation is, and I know that you’re a big-time low-cost index investor, and we will get back to that. But who do you find does the best with, let’s say, either delegating or working with you kind of as a team? And our firm, obviously, you know, let’s say all of us working on it, or even just delegating it, and who actually would be better off as a pure do-it-yourselfer?
P.J. DiNuzzo: Yeah, Jim, just one thought that re-entered my mind a number of times since we’ve been talking here on today’s show is, you know, you even had it in the promotional materials, was control what we can control, and that is really the essence of the show is to control what you can control. In 28 years of doing what I’ve been doing, I’ve never seen anyone fail who has controlled what they’re able to control, and we are, in our process, there’s a couple of dozen key variables that we go through, but the individuals that this would help would be … I would say the largest group is, basically I would look at them as family stewards. These are individuals, they could be male or female, the head of the family, every family sort of is delegated, or it’s worked out one way or the other, that there’s one spouse that’s more in control, sort of like we would call them the chief investment officer or chief financial officer, but they’re very concerned about their children, their grandchildren. That’s first and foremost to them. They really like our process because, I’ve heard this time and time again, that they have a tremendous amount of confidence from working through all these details, from working through the plan, everything they’re doing with the Lange companies from the tax planning, the estate planning, what they’re doing with us with the retirement planning, retirement income planning, the investment planning all being pulled together. We have just a ton of clients who I refer to as family stewards.
The next category that comes to us are people that want to be independent, and they’ll typically want to retire maybe a little bit earlier than normal, and you say it all the time, you do very great detailed dictations, and they’ve got a number in their head. “Hey Jim, I think my number is …” and you’ll give them feedback. “My number is whatever it is, one, two, three million, whatever.” And it’s really, to them, they like our process because, again, the organization. Again, nobody has tomorrow’s newspaper, but the higher probabilities that I would argue for success the way that we do things, and being able to give them the feedback and confidence on what is it going to take them to become financially independent, and then, equally important, on the backside for, let’s say, a 30-plus year retirement is are they going to be able to maintain their independence and maintain their standard of living. I’d say that’s our second largest group, and the third largest group may sound a little funny, but almost like investment phobics, and there’s nothing wrong with that because you and I are sort of geeks about this. You know, we talk about this and do research and we’re up late at night reading all these reports and everything, but there’s a lot of people that are the exact opposite. They come to us and say, “Jim, you’re the expert on this,” or “P.J., you’ve got a ton of experience. We want to delegate this to you.” I wish they wouldn’t use their gut as much, but they do use their gut feeling on, you know, do I trust someone? How much do I trust Lange companies and DiNuzzo Index Advisors? But I do think a lot of that trust has to do with them, again, going through our process, because I’ve heard just a ton of times over the years, especially referring to us working together, you know, “I’m not that knowledgeable on this.
I’m somewhat green, so to speak, but other people gave me very specific recommendations after I met with them with one meeting,” or “I met with someone and they were trying to sign me up at the beginning of the second meeting.” Again, these average individuals are having four meetings with us, very high-quality, in-depth meetings, a ton of advice that we’re providing to them, and I’ve said, you know, my whole entire professional career, that the average individual in Pittsburgh doesn’t have a Ph.D. in personal finance, but I think that they’ve got a Ph.D. in common sense, and we’ve got a lot of great, very successful common-sense folks that are able to sort that out and say, again, we’re fiduciary, there’s no charge, no expenses upfront. I just met with a gentleman that called me back from your office the other day. I just had my fifth meeting with him and you had two with him and I just had five, and again, he’s getting ready to come on board, but that’s just his style. He’s a little bit of a slower mover, but he’s going to come on board, and again, whatever it takes. There’s no cost, no obligation, and again, as you said, that’s what relates to that higher retention rate that we’ve enjoyed working together in the joint interests of our clients.
Jim Lange: Well, let’s be fair here. Who isn’t a good candidate?
