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The Stupidest Thing You Can Do With Your Money

I recently encountered one of the best podcasts that I’ve ever heard on the subject of investing.   In a re-broadcast from Freakanomics Radio, Stephen J. Dubner takes a look at a phenomena that I’ve wondered about for a long time.    In The Stupidest Thing You Can Do With Your Money he essentially asks the question, “why are so many people willing to pay for subpar performance?”

The assertion of the episode is that active management remains the preferred choice for most investors despite chronic under-performance.  There are about 60 years of research and data to support the idea that after subtracting fees - active management is very unlikely to generate value to the investor.   This well-produced show tells a fascinating story through interviews with Jack Bogle (the founder of Vanguard), Kenneth French (renowned finance professor), and Eugene Fama (Nobel Prize winner).  

Some other industry insiders are also represented to give opposing views, but there really isn’t much debate among professionals and academics.  The facts are hard to argue against.  In fact, it’s difficult to find anyone in the investment community that even tries to refute the premise that the great majority of active investors under-perform when compared to low-cost passive strategies.   Even Warren Buffet, arguably the single greatest investor of all time, advocates for index funds.  I’ve addressed this topic many times over the years, most recently in A Sucker’s Bet, which highlights how a passive index fund has clobbered the best hedge fund managers in a head-to-head competition over the last ten years.   Why then, do people continue to turn over their hard earned money to investment managers? 

Awareness of index funds is certainly increasing.  Money has been pouring into Vanguard funds in recent years at an astonishing pace, making it the largest investment company in the world.   The podcast describes this as a revolution, which I suppose it is, but it’s a “quiet” revolution.   Target date retirement funds are often the default choice for 401(k) participants and some are comprised of index funds.    To their credit, some large employers, like Ford and GM, have arranged access to very low-cost investments within employee retirement plans for those knowledgeable enough to sift through an array of choices.   Institutional money has to a great extent taken advantage of the abundance of research and data available, and some smart retail investors have also found their way to index funds, but there is not yet general understanding of the superiority of index strategies over active management.    To gain broader acceptance, I think more education is needed.

The Freakinomics podcast attempts to explain the logic behind low-cost investing.  Investing is a zero sum game before costs – because for every trade there is a buyer and a seller.  Investing is a negative sum game after costs, because both the winners and losers pay the fees.   The efficient market hypothesis, which is generally advocated by Bogle, Fama, and French, and which is one of the underpinnings of index funds, doesn’t mean that markets are perfectly efficient.  It just means that markets reflect all known information.   So, it is difficult for anyone to gain an advantage.  When all is said and done, very few investors can overcome the drag of expenses to take advantage of any inefficiencies to earn a higher return than a low-cost, buy and hold strategy.   Fama has found that only 2% or 3% of all investors had enough skill to overcome their costs.   These are bad odds for an investor looking to professionals for help.

Of the few investors who might seem to beat the market, it’s mostly by chance.    How do you identify the few extraordinary managers in advance?   Using past performance to select the best mutual funds or money managers is a futile exercise because the top performers are unlikely to remain in the top tier going forward.     As explained by Bogle, the end result is that investors put up 100% of the capital, take 100% of the risk, and get a fraction of the return!

Bogle goes on to ask, why did it take so long for index funds to become popular?  I wonder, why are they not more popular?  Clearly, the Wall Street marketing machine is one major reason.  The active money management industry has considerable resources to fight this revolution and they are highly motivated, because index funds are truly their “worst nightmare”.  

Sadly, there is much more to overcome than just industry opposition.   Human beings can be very irrational creatures.  There are numerous mind traps that make investors their own worst enemy.   One must delve deeply into the emerging discipline of behavioral finance to understand why smart people do stupid things with their money.   I hope to explore this mystery in future articles.   For now, I will do my part to advance the revolution by inviting you to listen to this excellent podcast The Stupidest Thing You Can Do With Your Money.  

The Holy Grail

To many people, retirement is the Holy Grail of financial planning.  Clients almost always list retirement as their top financial planning objective.    This makes retirement planning central to what I do for a living, yet I don’t spend much time thinking about actual retirement.  I’ve been focused more on the process of helping people grow and protect their wealth in order to have more choices in the future.  Prior to writing this article, I didn’t give retirement much attention except as my role as a facilitator for others in their pursuit.    My assumption has been that people know what they want and my job is to help them get it.   While largely true, not everyone truly knows what they want or have even given retirement any deep thought.

