Message from CFP Board

May is the bullish month, at least astrologically speaking, with Taurus the sun sign throughout most of May. Whether it proves bullish for the financial markets is not yet clear. In the first several trading days of this month, the trading losses in broad stock market has been 6 percent, prompting several Wall Street commentators to proclaim an end to the recent bull market which began in March 2009 and produced 75 percent gains by the end of April 2010.

The phrase “bull market” and its counterpart “bear market” are not precise technical terms, but rather metaphorical symbols used to describe the up and down trends of the stock market and other markets such as commodities or bonds. From the beginning of human history, bulls and bears have been important symbols – both have even been the subject of worship. Interestingly and appropriately, bulls were held sacred primarily in the hotter parts of the world such as India and Egypt, whereas the people in the northern, colder climes of Russia and Finland venerated bears, not to mention eating and wearing them.

The origin of these symbols’ association with trade and finance isn’t known precisely. One theory holds that “bear market” derives from the 17th century practice of trappers selling bear pelts before the animals were caught. These savvy businesspeople believed the price of fur would soon decline, and they hoped to take advantage of the current, higher price for the pelts they expected to catch in the future. Then, because a popular sport at that time involved baiting bears against bulls, the opposite term “bull market” was coined. The 19th century political and social cartoonist Thomas Nash, who gave us the Republican elephant and Democratic donkey, also popularized the stampeding bull and the hibernating bear as visual metaphors for our financial markets.

But for all the rich legend behind these terms, there is one respected, Nobel Prize-winning theory of financial markets that implies that bull and bear markets do not (or should not) exist! To understand this argument, consider first a widely-held definition of a bull market as one “where prices are expected to rise.” Modern Portfolio Theory (MPT), an empirical and mathematical analysis of stock market movements first developed in the 1950s, claims that if stocks are “expected” to rise, then they will rise immediately, leaving no more room for expectations. Given the abundance and availability of information on traded companies, and the fierce competition for profits in the stock market, MPT suggests that prices adjust instantaneously to reflect these future outlooks. The future, in other words, happens NOW.

There is a popular anecdote illustrating the intuitive “wisdom” of MPT:

Two men are walking down Wall Street. “Look!” says one man to the other, “there’s a $100 bill on the sidewalk.” “Nonsense,” says his companion. “If there were any such bill on the sidewalk, it would already be gone.”

MPT has come under challenge in recent years due to the stubborn fact of prolonged and extraordinary market trends. One significant challenge to the simple elegance of MPT has come from the field of behavioral finance, which asserts that investors are messy, complicated creatures prone to behaving irrationally or impulsively. Behavioral finance tells us that instead of approaching their investments objectively and rationally, people act like lemmings (another animal analogy!) doing whatever they see other people doing, often to their own detriment. If the stock market moves up, they buy. If it moves down, they sell. Behavioral finance suggests that greed and fear motivate people, not logical assessments of risk-adjusted profits.

The debate between the two schools of thought continues and will most likely never be resolved decisively. Both theories have important guidance to impart to a serious investor. On one hand, MPT would lead investors to take time to understand the value of low-expense index funds or ETFs in their portfolios. These funds simply replicate the market, and therefore will never “beat the market.” Using that objective approach and understanding, an investor would never expect to find that stray $100 bill before anyone else.

Meanwhile, behavioral finance alerts the investor to the power of irrational forces operating in markets. It says that people make choices and assumptions that aren’t always based in fact. It helps explain why the enthusiastic reaction to bull market growth so often results in overvaluation of stocks, and why pessimism generated by bear market declines often results in undervaluation.

The good news is that you don’t need to take a side in this debate. Proponents of either theory cannot dispute one smart investment strategy: Diversification. Quite simply, diversification says not to put all your eggs in one basket. You put a portion of your assets in investments that typically grow substantially during bull markets. And you put a portion of your assets in investments that aren’t expected to decline substantially during bear markets. The principle of diversification helps you keep footing among the bulls and bears. In other words, by maintaining a portfolio that is proofed against either type of market – positioning some of the portfolio for the bear market when the bulls are running, and some for a bull market when the bears are scurrying – investors are likely to achieve average returns over time.

And while “average” may not sound exciting, in yet another market paradox borne out by empirical research, being average, for individual investors, can make for above average performance over time. A diversified investment portfolio will not match the highest rate of return of a bullish stock market. But it will also not match the lows of a bear market. As famous cartoon bear Yogi Bear might have said, with diversification, you can end up with an investment portfolio smarter than the average bear (or bull) market.

-Eleanor Blayney, CFP® Consumer Advocate, CFP Board



Certified Financial Planner Board of Standards (CFP Board), the Financial Planning Association®, the Foundation for Financial Planning, and the U.S. Conference of Mayors recently announced a major initiative to host “Financial Planning Days,” free financial education and programming in numerous cities across the U.S. this October. The first-of-its kind effort is slated to involve thousands of financial planners and consumers through a series of clinics where qualified and experienced financial planners will provide free, no-strings-attached, financial advice and education. “There are millions of Americans who need trusted financial advice, but who do not have easy access to it. Combining the collective resources of four prominent organizations with proven track records in consumer financial outreach allows us to offer a much-needed solution, teach communities about the financial planning process, and empower individuals in need with information to help improve their financial situations,” said the Financial Planning Days organizers. Watch this enewsletter and CFP Board’s Web site for additional information as it becomes available, including event locations and registration details.

