The right financial advisor can help you achieve your financial goals faster and manage your money more efficiently. However, financial advisors are not one-size-fits-all. The best financial advisor for you may be very different than the best financial advisor for your coworker, neighbor, or even family member. There are financial advisors who specialize in different income levels, estate planning needs, budgeting guidance, and other niche areas. You don’t want to pay for services you don’t need or end up with an advisor without the specific knowledge needed to manage your unique assets.  

Finding a financial advisor whose investment philosophy matches your own is key to a happy relationship. All investment strategies share some common elements – no one has the goal of losing money – but take different approaches to choosing where to invest and why to make those investments. Investment philosophies are coherent ways of thinking about markets, how they work, and the types of mistakes that consistently underlie investor behavior. 

Why Does Your Financial Advisor’s Investment Philosophy Matter? 

“The stock investor is neither right or wrong because others agreed or disagreed with him; he is right because his facts and analysis are right.” - Benjamin Graham in The Intelligent Investor 

If all investment philosophies seek positive returns, then why does your financial advisor’s investment philosophy matter? Your personal investment philosophy should take into account your financial goals and capital needs, your risk tolerance, and your timeline. Choosing a financial advisor whose philosophy lines up with your own ensures that your investments will work for you in the ways you need. Most investors who are successful over the long-term refine their investment philosophies over time and do not switch between philosophies in response to market conditions. Common investment philosophies include: 

• Contrarian investing holds a belief that some crowd behaviors amongst investors lead to mispricings in securities markets that can be exploited by buying and selling in contrast to the prevailing trend of the time.
• Fundamentals investing focuses on companies with strong earning potential.
• Growth investing favors companies that show above-average growth, even with high current stock prices.
• Technical investing examines past market data to uncover patterns on which to base buy and sell decisions.
• Socially-responsible investing follows a set of moral/ethical business values to invest in companies with social and/or environmental values that align with the investor’s, such as low emissions or no animal testing.    
• Value investing seeks to buy securities that are underpriced by the market that the investor believes will rise in price significantly over time.   

These are broad categories and an individual investor or firm may incorporate elements of different philosophies into their own investment philosophy.  

What is Ridgewood Investments' Investment Philosophy? 

"Long ago, Ben Graham taught me that ‘Price is what you pay; value is what you get.’ Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” 
— Warren Buffett in a 2008 letter to Berkshire Hathaway’s shareholders 

At Ridgewood Investments, our investment philosophy draws on the considerable experience of our partners managing investments across market environments on an institutional scale. We seek to help our clients achieve exceptional long-term investment performance through the application of proven principles of a value investing philosophy that can succeed regardless of current market conditions.

• We treat investing like a business. Investing requires careful research and understands of past performance, market trends, and what fundamentals you can and cannot control. Our financial advisors apply patience, discipline, and plenty of hard work to hone our investment strategies and practice over time. 
• We are value investors. We believe that price-paid is important and that a value-based and value-conscious approach to committing a great business can be a poor investment if the price is too high. On the other hand, great investment opportunities can be found in areas that are currently overlooked and therefore offer lower prices with long-term return potential.  
• We use margin of safety to understand and manage risk. Margin of safety is when an investor only purchases securities when their market price is significantly below their intrinsic value. We design our investment portfolios to compound our investors capital over time while carefully mitigating unnecessary risk. Risk is permanent loss of capital as opposed to temporary market fluctuations. We believe volatility can create opportunities for long-term investors. This is an area in which we differ from the majority of advisors and individual investors. 

What Does Our Investment Philosophy Not Include?

“Understand the nature of the companies you own and the specific reasons for holding the stock. (“It is really going up!” doesn’t count.)” ― Peter Lynch, One Up On Wall Street: How To Use What You Already Know To Make Money In The Market 

Just as important is what our investment philosophy does not include: 

1. A short-term approach. We emphasize patiently compounding capital over time and focus on the long-term results of our investments. We invest for rolling investment horizons of between 5-10 years in most cases (although shorter/longer horizons may be used if needed). Investment success is built over years of steady compounding and not by forever chasing the hot stock of the moment.   
2. Investments outside our circle of competence. No one advisor or group of advisors can competently understand every minute investment option available. We limit our investment activities to areas of investment than we think we can understand, also known as sticking to our own circle of competence. Warren Buffet said “Know your circle of competence, and stick within it. The size of that circle is not very important; knowing its boundaries, however, is vital." Operating within our circle of competence allows us to capably evaluate potential investments and make effective decisions.  
3. Focusing solely on historical numbers. While those who don’t know the past might be doomed to repeat it, those who expect the past to neatly repeat are also in for a rude awakening. Historical numbers are only relevant insofar as they foreshadow future changes. Our advisors also examine qualitative factors such as the nature of the business, company culture, the quality and character of the individuals running the business, and the capital allocation policies the company is likely to implement in the future. We take all these factors into account, along with understanding past performance, to choose investments that will lead to long-term gains for our clients. 

Our investment philosophy draws from successful philosophies, practices and insights of outstanding investors like Warren Buffett, Philip Fisher, Benjamin Graham, Bob Kirby, Peter Lynch and other extraordinary investors. Using the knowledge and experience we’ve collectively gained over years of investing; we seek to provide exceptional long-term performance for our clients. If Ridgewood Investments seems like a good fit for your financial needs, contact us for a free investment review.  

When planning for retirement in the United States, Social Security is the common denominator for the vast majority of workers. After spending your working life paying into the system, being eligible to collect Social Security benefits is one of the hallmarks of American retirement.

Social Security is a federally-run insurance program that provides retirement benefits, survivor benefits, and disability income to provide economic security for millions of Americans each year. As of June 2019, approximately 64 million people received monthly Social Security benefits, about 48 million of whom were retirees and their families.

Retirees can start collecting a reduced benefit at 62. After working forty plus years, it can be tempting to start enjoying guaranteed monthly income as soon as you are eligible. However, there are tradeoffs to collecting early and many workers may benefit by waiting a few years to begin collecting.

Who Can Take Social Security Benefits?

Social Security benefits are available to older Americans, workers who become disabled, and families who experience the loss of a spouse or parent. Rules around collecting benefits for the loss of a parent or for disability are too complicated to address in a short article. If either situation applies to you, I recommend working with your Financial Advisor and/or contacting the appropriate benefit specialists at the Social Security Administration (SSA). For the average retiree, who is the most common beneficiary of Social Security, the rules are much easier to understand.

To qualify for Social Security payments, you or your spouse must have paid the Social Security payroll tax for at least 10 years over your working history. Nonworking spouses can be eligible to collect up to half of the working spouse’s benefit.

Your 35 highest-earning working years, indexed for inflation, are used to calculate your benefits. There is a limit to the amount of annual income that qualifies for the Social Security calculation ($137,700 for 2020). In general, higher earners can expect to receive more in benefits from Social Security.

When Am I Eligible to Collect Benefits? 

Retirees can begin collecting as early as 62 or as late as 70 (even earlier as a survivor of another Social Security claimant or with a disability).

Full retirement age depends on your birth year:

When is the Best Time to Start My Benefits?

The decision of when to start collecting Social Security benefits is highly personal. In deciding when to begin taking your Social Security benefits, you should consider:

• Current employment. Earned income (including self-employment income) can reduce your benefit. If you are working and collecting Social Security benefits prior to full retirement age, $1 in benefits is deducted for every $2 you earn above the annual limit ($18,240 for 2020). The reduction in benefits falls to $1 in benefits for every $3 you earn above a much higher annual limit ($48,600 for 2020) in the year you reach full retirement age.
• Your healthcare. While you can begin drawing reduced Social Security benefits at 62, Medicare eligibility is set to 65. If you do not have employer-sponsored health insurance through your employer or your spouse’s employer, private health insurance will wipe out a large portion of your Social Security payments each month.
• Your life expectancy. According to the SSA, average life expectancy for an individual turning 65 years old on April 1, 2020 is about 84 years for males and 86.5 for females. You can use the SSA’s life expectancy calculator to see the average life expectancy for an individual of your gender and date of birth. Of course, the calculator does not take into account your lifestyle, family and personal health history, education, and other factors that can affect your life expectancy. If you are in good health, the higher benefits over 20+ years may outweigh the benefits of early payments. If you are in poor health, immediate access to guaranteed income from Social Security may be the right choice in some circumstances.
• Your spouse. Married couples live longer on average than single folks and have an above average probability of one or both spouses living to 90. Many couples do the math and find that waiting to have the higher earning spouse claim benefits as long as possible, up to age 70, is the best choice for their situation. The lower income spouse may be able to claim earlier, depending on the couple’s finances. After the death of one spouse, the surviving spouse receives the larger of the two benefits for his or her lifetime. For couples with a large difference in average earnings over the course of their careers, this can make a significant difference in the financial health of the surviving spouse.
• Current cash needs. Do you have an alternate means of income? Working longer or drawing on other retirement accounts can help you maximize your monthly benefits.

