Archive for the ‘General’ Category

Financial Exploitation of Elderly Adults

Friday, May 29th, 2020

Earlier this year, we wrote a piece about the large and rapidly growing scourge of elderly financial abuse. And while we were only able to briefly introduce the issue itself, we promised to dive deeper into financial exploitation, financial fraud, and investment fraud in future pieces. In this piece we want to focus on financial exploitation of seniors; what it is, how it can happen, and how seniors and their families can prevent it.

Recall that we defined Exploitation as the illegal or improper use of a senior’s resources for another’s profit or advantage, perpetrated by someone the senior knows. In almost all cases, the perpetrator is exploiting their position of authority or responsibility. Having gained the senior’s trust, the perpetrator is given their authority / responsibility by the senior themself.

In other words, financial exploitation is perpetrated by an “insider”, which makes this form of financial abuse potentially less likely, but at the same time, more difficult to detect and ultimately more devastating financially. According to the FBI, the average financial loss to a senior when a stranger is involved is $17,000. Compare that to the average loss when a family member is involved ($43,000), a non-family care giver ($58,000) or a fiduciary, like a trustee or power of attorney ($84,000).  

Although there are countless scenarios we could discuss, for the sake of brevity, we want to touch on two: Caregivers and Designated Agents based on a Power of Attorney declaration.

Caregivers are in a unique position of authority and can use that position to extort money from seniors, by, for example, refusing to perform certain services unless the senior pays them to do so. Extortion may include threats of violence. Because caregivers are unlikely to have any legal authority to exploit a senior under their care, they rely on manipulation.

Exposing financial exploitation by caregivers can be challenging because perpetrators may instill fear in an effort to prevent the victim from notifying family members. But families can prevent this type of abuse by 1) carefully vetting any care-givers hired and performing background checks (including financial background checks), 2) designating a family member or members (none of whom are care-givers) to periodically review bank accounts and financial transactions, and 3) paying attention to the non-verbal signals that a senior may be displaying. If a senior family member is being exploited, they know something is wrong and are most likely uncomfortable with it, making it difficult for them to hide.

Designated Agents are authorized, through a Power of Attorney declaration, to handle legal and financial matters for the individual making the declaration. Agents per a Power of Attorney generally have no restrictions as to their authority, and although the majority of Agents handle their responsibilities fairly, the lack of restrictions can open the door for significant exploitation over long periods of time, which is why the average loss when a Power of Attorney or other fiduciary is involved is so high.

Before signing a Power of Attorney (which may be part of a senior’s estate planning documents), the senior must trust the designated agent without question. And even then, exploitation can happen. Even the best-intentioned Agents can make poor decisions if placed in stressful personal situations. If a senior executes a Power of Attorney, they should notify their other family members they have made the declaration and, in order to impose accountability upon their Designated Agent, provide at least one other family member with the ability to view bank and investment account balances, transactions, and statements.

Whereas caregivers rely on manipulation, Agents rely on deception. However, both rely on secrecy, which is why sharing financial information with other family members is critical.

Given the risks that a Power of Attorney entails, seniors may be tempted to simply add someone (such as a child) to their financial accounts as a joint owner. This is never advisable. It opens the senior up to the liabilities of the joint account owner and can alter or frustrate the execution of the senior’s estate plan.

So, while we highly encourage all our clients to draft and periodically review their estate plan regardless of age, it’s even more important that seniors draft their estate plan before they experience any limitations in their mental capacity. Once they become dependent upon someone else, the situation is fraught with risk and the potential for fraud.

If a senior’s estate plan incorporates a Power of Attorney, the plan must also incorporate a system of checks and balances to discourage and detect exploitation. It’s also important that the senior notify all family members of their intent to designate an Agent; it will prevent confusion, surprise, and potential animosity among family members, which often happens when a designation was made but not communicated until after the senior’s incapacity.

A senior’s other professional advisors (CPA / bookkeeper and Financial Advisor) have important roles to play in the prevention and detection of exploitation. Financial advisors have some authority to delay or in some cases deny withdrawal requests from investment accounts if they suspect fraud. This authority relies on a concept called a “Trusted Contact”, a topic we’ll discuss when we cover the prevention of investment fraud, but is one of the reasons we advocate that, when appropriate, our senior clients introduce us to their other professional advisors and to their children.