P.J. DiNuzzo: The individuals who aren’t a good candidate would be people who, there’s some folks that want to always be investing in what’s the newest and greatest gee-whiz-type of investment. They tend to chase asset classes. Right now, we’re not seeing any gold in client’s portfolios, new folks we bring on, but if gold had gone on a good run for a couple years, you see people … so, there’s a lot of people that want to chase performance. The other one, for lack of a better word, I hate to use the word gambler, but they just look at investing and they’re getting some type of visceral high off of it, so to speak, as far as they want to chase investments and look for things that go up well. A guy called me today and was lamenting that he missed the Bitcoin move, and I said, “You know, you shouldn’t lament anything!” It’s like the Dutch, the Netherlands tulip-bulb episode, potentially. But folks in those categories really aren’t a good fit, the do-it-yourselfers.
You know, the big one would be, there’s a lot of people that have been very successful, I’d refer to them as accumulators, where they’ve been very successful, great, I mean, phenomenal savers, in the top 1 percent, typically in the market wherever they live at, so they’re great savers, but they just abhor expenses. So we’ve had people come to us and we’ve gotten down to the ninth inning with them and if they’re thinking, “I just hate paying anybody for anything,” we could be the greatest fit for them, but again, it’s just not in their DNA to be able to delegate and be comfortable, and we do refer folks like that to Vanguard. We have over the years. If we’re not a good fit for them, we refer to them to go take a good, hard look at Vanguard’s indexes and their low-cost structure that they have if you are going to do it yourself.
Jim Lange: All right. Why don’t we go back to some of the core? I know that we are both big fans of Dimensional Fund Advisors, which is an index fund, but before we talk about DFA, let’s just talk about the index approach, and I know that you have, I guess first with Vanguard and then with DFA, been in indexes, is it your whole career?
P.J. DiNuzzo: Yes, when I founded the firm in the late 1980s, I was using Vanguard indexes up until around 1994. I knew DFA was the best efficient-market-theory access indexing firm, but they were only working with pension plans, cities and states and foundations and institutions. So we do think the world of Vanguard, but just the fact that Dimensional Fund Advisors, which we refer to also as DFA, they have the best four-decade track record of building indexes and accessing what we refer to as the premiums in the market, the stock premium, the small-stock premium, value premium, and then the profitability premium. They have that proven track record of being able to accomplish that, so we’re most confident with them going forward. They end up being sort of our de facto research and development, especially our research department. And again, things can change in the future. We’re literally watching them on a daily basis, but they have continued to improve and evolve their efficient-market-theory indexing strategy over the last four decades.
Jim Lange: All right, so some people call DFA an enhanced index because I think by the very, very technical definition of an index, they don’t quite meet that qualification, and I’ve looked at the statistics, and, of course, past performance does not guarantee future results, but they have beaten Vanguard. So the question that I would ask is, how does one index fund beat, let’s call it, an enhanced index fund, but is essentially still an index fund with a few things that maybe might not technically fall within the exact rules of an index fund? So, basically, what I’m saying is, how the heck can DFA beat the pants off of Vanguard?
P.J. DiNuzzo: Yeah, so they’ve done the best historically. I guess if the listeners want to think of a small index, let’s say the national benchmark would be the Russell 2000, so you’re looking at the smallest stocks in the U.S. equity stock market, and the Russell 2000, for example, they reconstitute, as in rebalance, that portfolio, repopulate that portfolio, one time per year. So for the last 89 years, small stocks have done about 1.9 percent, rounded up close to 2 percent, better than large stocks over rolling periods of time, but that’s the average over the last 89 years. So if we said there is something in there that’s small stocks since they bounce up and down more than large stocks do, there’s more inherent risks in those positions that they have rewarded the investors in that area of the market. I want somebody who’s going to access that and be as pure to those small stocks on a daily basis as possible, where there’s initial challenges rebalancing that portfolio one time per year, there’s a lot of leakage, so to speak. There’s things that get in there and there’s things that grow out of there that aren’t small-cap stocks. DFA would then rebalance the portfolio on a daily basis. They’ve been able to, again, maintain the integrity of that index with a higher degree of purity than the competition. They do other things such as securities lending. They’re arguably the largest small-stock manager in the country as far as the number of small stocks that they hold. They have tremendous trading power. They have a patient trading strategy. It’s been summed up a lot of times as saying “smart” indexing, but you don’t want to sound narcissistic, but they take a look at when a stock enters an index, when it exits that index, there is a momentum, not to the level of a factor or premium in the market, but momentum is evident in the market and certain stocks that are of a larger size growing, accelerating or decelerating at a certain rate of speed tend to continue to accelerate or decelerate for a few days. The same thing with small stocks. They have their own tendencies. So DFA, with these sort of top dozen variables around the portfolio, and again, a lot of them are just, if you take a look at them, are just pragmatic as can be, if you take a look at it, if they explain what they do and how they do it, it makes all the sense in the world. So, no smoke and mirrors, very pragmatic, but just saying instead of having to be enforced just to track that index on a daily basis, just giving a little bit of latitude and being able to achieve, as you said, past performance is no guarantee of future results, but again, in a four-decade track record of being able to make these smart decisions around the fringes and still adhering 100 percent to efficient-market theory.
