All Things Financial Planning Blog


What is Really Driving Your Financial Decisions?

A brain scan was taken just before an individual placed a stock trade. Another brain scan was taken just before someone was given a hit of cocaine. In both cases, the brain was flaring up in anticipation of a gain, and the scans were virtually indistinguishable.

Contrary to what we like to believe, decisions are made with the right side of our brains. This statement is controversial because we generally believe that we are rational people and make most decisions after an objective evaluation.

With respect to our financial decisions, this is even more controversial because as soon as we hear the word “finance,” our left brain springs into action. We have conditioned ourselves to believe that finance and mathematics are inextricably linked, and therefore, we make our financial decisions based on rational thought. In reality, we frequently make decisions before we are consciously aware of them and then attempt to rationalize them before we act. We must not confuse this with rational thought.

The left side of our brain tells us the two scenarios outlined above are different, but our right brain can not tell the difference. The left brain tells us that drugs are bad, and making money is good. The right brain simply knows is that we are about to benefit from something.

One of the things that makes us human is the ability to engage in rational thought. Unfortunately, this often results in bouts of overconfidence in our ability to control our emotions.

The brain scans above outline this phenomenon perfectly. Through rational thought, we have the ability to control our urges by recognizing the inherent danger in certain situations. However, we often neglect to acknowledge that danger when it applies to money (or we greatly underweight it), as we are conditioned to believe we ought to pursue more of it.

We must also recognize the overpowering nature of our emotions in reverse. Rational thought would not have led to so many people’s decision to bail out of the market (or not rebalance their portfolios) in 2009. Rational thought would have prevented millions of homeowners from purchasing homes with little or no money down. Rational thought would result in everyone spending less than they earn and planning more for the inevitable uncertainties in life.

We can not change how we are biologically wired, but we can make consistently better decisions by simply acknowledging how and where they are actually made. Like the deterioration of our bodies as a result of cocaine, the pursuit of short-term financial gain can set us up for long-term financial ruin. We insulate ourselves from the dangers of drugs through avoidance. It would serve us well to do more of the same in our financial lives.

Joe PitzlJoe Pitzl, CFP®
Director of Financial Planning
Intelligent Financial Strategies, LLC
Edina, MN

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The Reality of Compound Returns

Albert Einstein was reportedly quoted as stating that compound interest is the most powerful force in the universe. However, compound interest is also one of the most misunderstood, misrepresented and most destructive forces as well…even in the professional realm.

As the euphoria of “DOW 13,000!!!” takes hold of the investment world, the talking heads are, once again, bantering about whether it is safe to invest again. As I wrote in this blog just over a year ago, that is absolutely the wrong question to ask. Ultimately, your behavior and ability to stick to an investment philosophy will have a far greater impact on your investment success than the actual strategy or investments themselves.

Ultimately, successful investing depends on your ability to participate in the “miracle of compounding”. You can scour the internet for days and find endless examples such as the following:

Tom and Mary are saving for retirement.

  1. Tom begins saving $5,000 per year at age 25 and continues to do for 10 years. At age 35, Tom stops and never saves a penny again.
  2. Mary waits until age 35 to begin saving, but then saves $5,000 per year until she reaches age 65.

Assuming they each earn 8% per year, here is how the scenario breaks down:


Total Savings

Age 65 Balance







The critical take-away is to start early because the longer you allow your money to compound, the more significant the impact it will have.

Now, here’s the cold, hard reality about compound returns:

Negative returns have a far greater impact on investment performance than positive returns

Consider the following scenarios:


Period 1

Period 2

Average Return

Actual Return

Portfolio A





Portfolio B






On the surface, based on the average annual return, it appears that both portfolios end up in the same place, despite taking very different roads to get there. However, the end result is astonishingly different.

If Portfolio A starts with $100 and earns a 10% return, you end up with $110. If you then lose 10% the next year, you actually lose $11 (not $10), leaving you with $99. When you apply the same math to Portfolio B, your end result will be $75.

Circling back to the assumption of 8% returns from Tom and Mary above, if Tom earned 20% in year one, followed by -12% in year two, the average of those two returns is 8%, but the actual return experienced by Tom plummets to 5.6%.

