In my last post, Understanding Risk, the four tactics on to how to deal with risk, include:  reduction, retention, avoidance, and transfer.  To follow the correct path, one needs to pay attention to the likelihood of a result and the associated cost.  Today, we examine risk characteristics to gain a deeper understanding of how it applies to our lives.


Risk Capacity is your ability to withstand the impact of a negative outcome.  For example, a teenager typically recovers more quickly from a skateboard accident, while a senior citizen may experience a slower healing.

Financially, you need to review the importance of negative hurtles facing your goals.  If you are closer to retirement, pay attention to sequence risk.  It is the impact of having large negative portfolio returns in the first years of distribution.


Children often hear, “Beauty is in the eye of the beholder.”  The same is true for risk perception, where one individual may see excessive risk, another sees opportunity.   One important difference does exist from beauty; risk is not subjective.  Planners measure risk in many different ways:  portfolio beta, standard deviation, and upside to downside ratios.

When perceived risk does not reflect the real risk, a behavior may change.  For example, would the employees’ perception of the bankrupt companies, Enron, General Motors, Delphi, and Lehman Brothers lead to different behavior if they would have fully understood the risk before such a negative experience?


To achieve a stated objective, some risk is required.  From a financial plan view, resources, savings rate, goals, life expectancy, inflation, and taxes are just a few elements needed to discover required risk.

Usually, it is a minimum result needed to achieve the desired result.


Risk tolerance is a measurement of how people respond emotionally to taking a risk.  Psychologically no two people have the same emotional makeup so no universal standard applies.

In the investing arena, we often fill out a survey to “discover” our risk tolerance with questions like: How do you feel about a market decline of 20%?  What would you do in situation X?  Two problems exist with this approach:  1. Most investors do not realize when an X event has taken place to assess, how they felt or know what action they took.  Also, research shows we are inaccurate at being able to recall events. 2. As previously noted universal surveys are difficult to apply in these situations.  In reality, each person has his own history with risk.


After understanding the tactics and characteristics of risk, you now have better tools to assess opportunities and deal with a changing landscape.  Practice applying the principles by asking questions when you have meetings with your financial, and health professionals.



This weekend my family took a wonderful trip to a state park.  We hiked, laughed and played games while enjoying our time with each other.  Later, as we tried winding down, my two-year-old found her second wind and discovered the joys of jumping on the bed.  Soon, the nursery rhyme Monkeys Jumping on the Bed filled the room.  The more we sang, the more Nadia laughed and squirmed with delight.  As you can imagine and ironically as the song states, she soon fell off and bumped her head.  She escaped unharmed, but the parental instinct in me started weighing the risks of a horrible accident. The activity quickly ended.   I was soon asking myself questions about how we address the issue of risk.

What is risk?

Risk, as defined by the web, includes : 1. A situation involving exposure to danger. 2. Expose (someone or something valued) to danger, harm, or loss. These are two descriptions of risk, but the meaning slightly differs when examining it from the finance lens. Investopedia defines it as ” The chance that an investment’s actual return will be different than expected.”

There are four alternatives one can take in addressing risk:  avoidance, reduce, retain, and transfer.  The best choice depends on a function of cost and the likelihood of the event taking place.


In ten seconds, name as many activities as you can which you avoid.  The natural follow up question should be why do you avoid them?

You avoid them because of the high probability and high cost potentially associated with the event. For example, jumping out of an airplane without a parachute or bungee jumping is not attractive due to the highly catastrophic nature.


To reduce risk, choose a direction in lessening the negative result of the action.  For example, people put on a seat belt in a car.  Putting on the belt does not reduce the chance of a car wreck, but it does lower the cost of a negative result of not being thrown from the vehicle by keeping you restrained.  This is desirable for high probability and low-cost events.


Did you refuse to pay for the insurance on your smartphone?  If so, why?

People will retain the risks for events that are low cost and maintain a low chance of happening.  In our example, losing a phone is not preferred; however, the cost of a few hundred dollars does not create a life altering risk.


States request that we deal with the high cost and low probability events with automobiles by having insurance.  In a similar fashion, banks tell us to maintain a certain level of insurance coverage on homes if there is a mortgage.

The purpose for transferring the risk of low probability, high-cost events is to eliminate catastrophic dealings.

Wrap up

Below is a graphic illustrating the points we have discussed.  While risk may be a complicated subject, this information allows you to see it from a different angle.


Next Steps

What challenge are you addressing?  Review the potential cost and the likelihood of any outcome.  If you feel the issue remains complicated, contact the appropriate professional to review a plan of action.  If you do not know who to contact for a financial challenge, let me know, I will help you find the correct direction.