Which brings us back to the original point of our initial piece; protecting our seniors depends on a family’s willingness to work together with their professional advisors to protect their elderly family members. And while there are numerous laws and regulations in place to protect seniors, the first step in prevention and enforcement begins with you!

We would like to specifically thank Jeremy Cohen, estate planning attorney at Burns, Figa & Wills PC in Denver, for his input and help writing this piece.

For further resources:

National Adult Protective Services Association | National Adult Protective Services Association

Making Sense of the CARES Act Program for Small Business – Hint: It’s a First-Come, First-Served Program

Wednesday, April 1st, 2020

Covid19 is a big problem for many small businesses, which often lack the financial resources to withstand a prolonged revenue slump. In an effort to ensure the Covid19 outbreak doesn’t become an economic depression, the U.S. Federal Government passed the CARES Act, which includes a $349 billion provision for small businesses, defined as those with 500 or fewer employees. We prepared this synopsis for our business-owner clients and are happy to share it with you.

The first thing you need to know about the resources available: they are first-come, first-served. Although applications can be submitted right now through the Small Business Administration’s website directly (, the SBA has authorized its local lending network of banks, credit unions, and other lending institutions to begin processing applications on its behalf using the established guidelines starting on Friday. Applying through your local financial institution, with which you already have a relationship, will result in receiving a decision and funds quicker, even though the window doesn’t open until Friday. The SBA is encouraging businesses to apply through their local lending institution specifically for this reason.

The CARES Act contains four separate programs for small businesses: 1) Paycheck Protection Program (PPP), 2) Economic Injury Disaster Loans and Loan Advances, 3) SBA Debt Relief, and 4) SBA Express Bridge Loans. Qualifying businesses have 500 or fewer employees and are not engaged in federally illegal activities (no Pot shops, according to our reading of the guidelines), gambling, pornography, agriculture, or lobbying.

Independent contractors and sole proprietors are eligible for the programs, as are other forms of entities with 500 or fewer employees: private non-profits or 501(c)(19) organizations, cooperatives, ESOP’s, or tribal small businesses. Agricultural cooperatives, nurseries, or other businesses with more than 500 employees that are small under the SBA Size Standards are also eligible.

The Payroll Protection Program (PPP) – The PPP is designed to encourage small employers to retain their employees by providing a 2-year loan at 0.5% interest, whereby loan payments are deferred for 6 months. If at least 75% of the proceeds are used for payroll expenses (company sponsored health care included), the loan will be forgiven. The other 25% can be used for rent, utilities, and mortgage interest. No collateral or personal guarantees are required, and neither the government or lender will charge any fees for the application or the loan. Loan forgiveness is based on the employer retaining all its employees at their current salaries, or quickly rehiring them at their previous salaries. Forgiveness is reduced if full-time headcount is reduced or salaries / wages are reduced. Applications can be made through any SBA 7(a) lender, FDIC insured depository institution, federally insured credit union or Farm Credit System institution that is participating.

Economic Injury Disaster Loans / Loan Advances – The EIDL is an existing SBA program designed to provide small businesses impacted by disasters the capital needed for various expenses. In previous disasters, the loans could be used for any business expenses such as payroll, rent and utilities, but the PPP makes this program more useful for businesses that also need capital for working capital needs, such as inventory replenishment, making payments to vendors for accounts payable balances, making loan payments, etc. Loans are made at 3.75% annual interest rate (2.75% for non-profits), can have maturities as long as 30 years, and can be made for up to $2 million. With the CARES Act, applicants can apply for a $10,000 loan advance under this program, which would be forgiven.

SBA Debt Relief – The SBA will pay the principal and interest payments of any existing 7(a) loans for six months and will pay the principal and interest of new 7(a) loans issued prior to September 27, 2020 for six months.

