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Financial Advisors In Sheep’s Clothing

In recent months I have been asked on several occasions to speak to a friend or friend of a friend regarding something to do with their investments.  They come to know that I have managed my own investments for several years and have spent the time to learn about the various investment products available and generally about how the investment world works.  I’ve done this because, in part, I found that it’s something that interests me and it’s something that I enjoy.

I do not pretend that I am a financial professional nor that I am qualified to provide investment advice to others.  My interaction with these other people is simply to listen and sometimes to offer an opinion about certain financial products, etc.  In every case they have spoken to or are already working with a financial advisor of some sort.

The unfortunate truth is that there are thousands of people in the finance industry that call themselves a “financial advisor”, “financial consultant”, “investment advisor” or “financial planner”.  A small fraction of these people are required to act in the best interest of their clients.  That’s right, most of them would most accurately be called a broker or sales person because that is their role.  And the manner in which they earn money will cause them to select investments for their client that will pay themselves the most.

This article uses the highly regarded firm of Edward Jones to illustrate how the broker dealer model works and whether they are serving the interests of their clients.  When you read this article you will see that most “financial advisors” have no background in finance.  They are trained how to find and entice new clients to offer up their money and they are given a limited set of products to sell that will generate sales commissions for the broker.  They will not tell the client that he can invest in comparable products with much lower costs.

Please read the linked article and if you currently have a financial advisor, take the time to understand exactly how he or she earns their money and if that creates a conflict with your objectives.

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Long Term Food Crisis – Jeremy Grantham

You may not know Jeremy Grantham.  He is co-CEO of GMO, Inc., an investment management firm with around $100 billion under management.  His quarterly newsletters have a near cult following due to his unique perspective on markets.  He thinks in terms of big themes and global trends which will have implications for the economy and investments for many years.  He is not a stock picker so you will not come away with new ideas for trades but you will come away with your mind expanded in ways that can help to shape your own thinking and perhaps your investments.

His most recent letter, “Welcome to Dystopia” addresses what he sees as a sustained increase in price and decrease in supply of the world’s most important natural resources.  Now this is not necessarily a new notion, but he puts it into perspective and identifies the key factors that have led us to this point and will likely determine the trajectory of these trends in the years ahead.  Specifically, he identifies that we are 10 years into an era of rising resource prices and now are 5 years into a period of sustained food crisis in poorer countries, a situation likely to continue for the indefinite future. Read more…

SandRidge Mississippian Trust II

SandRidge Energy (SD) has formed a second royalty trust to help finance its drilling in the Mississippian formation.  In April of 2011, SandRidge offered SandRidge Mississippian Trust I (SDT).  This trust has performed well since its IPO, paying unit holders at over 120% of the target distributions for the past 2 periods which has caused the stock price to trade at over 40% above its IPO price.  Now the shares of SandRidge Mississippian Trust II (SDR) began trading on April 18th, offered at $21 per unit.

If you have not invested in a royalty trust before you should be aware that these are vehicles used to help finance the drilling operations.  The trust has a finite life.  The wells will be drilled, the oil and gas extracted and sold and over time the output from the wells will diminish as will the distributions from the trust.  The trust will liquidate after December 31, 2031.  If there is any value left in the output of the wells at that time, a perpetual royalty interest will be sold and any proceeds will be distributed to the unit holder.  Also, be aware that this is a publicly traded partnership so you will receive a Schedule K-1 at tax time. Read more…

SandRidge Mississippian Trust I Paying Above Targets

SandRidge Mississippian Trust I (SDT) is a royalty trust with interests in oil and gas properties in the Mississippian formation in Oklahoma.  This type of trust is very simple to understand.  As a unit holder, you are entitled to a portion of the revenue stream from the sale of oil and natural gas extracted from wells drilled on this property by SandRidge Energy (SD).  The only function of the trust is to collect royalty payments and distribute them to unit holders.  An investment in units of the trust is subject to certain risks.  Among them:

  • The EPA could suspend or forbid hydraulic fracturing.
  • Prices for oil and gas are volatile.
  • SandRidge might not complete its drilling obligations.

As for the first item, I don’t know how to counter this risk except to not own any stock participating in this market.  As for oil and gas price volatility, a little more than half of the expected revenues upon which the target distributions are based through December 31, 2015 are hedged in order to minimize the impact of this volatility.  Now let’s look at the third potential risk.

See the full article on Seeking Alpha.

4 AAA Rated Dividend Payers

US financial markets are off to a rousing start in 2012 with the Dow up 5.5%, the S&P 500 up 7.1% and the Nasdaq notching a YTD gain 11.5% (as of Feb 3, 2012).  What’s behind these gains?  Investors are starting to believe that a recovery is underway in the domestic economy, forward looking statements from big cyclical companies like Caterpillar (CAT) suggest that the emerging economies are back in growth mode and lately, the blowout quarter from Apple (APPL) and prospects for the Facebook IPO have ignited the tech sector powering the Nasdaq average higher.

Perhaps you’re not quite convinced that it’s OK to hoist the all clear flag.  Maybe you think that before the history is written for 2012 we will suffer a setback thanks to the Euro crisis.  Yes, the ECB has stepped in to address liquidity concerns for the European banks but you’re not ready to concede that the crisis has been averted and that it won’t affect the US economy.

But you’re a dividend investor and want to be invested.  However, you also want a measure of downside protection.  I would suggest that you could do no better than to look to the only AAA rated companies in the US, Automatic Data Processing (ADP), Exxon (XOM), Johnson & Johnson (JNJ) and Microsoft (MSFT).  Yes, the AAA rating relates to the debt of these companies reflecting the sterling nature of their balance sheets, but it is a noteworthy factor when looking for rock solid businesses.

The full article can be viewed on Seeking Alpha.

Pay Zero Tax on Qualified Dividends and LT Capital Gains

One of the advantages of a “self directed” retirement is that you have some flexibility in managing your tax burden. By self directed, I mean one in which your income is primarily derived from your investments rather than a pension. In a previous article I described a Zero Percent Withdrawal Retirement Plan. Someone following a similar approach can exercise some discretion when it comes to taxes by controlling the mix of income and the total amount. Your income may consist of wages, taxable interest, ordinary dividends, Schedule K-1 income and/or capital gains.

If you can live on an income that keeps your taxable income within the 15% bracket (or said differently, below the lower range for the 25% bracket) you will pay 0% tax on qualified dividends and 0% tax on long term capital gains.

Please see the entire article at Seeking Alpha.

Zero Percent Withdrawal Retirement Plan

In 1994, financial planner William P. Bengen analyzed different withdrawal rates and asset allocations to determine the optimum rate which could be sustained over a 30 year retirement period beginning every year from 1926.  Using a portfolio split evenly between stocks and bonds, he determined that an initial withdrawal of 4% adjusted annually for inflation could allow the retiree to continue withdrawals for up to 30 years without exhausting his funds.  In the years since Mr. Bengen published his results, the 4% rule has become the generally accepted “rule of thumb” for retirement planning.

My preference is to look at this from a different perspective.  I retired near the end of 2010.  In the time leading up to that point, I began to construct a retirement budget in order to arrive at an income number I would need.  So rather than focus on attaining the magic number (total retirement assets) this allowed me to plan for a particular income that I would need in order to stop working.  Here I did not use the “income rule of thumb”, ie.  plan for 80% of your pre-retirement income.  I would suggest that you start with a blank page and construct a bottom up budget.  Once I arrived at a workable spending budget, my objective was to extract the income needed to support that spending from my taxable account.

The full article which explains more about how this works can be found on Seeking Alpha.