Alternative College Funding

Alternative College Funding

Last Friday, The Chronicle of Higher Education website published an articleabout Mitch Daniel’s plan to change the way students may take out college loans (1.) Over the weekend, I became restless thinking about the merits if his proposal, so I thought a deeper review was in order.

A quick Google search leads to this article in the Indy Star from March (2.) In it, Daniels discusses the idea of having investors fund college education through revenue-sharing agreements.  The article also states this idea has existed for decades beginning with Milton Freidman in the 1950s. Recently, Senator Marco Rubio and Representative Tom Petri introduced legislation last year with an income-sharing frame which did not advance.

Fast forward a few months and a written testimonial from Mr. Daniels shows interesting data from the second annual Gallup-Purdue index. The article notes, “nearly half of recent graduates with student debt decided to postpone a graduate education because of their student loans. A third delayed purchasing a house or a car, and one in five put off starting a business (3.)”  His testimonial proposed three approaches to help address the escalating cost of higher education: 1. Financial Transparency and Literacy 2. Accountability 3. Alternative funding.

This article focuses on the alternative funding, with the article noting investors “will presumably price that risk accordingly when offering their terms. This is true “debt-free” college (3),”  but is an income- sharing agreement really “debt free?”  The universal acceptance of debt is built on the premise that some amount will be paid in the future to the investor.  Income-sharing fits this definition by the loan recipient paying future earnings to the financier.  In pricing the sharing arrangement, how much will costs increase?  We have seen Congress keep rates artificially low on existing loans; the private market will surely demand higher compensation for the risk.  Will it be a matter of time before the students find out about the income-based repayment plans, in the same way, baby boomers started finding ways to better understand the rules of Social Security?

Many questions are being asked as a result of Mitch Daniels efforts to maintain a quality education at an affordable price for the student. We cannot, however, forget about the university faculty and staff who also face the difficulties with students.  The discussion should lead to better ideas and stronger institutions.  Mr. Daniels, thank you for opening the door for alternative funding and inviting others to join the discussion.


  1. http://chronicle.com/article/Purdue-Students-as/234549. Please note this link requires a subscription.
  1. http://www.indystar.com/story/news/2015/03/17/daniels-asks-congress-try-alternative-student-loan/24911835/
  1. https://www.purdue.edu/president/speeches/2015/151030-JEC-Testimony-Mitch-Daniels-F1.pdf



Investors have many concerns, but most focus on one of the following four items: Fees and expenses, returns, explosive nature of the markets, and taxes. All four are important but personal bias remains strong for pointing out one focus.   What are these four concerns and how can you help lessen your bias?


Do you get what you pay for? Investment studies often show the lower you pay in expenses, the more your portfolio grows strengthening the effect of compounding. The most common investor behavior involves having many funds covering the same area of the market.

The idea, known as overlap, results in owning the same stock in different funds or exchange traded funds while the managers charge different expense  ratios.  This increases the overall cost and may not result in the desired diversification.

By paying attention to internal fees and overlap, cost is controlled.  Make sure you are optimizing value for the expense.


“How do I compare with the S&P 500?” “How do I compare with other people?” Investors love seeing how their portfolio stacks up.  It makes us feel good when we are “doing better.”  What does that mean?  Does the comparison help you create more dollars to spend?

Remember, returns are only a proxy.   Are you comparing your portfolio to a similar risk profile?  Does the risk profile fit the risk characteristics of your individual needs?  How much excess return over inflation are you realizing?  The planning world calls this excess return (Portfolio return- Inflation= Excess Return.)

While we cannot control the returns of the market we can control how much or little we participate, helping create a lot or little excess return.

Explosive Nature

Many people remember the technology bubble; everyone remembers the crisis from 2008. When the market blows up, asset values decline and people worry. Volatility is a requirement for the business cycle to work. New businesses spring up, markets become waterlogged and a consolidation takes place, leaving behind the stronger companies.

As outlined with returns, individual investors cannot move the stock markets by themselves, but how much you participate directly relates to the volatility a portfolio will experience.


No one likes paying taxes, but as the old saying goes, “There are only two things for certain, death and taxes.” We cannot avoid paying taxes, so the objective should be to lessen the amount paid over a lifetime. Year after year, we tell a story to the government via a tax return. It is told by numbers, what you did, where income originated, activities of your family.   Yearly, we seek to lessen taxes on the current chapter of the story.  In fact, to help reduce lifetime taxes, a few years require paying more to the government.

Change the way you look at taxes and practice diversifying your assets across the tax code, as well as practicing asset location (the act of placing investments in select accounts for tax efficiency.)