SBA Express Bridge Loans – A lending facility for small businesses with pre-existing relationships with SBA Express lenders. It will provide up to $25,000 with less paperwork than the EIDL. They can be used as either a term loan or as a bridge loan to help the business with short-term working capital needs until their EIDL application is processed, accepted, and funded.

It’s important to note that if a company applies for and receives funds under the EIDL for the purposes of paying payroll and/or payroll support, it is not eligible to receive funds under the PPP. In other words, the two programs are mutually exclusive. As a result, while the PPP is the preferred program to apply for, it may not sufficiently cover all business expenses in cases where non-payroll expenses and working capital needs are likely to exceed cash on hand / anticipated cash flow.

We recognize that each business will have its own unique characteristics that make the decision about whether to apply for assistance, which program to apply for, and how much to apply for different for each business. Making these determinations will require some financial analysis, budgeting, and financial projections. We encourage you to reach out to your financial advisor for assistance with these programs and making these decisions. And of course, if you don’t have a financial advisor to reach out to, we’d be happy to discuss your situation. Feel free to call or write.

In the meantime, stay healthy and safe, and enjoy this unusual opportunity to slow down and spend time with family.

The One Gift Covid-19 IS Giving Us

Friday, March 20th, 2020

As our society reluctantly adopts various measures designed to limit the spread of Covid-19, I’ve noticed more articles offering suggestions for how people can adjust to the challenges of social distancing, and in particular, how families can handle the stress of everyone being at home for a prolonged period of time. No doubt, certain aspects of the current pandemic are truly stressful, such as caring for an ill family member, a sudden and unexpected employment dismissal, or the unprecedented financial market volatility. But spending more time with family should not be one of them. In fact, spending time with family is one of the greatest gifts that Covid-19 is giving to us right now. It’s also an opportunity for me to highlight a broader, more comprehensive perspective of wealth, one that we continually try to reinforce with our clients.

The term “family wealth” is almost universally construed as “financial capital”, but in fact, a family’s wealth is much more than that. In his book, Family Wealth – Keeping it in the Family, James Hughes Jr. proposes a comprehensive framework by which a family can define its wealth, comprised of Human, Intellectual, and Financial capital.

Financial capital is relatively easy to understand since it’s what most families immediately think of. But what are Human and Intellectual capital? Human capital is comprised of the members of your family, who, by virtue of their existence and familial ties, make the family possible. Their individual characteristics, personality traits, desires, passions, skills and talents contribute to the identity of the family, imbuing it with a uniqueness that is infinitely valuable.

Intellectual capital is the knowledge each family member themselves, as well as the family as a whole, has acquired over generations. This can be thought of as formal education, but each family member also learns a tremendous amount outside of school: how to change a tire, how to throw a baseball, how to cook grandma’s special lasagna. Moreover, Intellectual capital has an intrinsically external element, since with it, each family member individually, and the family as whole can have a positive impact on their community.

Without dismissing the importance of a family’s Financial capital, it has value only in so much as it supports the development and advancement of the family’s Human and Intellectual capital. These, in turn, should be used to replenish the family’s Financial capital, as depicted in this graphic we often use with clients.

Would it surprise you if I stated that Financial capital is on the bottom of the graphic specifically because it’s the least important of the three?

So with this opportunity to spend more time together as families, let’s look for and be amazed at the Human and Intellectual wealth we all possess. Let’s not fret over the financial stresses, especially those that may arise from financial market volatility – this too shall pass. Let’s capitalize on this time with our family members, enjoying fun, enriching, and enlightening activities together. Let’s talk, play, learn, and even work (spring cleaning anyone?) together as a family, recognizing that Covid-19, with all the true stresses that come with it, has also brought a tremendous gift, an opportunity to unplug from life’s hectic pace and insatiable obligations, to simply revel in the true wealth we all have. Though we all hope to return to our normal routine soon, and that all those affected by Covid-19 will make a full recovery, I hope that this perspective on family wealth will bring tremendous joy and peace during these unusual and potentially traumatic days, weeks, and months.