How Can I Maximize My Benefits?

You can increase your monthly benefit amount in two ways:

• Keep working. If you have less than 35 years of income history, each additional year you work replaces a zero-income year in the calculation for your benefits. If you’ve worked a full 35 years but have moved up the company ladder, another year at your current income can edge out a lower income year from earlier in your career.
• Collect later. Beginning your benefits at age 62 results in a permanently reduced monthly benefit while delaying to age 70 yields the highest possible monthly benefit. Talk with your financial advisor about what your break-even age is for delaying beginning Social Security benefits. The break-even age will vary depending on what your tax assumptions are and the opportunity cost of waiting. In general, if you think you will beat the average life expectancy or if you are the higher earning spouse and want to maximize survivors benefits for your spouse, waiting to claim benefits may be the better option. If you are in poor health or are the lower income spouse (and your partner can delay beginning benefits), claiming earlier may make more senses for your situation.

Is Social Security Enough for Retirement?

Social Security was never meant to be the sole source of income for retirees. The average monthly benefit as of January 2020 was $1,503. The maximum monthly benefit for someone retiring at full retirement age in 2020 is $3,011. Social Security claimants receive modest cost-of-living adjustments (COLA) based on inflation each year, ranging from 0-3.6% over the past decade. The 2020 COLA was 1.6% and a similar COLA is expected for 2021.

Wondering if Social Security will still be around by the time you retire? You may have heard that Social Security is funded by current workers and the coming retirements of baby boomers could overwhelm the system. As of June 2019, about 177 million people worked and paid Social Security taxes. According to the SSA’s 2020 Annual Report, the Social Security Trust fund has enough resources to cover all promised retirement benefits until 2035 and will cover 79% of scheduled benefits for new retirees after 2035 without changing the current system.

While planning for retirement, it may be best to think of Social Security as a form of insurance, not as a primary income source for your golden years. Most financial advisors recommend that your retirement income needs to replace 70-80% of your pre-retirement income for a comfortable lifestyle throughout your golden years.

The amount of pre-retirement wages that Social Security benefits replace varies based on what your average earnings were and when you chose to begin collecting. The maximum yearly benefit for an individual collecting at the full retirement age in 2010 comes to $36,132. For many retirees, this is too little to support their desired lifestyle.

Don’t leave taxes out of your retirement calculations – about 40% of current Social Security beneficiaries pay taxes on their benefits. Filing as an individual on your federal tax return, you may have to pay taxes on your benefits if your total income exceeds $25,000 ($32,000 for couples filing jointly).

Your retirement plan should take into account your investments, savings, and Social Security benefits to provide the retirement income you need to support you throughout your golden years. A trusted Financial Advisor like our team at Ridgewood Investments will help you prepare your portfolio to provide the income you need in retirement so you can spend less time worrying about Social Security benefits and more time planning the hobbies, travel, or other goals you plan to pursue in retirement.

The United States officially entered a recession in February 2020, ending the longest economic expansion in American history. The contraction in March 2020 was so severe that the National Bureau of Economic Research declared a recession in June, without waiting for a second complete quarter of negative growth. 

The prevailing wisdom says that investors should hunker down and ride out market declines. In reality, a noteworthy portion of investors sell off their holdings when markets fall, fearing further loss. Earlier this year, I had a family member call me and say “I know you told me not to cash out, but I did. What do I do now?”.

My family member was far from the only one to sell off when the market fell. According to Morningstar, spooked investors pulled a net $326 billion from mutual funds and exchange-traded funds in March. For most of those investors, that money remains out of the market.

If you were one of the investors who sold out earlier this year, you may be wondering why selling out was likely the wrong choice and how and when to get back into the market.

Why Is Selling Out Likely a Bad Idea?

A well-diversified portfolio is designed to handle market volatility while still trending towards long term gains. Whereas a painful short-term loss may be unavoidable in a market-wide crash, diversification works to prevent losses from which your portfolio may not recover.

Moving to cash can seem like a prudent move to stem further losses when the market rapidly drops. However, holding a large portion of your assets in cash may be a poor choice for most investors. Cash can be a difficult allocation because:

• Interest rates are historically low. The Federal Reserve has kept interest rates low since the last financial crisis in 2009. The current rate is near zero which means that cash holding like bank accounts and short-term money market funds are earning less than the rate of inflation. Anytime your savings grow at less than the rate of inflation, you are effectively losing money. 
• Holding cash means missing out on market gains. The S&P 500 closed at a record high on August 18, 2020 and surpassed that high on September 2, 2020, erasing the market losses early in the coronavirus pandemic. Investors who pulled their money from the market in March endured the market plunge without the relatively rapid market recovery that followed.

How is the Stock Market Recovering Faster than the General Economy?

The economy and the stock market do not move in tandem, even in normal times. The economy is concerned with what is going on right now and in the recent past – higher unemployment, Main Street small business closures, and ongoing lockdowns to control the spread of the coronavirus. Economists look at historical data from the trailing one to three months to determine economic health.

The stock market is inherently forward-looking. Investors look at current conditions – of the economy at large and of the financial health of the consumer and of corporations – and estimate pricing for stocks today based on predictions for the future (typically three to six months in advance).

The market has benefited from Fed policies of low interest rates and a continuation of its quantitative easing approach of injecting liquidity into the financial system by purchasing treasuries, mortgage-back securities, and, recently, corporate bonds. These policies make holding assets in cash unappealing and are designed to drive investors into the market.

The stocks making the largest gains – big companies like Amazon, Google, Facebook, Netflix, etc. – have been largely protected from the current economic conditions. White collar workers can work effectively from home. Online ordering, video streaming, and social media all benefit from consumers sheltering in place. Companies like these dominate in the stock market, pushing the market up at the same time that small businesses are closing their doors.

Waiting for a full economic recovery before putting your money back into the market will likely mean missing out on significant gains.

When and How Should You Get Back In?

The best time to start investing again is almost always “now” – no matter when now is. The perfect is the enemy of the good. Trying to time the market to put your money back in at a hypothetical perfect time is a fool’s bet for most investors. 

To reenter the market, you have two options:

• Put all your money back in today. Stocks rise more often than they fall. Putting all of the money you have waiting to invest into the market today offers the greatest possibility of profit. However, this is a higher risk option – if you are unlucky with your timing, the market could theoretically fall again the day after you invest and stay low for a long period of time. Investors who pulled money out of the market in March 2020 are likely to have low risk tolerance and may find this method too emotionally draining to stomach.
• Reinvest slowly with a dollar-cost averaging strategy. Dollar-cost averaging involves investing a predetermined amount at regular intervals into target assets (regardless of fluctuations in their pricing). If you invest a portion of your paycheck in a 401k plan, you are already utilizing dollar-cost averaging. The same dollar amount is invested in the array of assets you have chosen each month, regardless of the price of any given asset that month. Dollar-cost averaging allows investors to minimize the impact of short-term volatility and avoid the risk of investing a large sum of money at an inopportune time.

Investing in the stock market will always carry some degree of risk. However, as you now know, holding large amounts in cash carries its own risk in losses to inflation and opportunity costs. Before reinvesting your money, make sure you understand that market investing is a long-term game and are prepared not to make the same mistake of selling out should the market fall again. Finding an investment strategy that you can stick to long term, through ups and downs, will allow you to feel good about how your money is working for you no matter how the larger market and economy are doing.

In a few short weeks, voters in the United States will choose between Democrat Joe Biden and Republican Donald Trump at the ballot box. A deluge of campaign ads from both Democrats and Republicans offer dire predictions for America if the opposing party wins the next four years of the presidency.

With the global coronavirus pandemic still raging in the United States, and Congress deadlocked on the best course of action to support an economic recovery, the 2020 election feels uniquely important to many Americans. In February 2020, the United States economy entered a recession, ending a record 128-month expansion that began in June 2009. The next president, together with Congress, will decide America’s path forward.  