Top News Stories

As Economy Heals, Many of Us Are Slipping Back Into Our Bad Habits
Mercury News (04/24/10) Serra, Dan

Many Americans feel that the country is emerging from the recession, based on such economic trends as higher consumer spending and healthier stock markets. The recent recession has helped change some people's financial approach, but many consumers will likely end up returning to their previous ways of saving and spending. Market research firm Decitica says roughly 20 percent of Americans remain frugal following a recession, while 30 percent return to their previous spending level. The remaining 50 percent experience no change in spending or saving habits. Developing a recession plan is crucial, and should include budgeting and a plan of action if money were to be tight. People also need to form and maintain an emergency fund to cover expenses during a financial disaster. Another strategy involves saving money in order to buy stock when the market and prices go down. CERTIFIED FINANCIAL PLANNER™ professionals can discuss different scenarios with their clients in order to craft a successful disaster plan.


Some Target-Date Funds Adjusting After Criticism
New York Times (04/09/10) Dunleavey, M.P.

Target-date funds were once considered simple, self-contained products for investors, but have faced criticism since the 2008 financial crisis. A Senate investigation and two government hearings examined whether some of the funds were too risky, charged excessive fees, and were regulated enough. To address some of this criticism, Charles Schwab last April said that it would cut the expense ratio of its target-date funds by 12 to 23 basis points, while last October Wells Fargo cut its expense ratio for institutional target-date funds by 17 basis points. Also last October, TIAA-CREF and Fidelity each launched target-date funds based solely on index funds, which generally have lower fees. Fidelity also added exposure to commodities and Treasury Inflation-Protected Securities to boost returns and protect against inflation. The concerns being addressed by the funds are paramount because target-date funds are becoming more popular in investors' retirement plans. About 7.3 million people had target-date funds in 401(k) plans in 2008, according to the Employee Benefit Research Institute, and that number is expected to increase because target-date funds are the default option in most company plans.


5 Big Financial Aid Lies
U.S. News & World Report (04/06/10) Clark, Kim

College and government officials too frequently mislead students and parents because numerous financial aid terms they have to employ end up having technical or legal definitions that run counter to commonly understood meanings, writes U.S. News & World Report columnist Kim Clark. "And in some cases, I believe, politicians or college officials have purposely crafted terms that give students more hope for aid than is realistic," she says. Clark calls attention to several such terms, starting with the expected family contribution (EFC) that the federal government estimates for students who complete a Free Application for Federal Student Aid. She writes that the government's formula for determining what families should be able to afford is not realistic, with the government expecting parents to contribute a minimum 22 cents of every dollar over an arbitrarily low family budget; furthermore, close to 100 percent of colleges lack sufficient financial aid money to ensure that every student will only have to pay their EFC. "Guaranteed" or "conservative" college savings plans is another dubious term Clark cites, observing that some state college savings plans have been giving parents too optimistic a perspective of saving enough for college. She also calls attention to "Teach Grants," noting that recipients must comply with many prerequisites, such as spending a number of years teaching specified subjects at certain schools, or else get billed for their grants plus interest. Renewable merit scholarships and 7.9 percent federal PLUS loans are other terms that Clark labels as myths.

Personal Finance News

Educating Children in Financial Literacy
Chicago Sun-Times (04/26/10) Knowles, Francine

The American Bankers Association Education Foundation believes that parents play an important role in teaching their children about money and finances. The foundation recommends that parents set a positive example by spending money wisely, saving, and paying bills on time. Parents should seek opportunities to discuss money and play games that focus on wise spending. To encourage budgeting, children should divide money they receive into four clear jars labeled sharing, spending, short-term savings, and long-term savings. They should place 10 percent of their money in the sharing jar, 30 percent in the spending jar, 30 percent in the short-term savings jar, and 30 percent in the long-term savings jar. Older teens can be instructed to list their expenses and income. Expenses can include such things as money spent on bus tokens, lunches, movies, and so on. They can then subtract expenses from income and consider ways to reduce their spending. A savings plan can be discussed if the teen's income is greater than their expenses. Children can also be given pretend budget assignments and tour a bank with a parent to see how transactions work.


Allowance Tips to Promote Financial Literacy
Associated Press (04/16/10)

There are a number of steps that parents can take to teach their children money management skills. For starters, parents should create a list of chores that kids can do to earn an allowance. This list should show how much the child can earn by performing each chore once or on a weekly basis. These chores should become progressively harder and more difficult as the child ages, though they should also come with higher rates of pay. Children should also be taught the importance of saving by either having a piggy bank or a savings account. Parents should reinforce the benefits of saving by helping the child put money in the piggy bank or by helping him fill out a deposit slip and checking his account balance. After children accumulate enough in savings, they should be taught about investing by allowing them to buy a single share of stock.