The Shocking Reality of Financial Exploitation and Fraud Against Seniors

Thursday, January 23rd, 2020

Let’s be blunt – there isn’t anything so despicable as abuse and exploitation of our most vulnerable members of society. And while child abuse / exploitation / trafficking is as despicable as it gets, the exploitation and fraud perpetrated on the elderly is just as malicious, in our opinion. And yet, it’s a shockingly common occurrence that, left unchecked, will continue to grow exponentially, as it has in the last 3 years.  

Every day in the United States, 10,000 people turn 65. In 20 years, there will be nearly 80 million Americans over the age of 65. The Baby Boomer generation has accumulated a significant amount of wealth, the fruit of decades of strong economic growth and rising investments and property values. It’s no surprise then that this demographic is also the constant target of abuse and fraud.

Consider the size of the problem:

  • $3 billion stolen or defrauded from millions of seniors every year – The Department of Justice
  • The North American Securities Administrators Association (NASAA), which polices and regulates small and medium-sized investment firms, estimates that at least ONE THIRD of the legal enforcement actions it takes every year involve senior investors.
  • 63,500 reports of suspicious financial activity involving seniors in 2017 – up 400% from 2013 – The Consumer Financial Protection Bureau
    • Average loss for age 70 – 79 = $45,300.
    • Average loss when a fiduciary was involved = $83,600
    • Average loss when a family member was involved = $42,700.
    • Average loss when a non-family caregiver was involved = $57,800
    • Average loss when a stranger was involved = $17,000

The frequency with which financial exploitation and fraud is perpetrated against the elderly might not strike you as a lot. But consider the fact that only a fraction of the perpetrated cases are actually reported to authorities, in large part because seniors may not be aware they have been exploited, they may be embarrassed to report it, or may be fearful of reporting it.

According to the FBI, seniors are particularly attractive targets for a variety of reasons. In addition to their sizable assets, they have excellent credit, which gives them access to additional financial resources that can be exploited, and they tend to be trusting and polite, which makes it hard for them to say “No” or hang up the telephone. They tend to be less astute with technology and can easily fall prey to email and other internet phishing scams. Moreover, they tend to make poor witnesses; because many of them don’t realize they’ve been exploited until some time has passed, they often have difficulty relaying details to authorities, which hinders the investigation.

But fighting financial exploitation doesn’t have to be complicated. It takes an awareness of how financial abuse of seniors is most commonly perpetrated and a family’s willingness to work together to protect its elderly members. And while there are numerous laws and regulations in place to protect seniors, the first step in prevention and enforcement begins with you! It’s important that your family understand the different types of abuse and fraud, the red flags that indicate a family member might be targeted, steps you can take to prevent it, and what to do if it happens.

Exploitation – the illegal or improper use of a senior’s resources for another’s profit or advantage, perpetrated by someone the senior knows.

Fraud – the theft or use of a senior’s resources through deception, perpetrated by someone the senior does not know.

Because Exploitation and Fraud are different in nature, preventing, identifying, and rectifying them require different approaches. In the next few posts, we’re going to take a deeper dive into Exploitation, Financial Fraud, and Investment Fraud, a subset of Financial Fraud. We’ll finish with a general discussion of best practices for families with elderly family members.  But in the meantime, we encourage you to review the following resources for additional information, and to begin having conversations within your family about it.


Through the eyes of a 10-year-old – The Fed’s Policy of Financial Repression is Suddenly Personal

Thursday, December 5th, 2019

I’ve written about the deleterious effects the Fed’s interest-rate setting policy is having on savers. Of course, as a saver, I have personal experience with the ramifications. But this weekend, my experience is about to get a whole lot more personal.

About a month ago, my 10-year-old son begged me to take him to the bank to open a savings account for him, like I had done the previous weekend for his older sister. Enamored with the idea that he would have his own savings and checking accounts (complete with debit card) he attentively listened to my explanation of how banks work, how savings and checking accounts work, and how interest rates work. He astutely placed all of his money into his savings account after determining there wasn’t anything he needed or wanted to buy in the near future. Plus, he really wanted his money to start working for him, to earn as much interest as possible.

