Some unsolicited financial advice

BY FREDERICK POLLOCK

UNLESS YOU ARE ONE OF A handful of lifetime public interest devotees, you will spend some number of your working years in the private sector earning a rather high income. The law school community, being what it is, chooses to acknowledge this reality when it can get money from you – helping you to monetize your future earning via student loans – and ignore it for all other purposes, sending the average HLS graduate off without much, if any, financial management instruction. To be fair, I’ve heard they do host some seminars. Where and when is a bit of a mystery.

This article attempts to rectify some small part of this gross negligence. It is not all-encompassing, but it is a start and may lead you to ask some of the right questions.

Lower Your Taxes – Take advantage of tax rules designed to encourage saving, including the use of 401(k)s, IRAs, and annuity plans. If you eventually make more than $250,000 a year, hire a tax advisor. They will save you more money than they cost. Cheating on your taxes is wrong. If you’re going to do it anyway, don’t do it in an obvious way. That is, make sure to avoid misreporting or failing to report something that another party did report to the IRS. For example, your salary is a deductible expense to an employer so they will undoubtedly report that figure and your lie will be detected. If you are audited, regardless of whether you have done anything shady, hire a lawyer. If you have accumulated measurable wealth and have large tax bills, look into investing in tax-advantaged municipal bonds as they will afford you a slightly higher after-tax return.

Invest Automatically – Have some fixed percentage of your income deducted from your paycheck and placed in an investment account. You need to save and this will hurt less. Max out the tax-deferred accounts first. Despite cocktail party chatter to the contrary, very few people can beat the market. And if you are still reading this article, you aren’t one of them. So invest your money without trying to time the market or pick “winners.” By investing at regular intervals (say every paycheck) in pooled vehicles like mutual funds, you will be “dollar cost averaging” your way into your investments, avoiding buying at highs and lows. No, you are not going to top the Forbes list by following a routinized, well-diversified investment strategy, but neither will you be checking the couch for change.

Build a Smart Portfolio – When you are young, invest aggressively in equities and other residual claim-derived securities with higher volatility and risk. As you approach events requiring cash (your children’s’ college years, weddings, retirement, etc.), start shifting the appropriate amounts into a less aggressive asset mixes, including a large allocation to bonds. If you have more than $500,000 in assets, hire a financial advisor. Make sure he or she is certified. Ask to see his average client’s performance history. Talk to some of the clients to verify their existence and gauge their satisfaction. Be on the lookout for “churning,” – trading in and out of assets to generate commissions. If a stock broker calls you, hang up immediately. Hang up even if you happen to be in the market for purchased companionship. Dogs are cheaper and won’t start avoiding you if your portfolio craters.

Keep Fees Low – In reality, for most people, the difference in risk-adjusted returns between one investment and another will be random. But fees aren’t random at all. Index funds have lower fees than actively managed funds. As long as you are investing in active, liquid markets like the NYSE, buy index funds, not actively managed funds. If you want to invest in something obscure like developing world bonds then an active manager could have enough incremental skill and informational advantages to warrant the higher fee. Make sure the targeted market really is one characterized by large, exploitable inefficiencies. Don’t trade in and out of assets as this will raise transaction costs and probably your tax bill. This also means that you should avoid mutual funds that do the same. It is still your money being spent whether you call in the order or the fund manager does.

Take Advantage of Liquidity Premiums – Very wealthy people or those with long-term investment horizons don’t need cash any time soon and thus don’t need liquid assets. Most people do. So if you fall into the first group, you can earn a “liquidity premium” since there is less demand for the financial instruments with distant cash realization events. For example, a 30-year bond pays a higher risk-adjusted rate than a 90-day t-bill. This carries over to complex investment interests like shares in privately held businesses and hedge funds, which have restricted cash-out and withdrawal mechanisms. Extracting a liquidity premium is one of very few consistent ways to outperform the average market return. If you live on the edge though, forget it.

Hedge Funds Can Be Attractive but are Perilous for the Ignorant -The wealthy tend to gravitate towards investment vehicles with greater risks and returns since they can bear losses more effectively than the poor. If you have more than $1,000,000, you should begin to consider such investment vehicles. Just be careful and consult your financial adviser to ensure that you understand the intricacies. Hedge fund strategies vary widely as do their risk levels. One warning that may mean nothing now, but will save you money in the future – hedge fund descriptions are deceptive. For example, a “market neutral” fund often has much more risk than the market as a whole. Understand the incentives that the hedge fund manager has concerning the fund. Not only should they earn most of their fees as an alpha on fund performance above the market average, they should also have a boatload of their own capital in the fund. If it isn’t good enough for their money, it isn’t good enough for yours.

Plan Your Gifts Intelligently – Money beyond some minimally sufficient level isn’t going to do much for you, unless you’re an asshole. Well, good luck with that. Everybody else can take satisfaction in seeing the money put to good use by charities and directed to those in need. Most charitable organizations would be thrilled to help you intelligently structure your gift so as to maximize the value. Take advantage of such services.

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