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A Sucker's Bet

It’s not supposed to be over until it’s over - but since most of the results are already in – I guess it’s over.   Hedge fund manager, Ted Seides of Protégé Partners, has conceded defeat before the “official” end of his public wager with billionaire investor Warren Buffett.   

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Animal Spirits

The term Animal Spirits seems to have replaced The New Normal as the description of choice for economic commentators.     The new normal describes an indefinite state of slow economic growth, while animal spirits represents a more positive outlook that is underpinning the surge in stock prices since the November election.    While intriguing language, neither term helps much with understanding or navigating the financial markets.    Let me give you my perspective and a potential solution to the inherent uncertainty of the current financial climate.

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Understanding Tax Jargon

Tax time is sure to bring out certain things, such as confusion, anxiety, and shoe boxes of records and receipts to name a few.  It also invariably invokes financial articles, providing advise such as “last minute tax saving tips” that are either irrelevant to the average reader or not really helpful.    Susannah Snider, of US News & World Report, took a refreshing twist in her piece, Making Sense of 10 Confusing Tax Phrases, where she asked financial professionals to list tax jargon that they would like to see disappear.  

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True Believer

Are you a true believer? If you are not, it’s okay. Most people who invest in index funds do not fully understand them. You can still be a successful investor, but it would be even better if you were a true believer.

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New "Fiduciary Rule" for Retirement Accounts

Last week, the Department of Labor (DOL) issued a rule change that imposes higher standards on brokers and other commission-based investment advisors in an attempt to reduce conflicts of interest.   The DOL, which overseas retirement accounts such as 401(k) plans and IRAs, issued the new regulations after six years of debate.  These regulations impose fiduciary responsibility on anyone giving advice regarding retirement accounts and are supported by the CFP Board, the National Association of Personal Financial Advisors (NAPFA) and the Financial Planning Association (FPA).  The fiduciary standard says that advisors must put the interests of the client ahead of their own. 

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Two Social Security "Loophole" Options Closed

With the recent Bipartisan Budget Act of 2015, Congress has closed the door on two social security claiming strategies that it considered “loopholes.”    The File-and-Suspend strategy allowed a person to delay his or her own benefit in order to get a higher amount later while still allowing a spouse to claim spousal benefits based on the worker’s earnings record.  The Restricted Application technique allowed a person to collect a spousal benefit, while delaying their own benefit to get a higher amount later.    These procedures had been used either separately or together.   Following a brief transition phase, the File-and-Suspend and Restricted Application strategies will no longer be available.  

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The Build-A-Bear Experience

When my younger son Kevin was just a little guy (he’s sixteen and six-feet tall now), he absolutely loved stuffed animals.  More specifically, he loved stuffed dogs.  He had dozens of them, which we called his “buddies.”  On special occasions such as birthdays, the family would visit the Build-A-Bear Workshop store at the local mall to shop for a new buddy.   The Build-A-Bear store allows children to follow an assembly line and create their own personalized stuffed animals.  Kids select an animal, fill it with stuffing, and choose outfits, accessories, scents, and sounds.    At the end of the production line to complete the Build-A-Bear experience, the child gives the new friend a name and even creates a birth certificate!

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Much Ado About Nothing

The investment world has been all a twitter lately, both literally and figuratively. Since Bill Gross announced he was leaving Pacific Investment Management Fund Co. (PIMCO), the company he co-founded more than forty years ago, and moving to Janus Capital, investors have been uncertain what to do.   The investors and advisors have been wringing their hands and anguishing about whether or not to stay with the PIMCO Total Return Fund managed by Mr. Gross, or move money to other bond funds.

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Piano Guy

Have you seen the PBS program where Scott “The Piano Guy” Houston teaches adults who have always dreamed of playing the piano to learn to play using a simple, easy method?  Whenever the Learn Piano in Flash program airs (usually during pledge week), I stop what I’m doing and watch.

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Lucky Man

As June rolls around each year, the time comes again for the annual graduation speeches.  Though most will be quickly forgotten (and probably should be), some do provide valuable inspiration and insight.   Thanks to YouTube, I stumbled upon a speech that struck me as particularly meaningful. In a baccalaureate address given by author Michael Lewis (Liar’s Poker, Blind Side, Moneyball) to the Princeton graduating class of 2012, Lewis made a succinct statement about the role of luck in life’s successes.

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Beware of Fido

Our family dog, Brittney, is very affectionate and has a sweet disposition most of the time.  However, when provoked she can get aggressive.  As with all dogs, you have to be careful around her when she might be protective of her food, yard or one of the family members.  As a comparison, I hope my clients will exercise similar caution when dealing with Fidelity Investments.