For the next week, he’d ask me every day whether he had earned any interest, to which I would reply, “Yes you have, but the bank only adds it to your account at the end of the month, and if you recall our conversation about interest rates, it’s not going to be a lot, so don’t get your hopes up too much”.

In our house, I balance our accounts every 2 weeks, to coincide with my wife’s paycheck cycle. And as part of this process, I now reconcile the accounts my children have. I then print a report for each of them and we review it, talking about what they’ve spent, what they’ve saved, and their ending balances. I find that it serves as an excellent opportunity to talk to them about concepts like wants versus needs, savings goals (future consumption versus current consumption), and how much they’d like to set aside to give to others less fortunate than they are (philanthropy). This weekend I get to talk about the interest he earned on his account.

One penny, to be exact.

And this isn’t because the amount of money is his account is very low. He actually made a healthy contribution to his saving account, one, that it a normal environment, could reasonably be expected to generate enough interest income over the course of a few monts to buy a used video game. But alas, I get to explain to him that he earned a whopping 1 cent. I realize we could shop around for better rates, and I could introduce him to other products, such as CD’s that would offer slightly higher rates. But that’s not the point of this piece. I’m thinking about his reaction, the conclusions he’s going to draw from it, and by extension, what our “lower for longer” interest rate environment is doing psychologically to an entire generation of children, adolescents, and young adults.

We know that our experiences with money during our formative years dictate our relationship to money. We know that, for example, the Great Depression severely affected how an entire generation viewed stocks and banks – their distrust was so strong that many of them swore never to own a stock or use a bank. Ever. For young children, growing up in a family confronted with financial scarcity profoundly effects their worldview when they become adults.

So, naturally I’m worried about his reaction this weekend. I fully expect him to be disappointed, and rightfully so. But what I’m even more concerned about is the lesson he’ll take from it, and the decisions he’ll make going forward as a result.

If his hard-earned money (and I mean hard-earned, a lot of his money came from 10-hour days of physically demanding yard work during the fall) is earning virtually zero, what’s the incentive to save at all? Will he decide to “screw it” and scrap his savings goals and splurge on another video game or lightsaber?

Theoretically, we save because the benefit derived from future consumption is greater than the benefit derived from current consumption. An inherent aspect of this trade-off is the expectation that by postponing current consumption, future consumption will be higher. And in fact, due to inflation, it must be higher.

But how can a 10-year-old child, who is constantly bombarded with the temptation to embrace the American Consumerism lifestyle in all its glory make the prudent decision to forego spending his money today and save it for tomorrow, when there is no incentive to do so? In fact, although he isn’t aware of it yet, there is a clear disincentive to save his money precisely because he is losing purchasing power every day his money sits in a savings account. In order to simply break even on an after-inflation basis, he would have to purchase a 30-year U.S. Treasury bond – and at the age of 40, his money would be no better off then than it is today.

The financial advisor in me is tempted to try to convince him that “because interest rates are so low, it’s even more important for you to save your money”, but I’m not confident he’ll be able to comprehend that logic, and even if he does, that he’ll make the commitment to see it out.

And by extension, how will his generation, and the generation before him, react when they start saving money and experience first-hand the paltry payback to making the prudent decision? I fully recognize the goal of the Fed’s policy – to incentivize spending today, even at the expense of spending tomorrow. And there is something to be said for the Fed’s efforts in 2009 – 2012, when the U.S. economy was still recovering from the Great Financial Crisis. But here we are, 10 years later, with a U.S. economy that is growing at / slightly above its long-term potential, and we still have extreme financial repression.

The consequences of the Fed’s financial repression on the baby boomer generation is well-known, and tragic to say the least. But until this week, I hadn’t considered the ramifications for the youngest generation of savers who are growing up to learn that their hard-earned money is not going to work as hard for them as they did for it.

How will they react? Are we creating an entire generation that will view savings as a futile effort? That in order to preserve purchasing power and maximize utility, they should spend what they earn as soon as they earn it? Or that because borrowing money is so inexpensive, the rational course of action is to accumulate debt to ramp up current consumption and “improve” their lifestyle?

As concerning as these questions are for me as an advisor, there is one question that keeps me up at night as a dad – how do I answer my son when he asks “What happens if the U.S. Mint stops making the penny?”

