Message from CFP Board

It's June, the beginning of summer and hot weather. We can only wish our economy would heat up as well, which would be good for employment rates and our federal debt burden. However, as many of us remember from Econ 101, there can be a trade-off between full employment and stable prices. With increasing economic activity, we usually expect our consumer price index – the common measure of inflation – to go up as well.

But what exactly is inflation, and is it always a bad thing? According to the noted economist Milton Friedman, inflation can be defined as "too much money chasing too few goods." When I was once asked to explain inflation to a fifth-grade class, I chose Friedman's simple definition as one that ten-year olds could understand. I gave each student $100 in ten-dollar bills, and then held a mock auction for a car. After a few preliminary bids, the price of the car quickly went to $100. I then handed out $1000 to each student, and held the auction again. No surprise when the car now sold for $1000. "What's happened here?" I asked the kids. Though they did not identify it as inflation, they did get the idea that more money in the system can result in higher prices.

In my simple exercise, the impact of inflation was benign – it did not matter if the car cost $100 or $1000 or even $1 million, as long as everyone in my classroom economy shared equally in the increased money supply. But the real world is not so egalitarian. In an inflationary environment, there are winners and losers. Those more likely to win are wage earners (particularly those who receive cost-of-living increases), holders of foreign currency from countries with stable prices, and owners of commodities or real or tangible assets. Another winner is the government. Because interest rates usually rise with inflation, the outstanding federal deficit that was issued at lower, pre-inflationary interest rates costs less for the government to pay.

The biggest losers are, of course, those who live on fixed income, such as retirees who rely on corporate pensions, non-indexed annuities, or portfolios of long term bonds. Furthermore, because rising prices do not impact the costs of goods and services uniformly, some individuals are more adversely impacted than others depending on their consumption mix. For example, the recent health care legislation has us all quite aware of the cost increases in medicine that have been trending well above the overall consumer price index. The same has held true for energy costs, particularly for oil. Those with chronic health problems who do a lot of travel may be scratching their heads when they hear that inflation is not currently a problem in the U.S.

There are many who believe a bigger current threat than inflation is "deflation" – a condition where prices start falling. Yes, everyone likes a bargain, but not the economic conditions that bring these falling prices about. High unemployment can cause former wage earners to consume less, causing industry to cut production and to lower prices to rekindle demand. A deflationary spiral can be set up when consumers start expecting continued price declines, and therefore postpone their purchases until a later time when prices might be even lower. The example of Japan in the 1990s illustrates a deflationary cycle where saving rates were extremely high and the economy was at a standstill.

At the moment, many in this country consider themselves stuck between a rock and a hard place when it comes to inflation and deflation. Both seem like plausible scenarios for our economy. The massive federal stimulus and injection of money into the economy sends up inflationary red flags. At the same time, stubborn high unemployment, foreclosures on mortgages, and the continued decline in home prices spell deflation. For investors – those, in other words, who have a choice as to what to do with their money – the conundrum is especially troubling. Buy inflation-indexed securities and commodities, or invest in long-term Treasuries? Sell your current home and downsize, or grab a mansion, perhaps in Greece, at a rock-bottom price?

The questions change depending on that evening's CNBC report, but the answer stays pretty much the same. Diversification – or building a portfolio or even a lifestyle – that anticipates either scenario makes the most sense. Investing in both short and longer term fixed income, holding domestic as well as foreign securities, and making some discretionary expenditures now and putting some money aside for future consumption, is a winning strategy that any successful sport coach would endorse. You need both a strong offense as well as a good defense, whatever the game.

-Eleanor Blayney, CFP^®, CFP Board's Consumer Advocate

Top News Stories

Fiduciary Provision May Be Most Important Part of Financial Reform Bill
Los Angeles Times (05/23/10) Kristof, Kathy M.