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The Right Stuff

When it comes to investing in commodities, I don’t recommend them to my clients for one simple reason: I don’t understand them well enough.

The first rule of investing is to never invest in something you don’t understand. Don’t get me wrong, I know what commodities are and I’ve done enough research to form an opinion. I just don’t understand enough to know specifically what to expect from commodities in the future or to have any confidence that the asset class will provide an adequate return on investment.

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The Best of Times/The Worst of Times

It was the best of times; it was the worst of times. This is what author Charles Dickens said of eighteenth century London and Paris around the time of the French Revolution. These same words could also be used to describe the current environment for investors in America.

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The Tyranny of Compounding Costs

Bringing awareness to excessive and unnecessary costs and fees has often been a subject of my writings, as it affects many portfolios and so few investors are aware of the “true costs” they are incurring.  On April 23, 2013 PBS Frontline aired a hard-hitting expose´ called The Retirement Gamble.  I don’t know if it will be broadcast again, but you can click here to see a replay from the PBS website.

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401(k) Awareness

E*Trade, known for its talking baby TV commercials, aired a different TV commercial recently stating that a typical family could pay $155,000 in hidden fees in their 401(k) over their lifetime.  The ad prompted viewers to Google “401k 155k” to learn more, so I did.  I found an article discussing the basis for the claim.

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March Madness

The NCAA basketball tournament (otherwise known as March Madness) tipped-off last week beginning three weeks of basketball frenzy that some have compared to a national holiday.  It’s certainly one of the best sporting events of the year, but it’s more than that.  Some studies have shown that when March Madness arrives, there is a huge productivity loss across America as many workers get caught up in the excitement.

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Making Smart Social Security Decisions

Lately, one of the hottest topics in financial planning concerns maximizing one’s social security benefits.   In fact, it’s hard to find an industry publication without an article on the subject.  Even the mainstream financial magazines, such as Money Magazine and Kiplinger’s Personal Finance, have made social security claiming strategies one of their favorite subjects.

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Benchmarking Performance

“How are your investments doing?” If you don’t know the answer to that question, don’t feel so bad. Most investors don’t know the answer either.

That said, it’s a logical question and one that should have an easy answer. After all, there is an abundance of financial companies touting numerous products and services as well as scores of investment advisors representing individual investors. The technology also exists to provide results with great speed and accuracy. Therefore, what makes it so difficult to know how well your investments are performing?

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The Top 1%

How would you like to be in the top 1%? You might be surprised how easy it can be to attain this elite 1% status.

No, I’m not talking about people with the highest income or net worth – those individuals who currently are the target of the Occupy Wall Street movement. If you’re not already there, I can’t get you into that group. However, I can tell you how to become one of the top 1% of the most effective investors.

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Free Lunch

The common phrase “there's no such thing as a free lunch” was made famous by the Nobel-Prize winning economist Dr. Milton Friedman. In economic terms, it means that everything must be paid for by someone in some way.

Have you ever been invited to a lunch or dinner at a nice restaurant by a local investment advisor? If you think the meal is really free, think again. There will be a cost, which could range anywhere from relatively small to extremely expensive.

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Gold Rush

Over the last few years, the price of gold has soared. Spurred by advertisements on television, people have been predictably rushing to buy. It has also been a topic of interest for many of my clients. While I had planned to write this article for some time, I have procrastinated until now, because it seemed like such a daunting task.

For one thing, it’s hard to define. Is gold an investment? Is it money? It’s even more difficult to place a value on gold. Will prices continue to escalate? Is it too late to buy? Are we in the midst of a price bubble?

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Downdraft and Downgrade

It was quite a week. We had just breathed a collective sign of relief after the debt ceiling compromise was reached, when the Dow Jones Industrial Average tumbled 512 points in one day based on fears surrounding the global economy. This was followed by the announcement late on Friday that Standard and Poor’s had downgraded the U.S. credit rating. While these are both unsettling events to say the least, neither should have been a surprise.

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High Anxiety

In today’s volatile market, I find it interesting that lately clients are showing higher anxiety about their bond holdings than about the stock market. They hear that interest rates “have to rise” and bond values “will get hammered” as a result. The logical inference from these ominous warnings is to avoid bonds, but there are some problems with such thinking.

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Speaking Plainly

Although it will go largely unnoticed by most consumers, there has been a major change within the investment industry.