Jim Lange: Well, let’s be even more specific. So, you were talking about small-company stocks. So, in addition to, let’s say, a more frequent rebalancing, are the small-company stocks for DFA smaller, for example, than the ones at Vanguard, and are the value stocks in the DFA indexes — do they have a lower price-earnings ratio than the value stocks at Vanguard, and could that be some explanation of the difference in performance?
P.J. DiNuzzo: Yeah, we’re painting with a real broad brush here because DFA does have a micro-cap, but with a real broad brush, and that is the end result of managing these portfolios the way that they do with a high degree of accuracy on a daily basis that they do maintain a higher positioning, a more pure positioning, in pure small caps. They would plot out typically more pure to small cap, and typically would tilt more to small value exactly for that reason. That’s correct.
Jim Lange: OK. Well, why don’t we get back to some of the things that we promised we were going to talk about. We were going to talk a little bit about 2018 and what we have coming up for 2018, and what investors should be doing for both 2018 and for long-term planning, and how does that fit in with the bucket approach that you were talking about earlier.
P.J. DiNuzzo: Yeah, Jim, for 2018, if we could leave the listeners with a few action items for them to take action and take movement on, to give yourself the best opportunity, if retirement is coming up around the bend and over the horizon for you, start to think that you want to get yourself in front of a qualified advisor at least five years before you’re going to retire. Really difficult, it continues to amaze me how many individuals we meet who come to us and say that they got referred and heard good information about us certainly, and they’re going to retire in three months, by the end of the year or by the end of next year, by the middle of next year, and anything under 12 months is very challenging. I mean, we do the best we can, but again, you just don’t have time on your side. So start to think to plan in advance and just making the right decisions in advance. Again, look for someone who’s under a fiduciary standard. Again, we’d recommend someone who’s on the indexing side of efficient-market theory, but if you’re looking for an advisor and a firm, in our case, we’re a little bit higher level with the strategic alliance, the strategic partnership that we have, you know, I would recommend looking for folks that are planning first because, with us, we refer to it as our financial-wellness life plan. It’s first and foremost about that plan, about controlling what you can control, and then the investments would be 1A. So, the plan would be Number 1, the investments would be 1A as the Number 1 addendum, the initial thing that you would plug in to make your plan work.
You know, as a result of the new tax law, what do you think investors should do in terms of long-term tax planning?
Jim Lange: Well, of course, at this exact moment, we don’t have a tax law plan that has already passed, but right now, we have the Republican House and the Republican Senate and they have both voted on a plan, and assuming that they come to some compromise, I suspect President Trump will sign it and it will actually become the law of the land, and I always hesitate to make any financial or political predictions, and especially these days when I think making predictions is tougher, but here is what I would say the big picture is. Right now, the plan does call for lower tax rates, particularly for those people in upper income, and there’s a lot of discussion that this will significantly increase the deficit, and there are certain triggers, or potentially will be certain triggers that will have taxes go up, and even forgetting the triggers, if we have a significant increase in the deficit, I think that that’s going to make a lot of people nervous, and maybe either this or even a subsequent administration will ultimately raise taxes back to the level they are now, or perhaps even higher. So if you think about it, what we have is, let’s say, current rates pretty high, then maybe a period where rates are low, and then they’re going to be back up again. Well, what does that mean in terms of strategic planning? That sounds like those are the years to make Roth IRA conversions, when we can make them when tax rates are lower, when the amount of income in each bracket is higher. So, we are going to be very strategic about Roth IRA conversions, and the other thing, one of the provisions in the law, depending on how you read the provision, is that they’re not going to allow Roth IRA recharacterizations, or undos. So we have to be careful not to overcompensate in terms of converting too much of a Roth. In 2008, when we converted a lot of money to Roths and the market went down, we undid it, and by the way, that ties into what you were talking about in terms of investing the Roth much differently than investing other money. So you mentioned the client that came in from, I don’t want to mention which competitor, but they had cash in all these fixed-income and short-term investments in the Roth, and that didn’t make any sense.