Stock markets main influences are corporate earnings, interest rates, and economic growth. Business cycles, globalization, and unpredictable major events like terrorist attacks or natural disasters all drive the market up and down.  Political events such as the US presidential election cycle can also have noticeable effects on the market.

Stock markets are more volatile in the months leading up to a major election because markets do not like uncertainty. 2020 has been a year of heightened volatility for the stock market, in part due to the normal election year reprising of the potential future administration’s policies. While we do not know how long a coronavirus vaccine will take to go to market or how many other disasters may arise this year, the question of who will be sworn into the office of the presidency come noon on January 20, 2021 will soon be resolved.

How will the stock market react if Biden wins? What if Trump wins a second term? Looking back at previous election cycles and their effects on the stock market offers us some insight.

How Have Previous Presidential Elections Affected the Stock Market?

Portents of doom regarding political opponents are nothing new. Before each election, both parties do their best to convince voters that the market will do poorly under the other side and thrive under their wiser set of proposed policies. The leader in the White House has many opportunities to influence the economy through fiscal policies, spending, taxation, regulation or deregulation, etc. However, our choice of an individual president has less effect on the economy, and therefore on the market, than one might think.

On average, markets may have shown somewhat of a cycle in regard to the presidency, generally performing below average in the first two years of a president’s term and above average in the last two years. Looking at the Dow Jones Index data dating back to 1896:

• Year 1: Average return of 2.4%
• Year 2: Average return of 4.2%
• Year 3: Average return of 10.4%
• Year 4 (Election year): Average return of 6%

On average, based on past data, the first two years seems to yield below average returns.  This might perhaps have to do with a new administration implementing a new agenda and change takes some time. The market may also be waiting to see what policies are going to be proposed and passed leading to greater uncertainty in the early years of a new term.

During the latter two years of a presidency, the president’s policies become clearer (less uncertainty for the market). The party in power begins to think about the next election and focus turns to fiscal stimulus. In the fourth year of a president’s term, election year, the added uncertainty of the next election may show reducing gains.

Interestingly, the correlation also seems to work in reverse.  The market’s performance before an election can be a guide to whether the incumbent party will maintain control. With only three exceptions since 1928, the incumbent party has won the presidency when the S&P 500 has risen in the three months leading up to an election and has lost power when the S&P 500 has fallen. The exceptions are Dwight D. Eisenhower, who was reelected in 1956 despite the S&P falling 3.2%. In 1968 and 1980, despite three months of a rising S&P 500, Richard Nixon and Ronald Reagan beat out incumbents Lyndon Johnson and Jimmy Carter, respectively, to take control of the White House. With a nearly 90% prediction rate, it’s not surprising that parties typically focus on improving market performance in the latter part of their terms.

Of course, it's extremely important to keep in mind that the above patterns are just based on the averages – individual presidencies may defy the trend as many other factors also have significant influence on the market.  As just one example, in 2008, an election year and the middle of a financial crisis, the Dow fell 34% as the subprime mortgage crisis brought on the Great Recession (versus the 6% average gain for election years as a whole).

How Will the Market React If Trump Wins Another Term?

Republicans are thought of as the more market friendly party and we can perhaps expect a positive market reaction if Donald Trump wins the 2020 presidential election. On average, stock market gains tend to be higher when an incumbent party retains power versus when a new party takes the White House. In most cases, an incumbent party, and in particular an incumbent president, is considered a known quantity, though 2020 and this President may be an exception to the rule of continuity.

However, surprisingly, the data seems to suggest that the overall gains could potentially be higher under a Biden presidency. Despite Republicans reputation as the more business-friendly party, market gains historically have consistently been higher (on average) under Democratic administrations than Republican ones.

Republican administrations promote growth by cutting taxes, allowing corporate profits to flourish. In 2017, the Trump administration cut the top corporate tax rate from 35 percent to 21 percent, increasing corporate profits. A Trump administration would keep the lower corporate tax rate in place.  This prospect led to a significant market rally once Trump won the election in November of 2016 that continued well into his term.

Financial stocks in particular might rise after a Trump victory. President Trump, in some cases with bipartisan support, scaled back some of the regulations of the Dodd-Frank Wall Street Reform and Consumer Protection Act and has signaled an openness to continuing to remove regulations in the financial sector. Energy stocks are also likely to do better under a second term of the Trump presidency as Trump continues to reduce regulations on fossil fuel production.

Trump has defied conventional wisdom in many arenas, and indeed the market gains during his first term have been far from typical. Average price gains for the S&P 500 in 2017 and 2019 (years 1 & 3 of the Trump presidency) were well above historical averages while 2018 and 2020 to date have fallen below the averages.

What Changes If Biden Wins the White House?

Whenever a new party takes power, it appears that market gains the first year tend to be more muted so if history is a guide, we can perhaps expect a smaller gain the first year of Biden’s presidency. Nonetheless, if Americans elect Democrat Joe Biden as our next president and historic patterns hold, the markets may rise at a greater pace over his four-year term than under a Republican president.

According to InvesTech Research, annualized total returns for the S&P 500 since 1928 have averaged 13.3% under Democratic administrations. Republican administrations averaged 7.7% annualized total returns over the same time period. Recent administrations have continued this trend – average gains under Bill Clinton and Barack Obama exceeded gains under George Bush Sr, George W Bush, and Donald Trump.

This may seem counterintuitive – Biden plans to raise taxes on corporations and the rich, which cuts into corporate profits and possibly spending by those paying higher tax rates. Increased taxes perhaps allow for increased spending (or investments) in certain sectors like healthcare and infrastructure, which may be helping to offset some of the impact of higher taxes. Democrat administrations generally increase taxes but also increase spending.

Biden has promised a significantly more robust fiscal stimulus plan than Trump has to date. The exact size of the stimulus Biden is able to pass will depend on control of Congress. If Democrats manage to hold onto the House of Representatives and flip the Senate, we can expect higher spending. Just like lower taxes, higher spending stimulates the economy and market for different, but similar, reasons that there is more money available to be allocated.

Clean energy stocks could do relatively better under a Biden presidency as renewable energy becomes a greater priority. Utilities and real estate firms did not see as much benefit from Trump’s 2017 tax bill and would be less impacted from the top corporate tax rate increasing to 28% under Biden’s plan. Infrastructure investment has bipartisan support and a large bill could rally industrial and material company stocks. Healthcare may also be poised to rise under a Biden expansion of the Affordable Care Act, although the details of the eventual bill itself will ultimately determine which stocks gain the most.

Is the 2020 Election Unique?

2020 has been a unique year in modern American history. A global pandemic, increasing partisan polarization, social unrest, and several natural disasters have made 2020 a year to remember. An expected record number of mail-in ballots mean we might not know who won the Electoral College until several weeks after Election Day. However, come January 20, the next president will be sworn in and life will go on and markets will adjust either way.

In Sir John Templeton’s wise words: “The four most dangerous words in investing are: this time it's different.” Investing is a long-term game. While it’s tempting to focus closely on the presidential election, doing so can mean you’ll miss the forest (larger market trends) for the trees (the politician du jour). Investors making smart decision can continue to make long-term financial gains regardless of whether the market is rising or falling or who controls the presidency.

Investing for the long term requires a comprehensive understanding of the risk and likely return of potential investments and how those investments correlate to your situation and objectives. Talk to a trusted advisor to make sure that your investments are the right choice for you. A good advisor will keep abreast of potential implications of the election cycle and the political winds on your portfolio so that you can focus on what matters most to you.

High performers in every field share some common attributes.  One of these is that they almost always seek out experienced coaches and advisors who help them achieve high performance in the first place.  Examples of high performers in various areas who work with coaches to reach or maintain high levels of performance includes:

• Olympic Level Athletes like swimmer Michael Phelps
• Elite Golfers like Tiger Woods and Rory McIlroy
• Top Fortune 500 CEOs like Indra Nooyi and Meg Whitman
• Wealthy founders of companies like Facebook and Google

As an Investment Advisor, one of the most enjoyable parts of my job is in educating and coaching my clients. Beyond the foundational work that we do in managing and growing their investments, we often guide clients through questions or issues related to entrepreneurship and financial or even life and career options.

As a financial coach, I can often see things they have missed, bring perspectives that clarify the choices at hand, and help my clients narrow down the right decision under the circumstances for them by asking diagnostic questions and helping weigh the pros and cons of each choice using the experience we bring to the table.