Which is better, giving your children an allowance, or paying them to do chores?

Friday, November 1st, 2019

When our clients with young children ask us whether they should be giving their children an allowance or paying them to do chores, our answer is almost always “Yes”. The question is most often posed as an “either/or”, but in fact raising financially literate and capable children is a “both/and” answer. Allowances and payment for chores each have their own purposes and benefits, and are therefore, both situationally appropriate and complementary.

It helps to step back a moment and consider the qualities that a financially mature and prudent steward of wealth should possess. These ideal qualities are both values (which we refer to as virtues) and skillsets gained through experience. While every family is unique, and therefore should draft their own list of virtues, we encourage our clients to consider the following:

  • Temperance / Self – Control: Let’s face it, we live in a consumeristic society on steroids that offers to satisfy our every need and want, often by tempting us to cast aside the virtue of temperance and self-control. But temperance and self-control are the foundation of proper saving habits.
  • Perseverance and Fortitude: Recognizing that the financial journey is more akin to a marathon than a sprint, and that the marathon will include extended phases that prove challenging and frustrating, perseverance and fortitude, which necessarily include patience, are essential to the accomplishment of long-term goals.
  • Appreciation for accomplishments earned through meaningful work: Psychological studies overwhelmingly prove the inherent importance of meaningful work. The ability to provide for one’s own needs is a factor (self-sufficiency), but the evidence also points to the satisfaction we derive from meaningful work that contributes to the good of something beyond ourselves.

Coupled with these virtues are specific skillsets that a financially mature and prudent steward will possess. These include:

  • Self-sufficiency: the ability to take care of one’s self.
  • Familiarity and comfort with the tangible and intangible concepts of money as a means of exchange and a store of value. This skillset begins with an introduction to physical money, bills and coins, the use of a wallet for safekeeping, ultimately graduating to an understanding of how a free market economy functions, how banks function, the difference between checking and savings accounts, the power of compound interest, credit, taxes and investments.
  • An appropriate work ethic, which includes the ability to pay attention to detail and the desire to demonstrate initiative.
  • An understanding of and rightful expectation to fair compensation for work performed. Receiving fair compensation is a critical factor in an individual’s sense of self-worth. Paying someone too much is just as detrimental to a person’s self-worth as paying them too little.

The above virtues and skillsets are just the starting point, upon which we encourage our clients to build. Yours will hopefully include these factors, as well as those you deem important. But let’s look now at how both an allowance and payment for chores can be used to imbue and teach these virtues and skillsets.

We view an allowance as the initial step in building financial literacy and prudent stewardship. It can begin as early as the child can count, and indeed, money is often used in schools to teach and reinforce counting, addition and subtraction. We encourage our clients to pay an allowance as cash (as both bills and coins) so that children develop a familiarity with the tangible nature of money; as they get older, this familiarity with the tangible nature of money will help them as their interactions with money become increasingly, and perhaps exclusively, intangible in nature. The point of the allowance is to develop familiarity with money, and its purpose: a means of exchange, or simply put “to buy or obtain things”.

Which is why we discourage our clients from linking the allowance to the performance of chores or household duties. Simple duties, such as picking up toys from around the house, keeping their rooms tidy, making their beds, brushing their teeth and hair, bathing and clothing themselves and doing their homework (if they have any), are important opportunities to learn self-sufficiency. But its too early, in our opinion, to begin teaching them the link between money and work. That comes later.

The value of the allowance should be appropriate for their age and the cost of the things they want to buy. An allowance that makes it too easy for them to buy whatever they want defeats the purpose of teaching them patience, whereas an allowance that requires them to wait an extraordinarily long time to purchase even the most inexpensive items risks exhausting their patience tempting them to mentally “checkout” altogether.

When used properly, the allowance is a powerful tool to teach children familiarity with money, the basic concept of a free market economy and the cost of items, while they are also practicing self-sufficiency, temperance and self-control.

