Estate Planning for the Modern, Blended Family

Following an Efficient Financial Strategy Produces Dividends

Guest: P.J. DiNuzzo, CPA, PFS®, AIF®, MBA, MSTx
Episode 120
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The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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TOPICS COVERED:

  1. Guest Introduction: P.J. DiNuzzo, CPA, PFS®, AIF®, MBA, MSTx
  2. Introducing Gamma
  3. The Bucket Analysis
  4. Other Key Aspects of the Gamma Strategy
  5. Tax Efficiency as Part of Your Financial Strategy
  6. Morningstar and Defining “Liability Relative Asset Allocation Optimization”

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Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.


1. Guest Introduction: P.J. DiNuzzo, CPA, PFS®, AIF®, MBA, MSTx

David Bear:  Hello, and welcome to this edition of The Lange Money Hour, Where Smart Money Talks.  I’m David Bear, here in the KQV studio with James Lange, CPA/Attorney and author of two bestselling books, Retire Secure! and The Roth Revolution: Pay Taxes Once and Never Again.  For decades, financial advisors and mutual fund managers have focused primarily on outperforming various stock market indices.  Moving forward, especially in the area of retirement planning, more attention is being paid to other factors that have been shown to individually and collectively provide better returns over the long run.  This new measurement tool is referred to as Gamma.  For insights into how Gamma can make investing and retirement planning more successful for you, The Lange Money Hour welcomes P.J. DiNuzzo back to the show.  A nationally recognized expert in investment management, P.J. has been featured in numerous business publications and TV shows.  Approved as one of the first one hundred Dimensional Fund advisors, he’s rated as a five-star advisor by Paladin Registry Investor Watchdog, scoring in the top one percent of America’s more than 800,000 investment advisors.  Based in the Pittsburgh area, his firm, DiNuzzo Index Advisors, also consistently ranks among the country’s top five hundred investment companies.  For the next hour, P.J. and Jim will discuss the elements of a Gamma investment strategy.  It’s sure to be an interesting and informative hour, and without further ado, I’ll say hello, Jim and welcome back, P.J.

Jim Lange:  Welcome, P.J.!

P.J. DiNuzzo:  Hello.  Good evening.

Jim Lange:  Before we get into the meat of the program, I do feel honor-bound for full disclosure.  Usually, when I have a guest on the radio show, it is typically, I try to get the best experts that I can that have great information for our listeners, and usually, they have written a book, and if it’s a good book, and I actually at least scan, usually try to read the book, and I will do a little plug for the book.  But, frankly, I don’t really have any stake or any ulterior motive other than just trying to have good information and potentially have somebody that might be interested in our services.  But there isn’t really any ulterior motive or motivation for me to plug the business of the guests that I have.  This is not the case with P.J. DiNuzzo.  I do have an interest, and I should be very straightforward about that. 

I believe that clients need two things for financial success: one is some of the strategies that we often talk about on the radio, things like Roth IRA conversions, and Social Security, and the safe withdrawal rate, and tax efficiency, and the kind of things that our office does and has been doing for thirty years.  And I also think that people need excellent money management skills using low-cost index funds.  I believe there is no finer financial advisor in Pittsburgh, or anywhere that I’ve met, for that matter, that does a better job than P.J. DiNuzzo, or that represents a better set of funds, which is Dimensional Fund Advisors.  So, a number of years ago, when I was finally permitted to distribute, or to represent Dimensional Fund Advisors, I knew that I, myself, and my firm were not really capable of doing the full job that I thought people needed.  I asked the people at Dimensional Fund Advisors, “Who is the best DFA advisor in the western Pennsylvania area?”  There was zero question.  It was P.J. DiNuzzo, who I had known but not known well.  Anyway, P.J. and I got together, and we have formed a deal where, more or less, if somebody comes in through me or this radio show or some of the efforts that I do, that our office does the, we call it ‘running the numbers.’  We do all the calculations, the Roth IRA conversions, the Social Security analysis, how much people can spend, the safe withdrawal rates, and then meet with people at least on an annual basis to do those conceptual things, and P.J.’s office actually does the money management, including not only investing in the excellent low-cost index funds, but also all the things that he does, and we’re going to talk about some of those things today.  And then, P.J. and I split the fee.  So, rather than a client paying for his services and then my services, they’re just paying one percent or less, depending on how much money is invested, and then P.J. and I split that fee.  We believe it is a win-win-win, that is, it is a win for P.J. because he gets clients he would otherwise not have received, it’s a win for me because that means I can do what I want to do, which is to be the trusted advisor without having to manage the money, but it’s a double win for our clients who get the benefits of our firm, our running the numbers, Roth, Social Security, tax efficiency, safe withdrawal rate, etc., and I believe the finest money management available.  So, anyway, we do, with that little disclaimer, say that I am not independent with P.J.  Again, welcome to the show.

P.J. DiNuzzo:  Well, thank you, Jim.