The American Dream says that anyone can work their way from nothing to become successful.  However, almost no one achieves success by themselves.  Hard work and talent focused in the wrong area will inevitably lead to failure.  The cost of even one error, if it is big enough, can be extremely high and delay the achievement of goals by years or perhaps even place them out of reach forever.  Correspondingly, the ability to sidestep risks and find the most efficient way to achieve objectives can be invaluable.

So why is it that even the most intelligent, best educated, naturally talented, hardworking and driven people still seek out coaches and advisors to succeed?

I recently learned about Solomons Paradox, and it holds the key to explaining why all these high performers and all of us as well can benefit from the right coaches and advisors if we wish to achieve our own goals.

What is Solomon’s Paradox?

King Solomon, the biblical king from the Old Testament, reigned over the consolidated Jewish kingdom from circa 970 to 931 BCE. Solomon was considered the wisest of kings and people would travel from near and far to seek his advice and mediation.

In the biblical tradition, young King Solomon has a dream where the Lord offers him anything. Instead of choosing money or power, Solomon asks for the wisdom to discern between good and evil with integrity. God is pleased with his request and grants him the wisdom to judge for his people.

In one of Solomon’s best-known judgements, two women came before the king to seek his help with a custody dispute of a newborn child. Both women had recently given birth to baby boys, one of whom had died, and both women claimed the living child as their own. Solomon sent for a sword and ordered the child cut in half, so that each woman could have a share. One woman readily agreed while the other begged him not to kill the boy, saying she would rather give the baby to the other woman to save his life. Solomon ruled that the woman willing to give up the child was the true mother and she was reunited with her little boy. The story spread throughout the United Monarchy and was retold as a sign of Solomon’s wisdom and justice.

While many of us know the tale of Solomon’s wisdom in the affairs of others, few realize that he seldom showed good judgement in his own personal life. Some examples of his personal bad judgement include his decisions to hoard vast amounts of wealth and build an extravagant palace on the backs of countless slave laborers. He also had hundreds of wives and concubines, many of them from foreign lands, and allowed his wives to bring the worship of their gods to his home (considered idolatry in ancient Israel).

Perhaps most egregious in his recounted failings, Solomon failed to prepare his son and heir Rehoboam to become a wise king. When Solomon died and Rehoboam took the throne, Rehoboam ignored the advice of his own advisors and dealt harshly with his people. His tyranny led to the end of the United Monarchy, where the Kingdom of Israel broke free of Rehoboam’s rule in the north and Rehoboam ruled the southern Kingdom of Judah alone. The culmination of Solomon’s lifetime of bad personal decisions ruined his once great kingdom.

The contrast between Solomon’s sage public judgements for others and the lack of wisdom in his personal life is Solomon’s paradox. Why was the wise King Solomon unable to apply more of his wisdom to his own personal choices and goals?

Does Solomon’s Paradox Still Apply? 

King Solomon lived nearly 3000 years ago. Entire empires have risen and fallen in the intervening years. Inventions ranging from the printing press to electricity and the Internet have transformed our daily lives. We now have access to the collective knowledge of the human race on a device we carry around in our pocket. With all the available information and advantages of the modern era, it’s might seem that the folly of an ancient king may no longer be relevant.

Igor Grossman, a professor of psychology at the University of Waterloo in Ontario, set up a series of experiments to see if Solomon’s paradox was still a factor today.  He wanted to measure if people were indeed better at giving advice to others than in evaluating and giving themselves the benefit of that same judgement ability.

Grossman’s studies found that:

• We are able give our friends better advice because of our relative objectivity. Participants imagined that their friend’s long-term romantic partner had committed infidelity. The participants were able to stay clearheaded and give well-reasoned advice.
• We give ourselves poor advice or don’t follow our own good advice. When those same participants imagined that it was their own long-term romantic partner who had committed infidelity, their responses were clouded by emotion and less reason than when it was a friends circumstances
• We don’t get wiser with age. Older participants (60-80 years old) fared no better at managing their emotions than young participants (20-40 years old) when dealing with a personal betrayal. Older folks may have more experience and a wider knowledge base but they are just as susceptible to Solomon’s paradox as the rest of us.

As poor Alice noted in Lewis Carroll’s Alice’s Adventures in Wonderland “I give myself very good advice, but I very seldom follow it”. 

Solomon’s paradox is not unique to the ancient era. There are countless examples of historical figures who would have benefited from their own good advice. In an early draft of the Declaration of Independence, Thomas Jefferson denounced slavery as a “cruel war against human nature itself, violating its most sacred rights of life & liberties” yet Jefferson owned hundreds of slaves himself.

Author George Orwell’s 1984 warned of the dangers of Big Brother, yet Orwell compiled a list of what he viewed as problematic writers for the British anti-communist International Research Unit in 1949.

Even today, we can find many examples such as politicians who sabotage their political chances through irresponsible extramarital affairs and many others.

Of course, Solomon’s paradox doesn’t just apply to the rich and famous. Plenty of average people make terrible choices that they would never encourage a friend to make – impulsive relationship decisions, hearsay driven investments, or merely giving up after a temporary setback.

How Can We Avoid Solomon’s Paradox?

Luckily, we are not powerless against Solomon’s paradox. Simply being aware that the paradox exists can help to a degree. Practicing psychological distancing by reframing decisions as if we were deciding for a dear friend can help us to remain more objective.

Instead of asking yourself “Should I have that last slice of cake?”, ask from a third person perspective “Should he have that last slice of cake?”. The simple pronoun change can help you focus on facts - I’m not hungry and am trying to cut back on sugar – versus feelings created by emotions and short-termism.

Wisdom is the quality of having experience, knowledge, and good judgment. Practicing psychological distancing helps us to make more rational judgements but is insufficient in areas where we may not have the right experience or knowledge. If some of the necessary components of wisdom are absent, and especially when the decisions are complicated, your unaided decisions are still likely to yield poor results.

In these cases, finding a good mentor, coach or advisor who has the right education, experience and ability to supply the missing components of wisdom from a more objective third person perspective can help you reach your goals in just about every area of your life far more efficiently.

Very high performers have not just one, but multiple advisors that they rely on to perform even better. A pop star might employ an agent, voice coach, stylist, nutritionist, personal trainer, and dance coach to continue rising in their career.

For those of us not blessed with Shakira’s voice and dancing talent, we can still benefit from advisors in certain areas of our lives:

• Relationship counselors assist couples with communications and trust issues that would lead to divorce if unchecked
• Personal trainers and/or nutritionists can help individuals with health challenges that can literally add years or even decades to your lifespan
• Investment advisors help you multiply your money and freedom without doing any more work yourself
• Business and career coaches can help you achieve greater growth in income and profitability from your work

As with all the above examples, even in things in which we have a good knowledge base and prior experience, a qualified outside observer can help us more clearly evaluate all the options to make the optimal decision and avoid needless mistakes. This is why top CEOs still employ executive coaches despite their own credentials. The unique vantage point of an outside advisor can help us grow and prevent unnecessary stumbles in whatever arena we employ them.

What Does this Mean for Investing?

Investing, and financial health in general, is one area where almost everyone can benefit from a good advisor. Financial markets are complicated and forever changing. Money decisions are inherently personal and clouded by emotions and past experiences. Loss aversion is deeply embedded in the human psyche, even when a small loss will eventually lead to powerful long-term gains.

As an investment advisor, I often help my clients counterbalance their instincts in the achievement of their financial goals and portfolios.

When seeking a great investment and financial advisor, its important to be thorough and find a worthy coach, so take the time needed to look for someone with:

• Experience – You want an advisor who has a history of achieving the results you want to achieve. I founded Ridgewood Investments in 2002 after seven years on Wall Street and am proud of the transformational results I have achieved for my many clients over the past few decades.
• Education – As with any field, education is important.  Many advisors work more as salespeople than anything else and their educational backgrounds reflect this focus. I have always been surprised when I run across clients who themselves are far more educated and thoughtful than their current “advisors” whom they turn to help them figure out what to do with their savings and financial decisions.
• Knowledge – The best advisors are always seeking to expand their knowledge and find new ways to make sure that calculation, not emotion, rules the day.  They write and create content to educate others around the many details and nuances needed to make good decisions.
• Courtesy and Responsiveness – This should go without saying, but your advisor should always treat you with courtesy and respect.  They should be available and responsive if you have questions or need to reach them.  At Ridgewood Investments, we believe in educating, not selling. Our skilled advisors provide exceptional service and responsiveness.