The financial reform package moving through Congress involved a heated battle over a little-noticed provision that's all about one word: trust. Two similar versions of financial reform were approved separately by the Senate and House and must now be reconciled to create a final law. Both bills address a variety of issues that received far more attention than a provision dealing with the duties of financial advisors to their clients. The House version demands a high standard for all advisors, the Senate version does not. Now there's a last-ditch battle to determine whether the reform package ultimately will require all financial advisors to be fiduciaries, as the House bill requires. The push for a fiduciary standard has been derailed by a relentless and well-funded campaign that has advanced misinformation about fiduciary standards, including “myths” that a fiduciary standard would increase costs for clients, limit their investment options, or that the issue is so complicated it requires a study before fiduciary standard is required of all who provide investment advice. "I think that if clients knew the difference upfront, they would never choose an advisor who was not a fiduciary," says Charles Jaffe, author and personal finance columnist.


Fiduciary: The F-Word a Year Later
CBS News (05/24/10) Schlesinger, Jill

Financial advisors held to a fiduciary standard put the interests of consumers ahead of their own interests or their company's. It is important that consumers ask financial advisors if they are licensed as a registered investment adviser, which means they're obligated to act as a "fiduciary." Another thing consumers should ask is how much the advisor is getting paid for making a recommendation. Consumers should be skeptical if the advisor says "nothing." Advisors should also be questioned about whether there are cheaper ways of doing the same thing, such as a cheaper mutual fund, insurance policy, or state 529 plan. Furthermore, consumers need to verify the advisor's training in a particular subject area. It is preferable to know up front whether a person has acquired a degree or designation that requires ongoing continuing education. Some designations include CFP^® certification (CERTIFIED FINANCIAL PLANNER™ certification), CFA (Chartered Financial Analyst), and CPA (Certified Public Accountant). CFP^® professionals take the most holistic approach to planning and personal financial management. Lastly, consumers need to determine how at risk they are. This includes spending considerable time on understanding an investment's potential gains and losses. It is okay to decline the services of an advisor who fails to provide satisfactory answers. Consumers should also take a few days to think about any major decision.

Personal Finance News

Seven Big Mistakes People Make When Hiring Advisers
MarketWatch (05/20/10) Jaffe, Chuck

Avoiding the common mistakes in the process of hiring a financial adviser will improve your chances of living happily ever after--moreso than if you were to allow fate to bring you someone to work with. The first big mistake that people make is to interview just one candidate, who will almost certainly sound great to you even though he could be selling you a bill of goods; people tend to hire the first adviser they meet because they received the person's name from a friend or relative whom they trust. The second big mistake is the failure to conduct a background or reference check to determine if the adviser is safe to work with; most advisers on the radio have paid for the time, and a journalist will use anyone as a source when they are on deadline. The third big mistake is focusing on the cost or ways to compensate the adviser, rather than on what you are getting for your money as well as determining a balance for services, costs, and method of compensation. The fourth big mistake is expecting an adviser's credentials to tell you all you need to know about the adviser; designations help determine whether the person is skilled but do not reveal whether the person has a personal style that will inspire your "emotional discipline." The fifth big mistake is looking for big returns when you hired the adviser to help get your finances in order. The sixth big mistake is letting the adviser call all the shots when you should be treated like "the boss." And the seventh big mistake that people make is doing business with a friend or relative; people who hire a friend or relative have more than money at stake and are likely to let their guard down.


8 Things to Consider When Budgeting for a New Baby
Kansas City Star (05/10/10) Forgach, Kate

First-time parents often overspend when it comes to their new baby, so they should plan a baby budget as soon as possible, experts say. All the relatives that intend to provide financial support for the baby should examine their needs, income, and wishes. They should next prepare a spreadsheet or ledger that reveals how much money is coming into the household and what expenses are likely to come up, both immediately and in the future. In light of all the expenses, it might not be the best option to splurge on a fancy crib, for instance. A baby budget needs to take into account the cost of infant gear like a car seat, stroller, bottles, formula (if needed), and clothing. The prices should be based on equipment available at baby stores, discount stores, second-hand shops, and Internet retailers. Another item to budget for is child care. The National Association of Child Care Resource and Referral Agencies says the average price for full-time day care can run as high as $14,591 in some parts of the country. Other things to consider include upgrading life insurance coverage, drawing up a will with the help of an attorney, maternity/paternity leaves, health insurance, a larger or newer vehicle, and a college fund.