All registered investment advisors must now provide a “Plain English” disclosure document to all clients and prospects outlining their business practices as well as any potential conflicts of interest. Some disclosure was required previously, but in a much less readable and less comprehensive way. Despite the mandate for advisors to write in “plain English,” the government regulators have titled the new document Form ADV Part 2 Brochure. Although the name lacks panache, it is a positive step for consumers and serves a useful purpose.

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Take It to the Limit

Like the 1970’s Eagles song “Take It to the Limit,” our political leaders are about to take it to the limit one more time.

The national debt sits just a hairsbreadth from the statutory ceiling of $14.3 trillion. Unless Congress votes to raise the debt limit again, as it has done a number of times, the government could default on its obligations within the next couple of months. If that happens, the full faith and credit of the United States of America will never mean the same again.

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Phone a Friend

Do you remember the prime-time hit game show hosted by Regis Philbin called Who Wants to be a Millionaire? If game contestants got in trouble answering a question, they had several lifelines to use. One lifeline was to “phone a friend” for the answer.

Every so often, I learn that a client has deviated in a significant way from the game plan that we had formulated together. They forgot their “phone a friend” option. For example, a client might hire a high-priced investment management service, even though there are much better options available. Since I have an open line policy that encourages clients to call before making any major financial decision, I do not fully understand a client’s reasoning for under-utilizing one of their financial information lifelines.

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How to "GRASP" the Investment Process

When new clients come to me for help in their implementation of an investment plan, I go through five major steps. Whether you intend to design and manage your own portfolio - or hire me as your personal consultant, it would help you to know the key steps for building a successful investment plan. The acronym G•R•A•S•P is a good way to remember the process:

  • G - Goal identification
  • R - Risk assessment
  • A - Asset allocation
  • S - Select investments
  • P - Performance monitoring

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How to Invest Like a Pro

In September 2010, I was quoted in the on-line edition of Financial Advisor Magazine in an article titled Pension-Style Investing Limits Individuals. Despite the title, I believe just the opposite is true. I think many individuals would do well to emulate pension plans.

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A Simpler Life

Especially around the time of the New Year’s holiday, thoughts come to mind of finding ways to simplify our lives. For this very reason, my new-client questionnaire has a section on lifestyle goals with a list of thought-starters. The purpose is to initiate discussion and to help clients prioritize what is most important to them. One of the most commonly expressed desires is to simplify one’s financial life.

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Shopping for Funds

Last Saturday, I was forty-five minutes early for an appointment, so I decided to wait in my car and listen to the radio. I listened to The Mutual Fund Show. This program is hosted by Adam Bold, the founder of The Mutual Fund Store. Although I’ve listened to the show before, I was especially struck by the amount of self-serving and disingenuous comments made in such a short period of time.

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The New Normal

According to Bill Gross, co-chief investment officer of the PIMCO money management firm, the U.S. economy is going to be sluggish for the next few years and investment returns muted. Therefore, investors should get used to it. Mr. Gross is one of the most highly respected investment managers on the planet. He is credited with coining the term “The New Normal” to describe an economic environment quite different than we have experienced during our lifetimes. The new normal will be characterized by a slower growth in economic activity, more government intervention and lingering high unemployment.

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Fix Our Mix

I recently participated in a “money makeover” project for Money Magazine. In the August 2010 issue’s Fix Our Mix feature, I advised a couple from Southfield, Mich. in their early 40’s on how to integrate their separate financial lives to better communicate in order to achieve their common goals. Since the subjects, Michelle and Scott, also needed to be more aggressive savers and less aggressive investors, I prescribed a 15% savings rate target for retirement and a significant reallocation of the investments.

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The Power of 'Best of' Lists

In the June 2010 issue of Hour Magazine, I was named one of the top wealth managers in the Detroit area. You might think that I would feel honored by the recognition, but I find it a little troubling that these types of lists carry so much weight with consumers. It’s natural to want to work with the “best of” any profession. Even so, I believe if you are serious about hiring someone to help with your financial life, you should do more than select from a simple list.

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As the Stomach Turns

Like an episode of the well-watched daytime soap operas, the stock market has been full of drama lately. On May 6th between 2:00 and 3:00 p.m. EST, the Dow Jones stock market average plunged nearly 1,000 points. If you didn’t watch the evening news that day, you might not have even known about it. You won’t see it reflected on your month-end financial statements, because by now the loss has already been largely recovered.

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Advice for the New Grad

Shortly after writing Taking Aim at Target Funds, I was contacted by Jane Hodges, who was writing a story for the Wall Street Journal. Jane was looking for funds that a new investor should consider for a fledgling portfolio. Naturally, I suggested target-date index funds. How can you beat an investment that is low-cost, extremely diversified, and easy to purchase and maintain?

