What is a Fiduciary?

I had a prospective client inquire the other day about my fiduciary duty. What is my fiduciary duty in my profession and why would a prospective client care?

A fiduciary duty can be defined as the highest standard of care at either equity or law. A fiduciary is expected to be extremely loyal to the person who he owes the duty (the principal) and must not put his own interests ahead of the principal. Personally, I expect this type of care any time I am entering into an agreement with someone to oversee something of value for me. I have also aligned myself with professional organizations and standards boards that require this level of professional conduct. Unfortunately, it can be difficult to find professionals who will agree to this level of care. We are all inherently selfish beings and tend to look out for ourselves first.

Regulations in the financial world allow for various types of arrangements between professionals and clients. Not all of these arrangements require the financial professional to act as a fiduciary. Because of the sensitive nature and the significance of financial matters in all of our lives, I encourage anyone I come in contact with to consider the types of arrangements they enter into with various professionals to ensure that their needs are being considered first instead of someone else's needs. Feel free to contact me if you are ever in question about a financial relationship and how it should be structured, considering all involved. I have also included a list of valuable websites on this blog that provide resources for finding ethical financial professionals.

Balance & Compromise

As I read the news headlines and follow happenings in the U.S. and around the world, I realize that many of our problems would be solved with more willingness to keep things in balance. We are seeing battles in Congress between taxing and spending. We see disputes between those preferring economic development versus those who want to preserve the environment. We also see fights in families and governments that can lead to heartache and sometimes even violence or wars. As I ponder the problems around me, I wish that more people could consider both sides of the story and compromise to solve problems and move forward.

When I work with individuals to develop a financial plan or manage an investment portfolio, it often comes down to the ideas of balance and compromise also. There are often choices to be made between short-term spending and long-term savings. There is balancing that needs to be done between asset classes in an investment portfolio. Compromises also have to be made between spouses about financial goals. Finally, a compromise is needed in determining how much risk can be tolerated and how much potential reward that might lead to.

A basic understanding of financial principles is something that all Americans could use. As we work to solve some of our state and national economic problems, we could all benefit by taking a look at our individual lives to see how we can bring things into better balance. A more realistic view of finances on the individual level would have significant benefits in solving some of the more significant problems in our country and around the world.

The Complexity of the Tax Code

As the tax season is now upon us, I thought I would address the complexity of our current tax code and offer some of my ideas about simplification. I attended a tax presentation at my local chapter of the Financial Planning Association where the presenter, a CPA, questioned the entire value and purpose of our tax code in its current form. Once certain provisions of the Health Care Act are enacted in 2013 (if they are enacted), we will effectively have three concurrent systems of taxation, an ordinary income tax calculation, an alternative minimum tax calculation and a tax surcharge calculation. Although our government does need to collect revenue to serve certain functions, the method and complexity of the taxation of individuals, trusts, estates, partnerships and corporations has gotten somewhat out of control.

A lot of discussion has been going on recently in America (see this article) about our Federal debt, deficit and method of taxation. I am in favor of dramatically simplifying the current taxation system and using some type of a "flat" tax. Although certain favored deductions would be eliminated, this could be done gradually or with some type of a standardized exemption. The new estate tax provisions are a fairly good example of this, although they are only effective for the next two years at this point. A large $5,000,000 exemption is available to all individuals and a lower 35% tax rate is imposed beyond that exemption. Although simplifying the tax code like this would dramatically reduce the need for various tax and legal professionals, the resources that are currently focused on our tax system could be put to use in much more productive and valuable endeavors. America is known for adaptability and ingenuity when it comes to our economy. I think we should reduce the complexity of our tax system and let all Americans decide how to better use their time and money.

The Efficient Market Hypothesis

So what is the "Efficient Market Hypothesis" and how does it apply to investing? This theory states that it is impossible to "beat the market" because the "efficiency" of the stock market causes existing share prices to always incorporate and reflect all relevant information. If this theory is true, it is nearly impossible to outperform the overall market, and higher returns can only be obtained by buying riskier investments.

A common perception about investment managers and "Wall Street" is that there are some super-smart people out there that know how to make money from investing in ways that no one else does. History has proven that the vast majority of "active" (those who use expert stock selection or market timing) managers do not outperform the markets as a whole. In most cases, the higher than market returns are obtained by taking on additional risk. Many on "Wall Street" also become wealthy by charging unnecessarily high fees for their advice.

If this hypothesis is correct, then what is the best approach to investing? For most people, index funds, exchange-traded funds, or low-cost mutual funds are the answer. Diversification, portfolio rebalancing and reducing costs are the three factors that can best increase portfolio values over time without taking on more risk than the individual would normally be comfortable taking. Like most fields, there are some true principles of investing, and I believe that the "Efficient Market Hypothesis" is one of these principles. I recommend that you look at this article and video for more discussion and advice on this topic.

Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010

As usual, Congress has passed a new spending bill with a long, complex name. Despite the tax savings (tax rate preservation) that comes with this bill, it also includes additional deficit spending, which has become the normal way of doing things in Washington the past several years. Political opinions aside, I will summarize a few of the highlights of this bill:

1) Extension of all current tax rates through 2012

2) Temporary modification of Estate, Gift and Generation-Skipping Transfer Tax for 2010-2012

3) AMT Patch for 2010 and 2011

4) Extension of "tax extenders" for 2010 and 2011

5) Temporary Employee Payroll Tax Cut

The average American might wonder what all of this means. With the exception of the new estate tax rates, Congress and the President have left our tax system very similar to how it is now for an additional two years. Most tax filers will see a tax return similar to 2009 for 2010 and 2011. One temporary tax reduction is the payroll tax "holiday" that reduces payroll taxes by 2%, saving most working Americans between $800 and $2,000 during 2011.

Although keeping tax rates low and temporarily reducing the payroll tax will provide a short-term boost to the economy, I feel that a better, longer-term, strategic approach to providing government services and funding our government is needed. We should let Americans work hard and innovate as they have in the past and the jobs and prosperity will follow. In the meantime, each of us should take a hard look at our personal financial situations and make any necessary adjustments in order to put our individual financial houses in order.

Long-Term Solutions

The bipartisan National Commission on Fiscal Responsibility and Reform has recently released some suggestions about how to reduce the massive federal budget deficit in the United States. One area that is being addressed is Social Security. In order to avoid massive reductions in benefits in the year 2037 (coincidentally the year I turn 65), the commission has recommended taxing more earnings, adjusting the benefit formula and indexing the retirement age, among other things. Although I don't want to debate the political merits of the various proposals at this point, I do feel that addressing significant problems with the federal budget with sustainable long-term solutions is exactly what our government should be doing. Although the outcome is yet to be determined, it is encouraging to see solutions being proposed.

I feel that my role as a financial planner is also to provide long-term solutions. My professional responsibilities can be compared to a doctor focused on health and prevention. I recommend that my clients have a financial "check-up" at least once a year. At these meetings I "prescribe" adjustments that will keep my clients' financial lives "healthy" and avoid "diseases" that might develop if financial "health" is not maintained. As it is in many areas of life, focusing on long-term solutions as opposed to short-term "band-aids" is the key to keeping our households and our nation on a "healthy" path.

Hard Work & Determination

I have heard about several employers recently that have positions to fill but are having trouble keeping them filled due to inadequate employee contributions. The news headlines might tell us otherwise, but there are jobs available to those willing to work hard, develop skills and be adaptable to change and progress. I realize that there have been dramatic shifts in the economy and things aren't the way they were before, but I feel like many of our problems could be solved by some more hard work and determination.

Although there might be a few rare exceptions, the key to a comfortable financial future is based on the same things. A realistic financial plan involves assessing one's current situation, setting realistic goals for the future and then putting in the hard work of saving, sacrificing and being determined to reach one's financial goals. In addition, it's the journey that often provides most of the fulfillment, not the destination.

I recently heard a presentation from a financially independent individual who encourages more hard work. Why would someone who doesn't "have to work" encourage the opposite. He has experienced a period in his life without work and it did not fulfill him. As a result, he has filled his life with meaningful service and reaped the fulfilling rewards that service provides. I would encourage more hard work and determination in all areas of our lives. This is what has led our country to where we are and it is what will help us move beyond our challenges in the future.