As children approach middle school, we encourage our clients to transition their children away from an allowance in favor of payment for chores in order to introduce them to the concepts of fair compensation and to experience the financial and emotional rewards involved with meaningful work. In our own home, when we transitioned our children to payment for chores, we stopped their allowance but required them to continue performing the duties they were already performing to reinforce self-sufficiency (and since the two were never linked, we received no pushback on it). We added additional chores that benefitted the family, such as routine household cleaning and helping with projects around the house and in the yard. We assigned a payment schedule to each chore, based on the difficulty of the task in light of their age and abilities.

As our children got older, we introduced the concept of pay for performance, by applying a sliding payment scale to the list of chores – a basic or mediocre performance earned a base / mediocre pay rate, whereas an excellent performance, where attention to detail was very good and they demonstrated initiative by doing something that wasn’t specifically requested, would earn significantly more, in many cases double the rate of the base / mediocre performance. As they got older, we allowed them to negotiate (to some extent) the payment for chores done so they could explore their own perception of fair compensation. As our daughter entered high school, we encouraged her to seek work outside of the house, with an eye toward helping her hone the work ethic skills and put her perception of fair compensation to the test.

While we didn’t touch on it here, the topics of wants versus needs, allocating money into “Save”, “Spend”, and “Give” buckets, and the introduction and use of piggy banks, wallets / purses, and bank accounts are inextricably linked to the question of whether to pay an allowance or pay for chores. For the sake of brevity, we’ll cover these topics in future posts.

In terms of the original question though, whether to provide an allowance or pay for chores, we’d like to conclude with this thought: children will adopt values / virtues and skillsets regardless of whether you intentionally teach them. If the point of parenting is to shepherd our children through the pitfalls and dangers of the world, while introducing them to the joy that comes from self-sufficiency, meaningful work, patience, temperance and self-control, and familiarity and comfort with money, we owe it to them to use both an allowance and pay them for chores, since both offer important experiential learning opportunities. If your children are too old for an allowance, that’s ok, you can always start with payment for chores, which, if structured properly, will still imbue the values / virtues and teach them the skillsets you want them to have.

Financial literacy is a fundamental necessity to happiness in life. Unfortunately, it’s not something our consumeristic culture is going to teach them. So it’s up to us, as parents, the first and primary educators of our children, to help them learn and grow into the financially literate, mature, and proper stewards of whatever wealth they have at their disposal.

Rising Interest Rates – Is a Bond Bear Market Such a Bad Thing For Investors?

Friday, September 21st, 2018

In the last few days, bonds have experienced a sharp upward movement in yields across all maturities, but especially so in what traders call “the belly of the curve”, maturities between 2 years and 10 years. And since bond yields and bond prices move inversely to each other, as bond yields have risen, bond prices have fallen, creating a drag on the performance of portfolios that hold a diversified basket of stocks and bonds. The decline in bond prices and the resulting drag on portfolio performance prompts two questions. 1) “Is the bond bear market, which pundits have been forecasting for years, finally here?” and 2) “If bond yields continue to rise, and bond prices continue to fall, should an investor maintain an allocation to fixed income in their portfolio at all?”.

While the first question makes for good cocktail conversation, we think it’s too early to forecast with any certainty whether bonds have entered into a prolonged, multi-year bear market. Only time can answer the first question.

The second question, however, is an important one. In order to answer it, we have to look at the key risks that bond investors face when allocating a portion of their portfolio to fixed income, and we have to look at what vehicles investors use to satisfy that allocation.

First, bond investors face a number of risks, most of which are peculiar to the specific bond they are considering purchasing, and therefore, can be eliminated simply by avoiding particular types of bonds (high yield bonds, for example carry greater default risk, whereas U.S. Treasuries carry virtually no default risk). For the purposes of our discussion, there are only two risks we need to consider: interest rate risk, whereby bond prices fall when interest rates rise, and reinvestment risk, whereby bond payments received (interest and maturity) are reinvested at lower interest rates.

Since bond prices fall when interest rates rise, allocating a portion of a portfolio to fixed income necessarily incorporates interest rate risk, BUT ONLY WHEN CERTAIN TYPES OF FIXED INCOME VEHICLES ARE — USED. As we discuss in a moment, investors can effectively mitigate the interest rate risk by avoiding certain types of fixed income investments.