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Agendas

Before accepting recommendations from anyone concerning your financial future, there is one thing you should always remember - everyone has an agenda.

Their agenda could support your objectives, or it could also be hazardous to your financial health. To protect yourself, you need to keep your eyes wide open.

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Taking Aim at Target Funds

In today’s market, it seems that target-date funds and other lifecycle funds have a bull’s eye on them. Many financial commentators have taken aim at these investments claiming that they have failed investors. I think it’s the critics who have missed the mark.

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Motley Fool Endorses Garrett Planning Network

I’m writing to let you know about an exciting new development in my business. The Motley Fool has exclusively endorsed and is promoting the services of financial advisors affiliated with the Garrett Planning Network, the international organization of fee-only financial advisors with which I am proud to be associated.

The Motley Fool has long admired Garrett’s approach to fee-only financial advice. And we are fans of The Fool’s approach to everything they do to educate, empower and amuse the public and their members about investing. Garrett, The Motley Fool and I share a commitment to make trustworthy financial advice accessible to everyone.

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Helpful Tip: Moving Funds to a Roth IRA

Recently, I wrote about the opportunities and potential pitfalls of employing a Roth IRA conversion strategy. In a previous article for those who otherwise would not qualify due to income limitations, I also presented a back-door way to get money into a Roth IRA. Although these techniques require careful thought and analysis, I can also present a much simpler way to take advantage of Roth IRAs that is often overlooked.

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Roth Conversion Confusion

If you’ve read the financial press lately, you’ve seen many articles trumpeting the benefits of converting traditional IRAs to Roth IRAs. The Roth conversion is the latest ‘hot idea’ in financial planning, because of a new provision in the tax laws to take effect January 1, 2010. This revision repeals the income limit and permits the tax bill to be spread over the two years following the conversion year. This change is undoubtedly a great opportunity for some people, but does it make sense for you?

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Garrett Planning Network

This past September, my three-year term as a member of the Garrett Planning Network Member Advisory Board ended. It was a privilege to serve on the inaugural panel of advisors, whose role is to provide a sounding board for Sheryl Garrett as she steers the organization toward her vision to make competent, objective advice accessible to all people. I’m please to have played a small role in helping shape the direction of the organization.

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Buffet's "All In" Bet

I must confess that I do something, which I tell my clients not to do. I watch CNBC.

I can’t help myself. I like watching CNBC, even though I don’t care about the daily machinations of the stock market or what’s happening with individual stocks. You can go crazy from the cacophony of financial information and endless commentary from talking heads throughout each business day. I watch more to follow the major events and trends that shape the financial markets. Every so often, something noteworthy happens.

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Milestones

The media loves milestones. Last month, there was a proliferation of “One Year Later” articles to mark the anniversary of the Wall Street meltdown. I almost wrote one myself.

Last week, CNBC ran a special called “Dow 10,000” to commemorate the stock average breaking the milestone. It was a feel-good story, but not nearly as exciting as their first “Dow 10,000” special 10-1/2 years ago when the stock market hit the landmark level the first time. They didn’t have a special when the market plunged below 10,000 on its decent to 6500, nor did I hear how the mark had been crisscrossed many times during this decade.

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One Week is Not Enough

I hope you are enjoying Financial Planning Week! If not, perhaps you haven’t heard the news.

The week of October 5-11, 2009 is officially Financial Planning Week. Each year around this time the Financial Planning Association (FPA) designates a week to help individuals discover the value of financial planning and make smart decisions to achieve life goals and dreams. I’m not really sure how official this is, but some states have issued proclamations to support the designation. I haven’t always given the FPA my full backing for this effort, so this year I’m determined to do my part.

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The Economic Stimulus Hits Home

I just realized that I qualify for a special 2009 sales-tax deduction for purchasing a new car. In fact, my household will get two deductions because my wife also purchased a new vehicle this year. It’s about time that some of the stimulus dollars stimulated my pocketbook.

I’d heard about this, of course, but I figured it would not apply to me. These types of tax give-a-ways never seem to come my way, usually due to income restrictions. But sure enough, I checked the IRS website www.IRS.gov/recovery and it says the following:

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A Blogger's First Blog

I never thought that I’d be a blogger - but here I am – blogging my first blog.

It seemed a little pretentious to think I’d have enough to say to warrant a blog. Of course, that hasn’t stopped many others from putting pen to paper - or should I say - keyboard to html? Political commentators, sports writers and financial columnists who have a hard time writing one good article now treat us to daily doses of their wisdom.

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