Updating Your Will and Estate Planning Documents
Boston.com (05/25/2010) Chan, Andrew

Most adults should have five basic estate planning documents, including a will, a durable power of attorney, a health care proxy, a living will, and a medical release. These documents should be seen as "living documents" that should be regularly reviewed and updated to reflect personal and financial circumstances over time, and should be reviewed and updated every 2 to 5 years, or following significant life events. These events include changes in family situation, such as marriage, divorce, new children, or grandchildren; changes in a career or professional situation like buying, starting, or selling a business, becoming a business partner, or changing jobs; the death, disability, or illness of a family member; or changes in the number of your dependents, like an elderly parent or adult child. Other reasons to review these document include significant changes in the value to your assets, borrowing or lending substantial amounts of money, taking on significant debt or liability, changes in life insurance coverage, changes in federal or state law, significant changes in a spouse's health, or changes in your or your spouse's wishes and goals.


How to Manage Your Death Portfolio
CNBC.com (05/24/10) Rao, Jessica

Death portfolio management requires more than just a will. Retirement planning specialist Craig Silverman recommends the provision of a Family Love Letter, a document that includes an inventory of advisers, a list of personal property, and other details that can prove crucial to determining the extent of the departed's estate. Attorney Louis Mezzullo says establishing a trust is a more sensible move than passing on everything to one's heirs for tax planning purposes, in the event one has a sizable estate or minors to provide for. Also underlying the appeal of trusts is the fact that in many states estate administration consumes a lot of time and the probate tax is costly, which is why many people try to avoid having their assets pass through probate by having them retained in a revocable living trust. Medical instructions, a living will, and general power of attorney also are elements that experts agree people should have in addition to a will and trusts. "The absolute number one rule is make sure that retirement account and life insurance beneficiaries are up to date," notes Herb Daroff, CFP^®. He also recommends that people make sure they own their own life insurance policies by keeping it in a trust outside the taxable estate.


Try to Avoid These Stupid IRA Mistakes
Norristown Times Herald (PA) (05/12/10) Benelli, Al

There are a number of common mistakes people make when saving for retirement, according to Al Benelli, CFP^®. One mistake that people often make is failing to open and contribute to either a traditional or Roth IRA, Benelli says. He notes that workers should talk with a CERTIFIED FINANCIAL PLANNER™ professional to determine which type of account is best for them. In addition, it is important to understand that traditional IRAs and Roth IRAs are each taxed differently, Benelli says. With a traditional IRA, savers can deduct what they contribute on their income taxes, while those who contribute to Roth IRAs pay taxes on their contributions now but can make tax-free withdrawals. Another mistake that employees often make is failing to designate beneficiaries who will inherit their IRA in the event of their death. This is important to do because direct transfers from a deceased individual's IRA to another qualified IRA can be treated as an eligible rollover distribution and thus non-taxable income, provided the beneficiary is not the deceased individual's spouse. Finally, withdrawing funds from an IRA before the age of 59 1/2 is a big mistake that employees make. Employees who make such withdrawals and fail to put the funds into another IRA within 60 days are required to pay taxes and penalties. To avoid this, workers who need to take funds out of IRAs and put them into other retirement accounts are advised to make a trustee-to-trustee transfer.

Have a Plan for Your Financial Planner
SmartMoney (05/20/10) Morgan, Sarah

If your portfolio has taken a beating following the market volatility of recent years, you may have considered firing your financial planner. That's the "kill-the-messenger" option, says CFP Board's Consumer Advocate, Eleanor Blayney, CFP^®, but an option that may not be your best choice. Blayney suggests that a better choice is to work to build a good relationship with your financial planner. It pays to be clear from the start about the type of services you want and the outcomes you hope to get. You need to know about the planner's background, compensation and potential conflicts of interest. But you should also find out how your assets and financial situation fit in with the planner's clientele: "You want to know that the planner deals with your kinds of issues frequently," says Blayney. When you've found a planner you're comfortable with, set up some ground rules so there are mutual expectations for the frequency and method of ongoing communication. And if your relationship takes a wrong turn, it can be good to have a meeting with the planner to discuss the situation, but you shouldn't hesitate to end the professional relationship if you're not happy. "It blows me away to think there are people who are worried about insulting the person they're paying to do something," says Michael Herndon, AARP's manager of financial security.

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