Being aware of Solomon’s paradox and finding ways to avoid its reach by harnessing great coaches and advisors is a key step in the journey to achieving your personal, financial, and professional goals.

In my work as an experienced investment and financial advisor, I am often hired to act as both an expert and a coach to my many clients.  Part of my job involves teaching and guiding clients to optimize complex decisions and sometimes even to fight against their own instincts, especially when markets are volatile and scary.

Theoretically, investing should be easy and involve a series of logical tradeoffs and choices determined by cold and calculated analysis.  However, the reality is that in many cases, emotions are as much in the mix as reason when it comes to trying to achieve investment success.

Even when you have a good plan and the right advice, sticking to that long-term investing and financial plan can sometimes be challenging for many people in the face of market volatility. This is why many who are on the right track cash out and fail to get reinvested when they get scared by the market.

Since I started Ridgewood Investments in 2002, and even in my prior life as a private investor managing my own portfolio and that of my parents, I was always aware that the ability to control and manage emotions is critical to success in investing.  This is why many outstanding investors, including Warren Buffett often talk about the importance of temperament (rather than just intellect) to the achievement of outstanding investment results.

This is true not only for individuals, but also for markets as a whole.  Markets themselves are sometimes driven by so-called animal instincts as chronicled in Scottish journalist Charles Mackay’s 1841 classic Extraordinary Popular Delusions and the Madness of Crowds.  Indeed, as I write this in 2020, there is possibly a mania underway again in certain very highly valued companies traded in the stock market.

It's not just an accident that so many individuals have difficulty making solid investment choices and sticking to them for long enough to get the benefit.  In fact, the culprit that explains why so many of us are so bad at making certain types of choices in the modern world (including investment choices) is how and under what circumstances we evolved.

The Direct Link Between Evolution and Bad Investing

The first Homo sapiens emerged approximately 200,000 years ago on the savannahs of Africa where individuals lived in small hunter-gather tribes that scraped out an existence in a very different world than our modern world of today.

The father of evolutionary theory, Charles Darwin observed that evolution works over eons because traits in a species are heritable and varied, with new traits popping up from what we now know to be genetic mutations. Evolution selects those traits that are advantageous to survive through the mechanism of natural selection.

Natural Selection can itself be further categorized into:

1. Environmental selection which allows traits that promote survival like strong bones to be passed to the next generation
2. Sexual selection through which traits that make a certain individual more attractive to the opposite sex and make mating more likely.

Evolution, however, works quite slowly.  The adaptations of our current bodies and minds were developed for survival in a very different environment than the one we live in today.  Many of the inventions that have made life so much more plentiful including things like money and stock markets and much of our technology are very recent (hundreds or at most thousands of years old), whereas our minds are mostly evolved for the world the way it looked fifty or even one hundred thousand years ago.

Since our lives today look very different than those of our ancestors but our minds have not had enough time to evolve to fit the modern world, many of our decisions today are still driven by mental short cuts and inherited traits that helped our ancestors survive but make us prone to making terrible choices.

Unfortunately, many of these traits operate at an automatic, emotional and subconscious level and thereby can be extremely difficult to recognize and neutralize even when they may be extremely counterproductive or even completely irrational.

Evolutionary Psychology Provides Insight into the Emotional Programming that Prevents us from Making Great Investment Decisions

Evolutionary psychology is a relatively new field of study focused on how evolution shaped human behavior.  It is a multidisciplinary field drawing from cognitive psychology, evolutionary biology, genetics, anthropology, and archeology. In the same way that physical traits were evolved through natural selection, patterns of behavior that increased chances of survival or mating were also passed down from one generation to the next and are cataloged in great detail by the Evolutionary Psychologists.

For context, Until the mid-twentieth century, economists maintained that humans were rational actors. However, there were too many counter examples of irrational decision-making that the economists had a hard time explaining.  A few decades ago, the field of behavioral finance emerged within economics to catalog and explain how in certain predictable circumstances people were consistently prone to making irrational choices. While behavioral finance explained the circumstances in which we tend to make poor choices, it could not actually explain why.

Evolutionary psychology goes further by explaining that the problems identified in behavioral finance are caused by traits that evolved for very good reasons and helped us survive and pass on genes that reinforced those adaptations.

Traits that reinforced survival and mating advantages in a world of danger and a never-ending search for basic sustenance no longer serve us well in an environment of plenty and dynamic complexity.  Some of these traits include our tendency to make split second emotional decisions and run away from perceived danger.  A good example of our flashing danger reflex is that our brains constantly and subconsciously look for patterns as a short-cut to identify future peril.  On the plains of Africa, yellow and black stripes in our peripheral vision automatically triggered an involuntary spike in fear and heart rate followed by an urge to flee.

However, investing is a great example of how this same evolutionary programming can work against us in the modern world.  Markets and investing are a relatively new idea in the human species, only emerging in the last ten thousand years or so as primitive markets developed in our settlements and slowly became more sophisticated.  That same part of our brains that is great at automatically detecting tiger stripes in the distance also kicks into high gear when it encounters other patterns in the modern world that have very different effects but can still trigger the danger and panic based emotional response.

Some of Our Evolved Behavioral Traits That Lead to Bad Financial Decisions

There are many behavioral traits from our evolutionary programming that can cause us to make poor choices (including investment choices).  A few of the most relevant to investing are:

1. Emotional Decision Making – Humans are emotional creatures. We have evolved to feel strong emotions in reaction to our environment and thereby make instinctual decisions where slower, more considered and nuanced decisions would be more appropriate.
   
2. Loss Aversion – The prehistoric world was one of scarcity. Our ancestors could not afford to lose what limited resources they had.  As a result, we evolved to feel intense pain and discomfort when faced with losing something we have.
   
3. Overconfidence – Confidence was key for high standing in the tribe. We have evolved to feel confident about things we know next to nothing about because that same air of confidence made us more attractive to mates.
   
4. Classification – Our minds are good at classifying things. We use limited information to form sweeping generalizations that allowed us to find food, avoid predators, and identify our tribe members from other potentially hostile humans.  Our brains also consume the maximum amount of energy in our bodies and so classification also helps us to conserve energy and effort for survival instead of processing every occurrence individually and from scratch.
   
5. Reliance on Gossip – Humans are social creatures. The ability to rapidly exchange information, even if it was potentially unreliable, with members of our tribe in unpredictable environments allowed us to survive.

Compare these traits with those needed to be a rational investor. The same tendencies that were essential to our survival undermine us in making rational long-term decisions. Markets fluctuate all the time and when they do, we’re hit with constant feedback from our investments. This feedback hits its apex during a market crash or market panic when value is being “lost”.

Unfortunately, just as this is happening, our instincts kick in and we can experience very intense emotions that surface in response to the perceived threat or loss. The drive to run away from the danger and not lose what we have explains why otherwise intelligent, thoughtful investors will pull their money out in a bear market (typically the exact opposite of what reason suggests you should be doing).

Even when we know rationally that the loss is likely temporary, the pain of loss can be so intense that most people find it difficult to not give in to their emotional impulses.  Even if you are one of the few that does not panic and sell, you might still be unable to actually put new money to work and thereby really benefit from the opportunities created by the bear market declines.

Optimal financial decisions should ideally be based on long-term calculations and careful research. In most cases, however, our emotions serve as a hindrance to enjoying investment success by bypassing our ability to weigh complex decisions carefully.  Let’s look at how a few of the above evolved psychological traits can commonly lead to bad investment decisions.

Our tendency to automatically classify things means that we tend to oversimplify. Classification which was useful in determining things like what berries were safe to forage can be too simplistic when applied to the complexity of the modern financial system. 

As Einstein observed, “Everything should be made as simple as possible, but not any simpler.”  Unfortunately, our tendency to automatically classify makes us likely to assume we know what we are observing and thereby make poor financial decisions.

Similarly, our instinct to gossip leads us to give undue consideration to the casual ideas we pick up from friends, family, celebrities, and self-styled money gurus. Your father-in-law might be an excellent doctor, but if you are investing in a certain stock or keeping your life savings in cash because of his opinions, you may be doing yourself a disservice.

Instead of relying on our evolved mental short cuts, financial decisions need to be highly personalized and based on a careful weighing of the pros and cons of the choices we have to select from.  Prior experience making similar complex choices and access to the analytical tools and mental models needed to sift through all the options is extremely helpful to making the right decisions.  Ones that would increase your wealth while sidestepping unnecessary pitfalls.

