Paul Ferraresi

All of us are generally aware of recent awards of large liability settlements. Usually, these are written up in the newspapers as they relate to aircraft accidents, hotel fires or similar catastrophes.

To a lesser extent, we read of individuals being sued for large amounts of money because of some unusual occurrence such as a water skiing or automobile accident.

Typically, we buy specific insurance to cover us against the more common types of liability. For example, we purchase automobile liability insurance to cover us for the operation of our cars. We buy comprehensive personal liability insurance to cover us for activities arising out of our residence or personal activities. Frequently, the limits on these policies are $100,000 or $300,000.

We tend to feel comfortable behind this shield of protection. However, the diversity of activities that individuals now engage in at times, goes beyond the limits of coverage of those policies. Therefore, the insurance industry has developed an umbrella policy that provides a broader scope of coverage with higher limits of liability than is normally encountered. The purpose of the liability umbrella policy is not to replace the other policies, but to provide excess liability coverage over and above what is referred to as the underlying limits.

The liability umbrella policy has two deductibles. The first deductible constitutes the limits of the underlying auto and personal liability policies. The second is a deductible, usually $250, for any liability exposures beyond the scope of underlying policies.

In acquiring a personal umbrella liability policy, it is very important to choose an adequate limit of liability ($1,000,000 to $5,000,000), and to fully disclose all underlying policies and all liability exposures. Then the policy’s exclusions should be reviewed to make sure they do not delete coverage for an exposure to which you are subject.

Liability insurance is vital to protecting your assets and future earning power.

An emergency fund is needed to meet unexpected expenses that are not planned for in the family budget, such as short-term illness causing a loss of income, unexpected medical expenses, property losses that purposely are not covered by insurance (deductibles and co-insurance) and to provide a financial cushion against such personal problems as prolonged unemployment or some other financial crisis.

Need for an emergency fund has received greater attention in recent years. Many capable people have lost their jobs because of mergers and acquisitions, economic dislocations or plant closings. A reasonable emergency fund can help to prevent a temporary unemployment from becoming a financial crisis. The fund will give the family time to adjust without having to drastically change its living standards or disturb other investments.

The size of the needed emergency fund varies greatly. It depends upon such factors as family income, number of income earners, stability of employment, assets and debts. The size of insurance deductibles, health and property insurance exposures, and the family’s general attitudes toward risk and security are also important. The size of the emergency fund can be expressed as so many months of family income. As a guideline, it is advisable to reserve a minimum of two and a maximum of six months of income. The larger the percentage of your monthly expenses that are fixed and must be paid, the larger should be the emergency fund.

By its very nature, the emergency fund should be invested conservatively. There should be almost complete security of principal, marketability and liquidity. Within these investment constraints, the fund should be invested so as to secure a reasonable yield, given the primary investment objective of safety of principal. Logical investment outlets for the emergency fund would include:

• Bank savings accounts (regular accounts)
• Credit Union accounts
• Money market accounts
• Mutual Funds
• Life insurance cash values

Access to emergency funds is important. If check-writing services are available, even at a fee, it might be wise to arrange for them. The careful person may also want to have some ready cash available for emergencies, even if it is non-interest earning. Such an individual might consider setting aside $200 in cash at home to be used ONLY in case of dire emergency.

When it comes to your personal finances, which are you more like, the Alfred E. Neuman (What, me worry?) type, or the neurotic Scrooge McDuck? Take this quiz to find out whether you are worrying too much, too little, or just the right amount. Circle the answer that corresponds with your feeling.

1. I check my stocks and mutual funds in the financial pages…

a. every day – 20
b. every week – 10
c. only once a year or so – 5

2. I will be able to afford a comfortable retirement because…

a. I am saving to the max right now – 10
b. I am counting on a relative to leave me a pile – 5
c. Fat chance! I am going to end up working until I drop – 20

3. When I get my bank statement…

a. I throw it in the wastebasket – 5
b. I go crazy if it does not match my checkbook balance – 20
c. I give it a once-over to make sure I know roughly how
much is in my account – 10

4. If I am laid off…

a. I’ll get through the following three months on the money
in my emergency fund – 10
b. I bet I will find another, similar job quite fast – 5
c. I will be a wreck – 20

5. I clip cents-off newspaper coupons…

a. every day – 20
b. only when I see one for a product I like – 10
c. never – 5

6. If I buy something I have to stretch to pay for…

a. I cannot sleep for weeks thinking I overpaid – 20
b. I am pleased that I got my money’s worth – 10
c. I just put it on plastic and forget about it – 5

7. When I get cash from a cash machine…

a. I do not bother to get a record slip – 5
b. I always enter the withdrawal in my checkbook – 10
c. I always get a queasy feeling that I’m taking out
money too often, even when I am not – 20

HOW TO SCORE YOURSELF

Add up the numbers to the right of the response you made to each question. If you did not answer an item, give yourself a “10.” The total score will be a good indicator of your “Worry Index.”