Reinvestment risk, on the other hand, is a bond investor’s friend when interest rates are rising. When a fixed income investor receives interest payments, and especially when a bond matures, those cash flows can be invested at higher interest rates at that moment in time, which increases the investors’ overall rate of return, all else equal. So in a rising interest rate environment, reinvestment risk IS ACTUALLY BENEFICIAL to fixed income investors, and therefore, argues in favor of an allocation to fixed income when interest rates are rising.

But not all fixed income vehicles are created equal. In fact, there is a wide disparity between the effectiveness and therefore usefulness of various fixed income vehicles. On one end of the spectrum are individual bonds, which, when used properly, are effective at mitigating interest rate risk, leaving only the positive impact of reinvestment risk. On the other end of the spectrum are bond funds, whether they be exchange traded funds, actively managed mutual funds, or passively managed index funds. In truth, these funds have more in common with stocks than they do with bonds.

Let’s start with individual bonds. An individual bond’s ability to mitigate interest rate risk is solely the result of its nature as a contract, which specifies a defined maturity date and maturity price. Excluding the possibility of default (breach of contract), an investor can be assured of their rate of return when they purchase the bond, because they know exactly what price they paid for the bond, what their cash receipts will be, and when they will receive them. This assurance is what gives bonds their “anchor to windward” characteristics, and why they are considered to be, in general, a risk-averse, defensive, less volatile asset class than stocks. Granted, between the time an investor purchases a bond and the time it matures, the price of the bond will fall if interest rates rise, but the bond’s price decline IS ONLY TEMPORARY. Once the maturity date of the bond draws closer, the bond price will approach the maturity price, such that upon maturity, the investor will receive exactly what they expected to receive. In this way, an investor can ignore the negative impact of rising interest rates on an individual bond, with the confidence that the price will recover, and that ultimately they will earn the rate of return they expected when they purchased the bond.

On the other end of the spectrum are bond funds, which are fully exposed to interest rate risk. Unlike individual bonds, bond funds lack the contractual mechanism (stated maturity date and maturity price) that offsets interest rate risk. There is no mechanism that returns a bond fund’s price to a pre-determined level at a pre-determined time. Moreover, the absence of a stated maturity date and maturity price robs an investor of the certainty and confidence that an individual bond would otherwise provide. Because a bond fund investor does not, and cannot, know the price at which they will sell the fund, their ultimate rate of return when buying a bond fund is not only unknown but unknowable. For this reason, a bond fund is more akin to a stock, which has the exact same characteristics, than an individual bond.

In most cases, the interest rate risk is larger than the potential gain an investor would receive from reinvestment risk when interest rates are rising. Therefore, it’s entirely feasible for a bond fund investor to LOSE money during a rising interest rate environment, while an investor using individual bonds would MAKE money during a rising interest rate environment, AND be in a more attractive position since they can now reinvest their cash receipts at even higher interest rates.

As with all things, there are a few caveats. First, an investor who buys an individual bond and sells it prior to maturity would take on interest rate risk, in exactly the same way a bond fund investor does. Offsetting interest rate risk requires an investor to hold the bond to maturity. Second, there are bond funds that have stated maturities, and while they have stated maturity dates (roughly, within a few days), they do not have a stated maturity price, and therefore, the ultimate rate of return is still uncertain, just like it is for a bond fund.

So, back to our question – “If bond yields continue to rise, and bond prices continue to fall, should an investor maintain an allocation to fixed income in their portfolio at all?” The answer is “Yes, as long as they use individual bonds for their fixed income allocation.” In fact, we’d even go one step further; an allocation to Fixed Income using individual bonds is especially important when interest rates are rising because rising interest rates often mark the final phase of an economic expansion, before economic activity declines and stock prices decline with it. But we’ll save that topic for our next entry.

In the meantime, if you have questions or comments about this piece, or own bond funds and have already experienced losses in them, or concerned you will in the future, shoot us a note. You can use the “Contact us” form at the bottom of this page, or simply email us directly.