How to Avoid Giving Uncle Sam a Free Loan
MarketWatch (04/16/10) Truong, Alice

For those who received a tax refund this year, it might pay for them to consider adjusting their withholding now so that they do not give the government an interest-free loan until April 2011. Some financial planners recommend that taxpayers structure their finances so that they receive no refund and owe nothing when they file a return, but this is difficult to achieve. Still, adjusting the withholding now can at least lower the refund. Taxpayers can opt to have fewer taxes deducted from each paycheck, and instead invest or save that money. Christopher Rhim, CFP®, says most taxpayers should withhold at least 100 percent of their tax liability from last year or 90 percent of their estimated liability for the current year. Adjusting withholdings requires taxpayers to revisit their W-4, and they ought to know what modifications they would like to make before they approach their human resources department. Rhim also recommends against waiting to do taxes until the last minute. Taxpayers who are expecting major life changes should contact an accountant early enough to know how the changes will impact their taxes.


5 Tips for Cleaning Up Your Credit to Buy a Home
Associated Press (04/25/10)

Long before searching for a home to buy, it is important for consumers to examine their credit report and take steps to fix any problems. This includes obtaining a free, annual credit report from the three main credit reporting agencies: Equifax, Experian, and TransUnion. People should know what their credit score, or FICO score, is and what it indicates. The score helps determine if a person qualifies for a loan and at what interest rate. Credit scores are based on several factors, including making payments on time, amounts owed, duration of credit history, number of credit inquiries and new accounts, and types of credit used. Ways to improve the FICO score include getting caught up on any late bill payments and paying down credit balances that are near the maximum credit limit. It is also prudent to stop applying for new credit in the months leading up to buying a home. Another key step is finding the right banker or mortgage broker, usually by word of mouth. This person will examine the client's credit and focus on how to enhance their qualifications for a loan. Finally, it is beneficial to get pre-qualification for a mortgage. A broker or banker can assist with the pre-qualification process by gathering basic financial information. If a person qualifies, a loan pre-qualification letter provides an amount they can probably borrow to buy a home.


Hip Hip Hooray! No More Estate Tax!
Tampa Bay Newspapers (04/21/10) Wold, Tish

There are a number of steps individuals and families can take to ensure that their estates are in order when they or their parents pass away. For starters, individuals should look at their estate planning documents to see how the amount of assets that will fund a trust or be given to the next of kin is determined. If these documents show that this amount is determined by a formula, an attorney should be called for help in revising or restating the documents. This is important because the use of formulas that are related to the limit for assets that can be stepped up--which currently stands at $1.3 million, plus as much as $3 million for surviving spouses--may result in a trust fund for a surviving spouse not being properly funded. In addition, individuals need to be sure that they have the cost basis information available for all of their assets. It is important to have this information because the cost basis is used to determine how much income taxes the recipient must pay after the death of the asset's original owner. Cost basis information for securities is usually available from the investment firm the owner bought the asset from, though it is not readily available for assets such as investment properties. Finally, individuals should be sure to call and ask for advice about estate planning from an expert.


Firing Your Financial Adviser Requires Reflection
Dallas Morning News (TX) (04/17/10) Yip, Pamela

Consumers sometimes complain that their financial adviser charges too much, and that they want to manage their own money. However, people might not realize what they would be taking on, and the first thing they should do is determine what has angered them enough to want to go it alone. "In most cases it probably is not fees, since they presumably knew the fee structure prior to engaging the adviser," says Michael Busch, CFP®. "It may be more likely that they are not happy with either market performance or customer service." Before cutting ties with a financial adviser, you should try to negotiate fees, and ask yourself whether you are getting your money's worth. People should determine whether their expectations are realistic, and consider whether the financial adviser has "soft skills" and treats them right. You also need to determine whether you have the time to manage your investment portfolio, as well as insurance, college savings, an emergency fund, and estate planning.

Financial Alerts

Debt-Settlement Firms Misled Consumers, GAO Says
Washington Post (04/23/10) P. A16; Mui, Ylan Q.

At a recent hearing of the Senate Commerce Committee, a report by the Government Accountability Office was presented indicating that many debt-settlement firms have misrepresented themselves to consumers by claiming affiliations with federal stimulus programs or government agencies. Audio recordings of salesmen reveal that some recommend consumers stop making payments to creditors, despite standards set forth by the U.S. Organizations for Bankruptcy Alternatives and the Association of Settlement Companies prohibiting such a practice; only three of the 20 companies contacted by undercover investigators did not encourage borrowers to cease bill payments. Moreover, the Federal Trade Commission (FTC) pointed out that debt-settlement firms claim 85 percent to 100 percent success rates, when in actuality the success rate is under 10 percent. The FTC wants to make it illegal for these companies to charge fees in advance of negotiating with creditors, but the industry organizations insist that advance fees are necessary for companies to stay in business. In the meantime, Sen. Charles Schumer (D-N.Y.) plans to introduce legislation that would outlaw advance fees, restrict the total amount charged to the consumer, and allow consumers to cancel their participation and get a refund.

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