And just to drive things home further, assume Tom earns 50% in year one and -34% in year two. The two year simple average is +8%, but the actual return is -1%. It is possible to have a positive average return, but negative results.

So what does this look like in the real world?

I recently came across a video produced by a large investment advisory company that provided a classic example that even professional investors misunderstand how compounding actually works.

In this case, the fund manager only produced “alpha” for his clients in 9 of the 18 years since he launched his fund. In other words, he beat the index only half of the time. Further, if one were to calculate the average alpha produced during those 18 years, it would be negative. Therefore, the folks in the video concluded he actually produced negative alpha for his clients over that period.

In reality, people who actually invested in this fund for that period would have made 50% more money (or 50% more alpha) than if they had invested in the index. The exercise of comparing year-to-year performance against an index is extremely counter-productive.

To restate these facts again, the fund only beat its benchmark 50% of years, yet produced a total return 50% greater. The explanation of this paradox is quite simple. This fund avoided large losses. It outperformed the benchmark when it was down, and underperformed when it was up.

None of this is meant as an indictment of folks who index or the indexing philosophy. In fact, due to investors pouring out of the fund while it was lagging in the tech boom (and just before the 2000 – 2002 crash), index investors likely fared better than this fund’s investors…an indictment of poor investor behavior.

When investors like Warren Buffett explain that rule #1 in investing is to not lose money (and rule #2 is to never forget rule #1), this is one of the concepts they have in mind. They do not mean that your portfolio should never decline in value, but jumping out of an underperforming fund (or stock, or index) into something else at the wrong time will land you on the wrong side of the compound interest formula.

The US stock market continues to be one of the greatest wealth building machines ever created, but the extent of your participation is entirely dependent on which side of the compounding equation you fall.

Joe PitzlJoe Pitzl, CFP®
Director of Financial Planning
Intelligent Financial Strategies, LLC
Edina, MN

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Get Off the Roller Coaster

The past 12 months perfectly captured the proverbial roller coaster of the stock market. It went up and down, it zigged and it zagged, and it ultimately came to rest very close to where it started. Each time we started to climb out of a valley, we experienced something to get excited about – a nuclear meltdown, civil wars, the US debt fiasco, Occupy Everywhere, the Greece/Euro threat.

The media likes to portray investing as if it were a game. Pundits blabber on TV about (insert investing guru here) making a “play” on ABC Company by loading up on shares on X date and talking about whether it “worked” several weeks or months later. And particularly during this time of year, comparisons showing winners and losers from the past year are everywhere. Furthermore, every Tom, Dick and Harry is casting their predictions for the year ahead.

As you know by now, I am a big fan of  Carl Richards ( Carl has made a name for himself by having an uncanny ability to capture the complex paradigms of finance in a series of elegantly simple sketches.

One of my favorite sketches by Carl is shown to the right. Nearly everyone who glances at the image will agree with the general message, but the reality of how we experience this paradox is not that simple.

Consider the following: “the neural activity of someone whose investments are making money is indistinguishable from that of someone who is high on cocaine or morphine.” In the book, Your Money and Your Brain, Jason Zweig shares brain scan images from a Harvard Medical School study that clearly show the exact same location of the brain flaring up during each experience!

The rational part of our brain (which processes these very words and the logic behind it) recognizes that there is a big difference between financial gain and getting high, which makes this very difficult to comprehend. However, the limbic part of our brain (which experiences emotion and feeling) is literally incapable of processing logic. These parts of our brain are physically divided and engaged in an eternal tug of war whether we like it or not.

Investing is not a game, it is not an amusement park ride, and it is not gambling. As such, as soon as we begin to feel the same emotions with our investments as we experience while playing games, riding amusement park rides, or gambling, we may as well cash in our chips.

Many investors often believe they have special information about a particular company, industry or the economy that will yield significant gains in the market. They may have even achieved financial gain through the same type of thinking in the past. But the reality is this: logic would tell you that thousands, perhaps millions, of other people have already had access to that information or have thought of the same thing you so strongly believe. So what part of your brain is really talking to you?

The stock market is merely comprised of thousands of businesses. This is incredibly difficult to fathom in the rent-a-stock world we live in, but it is unquestionably true.

People own businesses because it provides an income stream and/or an opportunity to sell the company for financial gain in the future. Ultimately, the amount of gain realized depends on the price paid for it, but you can only sell it for the price someone else is willing to pay. Every business goes through good times and bad, but serves a specified purpose in the business owner’s life. Great business owners rarely attempt to shoot the lights out because they recognize that doing so introduces an enormous amount of risk to their current and future well-being. And they certainly do not care what they could sell their company for on a minute by minute basis.

Our portfolios are a collection of businesses. As such, we ought to run them more like businesses. We ought to recognize that they are going to go through cycles. Good businesses do not expect the capital they invest back into the company to yield immediate results. Sometimes it takes years to pay off. There are going to be good years mixed in with bad years, but over time, good businesses will succeed. As Warren Buffett has stated, “time is the friend of a wonderful business, the enemy of the mediocre.”

We need to focus on making good business decisions with our money. When we make investment decisions based on what worked well in the prior year, it is not logic talking. A quick way to go bankrupt in retail is to load up on 2011’s hottest holiday item in anticipation of selling them all during the 2012 holiday season.

When we “invest” in a stock with the belief it will double in value overnight, it is not logic talking. You have either done extensive research and determined the stock price is below true value, or you are subscribing to the greater fool theory with the hope that someone will come along later and pay you more. Even if the former is true, great investors will tell you it may take years for the market to reflect reality…it rarely happens overnight. But like gravity pulls everything back to Earth, valuation will ultimately pull market prices toward equilibrium. Like a great business exercises patience waiting for an investment to pay off, sometimes we need to exercise greater patience with our portfolios.

The future is uncertain and loaded with risks. The experience of a roller coaster is riveting because it packages the uncertainty of what is coming around the next corner and the anticipation of another high into a brief series of twists and turns. However, because of countless safety measures, we can jump on the ride feeling confident that we will end up where we started. In financial markets, those safety measures do not exist, so get off the ride and get down to business.

Joe PitzlJoe Pitzl, CFP®
Director of Financial Planning
Intelligent Financial Strategies, LLC
Edina, MN

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This Holiday Season, Ignore the Relatives

‘Tis the season to gather and celebrate with friends and family. Each year, old traditions are remembered and new traditions are made. We reconnect with those we see often and long-lost relatives alike. Reliability has become an evasive event in the busy world we live in today. In the craziness and uncertainty of our day-to-day lives, we take solace in the certainty that some of these events provide.

In some families, it is a holiday tradition to attend church or temple together. In others, it is a certainty that Grandma will play the piano while everyone sings along. And in others, it is a virtual certainty that everyone will get their year’s worth of invaluable wisdom from that goofy brother-in-law that goes by “Blaze”.

Celebrating with relatives is a wonderful thing, but this time of year, we must all be more conscious of the unrelenting human desire to compare ourselves and our decisions to the people and things around us. The relatives you ought to ignore are not people, but perceptions.

In his book, Predictably Irrational, author Dan Ariely describes that “humans rarely choose things in absolute terms. We don’t have an internal value meter that tells us how much things are worth. Rather, we focus on the relative advantage of one thing over another, and estimate value accordingly” and later “we not only tend to compare things with one another but also tend to focus on comparing things that are easily comparable – and avoid comparing things that cannot be compared easily.”

In other words, we often use completely irrelevant benchmarks to gauge our success and make decisions. We make comparisons about the car we drive or clothes we wear relative to our siblings. We draw comparisons about how our children act relative to the neighbors. We decide how much to spend on our holiday shopping after we figure out how much our friends or family members are going to spend on theirs.

None of these comparisons make any rational sense. However, it is far easier to take a shortcut and follow something easily comparable than it is to really figure out what makes sense in our own lives. After all, these comparisons provide a simple, concrete (but irrelevant) answer, while the question about how things fit into our own lives seems far more abstract.

People often share that they refinanced their mortgage at 4% while their brother got 3.75%. The interest rate provides a simple comparison for people, but misses the big picture. Digging a touch deeper, we find out that their brother paid closing costs and they didn’t. The monthly savings of that 0.25% difference would finally cover the closing costs after 10 years, while they only want to stay in the home for 5. Indeed, the rate is lower, but will end up costing them more.

No where in the world is relative benchmarking more prevalent and more irrelevant than the investment realm. How you perform against the S&P 500 has no bearing on your financial well-being. I am guessing almost everyone reading this beat the S&P 500 in 2008. I am also going to surmise that each one of you didn’t feel very good about that. Earning returns of -30% when the market is at -37% hardly provides a reason to celebrate.

If you own a business, you most certainly understand the cyclical nature of being a business owner. Your revenue goes up and down, your profits rise and fall, and the value of your business goes along with it. However, you choose to continue running it because of the lifestyle it provides for you. In fact, the goal of most business owners is to run the business in a way that allows them to live the life they want. It provides a nice income stream, job security and the hope of a nice payout when they sell.

A large minority of business owners really run their business to maximize returns at all times. Those that do are often hung out to dry when things get rough. We ought to consider our portfolios as our own small business. After all, our portfolios are literally comprised of ownership in thousands of very real, functioning businesses you can touch and feel. If we strive to maximize gains at all times, we are inevitably going to get burned. The business (portfolio) performance of the bicycle shop guy down the street has no relevance to that of your bakery.

Your portfolio is (or should be) designed to provide you with the lifestyle you want to live. In most cases, that does not result in a blind effort to maximize returns. Comparing it to an arbitrary benchmark (especially in short time periods) tells you nothing about whether it is going to allow you to achieve your life goals.

As it pertains to holiday spending, your holiday budget should reflect your own budget, not that of your relatives. Your relatives are trying to accomplish very different things in life than you are. As these comparisons begin to creep into your mind, ask yourself if they are relevant.

Invariably, year-end often provides a time for reflection on the past year and an opportunity to look forward toward the year ahead. In reality, it simply marks another day on the calendar. Our lives do not follow a calendar – they do not start over on January 1. Yet we somehow find ways to take comfort in the opportunity to start over again, to try new resolutions or to retry those we set the year prior. Year-end provides that certainty we strive for, so take comfort in that and your family traditions, and set a goal to ignore those irrelevant relatives you drag around with you in your day-to-day life.

In my extended family, we celebrate together with an appetizer contest that has become exceptionally competitive in recent years. Despite the herculean efforts of many of my cousins, aunts and uncles to garner votes for their dish, we all know full well that the newest member of our family wins every year. It is a certainty that the husband of my recently married cousin will magically procure enough votes to win the 2011 prize. Congrats in advance, Jim!

Joe PitzlJoe Pitzl, CFP®
Director of Financial Planning
Intelligent Financial Strategies, LLC
Edina, MN

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Mirror, Mirror…

Occupy Wall Street is creating a great deal of buzz around the globe, and it is a remarkably fascinating movement to witness. No matter what side of the proverbial fence you reside on, this movement is drawing a great deal of attention to several issues our country’s leaders have long ignored.

Opponents argue that there is no leadership, no direction and no central reason for its existence. And while proponents may have had no consensus rationale for participating in the first place, they are beginning to realize that the true underlying issue is that they believe their future has been compromised in one form or another.

It is unfortunate that it often requires devastating pain and suffering to draw attention back to issues that we turned a blind eye to in the past. While the Wall Street movement is drawing some attention to our macroeconomic and political issues, we ought to pause individually to consider the personal financial decisions we, collectively, have turned a blind eye toward the last several years.

While our political leaders and the big, bad banks had plenty of involvement in the financial crisis of the past several years, consumers played an equally vital role. While it is unpopular to state this, much of the angst and turmoil “caused by the financial crisis” is really the result of poor (or a complete lack of) planning.

Before we cast stones, let’s take an honest assessment of our personal situations and the decisions we have made to ensure that we have built an adequate moat around our financial lives.

We talk often about creating a margin of safety in your financial life. This concept is derived from Benjamin Graham’s book, The Intelligent Investor. It merely means that when making investment decisions, one ought to ensure that they are buying a company at a price well below its real value. This concept is equally important in our ongoing financial decisions.

As an example, consider how many people purchased a home that stretched their budget to the max (or beyond the max!). The banks’ role in this process was knowingly allowing people to purchase more home than they could afford. However, the purchasers of these homes were equally responsible for allowing their eyes to get bigger than their stomachs. In the pursuit of bigger and nicer, we forgot to consider what happens when things do not go as planned.

Most households manage their cash flow pretty effectively until a “surprise” expense throws them off. Another “surprise” expense pops-up the next month, and then two more arise in month three. This creates a cascading snowball effect and results in a death spiral it is extremely difficult to recover from. What makes these scenarios worse, however, is that the “surprise” expenses often come in the form of car repairs, health care costs, a broken furnace, etc., which are really not surprises at all. The timing is unknown, but the expense itself can be reasonably anticipated.

The alternative to the death spiral is something like a job loss. Without question, a job loss is a far more financially devastating event, and far more difficult to prepare for. However, these are precisely the reason financial planners insist on their clients maintaining substantial cash reserves, or emergency funds. When a financial expert jumps on CNN or Fox News and tells everyone to maintain reserves of 3 -6 months of living expenses, they have situations like this in mind. For many folks, the idea of establishing and funding an adequate cash reserve was deemed unnecessary or far-fetched. In reality, if you can’t afford to build a cash reserve with your current cash flow situation, you are living beyond your means with no margin of safety.

Bruce Berkowitz of Fairholme Capital Management has famously discussed his methodology for protecting himself and his investors: kill the company. “We spend a lot of time thinking about what could go wrong with a company, whether it’s a recession, stagflation, zooming interest rates, or a dirty bomb going off.”

Consumers could gain a lot of ground on their financial security by simply practicing this with their ongoing financial decisions. In your personal space, the company is your household’s finances. Instead of focusing on what could go right, focus on what could go wrong, and make sure you are adequately protected against it.

Cash reserves are critically important in this regard. Adequate life and disability insurance will protect against the loss of the breadwinner’s earnings. Be realistic about your job security and forward-looking earnings. Do not over-commit to future expenses. Save consistently and with purpose. If you realistically have a hard time “killing the company”, you can probably afford that bigger house or car. However, if this exercise highlights significant exposures in your financial life, or a relatively likely event will lead to financial ruin, you must have the discipline to walk away.

Joe PitzlJoe Pitzl, CFP®
Director of Financial Planning
Intelligent Financial Strategies, LLC
Edina, MN


Medicare Open Enrollment Changes for 2011

As we approach the final quarter of 2011, folks enrolled in Medicare prescription drug plans ought to be prepared for some changes to the open enrollment period.

First and foremost, the period in which you are allowed to change plans has moved up to the period beginning October 15, 2011 and ending December 7, 2011. In previous years, this period ran from November 15 through December 31. The last application you submit in 2011 before the December 7 deadline will be the plan that becomes active on January 1, 2012. In other words, if you submit an application on November 30, but change your mind the following week, you may still submit another application before December 7. The second application will trump the first.

Unfortunately, marketing activities from Medicare providers can not begin until October 1, leaving a shorter window of time to evaluate options and make decisions in 2012. This not only means that companies can not begin marketing their products to you until October 1, but also means that agents and advisors are not made aware of plan changes and new offerings until the marketing period begins.

One of the more controversial issues surrounding Medicare and prescription drug plan involves the so-called “donut hole”. This gap in coverage has changed slightly in 2012 and will begin after you and the insurer have paid $2,930 for covered drugs and continues until you have spent $4,700. In 2012, there will be some continued relief in the form of discounts in that gap. Brand name drugs will become available at a 50% discount, while generics will receive a 14% discount.

As you are considering your options, there are several factors you want to ensure that you are paying attention to:
– Your current formulary, including the tiers your drugs are placed in
– Co-pays for brand names and prescription drugs
– Deductibles
– Make sure that your pharmacy is an in-network provider
– Alternative options, such as mail-order, that may reduce your costs
– Pay particular attention to your total out-of-pocket costs rather than focusing on premiums

With an earlier enrollment period beginning in just over a month, it is important to begin planning and organizing your information now to ensure you can make a smart decision in the weeks ahead.

Joe PitzlJoe Pitzl, CFP®
Director of Financial Planning
Intelligent Financial Strategies, LLC
Edina, MN