1. If your score is 35 to 45, get real! You need to worry a little more. You may not be accomplishing what you could achieve – perhaps due to inattention being paid to your financial matters.

2. If your score is 50 to 70, you have a fine grasp of your personal financial situation. You are taking an interest as well as taking many of the steps that will assure success.

3. If your score is 75 or above, get a life! You are worrying way too much. Perhaps you should delegate more of these responsibilities to professionals – and let them worry for you! You need to have a financial plan and let it work for you.

AVOID THE PARALYSIS OF WORRY

Some persons acquire a sense of helplessness about their financial circumstances. Perhaps it is worry about debt, concern over ever-rising inflation, career limitations and hazards, family health matters, or maybe prior financial problems. It may be simply a lack of comprehension about financial and tax issues that grow more complex each year.

Worry will not help conquer these issues. The guidance of a financial professional, steady attention to a financial plan and a slow diet of financial reading will produce the desired results. Plus time, of course…

Watching the Dow Jones average approach a higher level, I smiled with peace within myself.

As I have instructed all my students, over the past 35 years, the markets go up and down daily, but, the long-term trend is always up. In fact, the stock market looks like a yo-yo going up and down in the hands of a man walking up steps. Hopefully, you learned from my teachings, and your own research, that equities will always beat out every other asset class over time. You, personally, can remember the Dow hitting 11,700+ in 2000. Then, the tech-wreck and 9/11 caused it to drop to 7,400. If you sold out at the bottom, you probably lost money. If you held on…then, no money was lost. You have experienced and learned a valuable lesson. Buy and hold will always win out (unless there is a worldwide thermo nuclear holocaust – if so, the world is over and who cares). Over these past years, the “drive-by media” simply dumps bad news on you. Even with “all” the bad news in the world, the markets keep going up. (You know, it has been the same bad news reported for the past 200 years.

You know, it is funny, the Investment Company Institute, that tracks individual investor behavior, noted the following: In 1982, when the Dow was at 762, money was flowing out of the stock market. In 1987, at 2,100-2,200, money was flowing in. When the Dow dropped to 1,700, money flowed out. In 1997-2000 money poured into the market during the tech bubble on the way up to 11,700. When the bubble burst and the Dow dropped to 7,400, guess what, money poured out.

From 2004-2007, money again poured into the market as it rose. In the 2008 stock market drop, trillions moved out of the market and into cash. March 9, 2009, the market hit the low point. One year later, the market was up over 65%. Now that the market is back to a level prior to the drop, money is coming back in…just about the time when a mild correction will take place. So, looking back at the recent drop, people poured money in at the top, took a 40-60% drop, sold out at a loss and, now after a huge gain, these same people are investing again near a top. I thought the rule was “buy low, sell high.” The masses are all doing the opposite of buying high and selling low.

Watch…once the “drive by media” notes a new record on the Dow, money will pour in. Enjoy the ride, stay on the course.

Three books on investing reside in my office. Sitting next to Jeremy Siegel’s Stocks for the Long Run is Al Frank’s New Prudent Speculator and Benjamin Graham’s The Intelligent Investor, the bible for value investors. (Warren Buffet proclaims Ben Graham’s book to be the best investment book ever written.) Buffet continues to write “To invest successfully does not require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding the framework”.

All great money managers know that emotions are the investor’s worst enemy. Psychologist Kahneman and Tvesky have confirmed in studies that for most people the pain of financial loss is more than twice as intense as the pleasure of an equivalent gain.

How does this normal human tendency make for poor investment decisions? Follow me in a little arithmetic. I give you twenty $1 bills and ask you to make twenty investment decisions based on the toss of a coin. In each round, you can choose not to play and keep the dollar. If you do invest, you will receive nothing if the coin comes up heads, but you get $2.50 if it comes up tails.

Don’t play at all and you still have $20, but assuming an equal number of heads and tails, the investor who plays every single round would end up with $25. I would hope our readers would choose to play every round. However, that is not the way most people act. After a few painful losses they are likely to stop playing rather than stay in the game and let the odds work in their favor.

In “Investment Behavior and Negative Side of Emotion”, published in Psychological Science, researchers studied ‘normal’ participants and individuals with lesions in the region of the brain that controls emotions. In the coin toss game, the brain-damaged players made better investment decisions – they chose to invest more often. Having weaker emotional function, they performed more rationally than investors with normal emotions.

The full text of the report also said that this “myopic loss aversion” explains why so many prefer to invest in bonds, even though stocks have historically provided a much higher rate of return. (Equities have posted annual returns of 10.3% to 12.6%, versus 5.3% to 6.0% for bonds, over the last 80 years.)