How We Can Counter Evolutionary Instincts to Make Better Decisions

Now that you know why we tend to make seemingly irrational financial decisions - how can you avoid that fate?

Our innate programming is hard to suppress, however, there is hope.  Awareness that evolution has programmed us to make poor decisions is the first step in being able to minimize the possibility of being victimized by this programming.

Some steps you can use to counteract our evolutionary programming when it comes to investing and other complex decisions include:

1. Make it a habit to pause and try to recognize and remove emotion from the equation when making financial decisions. Look at your situation from a third-party perspective. What would you advise a friend to do in the same circumstances?
   
2. Reframe short-term losses by forcing yourself to also think longer term. Ask yourself prior to making any moves to also focus on what will be the best choice for your finances 5 to 10 years down the line? Suppress the urge to give into fear and act on your short-term loss aversion instinct.
   
3. Avoid overconfidence and simplistic classifications. Ask yourself if your model of the current situation is appropriate under the circumstances.  Do the research and weight both sides carefully before making any changes or choices.  Take your time.
   
4. Avoid gossip.  Recognize that great investments are rarely made as the result of hearsay or casual dinner conversations.  At an absolute minimum, any “hot tips” should be researched thoroughly or ignored, and never followed blindly

Few people are aware that our evolutionary instincts can undermine our results in the modern world.  Fewer still have the experience and maturity to replace these evolved instincts with intellect and reason in the quest to make better investing decisions.

Even many financial advisors fall into the same traps (they are human too). Finding advisors you can trust and who have honed their ability to avoid basing complex modern decisions on prehistoric emotions and behavioral patterns is one of the most important criteria you should consider before selecting your advisor.

In the long-term, investing in stocks generates good returns.  Over the last 70 to 100 years, long-term investors in the stock market with a 10+ year horizon have been able to generate 8 to 10% average returns but this is by sticking to investing for the long-term.

The unfortunate reality is that for many investors, actually capturing long-term stock market returns can be challenging because not everyone has the patience, time or the stomach to ride out the ups and downs.

As I write this in the summer of 2020, the Corona virus and Covid-19 illness have spread around the world.  Markets have been on a roller coaster ride, and after a great year for US markets in 2019, 2020 has been scary enough that many investors have sold out and are sitting on the sidelines in cash even as the market has started to mostly recover from its late March losses.

This year has been a great illustration and test of the challenges that investors can face in their ability to withstand market volatility.  Every time the market has a major pullback, it reveals that many investors just cannot handle watching their portfolios drop by 20 to 30% or more, even if the drop is temporary.  For these investors as well as those approaching retirement, the ability to generate a steady return would perhaps be more attractive – at least for a portion of their money.

Traditionally, investors looking for safety and steadier income returns have looked to bonds as their main alternative to stocks.  Bonds are considered less risky than stocks but also trade and fluctuate in public markets as well.

Unfortunately, right now, interest rates are at historical low levels.  As a result, it is very challenging in today’s low interest rate environment for investors to find high quality bonds that generate a worthwhile interest or income rate of return.

Normally, longer maturity bonds have higher interest rates than shorter maturity bonds (and this is still true today).  However, interest rates are so low right now that even 30 year treasury bonds yield less than 1.4% per year.  This income will probably be lower than inflation over the next 30 years.  This means that the actual “real” return from holding long-term treasuries will likely be negative.

Inflation rising should be a worry for many reasons.  The federal reserve is printing money to combat economic disruptions caused by Covid which could lead to future inflation. Even without the money printing presses, long-term bonds also fluctuate significantly when interest rates move. 

The relationship between the value of bonds and interest rates is an inverse relationship.  If interest rates fall, the price of long-term bonds rises creating gains.  However, if interest rates rise, the value of the bonds will fall, potentially creating significant losses.  Thus, just like stocks bonds are also subject to quotational market fluctuations as they trade.

Due to this exposure to interest rate risk, bonds and especially long-term bonds can also be subject to market volatility and credit risk as well.  However, since interest rates are already at all-time lows, the risk of interest rate fluctuations seems more to the upside.

Despite the challenges associated with bonds today, the need for income has not gone away. Ideally investors could find sources of income that are both high enough in the amount of interest earned to live on the income, but also steady and predictable.

What can an investor who wants or needs higher income or returns, like stocks, but with more safety and steadiness like shorter maturity bonds do? 

The case is not hopeless if you know where to look.  Read on as we discuss how investors today may have the opportunity to earn steady and secure returns of 6% to 8% by participating in investments in private debt.

Steady Income Returns from Investing in Private Debt

The US Stock market is very large and valuable – as of mid 2020, the value of the entire US Stock market was estimated at around $35.5 Trillion.  While this is a large market indeed, the US Real Estate Market including commercial and residential real estate is estimated as over $50 Trillion so it an even larger pool of assets.

Within the real estate market, there are quite a few niches.  One of the large areas of activity and opportunity is lending against real estate.  Much of this lending is done by banks against residential and commercial properties.  Typically, banks will lend 60 to 80% of the value of their real estate collateral, but they also verify many other items such as income and credit worthiness before extending loans.  Bank loans are usually slower to obtain, involve a multi-step application process, and have their own restrictions, but also feature lower rates.  One key is that because banks have many rules to follow they cannot move quickly and say no to many lending opportunities that fall outside their guidelines.

However, there are niches within real estate markets that require faster availability of loans or more flexible lending criteria.  One of these areas involves so called fix and flip properties whereby an experienced real estate operator finds homes or other properties seeking to buy them in as-is condition at a discount.  These properties typically involve an experienced investor who is planning to rehab property to create value and then resell it or rent it.  Most fix-and-flip projects have a 3 to 9 month projected turn around.  The margins are high enough for experienced operators to pay higher interest rates in exchange for speed and flexibility. However, in many cases, banks are not comfortable providing financing to these operators or cannot move quick enough.

It is this gap between banks inability to move quickly and the needs of private investors who can find and rehab and sell properties that creates the opportunity for savvy investors, who know what they are doing and can identify the right operators to make higher returns through private money lending secured by real estate.

Investors who want to diversify, earn higher returns than banks and bond markets, and put idle money to work can lend their own capital to other investors if the borrowers have the experience and track record to find good projects and renovate them to create value.

Private investors usually lend when the private loan is secured with a mortgage against real estate, so it’s backed by valuable real estate collateral.  To the investor, it offers some of the underlying security of and profit potential as rehabbing or wholesaling, but without acquiring properties and with less risk since the private loan is in a senior position compared to the equity that the sponsors or developers are bringing to the project.

Private money loans generally charge higher rates than banks, but they are used as an alternative when a combination of speed and flexibility is critical to the borrower. The speed of implementation is the key here, because for the fix-and-flip borrowers it can mean the difference between closing on/or losing a deal with a lot of profit at stake.

Private debt opportunities are generally created when the borrower has good collateral, usually valuable real estate and has an urgency to borrow or is dealing with time-limited special situations.  Generally, private loans are originated within one to four weeks, as opposed to most banks that require two to three months along with income and credit checks. 

The borrowers who are sourcing funds from private lenders are typically doing so for one of the following types of real estate projects:

• Fix/Sell: Loans to investors who are buying real estate at a discount to fix and sell at higher prices. They pay higher rates for short-term loans secured by their real estate projects because they need to move quickly to buy from a discount seller.  If you have you ever seen the signs “We buy houses for cash” in and around your area, these are generally posted by real estate investors looking for fix and flip opportunities.  In most cases, they will have relationships with private lenders to fund any opportunities they fund to buy the property, improve it and sell it (flip-it).
• Fix/Rent: These investors generally purchase a residential property and complete renovations with the intention of renting the property for cash flow purposes. Once the property is rented and “seasoned” with a few months of rental payments, the investors can generally refinance at a lower interest rate and pay back the private lenders with interest.
• Builders/Developers: Builders and developers will purchase vacant land to permit and develop into residential or commercial use. Borrowers in this sector are interested in private money primarily based on the speed with which the funds can be accessed. Also, many banks will not lend on speculative development.  This area usually has more risk and somewhat longer time frames for private lenders than fix and flip of existing properties, so the returns and interest rates can be higher.
• Commercial Investors: This population of real estate investors may seek to use private money as a “bridge loan” for a commercial property when a conventional bank will not lend on an un-stabilized asset.  They will invest to stabilize the asset which may require some reconstruction or repositioning and then refinance from a bank at lower rates to pay back the private lender.
• Buying secured loans from banks: The loans may be performing or non-performing and the bank can sell the loan at a discount. Buying existing loans from banks or other investors is a specialized area.  These loans are generally collateralized so an understanding of the collateral value is important.  Sometimes, the loans are purchased with the idea of foreclosing on the underlying collateral in a so-called “loan to own” scenario.
• Mezzanine loans: These can also be backed by investment real estate where we provide some additional loan amount between the more senior bank loan and the equity owners of an income producing real estate project, effectively allowing a project to reduce its amount of equity needed and increase the leverage (and returns) available to the sponsors.