2. Introducing Gamma

Jim Lange:  All right.  So, one of the things that we wanted to talk about today is not how wonderful our funds are (although I think they are) and how they’ve outperformed the market (although I think they have), but to talk about really some of the really important things that financial advisors and a financial advisory service really can add value, and even John Bogle said…which shocked me because I kind of consider him, as wonderful as he is, this is the guy that founded Vanguard, probably one of the cheapest men in America, and even he said having a financial advisor was a “very valuable piece of work,” in his exact words.  So, P.J., can you tell us a little bit about Gamma and some of the value that the appropriate type of advisor could potentially add to the, let’s say, to the game for an investor?

P.J. DiNuzzo:  Yes, Jim.  And I was just thinking, you just mentioned a very important topic, if I can just assist the audience, and whenever we’re meeting, as you said, you and your team of CPAs and estate planning attorneys in the office, we tell individual investors that with our relationship with DiNuzzo Index Advisors and the Lange financial organizations, that we have your entire metaphorical personal financial life, your entire house covered with all four corners.  Jim, again, as he said, being an expert in estate planning, wills, trusts, everything associated with those, tax planning and tax preparation, Roth IRA conversions, as he said and on our side of the room, in one of the corners, the investment planning, investment management, and in the other corner, the financial planning, the retirement planning. 

So, one thing that a lot of clients do come for us, Jim, is what you had mentioned earlier, that one-stop shopping, and the comfort that when they’ve been with other advisors, other firms, a lot of the things fall through the cracks because they’re having to go outside of that room that we have everything covered, and the CPA is not talking to the estate planning attorney, the estate planning attorney has no idea how the investments are being managed.  So, that is, as you had mentioned, a major plus for our relationship.  And probably, Jim, the specific topic that you came up with the evening, one of the happiest days I’ve had the last couple of years was in every Morningstar, David Blanchett, head of research for retirement planning at Morningstar, which a lot of the listeners will recognize, came up with a name basically for what you and I do, all these good things you’ve done for clients for years, and I’m meeting with him, like, “Hey, I love Jim.  He’s done great for me by a, b & c.”  They finally put a name to it, and it sounds a little bit esoteric to the audience, maybe Gamma, but, you know, where Mr. Blanchett and his group came up with a name was…the audience may not be familiar, but there’s a name for the market returns, the Beta of the market, and the Beta of the S&P would be 1.0.  That’s just the return of the market.  And everybody, as you had said earlier, Jim, in the introduction, is after that elusive, what we call professionally, Alpha, in plain English, outperforming the market.  And what Morningstar came up with was quite astonishing in that they’ve gone back for a number of years and they’ve started to quantify the value that our firms, synergistically, what we do brings to the end user to our clients, and it is quite dramatic.  And again, it’s one of the most exciting topics that I’ve been exposed to the last couple of years, and the Gamma…what we’re going to talk about in Jim’s show today for the next hour, are a half a dozen or more major topics that, in combination, as per the research by Morningstar, increase a retiree’s income by approximately 25% upwards in retirement.  So, if an individual has a total portfolio structure where they may be able to receive $2,000 a month, an additional 25%, that gets them up to $2,500.  If it’s $5,000, that’s an additional $1,250.  So, the audience can certainly appreciate that’s a significant increase in disposable income.  The first, Jim, the most comprehensive, is the…the first one that Morningstar has listed is what they refer to as the total wealth framework to determine optimal asset allocations, and we’ve worked together on that and I know you’ve always liked our money bucket stack approach that we discussed.

Jim Lange:  I love that, by the way, and whenever you hear total approach like this, I think it’s critical, and whether somebody uses us or somebody else, I think it’s critical if you’re using a total approach, that rather than going to somebody who’s going to sell you a product, for which they are going to receive a commission, that you have a fee-based arrangement with fiduciary advisors, meaning that we not only have the moral, because I believe we all have the moral, but also the legal obligation to do what is in the client’s best interest, which is one of the things that I love about your firm, that you do that so consistently.

3. The Bucket Analysis

P.J. DiNuzzo:  Yes, we were, and like I said, really elated that someone has actually identified this and named it, so to speak, given it some proper finance nouns, but this optimal asset allocation, Jim, that we’ve been able to help a lot of our joint clients with is, we’ve talked about it on the show before, is that the individual listeners, as they’re preparing for retirement, or if you’re in retirement already and wondering regarding your overall plan, we like to divide it into, what we call, your needs bucket.  That would be your food, clothing, shelter, healthcare and transportation.  Then, your wants bucket, that would be all of your discretionary income, vacations, travel, extra dining out, helping your children or grandchildren.  And then, your dreams and wishes bucket, that’s your legacy after you pass on, your dreams for extra vacations, etc., that second home, or maybe you spend two or three months out of the year in Florida or Arizona.  But as the audience can appreciate, those are three completely distinctly different objectives and goals, and where we see a lot of clients…I mean, I can think off the top of my head, Jim, we probably brought on five to ten new clients last year in 2013 just because they were at firms that had their complete strategy, all those objectives, in one strategy.  And it doesn’t work out well.  If an advisor’s placed someone with a hundred percent in stocks for their needs bucket, for food, clothing and shelter, when we go through any type of market volatility, in plain English, they’re having a very difficult time sleeping because it’s not matched up with their own unique objectives and goals.