Four causes create issues for investors.  Investors control two (fees and taxes,) while two are independent of individual influence.  To have long-term success, balance remains a key.  At one moment taxes need to be addressed, another requires a change to the portfolio as risk may change.  I think of a labyrinth game with the marble moving around the board. To finish, you need to avoid the holes along the way. Progress is made by making slight tilts along the way.

Take a look at your portfolio to see how it is balanced.  If you need help contact your advisor or check out some of my other posts for more insight.


As we slide into the last two weeks of the year, many people begin their tax planning. This often includes setting goals for the new year.  The end of 2015 brings with it changes to college funding that are substantially different from previous years.  President Obama recently announced changes for the Free Application for Federal Student Aid, aka FAFSA. While the announcement came late, there is still time to look make adjustments lessening the impact of the new direction.


Two changes start with the 2016-2017 FAFSA.  Firstly, the form will no longer share the list of colleges that students place on the application. On a recent teleconference call, Mark Kantrowitz discussed the unspoken practice of colleges reviewing the list of colleges placed on a student’s FAFSA form.  The reviewing institution prefers to see their name listed in the top 3. Students typically list colleges on the form in order of preference (1.)

The second and larger change deals with the timing and tax returns used for FAFSA filing.  First, please note there are NO CHANGES for the 2016-2017 filing for parents and students (2).  However, starting with the 2017-2018 school year FAFSA,  parents and students will no longer be using the prior year tax returns and they may submit the form as early as October  1st.  The information from tax returns from two years ago will be used for the application.  See the table below (2).

Fasfa changes

After reviewing the table,  note the 2015 tax return will be used for two years and the submission date is earlier. Earliest submission is recommended by financial aid advisors because colleges can choose to decrease the amount of funds available as the application period progresses.


The Federal Student Aid office uses personal and family income as an important determinant of the amount of funding  a student may receive.  Better understanding of that formula helps parents and students  develop strategies that  increase the amount awarded. Kids and Money

The funding formula may require zero to 47% of a parent’s income  (minus taxes and allowances) to fund a college education plus  5.6% of reportable assets (not including the family home, retirement accounts, small family businesses, or assets
up the protected amounts (1.)) The number of children in college adjusts the amount of expected family contribution.  Students should be ready to use half of their income over the income protection allowance plus 20% of all reportable assets (typically UGMA/UTMA, and other savings accounts (1.))


  1. As noted above, 2015 will play in important role in college planning for the next two years. Since the calendar year closes soon, here are a few items to consider for reducing your income.
  2. If you have large realized capital gains, consider selling your losers to reduce income.
  3. Contribute as much as you can to tax deferred accounts (IRAs, 401ks.)
  4. Consider placing your dividend and interest paying investments in your tax-deferred and Roth accounts. Consider the potential gains paid out by mutual funds.
  5. Make two years of charitable contributions in 2015 (up to the allowable limits.)
  6. Make your January house payment at the end of December to claim the extra interest on your 2015 taxes.
  7. If you itemize deductions,  pay your state taxes by year-end.
  8. Some states allow deductions for contributions to your state sponsored 529.  Here is a link for more information.  http://news.morningstar.com/articlenet/article.aspx?id=718471


As you head into the end of 2015 and examine the story you tell the IRS, keep in mind the potential impact on your college funding for the next two years.  Any income deferred may help increase the chances of receiving aid. Please check with your financial or tax professional for additional information and questions about your situation.


  1. 10/20/15 Teleconference  with Mark Kantrowitz.  The Fundamentals of FAFSA & College Planning
  2. https://studentaid.ed.gov/sa/about/announcements/fafsa-changes. Information accessed 10/22/15

Need to raise funds for a university, church, or charity?

As Congress was pushing up against their deadline working to “fix” the budget issue last year (as they had before), a great planning opportunity arose for many people and institutions. Specifically, by making the charitable donation of your required minimum distribution (RMD) permanent, charities may receive funds earlier versus passing the assets to the institution by means of an estate.  The RMD (up to $100,000) will stay off the donor’s tax return which may help in avoiding the impact of additional income on a 1040.

Important Considerations

For the provision to work, consider the following:

1.    You must be taking RMDs. If you are not 70.5 then the rule does not apply.

2.    You may donate up to $100,000 of your RMD yearly.  (This is not a problem for most people.)

3.    Only the amount up to your RMD will qualify. Any donation above your RMD will still be placed on your tax return. It would then be then taken off as a charitable contribution, but may be subject to the previously stated issues.

Next Step

If you plan on giving to a charity, church, or university review the updated provision so see how it may affect your philanthropic giving.  Contact your advisor for more details.

Please feel free to review IRS Notice 2007-7 for more information (1.)



2. http://wealthmanagement.com/retirement-planning/sixteen-examples-qualified-charitable-distributions-individual-retirement-accoun