You may be asking yourself how all this translates to getting 6% - 8% returns. Well, private loans allow lenders to negotiate exactly how much they will charge and the terms of when they will be paid back. As long as the property is being used for investment purposes, it falls outside of the Dodd-Frank Act and allows the investor to determine the interest rate or loan terms that are agreed upon between both parties.

The majority of private loans provide a return to the lender/investor from two sources:

• Interest Payments: The most common set up, you can set an interest rate at the time of the loan approval and wait for the money. Interest rates to private loans backed by real estate are generally much higher than the rates banks charge.
• Points: These are fees paid by borrowers upfront to originate the loan. Generally calculated as a percentage of the overall loan value, with one point referred to as 1% of the loan. Points are often paid at the beginning of the loan term as an incentive for granting the loan.
• In addition to interest and points, some private loans may have other structures that can be sweeteners such as:
• Profit share: Investors can sometimes negotiate to a receive a percentage of the final profits, the amount will vary based on the contract and the investment.  Since profit is less certain that interest, most lenders stick with interest payments
• Exit Fees: Requires the borrower to pay a predetermined amount at the end of the loan term, it is often negotiated as a percentage of the overall loan sizet. You can even negotiate an increasing exit fee that changes depending on when the loan is paid in full.

The main pro of private money lending is participating in the real estate market passively while receiving a steady and predictable income funded by the cash flow that comes from the loan payments. The main cons of private money lending are the risk of borrower default, having to taking legal action to recover interest or principle can be a timely and costly hassle, and also the illiquidity of having private loans, you may have to wait until they mature to get your principal back.

Who can be a private money lender?

• Investors with cash or investments looking to generate predictable income.
• People who have a sizable retirement savings account.
• People who can convert a traditional IRA or 401k plan into a self-directed IRA plan.
• People who may be more risk averse and are uncomfortable with stock market fluctuations

If the idea of making 6 to 8% returns from lending against real estate sounds appealing to you, the first step is to figure out how much you are willing to lend and how much would be appropriate to put into private loans given your overall situation.

Obviously, it is rarely a good idea to put your entire portfolio into just one area or one category.   Rather, its still important to follow sound principles of investing and diversify your funds across different investment opportunities to mitigate risk.

Private lending is a specialized area with a learning curve just like any other.  If you are going to be a private lender, you need the right attorneys and access to borrowers who are worth lending to.  You also need the ability to inspect and value the collateral and to monitor the progress of the borrowers project and rehab timelines. 

Besides having the money and finding good experienced private debt borrowers with worthwhile projects, you would have to conduct due diligence on each investment and each borrower to determine the loan terms and finalize the loan.  After each loan is originated and the money lent, the loan needs to be serviced, i.e. payments tracked and notices sent etc.

As we age, health concerns arise increasingly frequently.  Especially in retirement, covering rising medical costs can be a big concern.  Fortunately, if you prepare ahead of time, there are powerful tools to incorporate into your overall financial plan that can help you to cover rising medical costs.

One of the best options to consider adding to your portfolios is called a Health Savings Account (HSA).  If you qualify to establish and fund an HSA, you can get many benefits that can significantly improve your financial plan and ability to cover medical costs in retirement.

Introduction to Health Savings Accounts

According to the Employees Benefits Research Institute, the average U.S. couple will need over $300,000 to cover out of pocket health-care costs in their retirement years.  Compared to the average retirement plan balance, this is a significant amount for most families.

HSA’s are less than 20 years old, a key reason why many financial advisors and their clients have not really begun to take advantage of the many benefits that HSA offer when used properly in a comprehensive financial, investment, and retirement plan. 

In order to help American’s address the growth in medical costs, Congress established HSA’s in 2003 as part of the Medicare Prescription Drug, Improvement and Modernization Act.   HSA’s are evolved from and have some advantages over Flexible Spending Accounts (FSA). Unlike a FSA, the dollars in your HSA account can accumulate and roll over if unused from one year to another.  In contrast, the biggest drawback of FSA accounts that limited their appeal was the use-it-or-lose-it nature of FSAs.  Any money not used in one year was effectively lost thereafter.

Health Savings Accounts, or HSAs, continue to grow in awareness and popularity.  Today more than $60 billion in assets is held in HSA accounts, and this has grown over 10x since 2010.

Not everyone is eligible to establish an HSA.  In order to qualify to contribute to an HSA, you must be enrolled in a high-deductible health-insurance plan and have no other health coverage.  You also must not be claimed as a dependent by anyone else.

A High Deductible Health Insurance Plan in 2020 is defined as a health insurance plan with a deductible of at least $1,400 if you are an individual and $2,800 if you are a family.  In addition, the total out-of-pocket expenses including deductibles, copayments and coinsurance payments cannot be more than $6,900 for an individual or $13,800 for a family.

Note, that many medical insurance plans offered by employers are not qualifying high deductible plans (if you are not sure, ask your employer or insurance provider).  Because they don’t understand the many benefits of having an HSA, many employees and even business owners actively avoid higher deductible insurance plans because they prefer to pay more for plans that cover more of their upfront medical costs.

However, by choosing a high deductible health insurance plan, you will typically be charged lower monthly or annual insurance payments (to compensate you for taking on the high upfront deductible exposure), and just as importantly, it also qualifies you to establish your own HSA and then put funds into the HSA as well.

The funds you put into a HSA are tax deductible.  This means that the money you put into the HSA is deducted from your taxable income thereby reducing your tax bill in the year that you make your contribution to the HSA.  In 2020, the maximum contribution amounts are $3,550 if you are an individual and $7,100 if you are a family.  For individuals aged 55 or older, you are also allowed an additional catch up contribution of $1,000 for each individual up to a maximum of $9,000 as a family.

Depending on where you establish your HSA, you can invest the money in your HSA into growing or income producing investments.  Additionally, the earnings you accrue in the HSA account accumulate tax-free. When you need to use the money for qualifying medical expenses, you can withdraw from the HSA tax-free.  Notice that because of this triple combination of upfront tax deduction, tax-free growth, and tax-free withdrawal for medical expenses, HSAs are a rare and very valuable tool in the right hands. 

How HSA’s Work

HSA’s are meant to cover costs that are not covered by your health insurance plan. Some employers that offer high-deductible health plans also offer HSAs.  Either way, you can open a separate HSA account either with your employer or choose from any qualified HSA custodian as long as you have a qualifying high-deductible health insurance plan. Each year, you make a decision as to how much money you wish to put into your HSA, up to the government-mandated maximum.

The best way to open a Health Savings Account is to establish it at an HSA custodian or HSA provider. There are many HSA custodians you can choose from.  Some of the points to consider in choosing an HSA provider include account minimums or fees charged, investment options available and the size and reputation of the custodian firm.

Based on our research, there are multiple good HSA custodian options.  One of the higher rated options is the Fidelity HSA custodied by Fidelity Investments because Fidelity is a well established firm and their HSA has good investment options and no account minimums or fees.  If you already have an HSA at one custodian, you can also transfer that money directly into another HSA without any issues or adverse tax consequences.  Many HSAs are held at banks, however, that treat the HSA funds as low interest earning deposits.  If this is the case, these HSA owners could often be better off moving these bank custodied HSAs to other firms like Fidelity with a broader range of investment options and greater flexibility and higher earning potential.

Who Can Benefit From HSA’s?

You can benefit from having an HSA if you can anticipate having out-of-pocket health-related costs at some point during your lifetime.  Another benefit is that HSA’s are quite flexible. You can use the dollars in your account to pay for current medical expenses or save the money for future needs. You also control how much money to contribute to the account and which medical expenses to pay from the account and how to invest the money to help it grow.  If you need investment or financial guidance to help you, you can work with an experienced advisor such as Ridgewood Investments to help you along the way.