Jim Lange:  Well, let me ask you this: let’s say that you just go to an advisor and he doesn’t do any thinking, and he says, “Okay, you should be 50% stock, 50% bonds, and you don’t need all the things that you do.”  And I would like you to talk a little bit about the bucket analysis because I think that it adds tremendous value.  What’s the problem with just saying, “Okay, 50/50 and forget about it?”

P.J. DiNuzzo:  Yeah.  Generally, Jim, our average retiree that we work with has three to four different asset allocation investment strategies.  So, for the audience, for the listeners, an asset allocation basically would be the percentage of stocks and bonds in your portfolio.  So, for example, 30/70, 30% stock, 70% bonds, as Jim had mentioned, 50/50 balanced, 70/30, our average client has three to four.  So, the global observation would be that if they were all in one allocation, they have a significant portion of their assets that they could afford to have grow at a higher level.  Let’s say, a portion of that 50 should be in 70%, and also, on the other side, there’s probably a portion of that 50 that should only be in 25 or 30% in stocks for the type of guaranteed income.  Now, we, for that needs bucket, you have a tremendous amount of professors from the University of Pittsburgh, CMU and other universities and colleges through the tri-state area, and a lot of those…that’s where we’ll plug in their TIAA, their traditional annuity, the TIAA solution that they have.  So, this isn’t just something that we’re looking to sell someone 100% of their wallet.  If you have something that’s better than what we can come up with, we’re going to utilize what you have and, as you know, we have tons of money in the TIAA annuities to take care of these individual solutions.  But when we take a look at the market, the last twenty years approximately, the S&P’s done a little bit over eight percent.  The average individual investor’s done a little bit over four percent.  It’s not just the numbers.  It’s this behavioral science, the emotions of investing, and what our position is that in retirement, if someone does have their food, clothing and shelter hyper aggressively invested, that just the average person is going to overreact and say, “I’m paying my electric bill, my gas bill, my property taxes out of that account, and if it goes down much over ten percent, I’m looking to bail out, or I’m uncomfortable.  I’m losing sleep.”  And that’s the exact opposite thing that we would want anyone to go through in retirement.

Jim Lange:  Right, so you literally have one portfolio to the, let’s say, shorter term needs analysis.

P.J. DiNuzzo:  Yes.

Jim Lange:  All right.  But then, for, let’s say, moving out in time, and, let’s say, going to the wants, you’re going to literally have a separate portfolio.

P.J. DiNuzzo:  Yeah, separate accounts, separate portfolios.  So, even if we took more of a simplistic situation (and I’ll just use a large number for the audience), but if we had a million dollars in a 401(k) or 403(b), and if we decided that their needs were a third of that, let’s say $330,000, their wants were a third, $333,000, and their dreams and wishes were a third, another $333,000, when we would do the transfer of assets, we would set up three separate IRAs and manage three separate strategies, and again, two of those would have unique withdrawals coming out of those portfolios to pay, again, the food, clothing and shelter, and then the other one for paying vacation and travel, etc.  But what individuals like about it is, and we’ve said before, very few people, in fact, hardly any we’ve ever run into, have a PhD in investments and personal finance, but folks in Pittsburgh do have a PhD in common sense, and they just know when it’s not right.  I mean, how many clients last year we brought onboard had a hundred percent of their retirement assets in stocks?  Again, the audience doesn’t need a PhD in finance to say, “Well, that just doesn’t sound right.”  I mean, but yet, you know, advisors have placed them a hundred percent in stocks.  They got uncomfortable.  They still had experiences they haven’t made up with from 2008 and 2009.  What clients like about our process is it’s blue collar understandable.  They can look at it.  They say, “Okay.  I know that makes me happy.  I’ve got a conservative portfolio for food, clothing and shelter.  I understand I need a little bit more growth.”  And then, the other one for dreams and wishes, they love that bucket because we’re not going to touch it, generally, for at least ten years, when we can afford to have more growth in that bucket.

Jim Lange:  Right, and then I know you do a great job of having different types of investments in these different buckets.  So, for example, I’ve noticed that you have been putting the Roth IRAs, and I often recommend Roth IRA conversions, that goes in the last bucket because you’re not planning to spend that Roth for the next two, five, ten, or maybe never.

P.J. DiNuzzo:  Yes.  Typically, the Roth, most clients have a minority of their investments in the Roth IRA.  So, that is great for a lot of investors to have the full growth in that portfolio.  The other one, Jim, I just wanted to mention was these half dozen or so Gamma points.  The second one is the dynamic withdrawal strategies, and I can’t overemphasize the importance that, as you said earlier, and I’m not sure if the audience really fully internalized what you said, but you have at least an annual face-to-face consultation with your clients.  We’re, on average, meeting with them face-to-face once, if not twice, a year because we’ve got, you know, more detail to go through.  But it’s in these meetings where, I like to say that’s where the magic happens.  Really, meeting, on our part, every six months face-to-face in the minimum amount of cases that we do, but whatever our projections are, if we project X for the market for the upcoming year and we’re working off that from a basis for our financial planning, the market’s going to do either X plus three or X minus three.  So, there’s all this fine tuning and tinkering that goes on on an annual basis, and that’s what you’ve been, Jim, an expert on uncovering, you know, there’s changes that happen, illness in the family, something else happens, there’s additional grandchildren, people move, they’ve relocated to another state where the taxes are different.  So, you know, when these dynamic withdrawal strategies, our portfolios are either going to grow above average, or maybe right in line or a little bit less, and it’s all these minor adjustments that we make from year to year, from meeting to meeting, that help us maximize our client’s lifetime withdrawals that they can take out of these portfolios.  So, this isn’t just a monolithic thing that we set up.  We’re planning on at least thirty years for every individual we meet with for retirement planning, and there are a lot of ongoing adjustments that you and I make to help add value to their retirement plan.


4. Other Key Aspects of the Gamma Strategy

Jim Lange:  Well, just one example on our end.  We haven’t had it lately, but in 2008, we were still making Roth IRA conversion recommendations, and a lot of people did, on our advice, make Roth IRA conversions, and then the market went way down.  So, jeez, wouldn’t that be miserable to pay income tax on $100,000 now the Roth IRA’s worth only $60,000?  Well, in those review meetings, we said, “Okay, let’s recharacterize, or undo, the Roth conversion,” and frankly, you have been the best advisor to work with in terms of rolling up your sleeves and instead of complaining about the extra work, seeing it as an opportunity to add value to the clients.

P.J. DiNuzzo:  Yes, and that is one of our key bullet points in the Gamma.  The Roth IRA conversions, when Jim runs numbers, and you have a number of CPAs in your office that, I mean, the word ‘expert’ is thrown around, but truly, Steve in the office…

Jim Lange:  Steve and Cheryl.

P.J. DiNuzzo:  Yeah, I’ve worked with every…I mean, with numerous CPAs, and he’s the best that I’ve ever worked with regarding the Roth IRA conversions.  And again, those details…the other one that’s overlooked in the Gamma, Jim, is, you focus on it as well as we do, is the Social Security maximization.  It’s amazing how many individuals have filed massively sub par elections with their decisions that they’ve made, and I can think of even two or three cases, literally within the last two weeks, that we have made, one in a same-sex marriage, a couple actually that you recommended and gave them some great advice.  They went to New York, they had a big party, they got married and, you know, very happy.  But, you know, we just ran a calculation today, and actually, we’re going to present this tomorrow at your office, and the difference between what they were thinking about doing for their Social Security election and what our recommendation’s going to be is going to be approximately $105,000 more over their lifetimes if they were just to live to average life expectancy.  So, these aren’t small amounts of money.  These are major improvements.

Jim Lange:  No, and I’m going to try to shut up, but I will say that sometimes $105,000 might pale, and the other reason why…and by the way, we have actually done four shows on Social Security.  So, if you’re interested, you can listen to Jane Bryant Quinn, Mary Beth Franklin, the woman who, I forget her name, but she wrote a book on Social Security, and Larry Kotlikoff.  And all of them are basically saying the same thing.  I’ll just do the one-minute summary because I can’t stop myself.  In general, we don’t like the higher wage earner, at least, in the old days, was the man, we don’t like them taking Social Security at 62.  We prefer that they wait until 66.  Even at 66, we like to do something called apply and suspend, particularly if their spouse is roughly their age, and that way, their benefit can continue to grow at eight percent per year, then they take it at 70, they have a much higher benefit at 70, and this is what I wanted to add, if they then die and they are survived by their spouse, who might live much longer than them, the spouse will get the higher Social Security benefit for the rest of their life.  And sometimes, it’s not just the difference of $100,000, but several hundred thousand.

P.J. DiNuzzo:  Yes.  Yes, it can be, and also the cost of living increase, which very few investments have the cost of living increase that Social Security provides, as well. 

Jim Lange:  That’s right.

P.J. DiNuzzo:  Yeah, a lot of added value there.  The other point, Jim, talking about in discussing the Gamma that’s added is, one of the things that Morningstar identified was the incorporation of guaranteed income solutions, and what they found was, in what we refer to as the needs bucket, was having that locked down, so to speak, as well as possible.  So, we generally have one of two options where we go.  You have so many clients that have the TIAA annuities that we count that as guaranteed income along with their Social Security.  That qualifies, by our definition, a guaranteed income.

Jim Lange:  Or a pension, I assume?

P.J. DiNuzzo:  Or a pension, yeah, any defined benefit pension plan.  There’s still about one out of every five clients that we consult with that have a defined benefit pension plan, and if they don’t want that for one reason or another, don’t have that available, and if they say, “You know, P.J., we’re willing to take a little bit of market risk here with this portfolio.”  Because when you get into annuities, and you look at that, generally, high fees, high expenses, there’s a lot of minuses on the analysis.  But if you take a look at, for example, a 20/80 DFA portfolio all indexed, that was down approximately five percent in 2008, it’s something that a lot of people can live with.  I mean, so we’re trying to build a portfolio for those needs if they don’t want to go the annuity route, or don’t have it available, that we can build that with an ultra-conservative portfolio that would not go down more than ten percent in one calendar year.

David Bear:  Well, let’s take a quick break now and hear about how listeners might be able to avail themselves of some of this information.

BREAK ONE

David Bear:  Hello, and welcome back to the Lange Money Hour.  I’m David Bear, here with Jim Lange and P.J. DiNuzzo, talking about Gamma.

Jim Lange:  At the beginning of the program, I did a long disclosure saying that I am not independent with P.J.  I just want to do a very short repetition in case anybody has gone on.  I am not independent with P.J.  We have an arrangement where our office does certain conceptual things like Roth IRA conversion, Social Security analysis, wills, estate planning, tax potentially preparation, but certainly planning.  P.J. actually does the investments using, what I believe, is the best low-cost index set of funds on the planet, and then we share fees, and we share one fee.  That is, a client pays one percent or less to the combination of both of us.  So, I am not independent with P.J. 

But one of the things that I like about P.J. is he is a true fiduciary advisor, meaning that he has your best interests at heart, and he not only has that moral obligation to do what is in your best interest, but also the legal obligation.  And he was just talking about fixed income, and I thought I would mention that one thing where I think P.J. is very good, where I think most financial advisors are not good, is if somebody comes to his office and has a good fixed income solution in place, certainly for at least a portion of the portfolio, people that, for example, come in with a portion of their portfolio in TIAA, which is a much better than average fixed income fund, that literally it would be near impossible after paying a fee to beat, or if you came in with CDs that were locked in at a good interest rate, or annuities that might have a penalty provision if you withdraw them early, P.J.’s been wonderful about utilizing those as part of the overall portfolio, and then also not charging for the oversight of that entire portfolio, which I really, really like.  So, we were just, I think, finishing up the, let’s call it, needs bucket or the fixed income part, but also taxes play a big role.  Could you talk a little bit about how somebody, other than the Roth IRA conversions, which, by the way, we probably have about twenty shows on that if you’re interested, all, by the way, that can be found at www.paytaxeslater.com, and you can just go to the archives, and there’s actually about a hundred hours of radio shows on those archives, including a number with P.J.  But can you talk a little bit about tax efficiency and some of the things that you guys do to cut your clients tax bills?

5. Tax Efficiency as Part of Your Financial Strategy

P.J. DiNuzzo:  Yeah, Jim.  Regarding tax efficiency, and again, I just want to remind any listeners who may have just tuned in, the topic of our show this evening that Jim came up with was based on the research by Morningstar, titled Gamma, and the research has shown that it’s possible to generate an additional 25% annual income for retirees by five to ten processes, functions that wealth managers can serve, and the question you just asked, Jim, of course, is right in line with the tax efficient decisions.  With the tax rates going up here within the last couple of years, we had sort of been lulled to sleep a little bit with lower tax rates now.  With the rates, of course, at 39.6%, with the NIAT at 3.8%, the additional Medicare at 0.9%, it can start to get into some rarefied air, and even not just for high wage earners, but a lot of people have been moved up across the board, and on the tax efficient decisions, you know, our overall philosophy that we’ve told individuals is, it’s sort of back to the future.  A lot of things that didn’t make sense before have come back into vogue now, and one that we’ve been using the last couple of years a lot more are tax-deferred growth vehicles, such as a variable annuity.  And if you would’ve ever told me years ago that I’d place a client in a variable annuity, I would’ve thought that something was wrong!  But it’s amazing, improvements in the marketplace. 

There’s a company that we work with that literally charges just a couple of hundred dollars a year in expenses.  And we have a lot of DFA indexes available.  Since it’s an annuity, they don’t have all the indexes available.  What we don’t have, they do have Vanguard available.  So, really, the benefit here is for individuals who are not able to save enough in their qualified plan, if we need to save another $5,000 or $10,000, or, in some cases, $20,000 or more, but even if it’s another $5,000 a year, and if someone’s a younger professional, especially in their twenties or thirties or even into their forties, and looking at that tax strategy without being in the taxable portfolio versus a tax-deferred portfolio, and again, just as you were referring to the numbers earlier, Jim, I mean, improvement of tens of thousands of dollars in the lack of that friction, that tax friction and tax drag. 

One of the other ones regarding these tax efficient decisions are…the last time you had had me on, we had focused the concept of the show on asset allocation, and there’s another strategy that’s a little bit of a higher level regarding asset allocation, and we refer to it as asset location.  So, some individuals, given their own unique tax bracket, it may be better for us to allocate different types of asset classes in different portfolios.  And again, a lot of these strategies have just come about and taken on a lot more material importance the last year to eighteen months for certain individuals in certain brackets, where we may be placing all of their fixed income into their IRA accounts.  We would place all of their highest growth assets into the Roth IRAs.  We’d place the equities, positions that would have lower taxable distributions, and again, DFA’s great for that because they have a lot of tax manage asset classes into their taxable accounts.  And by this asset location of different investments…now, we still go through our fundamental analysis of, as you’ve seen sort of painstakingly, our balance sheet, all the assets and liabilities, the income and expenses, and, as you know, we capture everything basically if it’s ten dollars or more per month.  So, we’re as accurate as possible, and we’re still taking a look at what those asset allocations would be, typically in our buckets. 

But when we take a look at how the additional value that this places for individuals…and one of the things, again, the CPAs in your office that we’ve been able to plan and work hand in hand very well, is what we would talk…we’ll refer to it, it’s associated with this, are tax bracket management.  And again, it wasn’t paid as much attention to before, but now, there’re certain times in people’s lives, maybe one of the spouses was maybe downsized in their job or something, for example, and they have a year where there’s very low income, and I know we’ve done a lot of Roth IRA conversions in those instances.  But in those instances, what we’ve also done in the last year or so is doing capital gain recognition in those years.  So, if we take a look at…we’re able to plan with ourselves, and working with your firm, that if the audience can think of when you need to start taking your required minimum distributions at age seventy-and-a-half, very often, you’re locked into a tax rate that never goes down the rest of your life.  It’s sort of golden handcuffs, so to speak.  You’ve got your Social Security coming in, let’s say, for both spouses.  Both spouses may have required minimum distributions, and you’re not going to be able to lower that bracket.  So, if we’re going to be (just to make it simple), let’s say, at 20% at age seventy-and-a-half, we certainly want to a least fill up brackets at that point.  We don’t want to have any years, let’s say, if both spouses retired at 62, we don’t want to have years between 62 and 70 that we’re not…and it’s a little bit counterintuitive to the people sometime.  Hey, let’s recognize these gains now.  We’d rather pay ten cents on the dollar.  What happens a lot of times is people are never able to sell these again because they’re going to pay at least twenty cents, or twenty-five cents, on the dollar.  So, the capital gain recognition, the bracket management, the bracket smoothing over time, this also helps with a lot of cases we’ve worked on, as well as gifting strategies on…you have a lot of your clients that like to help out their children and grandchildren, and, I mean, I can think of dozens and dozens of cases just in the last couple years where your CPAs and we’ve worked back and forth, how could we maximize this?  Here goes the objective of how they want to help their son or daughter or grandson or granddaughter.  It can be education, it can be the purchase of a residence, maybe first time, or maybe they’re upgrading, but a lot of tax savings, and especially with the rates going up now, we’re able to add a lot more value.

Jim Lange:  Yeah.  I actually think it’s tremendous that you do this, and a lot of times, clients don’t even know what you’re doing, which is one of the things that I really like about your firm.  So, for example, if I hire a service person, whether it’s a plumber or a contractor or a roofer, wouldn’t it be nice…now, of course, you’re supposed to do your due diligence in picking the person, but wouldn’t it be nice if that person truly did have your best interests at heart, was going to do things, if you’re not paying attention, that ends up being in your best interest.  You know, for example, recommending a Roth IRA conversion, or triggering a sale at a capital gains rate that might be at zero if you’re in the 15% bracket, or still low.  To do these things that you might not even realize it’s happening, I actually think that that is the ultimate that people really want, not that you shouldn’t do your due diligence in picking the appropriate advisor, but, to me, since that’s what I want as a consumer, I want to go to somebody who knows their stuff, is going to do it in my best interest, you know, for a fair cost, and you guys have just been doing a great job with that, and, to me, one of the beauties about what you do is that I think that you could save people a heck of a lot more than you’re charging.  I sometimes say I wish I could save you one percent of what I’m going to save your family down the road.

P.J. DiNuzzo:  Yeah.

Jim Lange:  Of course, that’s not ethical!  But I think that you’re doing a lot to add some of these areas on tax efficiency.

P.J. DiNuzzo:  And one point you made there, Jim, I think, just to add on to it, how we’ve had the fiduciary responsibility to anyone that we’re talking to, prospective client or existing client, and how we work around existing holdings that you had mentioned, in their portfolios where we incorporate those.  So, a lot of times, we don’t want audience members, a lot of times, when people first come in to talk to you, I think they’re like, “Oh boy, you know, if I go with you, you’re going to blow everything up and sell the whole portfolio.”  But, again, from a fiduciary standpoint, if prospective clients have any thing that we cannot improve on, we’re going to leave that in the portfolio, and oftentimes, as you know, we may think that they have, let’s say, a grade of a ‘B’ regarding their investment in an existing portfolio, and we think that we can improve that with an ‘A’ on our investment, regarding the indexes with DFA.  But if they have a $20,000 or $30,000 unrealized gain, in a lot of cases, we’re not going to have them recognize a gain of $30,000 just to place that in a different investment.  So, we do incorporate their existing investments as well as possible into our new plan. 

Jim Lange:  Which I actually think is a great service because you’re not saying, “Okay, you have to sell everything tomorrow, have a huge capital gain, and then we’re going to take everything you have, no matter what it is, and we’re going to put it into our funds.”  I know, in some situations, people literally are afraid to tell their financial advisor what assets they have for fear that the advisor’s going to want to manage everything, where you have a much more pro-client approach of, “Okay, whatever we’re going to manage, we’re going to take into account everything else, so that your entire portfolio will look like a well allocated pie.”  So, for example, let’s say in the portfolio that you’re not going to manage, there’s a zero percent small cap, or zero percent international.  The one that you might manage would be overweighted in small cap or international.  So, people get truly the benefit of a financial advisor, which, I think, is one of the ideas of Gamma.

David Bear:  Is this a good time to squeeze in one final break?

P.J. DiNuzzo:  Sounds great.

David Bear:  Let’s do it.

BREAK TWO

David Bear:  Welcome back to the Lange Money Hour, with P.J. DiNuzzo and Jim Lange.

Jim Lange:  We’re talking about different ways to add value to a client, a combination of things that our firm typically does, like Roth IRA conversions and Social Security and estate planning and tax planning and safe withdrawal rates, and then also everything that P.J.’s firm does, which is actually investing, typically using low cost, or almost exclusively, using low cost index funds and doing really a huge amount of work, which we really didn’t talk about.  You know, his personalized balance sheet and his personalized income statement and personalized budgets, literally down to the cable bill.  But we’re trying to add value to a client’s portfolio and their lifestyle, and one of the things that we have not yet talked about is liability relative asset allocation optimization.  P.J., could you tell the audience what you mean, and what actually…and it’s not just you, because right now, I know you’re quoting from the white paper…

P.J. DiNuzzo:  From Morningstar, yeah.

Jim Lange:  …from Morningstar.  And by the way, we’ve referred to that a number of times.  If anybody is interested in that paper, we would be more than happy to send that to them.  If anybody wants to call our office at (412) 521-2732 and ask for that white paper, we would be delighted to send it out to you.  But what is the white paper, or what you mean by ‘liability relative asset allocation optimization?’


6. Morningstar and Defining “Liability Relative Asset Allocation Optimization”

P.J. DiNuzzo:  Yeah, that’s a mouthful, Jim.  In plain English, individuals have been focusing entirely too much on the investment, or investment strategy, in their portfolio, and the risk around that investment strategy.  So, for example, if the overall portfolio expected rate of return was eight percent, and you would look at the standard deviation around that return and just start to project your downside risk, etc., what we’d rather get clients to think of is what is their unique number?  What do they need?  Their own sort of personal family index, if you will, and oftentimes, individuals need five percent overall growth in their portfolio per year to be successful.  It might be six percent.  It might be seven.  So, if you take a look at, again, over the average ten-year period of time, three out of four active managers on average are underperforming the index that they’re up against.  If they’re a large manager, the S&P 500, if they’re a small cap manager, the Russell 2000, and instead of having…what Morningstar is saying is, all this focus that everyone’s had has been really misdirected and misguided because if you are able to outperform your respective index, generally it’s a very, very small percentage.  They’re saying there’s a lot of meat on the table here, so to speak, that’s being left untouched that we could apply and put on the center of the plate, so to speak, in all these additional areas of Gamma.  So, the liability driven, you know, a lot of cases I can think of, Jim, if we sort of start at the top at the pyramid and work down, is when we take a look at…one of the main things we’re thinking of globally, when we go in to a consultation, and again, most of your individuals meet you at a workshop where you’ve spoken with them in a small group at a workshop, medium-sized group at a workshop.  They talk to you in between.  They come into the office and have one or two consultations with you…

Jim Lange:  And we give them a huge box of books and CDs and DVDs…

P.J. DiNuzzo:  A lot of reading material, yeah!  A lot of material.

Jim Lange:  As much as they can stand, usually.  Sometimes more! 

P.J. DiNuzzo:  A lot of educational material, yeah, a lot of…

David Bear:  And dark chocolate. 

P.J. DiNuzzo:  Yes!  Yeah, they get a lot of goodies.

Jim Lange:  No, popcorn, actually.

David Bear:  Popcorn.

P.J. DiNuzzo:  Yeah, and then, you know, we have, on average, two, and sometimes three, consultations.  So, there’s a lot of information.  We’re getting to know them really financially intimately.  And one of the things that we’re looking at, very simply, is…and I’ve always phrased it to individuals, is, you know, when we’re looking at your situation, as an individual or as a couple, what is it out there that can knock over your little happy retirement applecart?  I mean, what is it that you’re not thinking about that can still defeat from the jaws of victory, so to speak?  And when we’re looking at matching up your asset allocation, it gets back to the points we made earlier, it’s surprising that oftentimes, the only thing that could possibly derail, or cause someone to fail in retirement, is that they’re invested too aggressively.  So, again, one of our mantras at our firm is if we only need an overall allocation of 50% in stocks, that’s all we’re going to place is 50% in stocks, and it may sound like common sense to the audience, but again, we operate, as Jim said, under a fiduciary standard.  Most people who invest money only operate under a suitability standard, so completely different.  Something only has to be suitable.  What we’re recommending is what we would do in your same exact situation.  Everything that I have is invested exactly the way as what I recommend to my clients.

Jim Lange:  And by the way, I will mention, after you gave a little talk to our firm, that we voted fifteen to nothing to move our retirement plan to Dimensional Fund Advisors. 

P.J. DiNuzzo:  Yeah, with us at DiNuzzo, all 100%, Jim as well, his entire retirement assets in his 401(k) are with us, with DFA, Dimensional Fund Advisors.  So, it’s a lot different from a fiduciary standpoint.  What we would do in someone’s shoes…so, if we don’t need more that 50% in stocks, so oftentimes, it’s better for the firm that’s managing the money to have as much in stock.  So, there’s competing objectives here.  If someone’s managing a firm, yeah, you want as much in stock as possible because your overall firm’s going to grow a lot faster to higher numbers in assets under management, which means you get billed more, but unfortunately, there’s a lot of people that get left on the side of the road, so to speak, that, you know, there’s a lot of grandmas and grandpas that can’t handle 100% in stocks, or 80% in stocks.  So, again, that gets back to that liability driven.  So, we take a look, and we even dig down to that extra level that we discussed earlier, Jim.  What are the specific liabilities?  And I think the audience can agree, if they’re thinking, sitting at home, or driving their car now, that their needs, your needs are different than your wants, and your wants are different from your dreams, and they can appreciate the different strategy to be able to meet those objectives and goals.

Jim Lange:  Well, I know that when people meet with you, they know that you’re the real thing, and then, the other thing that I’ll mention, which is unheard of, and I don’t think it will continue because somebody’s going to die, or somebody’s going to become disgruntled for one reason or another, but in a little bit over two years, we have actually gone from zero to…the last number was $107,000,000 under management.  You probably have a new number for me that’s even higher.  And not one person has said, “Hey, this isn’t working,” and then backed out.  So, we have an unheard of 100% retention.  But there’s some other things that you can, and I should say, we can do to really help a client in their overall planning and to succeed financially, which isn’t always the riskiest strategy having the most return.  Should we go on to some of the areas like Social Security and Roth IRA conversions, etc.?

P.J. DiNuzzo:  Yeah, the Social Security, and one thing, Jim, I think we were focusing on strictly the Gamma, but also built within our portfolios, when you go through years like 2008 again, you really see the benefit of proper asset allocations.  All of our bonds, we call them the ‘Big Four,’ the first four bond funds, ninety-something percent of our clients have our four bond funds, which basically represent a short-term bond index.  They all made money in 2008.  There was, believe it or not, some national, some of the top bond funds in the country lost 10, 15, 20, 25% in ’08, so also, we’re mitigating a lot of risk from that perspective. 

One thing I was going to mention, Jim, too, we had touched on it earlier, that dynamic withdrawal strategy, and I just have a chart in front of me, for example, because it’s impossible to remember all these numbers, but we’re looking with clients, what are safe rates of withdrawals if we have anywhere from five years to forty years remaining, over our lifetime, in the portfolio, and it can change quite dramatically, and it’s nice to know, for clients, that in portfolios, and we check portfolios from 20% in stocks up to 60%, normally, we don’t go about 50% for withdrawals, 60% at the maximum, but as you get older, because a lot of times, people are thinking, they come in to us, and they’re actually being too conservative on the withdrawals.  I know you have had that conversation with individuals.  They come in and say, “Jim’s begging me to spend money!  You know, please travel.  Take that extra trip to Europe, etc.”  But it’s nice whenever we can show them that we do have an extraordinarily high probability of success.  At a certain age, that they could withdraw five or six or seven percent as they get older, that it’s not just the four percent.  So, again, the point we want to make with the audience, the last point that I have is it’s a dynamic.  The magic happens when they’re meeting with you on the annual basis, and your team of CPAs and estate planning attorneys, when they’re meeting with us on a semiannual or annual basis, and it’s all these continuous minor adjustments, listening to the client, going through life with them, and adjusting their retirement plan to help them maximize their success.

Jim Lange:  And finally, I’ll close on one last note, because I know that we both have this in common: that we both see this as our fiduciary duty of literally watching over people’s portfolios, knowing it makes a huge difference in the quality of their lives, the lives of their children, and just do everything in our power to make sure that we protect and watch over people.  We see that as really a critical, critical obligation and opportunity to do the best we can for our clients.

David Bear:  And to be there for the long haul.

P.J. DiNuzzo:  Yes.                         

David Bear:  To be there for years to come.  Well, I guess this is a good place.  We might as well stop the show here, and I want to say thanks to P.J. DiNuzzo.  You can reach him directly if you’d like to, at his firm’s website, which is www.dinuzzo.com.  Thanks also to Dan Weinberg, our in-studio producer, and Lange Financial Group program coordinator, Amanda Cassady-Schweinsberg.  As always, you can hear an encore broadcast of this show at 9:05 this Sunday morning, here on KQV, and you can also access the audio archive of past programs, including written transcripts, at the Lange Financial Group website, www.paytaxeslater.com, under ‘Radio Show.’  And while there, check out the series of short videos from Jim’s interview with John C. Bogle, founder of the Vanguard Group.  You can also call the Lange offices directly at (412) 521-2732.  Finally, mark your calendars for next Wednesday, April 2nd at 7:05, and the next new edition of the Lange Money Hour, when Jim will welcome Robert Siciliano, an expert on seniors and identity theft, to the show.

END

 

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James Lange, CPA

Jim is a nationally-recognized tax, retirement and estate planning CPA with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania.  He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again.  He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans.  His plans include tax-savvy advice, and intricate beneficiary designations for IRAs and other retirement plans.  Jim's advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger's Retirement Reports and The Tax Adviser (AICPA).  Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.

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