That might lead into, let’s say, some of the process that you go through, because that would’ve never, ever happened at your firm because there’s just too many checks and balances. Can you tell us a little bit about your process and what actually happens? So, typically again, people usually first contact me. Usually, going to a workshop is a terrific start, and usually people stay there for two 2 ½-hour workshops. I give them all kinds of materials to read. I actually like to give them personalized reading, in other words, “Well, for your situation, based on the estate-planning need that you said, I would recommend you read chapters 13, 14 and 15. You’re also a great candidate for Roth IRA conversions. Here’s a two-hour DVD just on Roths,” et cetera, et cetera. So, we go through that process, and then, let’s say that they come in, they meet with us, we model their portfolio, we say, “This is what Morningstar says you have. This is where we think a closer fit would be. We’re also going to recommend these changes in your estate plan, Roth IRA, et cetera, and then we also think you ought to go see P.J. DiNuzzo.” So, why don’t you tell us a little bit about what happens both in the process of becoming a client, and then after they become a client?
P.J. DiNuzzo: Sure, Jim. After the on-average two meetings they have with you, we have a two- to three-meeting process. It all depends on how much work they have and at the pace that we’re moving, but in the initial part whenever we first meet them, I think we’ve gotten very good at it over the years, but if the audience can think, it’s a large challenge for any firm because we want to get to know you personally as well as possible, and then the other half of the equation is all about the numbers, and I apologize going into it, when I schedule that initial consultation, initial discovery meeting, that there’s going to be numbers involved. So, getting to know individuals, and I tell them that meeting every household, that it looks like figuratively there’s 10,000 puzzle pieces stacked on the middle of our conference table whenever we’re meeting together, and every household, the 10,000 jigsaw-puzzle pieces for their retirement plan are completely different from every other household. So, we have to get to know them personally, what’s most important to them first and foremost, their second priorities, et cetera, and we do.
And then, often times, partners have different perspectives, the wife has a different perspective from the husband. So, we go through getting to know them personally, and that’s the soil from which their goals are going to grow out of. So, we’re doing goal-based planning, what’s most important to each household, they may have three larger goals, maybe seven or eight, and we’re going to find that out. So we go through the process of getting to know them personally as well as possible, and then we go into the financial statements, their assets, liabilities, income and expenses.
So I can just think of a case we’re actually working on today that we’re going to be putting the finishing touches on that we’re meeting with Friday. What we want our clients to know is what is their life going to look like the morning when they wake up when they are fully retired, and what is it going to look like the first morning when they wake up and both spouses, or both partners, are fully retired. So, in this case, we had a cash-flow statement for the wife when she was retiring. She was retiring at age 60. The husband who’s going to retire a few years later, we had another cash-flow statement. We had another cash-flow statement billed out. I mean, this is down to the details. We joke around and say we’re measuring how much toothpaste you’re using per month. Great amount of detail, whenever they both had Medicare available at 65, another one when they were starting Social Security, and the final one for the RMDs, et cetera. So, people really like that process of not having surprises, knowing what their life’s going to look like, and then, in the interests of time, I can’t go through the whole process, but we fold all of that up into our financial-wellness life plan, and we’re inputting rates of inflation, health-care rates of inflation, higher-education rates of inflation, what state are you going to be living in, what’s a reasonable planning age for both spouses, reasonable withdrawal rates, how much money do we have in the cash-reserve bucket, the needs bucket, the wants bucket, the dreams and wishes bucket, what are the investment strategies, the asset mixes related to those. So, as I said before, you’ve got at least two-dozen key variables in those forks in the road, and if the audience can believe me on one thing, you want to be knowledgeable when it comes to those two-dozen key variables in your life that are going to affect the next 30-plus years of retirement, and you also want to make an educated decision. No one has tomorrow’s newspaper, but a lot of these forks in the road, I think it looks like we have an 88 percent probability if we turn right at the first fork, and we have a 77 percent probability if we turn left at the next fork, and it’s not so much about that one decision or those two decisions, but you stack a lot of very high probability decisions on top of each other for 20 or 30 key variables for your retirement and monitor that, again, on a high-quality ongoing basis, we’re monitoring every four months, on average, that we’re having a meeting with our clients, and again, it gets back to the moral of the show, in my mind: Educate yourself and be knowledgeable and control what you can control, and again, I’ve never seen anyone not be successful if they’ve done that.
Jim Lange: All right, and by the way, I don’t know if everybody has picked up on this, but so what you’re doing is you’re actually doing a balance sheet for people, which is a traditional statement of assets and liabilities with an emphasis on what is liquid, with a distinction between after-tax dollars, highly appreciated after-tax dollars, traditional IRA or 401(k), or, what I would call tax-deferred dollars, and then Roth dollars, and then also what liabilities they have that might be, let’s say, a remaining mortgage or something like that. You’re doing that, then you’re going through all this cash-flow analysis. I don’t know if you get it down to the toothpaste, but what you said earlier is, if you’re way off on this, your asset allocation is not going to be the asset allocation that is most appropriate for you. So, for example, I know that you build in an occasional car, an occasional roof, an occasional furnace, and even missing those types of things, if somebody is too highly invested in stocks, like the one guy you said, he wanted to be 100 percent in stocks and he was just about to retire, and what happens if we have another 2007, the market goes down and he has no choice but to sell, and you’re never going to put somebody in that situation. So it is a huge time investment, and I know how much money you put into it.
So, we only have a few minutes left. I want to do one quick warning, and then I’m going to ask you for one other question, and I have to get this in because otherwise I would not be fulfilling my fiduciary duty. As I had mentioned earlier, I am not independent with P.J. We have a joint venture. Our office, which tends to be the initial starting point, assuming that you go through our process, which is pretty extensive, and we provide a lot of information, we will ultimately, if you become a client, come up with what we call a masterplan: Roth IRA, Social Security, how much you can spend, what we think is the best estate plan, whether we’re drafting the documents or not, tax plan, et cetera, and then P.J.’s actually doing the investing using low-cost index funds, and instead of having to pay two fees because of the work that we do and P.J., you’re actually paying one fee and P.J. and I are splitting that. We have roughly $315 million under management with that arrangement. We’re growing between $50 million and $60 million a year, and, perhaps more importantly, we have a 96 percent retainage rate.
So one of the questions that we are getting these days is, well, gee, for the asset allocation, certainly fixed income is important, and not a lot of people really cover much about fixed income. So, in the time that we have left, unless there’s anything else that you’d like to talk about, which is fine, could you tell us, let’s say, your approach to fixed income and, let’s call it, the bond markets, and then also, what Jane Bryant Quinn calls Harvey the Rabbit, inflation?
Dana Anspach: Yeah, and sometimes people need you, as their planner and advisor, to give them permission to do that. They need someone to say, “Look, this is really OK. It’s not going to put your plan at risk,” and there’s that sense of relief that shows up when an outside party tells them, “Yeah, this is OK.”
Jim Lange: OK, we are with Dana Anspach, the author of a book that I would recommend called Control Your Retirement Destiny. Dana, when I was reading your book, I read that you actually prepare balance sheets for your clients as well as income or cash-flow statements, and, interestingly enough, we do the same thing, which is a lot of extra work, and I know the reasons why we do it, but I was going to ask you why do you actually go to that extra work of preparing a personal balance sheet and a personal income statement or cash-flow statement for your clients, and do you think that this is something that everybody should do, even if they are a do-it-yourselfer?
P.J. DiNuzzo: Yeah, so the bond markets, that’s an equally important … we talk about the risk and reward of our portfolios, so the return side, of course, is being generated primarily by the stock positions, and the risk, what’s protecting us primarily again is the bond positions. One thing I will just mention is the bond market is every bit, and oftentimes even more efficient than the stock market. So, if we look at the most recent 15-year period of time, if you looked at all U.S. stock mutual funds in the Morningstar database from 15 years ago, only 18 percent of all U.S. stock mutual funds beat their respective index over the last 15 years. If we look at the bond market, it’s just about exactly the same. Only 19 percent, only 19 out of 100, bond managers beat their respective bond benchmark index over the last 15 years. So, again, the market’s very, very efficient. We’re using bonds first and foremost, Jim, in our client’s portfolios for safety and protection.
Again, yields are down right now around historic lows, but that still doesn’t mean that the bonds aren’t providing us with that protection. Whenever the market’s down, they are the ballast for the portfolio. We can’t speak of specific market numbers, but just using ranges, if I were to say like an all-index portfolio, when we were going through the 2008 crisis, the average 50/50 all-index portfolio was down less than 20 percent, something in that range, when the market globally diversified portfolio was down in the low-40-something percent. So they’re providing a lot of protection in down markets. Again, the market’s very efficient. DFA has a tremendous bond that’s basically the core of our portfolios. It’s a total bond-market index-type fund. We have a couple of core five-year funds. One thing that’s different about us, as well, on the bond side is … and human beings are just creatures of habit. You see them making the same mistakes over and over, and unfortunately, as interest rates have been low for a number of years, we see newer clients who come to us and they’re investing in really risky bonds, things that are well done into the junk-bond category, or they’re out there going out for really long-term bonds where they’re buying 15-, 20-, 25-year bonds. So they’re going about it the wrong way. The weighted average term for our clients on our bond side of our portfolios is in that three- to four-year range. So trying to keep interest-rate risk, once interest rates do start to rise at a minimum, and just trying to find that sweet spot. But again, our bonds have provided historically a tremendous amount of risk protection but also are producing a decent yield, even in today’s environment.
Jim Lange: All right, so, when you say average three or four, does that mean that you have some that’s one and two and some that’s four and five, or the average, or do you have one particular bond fund?
P.J. DiNuzzo: Yeah, our average client has between three to five bond funds in their portfolio, and if you think of the bonds sort of being used in a ladder-type strategy, so there are some that are shorter than that, right around that average, and one or two that are a little bit more towards the intermediate term range, which gives us a weighted average, again, in the middle, as you said, some that are a little bit shorter, some right around there and some a little bit longer.
Jim Lange: All right, well, that’s again part of that cash-flow planning. So, when you say ladder, that means the bond matures, that money’s available for spending, the long-term money can continue to grow and even fluctuate, and then, let’s say, the following year, the next bond matures, that money’s available for spending, obviously supplemented with some cash.
P.J. DiNuzzo: Yeah, similar to that. You know, we’re looking at a total return strategy. So for our clients, we’re generating their withdrawals for hundreds and hundreds of clients that are getting sent a check every month from the growth on the stock portion, from the dividends on the stocks and the interest that’s being generated by our bond funds.
Jim Lange: Well, thank you very much, and thank you for participating in our second videotaped radio show.
P.J. DiNuzzo: Thank you very much. Happy holidays to the whole team here. Thank you.
Dan Weinberg: All right, thanks so much to Jim and to our guest P.J. DiNuzzo, and listeners, if you’d like to meet with Jim Lange in person, give the Lange Financial Group a call at (412) 521-2732 to see if you qualify for the Lange Second Opinion Service, or connect with Jim’s office through his website, which is www.paytaxeslater.com. While you’re there, you can also get a free digital copy of Jim’s book, The Ultimate Retirement and Estate Plan for Your Million-Dollar IRA, including how to protect your nest egg from the pending death of the stretch IRA legislation. Also, feel free to visit www.saveourstretch.com where you can learn more about the stretch IRA and how changes in the law might affect you. For now, I’m Dan Weinberg. For Jim Lange and P.J. DiNuzzo, thanks so much for listening as always, and we’ll see you next time for another edition of The Lange Money Hour, Where Smart Money Talks.