Tax Advantages Of Using HSA’s to Fund Health-Related Expenses in Retirement 

In addition to providing a means for saving for future health-care costs, HSA’s have three wonderful tax advantages. The contributions are deductible, they can grow free of taxes, and in many cases, these funds can be withdrawn tax-free if used for or to reimburse past qualifying medical expenses. 

Keep in mind that if you are younger than 65 years old, you must pay income taxes and a 20% penalty if you withdraw or use funds from your HSA for anything other than qualified health-related costs.  This is why you should only use HSA funds for qualifying medical costs especially prior to age 65.

Upon reaching the age of 65, additional powerful provisions come into effect. For example, certain insurance premiums can be paid tax free with HSA distributions after you reach age 65 and enroll in Medicare. 

Note that once you reach age 65, which is when your Medicare benefit starts for most Americans, you then become ineligible to make further contributions to your HSA. Unlike traditional IRAs where you need to begin making withdrawals at age 72 and beyond, you are not required to begin withdrawing HSA funds at any age.  Therefore, if you can afford to defer withdrawals for a significant amount of time, you can do so with an HSA,

After age 65, as long as you use your HSA funds to pay for (or to reimburse yourself for) qualifying medical expenses, there is no tax on the withdrawal from your HSA.  After age 65, if you use the funds for anything other than qualifying medical expenses, that portion will be taxed to you as ordinary income.  Distributions that you take from your HSA after age 65 are never subject to penalty, no matter what you use the funds for after age 65. 

Advanced HSA Techniques and Strategies

As you can see, HSA’s enable you to save pre-tax or tax-deductible money, enable it to grow tax-free, and then to use the account to cover medical costs free of any taxes. In addition to these main benefits, there are several advanced techniques and strategies with which you will want to familiarize yourself.

Do you work in a position that offers you retirement benefits funded by a traditional defined benefit plan? If so, consider yourself fortunate. Defined benefit plans offer attractive benefits for employees and were once far more common than they are today. 

However, since they often cost employers more money in employer contributions than today’s more popular defined contribution plan counterparts like the 401(k) plan for private for-profit companies and 403(b) plans for non-profit organizations and government employees, they have gradually become much less common than they used to be in the last three or four decades.  In many cases, government workers and certain larger companies with union employees still offer their employees retirement income options funded by their defined benefit plans.

The benefit of having a defined benefit pension plan, if your employer offers one, is that under this type of pension, it is your employer (and not you) who has the responsibility for contributing to a plan in a way that guarantees to give you a certain level of benefits at retirement.  Your benefits are usually based on your years of service and your income while you were employed by the company or employer.

When somebody who is a participant in a Defined Benefit Pension Plan (DB) is about to retire or offered a voluntary retirement package, they are often presented with the option to take their benefit as either an annuity (monthly distributions) for a certain period or as a lump-sum.

Like many choices in life, few people are equipped to appreciate the trade-offs involved between choosing a lump-sum which pays out the entire balance upfront (or into a rollover IRA) or the option to select an annuity stream which spreads out the amount you have earned through your service into monthly payments released to you over many years. 

To make a decision like this property requires experience, thought and planning.  Unfortunately, the choice is a complex one in which it is challenging to appreciate all the factors and trade-offs that need to be considered.  When you are in this situation, it may be a good idea to seek out professional guidance because the stakes are quite high!

The choice can be complicated by a number of trade-offs that have to be weighed carefully, in many cases the best way to decide would be to actually create a detailed financial model that actually projects the cash flows under various options and assumptions and matches up those choices to your own personal situation and life priorities.

This type of analysis is called financial analysis and is not to be taken lightly.  In fact, choosing the “right” option for you could literally mean tens of thousands if not hundreds of thousands of extra dollars in your pocket over time.  On the other hand, picking badly could really diminish your future income, or in some extreme cases even leave you without a comfortable retirement.  Read on below as we describe the process of reviewing your likely options and provide valuable insights on a sound framework you can use to make an intelligent choice.

Unfortunately, there is no single universal standard for how your choice will be presented to you.  Each pension plan frames the choice in slightly different ways.  In most cases, you will receive some sort of document or brochure from your plan explaining the choice you have to make and how to make the election (and by when).  Its very important if you are given such a document to save it and review it carefully.

Also remember that these type of documents (also known as disclosures) are often drafted by lawyers to meet technical and legal requirements.  Its not uncommon for these types of documents to be lengthy and contain some legal “fine print.” If you don’t understand exactly what it says or the choices you have to choose from then this is probably a sign that you might benefit from consulting with a highly qualified professional who can review it on your behalf and explain it to you in plain English.

What is the difference between a lump-sum and an annuity?  In the case of the lump-sum, you will be given the ability to get all the money you are owed in one payment.  In most cases, this means that you will tell the plan to “roll over” this amount of money into your own IRA (individual retirement account). 

By taking your lump-sum as a rollover into your IRA there are multiple benefits: 1.) You or an advisor can invest this sum and if it is done competently, your money can grow and perhaps give you a lot more income over time than the annuity you are being offered 2.) Rolling over the lump-sum into an IRA prevents you from having to pay any taxes upfront and therefore can allow your investments to enjoy tax deferred growth for quite a while 3.) Instead of being reliant on the solvency of the pension plan many years from now, by taking the lump-sum you no longer have to worry about whether the plan will have run out of money down the road.  On the other hand, the main drawback of the lump-sum option is that you have to assume some responsibility and if you do a bad job you have to live with the result.

Taking the annuity option means that you are leaving your money in the hands of the pension plan for the rest of your life. It also means that instead of getting your money and then investing it yourself, you want your plan to do it for you and keep the responsibility.  Instead of that lump-sum now, you are asking them to pay you what you are owed over a long-period of time.  In theory if the plan is taking on that responsibility, they will simply calculate what a mix of “safe” investments will give them over time (given very low interest rates today on "safer" bond investments, annuity payments are lower than they used to be).   The plan then calculates your monthly benefit payment low enough to make sense for them given the return that they project to generate over time and your expected lifespan.

Another complicating factor is many companies who offer you a choice between a lump-sum and an annuity then also give you multiple types of monthly payment options during the annuity selection process.

Some of the most common options to the annuity monthly payments to you are:

1. Monthly payments based on a single life – typically the life of the employee who is retiring.  In this option, the pension will pay you a certain amount each month for so long as you live.  In this option, monthly payments stop when the person dies.  This means no benefits for the survivor and anyone unlucky enough to die much sooner loses their payments without ever recovering what they are owed and, theoretically, someone far outliving their projected life expectancy would benefit by collecting payments for far longer than originally expected.  Think of this aspect of annuity payments as the lifespan lottery.
2. Monthly payments based on single life but with a minimum term – in this case, your payments would likely be a bit less than option one, because if you die prematurely, your beneficiaries are still guaranteed to get payments for at least a minimum period that is specified at inception
3. Monthly payments based on reduced joint and survivor benefit – In this option, the monthly payment is typically lower still, but in case of the death of the original covered person, their survivor (usually a named spouse or partner), gets a reduced level of month benefits (often 50% but could be a bit higher or lower) as compared to the payments level provided while the first person was still alive.  This reduced level of benefits would then continue as long as the second person was still alive, guaranteeing them at least some income.  Note that social security is essentially a type of monthly annuity that is also based on joint and survivor because the widow and/or minor children of the deceased can continue to receive survivor social security benefits at a reduced level.
4. Monthly payments based on 100% joint and survivor – In this option, the monthly payment is typically the lowest of all of these four options. However, the payment stays at one set level and continues at the same level for so long as either spouse or partner is alive.

Note that between the lump-sum versus the annuity and then even among the various annuity payment types above, there are trade-offs involved.  Whether one or the other is better in your own individual circumstances depends on how much they are offering for you to get upfront versus how much each monthly option will pay you and for how long if you were to chose to receive the stream of payments overtime.

Most people facing such a momentous choice are likely to be better off consulting an experienced financial advisor like Ridgewood Investments who has experience helping clients make complicated financial choices that could affect their retirement security and that of their families over many years.  Typically, when analyzing a choice like this one of choosing between a lump-sum and an annuity, the experienced investment advisors at Ridgewood Investments will use a tool such as Excel, a spreadsheet program made by Microsoft, or other sophisticated cash flow or financial planning software to model various scenarios.

See below as we explain the factors that would be involved in a proper analysis.

The first factor that must be considered is your personal circumstances:

After this it is necessary to compare other risks: