Personal Finance

Goals are a “destination”.  A Financial Plan is a “roadmap”.  Creating a roadmap requires you to identify your starting point as well as your ending point.

Many business coaches and books tell the story of a famous study of 1979 Harvard graduates (or 1953 Yale graduates).  Ten years after graduation, the 3% who had written goals were earning ten times the average income of their peers who had no goals.  The story is an urban myth, but verifiable research at Dominican University has confirmed the power of putting your goals into writing.  Develop a Financial Plan, have SMART Goals in writing (SMART stands for Specific Measurable Achievable Results in Time) and join the fabled 3%.

This is a critical step.  The difference between dreams and goals is a written plan.  Look at the four walls around you.  The building first existed as an idea in someone’s mind.  The blueprint was a key step for converting the dream into the solid structure you can see and touch.  There’s an old saying that people don’t plan to fail, they just fail to plan.

After creating the blueprint, the next step for turning dreams into reality is massive action.  Are you ready to act on your plan?

Your beliefs determine your behavior.  Therefore it is extremely important that you believe your plan is achievable.  Achievable is the “A” in SMART goals.  What you achieve is primarily mental.  “Whether you think you can or can’t, you’re right.”(Henry Ford).  Only human beings have the ability to create the future in their minds first.  Remember the building illustration.  Every human accomplishment, from the invention of the plow to smashing the atom and putting a man on the moon, was first a thought in the human brain before it became a reality.

Every one of us has this amazing ability.  We just don’t use it.  If you can plan a vacation, build a home or plan your day, you can plan and achieve financial independence.  It’s 99% mental.

The final step of the financial planning process is to monitor the plan.  Monitor how your net worth grows by recording your income, savings, portfolio, real estate, and amortization over time.

Unemployed will have specific list of actionable steps for:

1. Short term damage control
2. Regaining long term employment
3. Overcoming dysfunctional emotions of guilt, depression and procrastination

 What Causes Unemployment? 

Technology causes unemployment.  150 years before the Great Depression over 90% of all Americans worked on small farms, ranches or large plantations.  Today less than 3% of Americans work in agriculture.  Engine power replaced manpower and horsepower.  During the Great Depression we experienced 25% unemployment as technology destroyed old jobs faster than new ones were being created.  The Great Depression marks the transition of the United States from the Agricultural Age to the Industrial Age.

Today we are experiencing the highest unemployment since the Great Depression as the forces of creative destruction accelerate their work.  From May 2008 to October 2009, technology destroyed a net 250,000 jobs per month faster than it created new ones.  The Great Recession made the transition of the US from the Industrial Age into the new Age of Information & Communication.

What Should Do To Limit the Economic Damage of Unemployment?

Implement the following check list for the unemployed

• Create a cash flow projection or budget for the next 12 months and always keep it up to date.
• Increase liquidity.
• Apply for unemployment insurance.
• Review insurance needs and use COBRA to keep your existing health insurance until the new Obama health care legislation takes effect.
• Pay off debts.
• Rollover your Qualified Retirement Plan (e.g., 401k) to an IRA.
• Create a tax plan and verify any opportunities for tax free Roth Conversion during low income years.
• Plan for worst case scenario.

What Should You Do To Regain Employment in the New Information-Communication Age? 

Invest in yourself.  To find and keep employment in the new age requires more thinking than in the past.  In the Information Age it is your ability to think that will bring wealth and job security.  Unless you have unique physical skills that cannot be automated (plumber, waitress, professional athlete, etc.) the muscle in your head is the key to job security.  Only your brain can process and manipulate information to create wealth.  You begin that process now with your search for employment.

• Understand the job market.  In the United States there are three automobiles for every household while in China there are 30 households for one automobile.  What does this information tell you about searching for work in the manufacturing or construction industries?  Many manufacturing and construction jobs have gone the way of the blacksmith and farmer.
  • The same technology that destroys old jobs also creates new ones.  What are the new jobs that are being created?  Will clean energy replace the automobile industry?  Do you think there might be a growing demand for career counselors and other people who gather, analyze, manage and provide information about the job market?
  • The US Department of Labor project job growth for every industry and career in the county.
  • The internet is another source of information about the job market.
• Could you qualify for the new jobs created by technology?  Are some of your skills transferable?  Farmers who used their hands to repair equipment, learned how to assemble or repair automobiles.  Blacksmiths became tool and die makers.  You have skills and values that are marketable and may require minimal training to apply in a different field.  Do an inventory of your skills.  Read books like What Color Is Your Parachute? by William Bolles.  Use the internet and Google to find other resources.
• Contact a nearby College, University, technical or community college.  All offer classes on Career Planning and Development.

As a general rule of thumb, you need a portfolio that is 10-15x your unfunded living expenses in order to stop working.  Factors that impact the ratio are: your life expectancy at retirement, your income replacement ratio from non-portfolio sources and your tax bracket.  The younger you are when you retire, the longer the time the portfolio must support you and the larger it must be. 

Assume for a moment that your living expenses are the same as your income.  If your pre-retirement income was $20,000/year, you can expect Social Security to replace 69% of your income, so you may need a portfolio of $62,000 to $93,000. 

If your pre-retirement income was $90,000/year you can expect Social Security to replace only 36% of your income, so you may need a portfolio of $576,000 to $864,000. 

That’s a significant difference.  The difference in income is 4.5X.  The difference in required retirement portfolio is almost 10X.  To compound the challenge, the higher your required retirement income, the larger your portfolio must be to pay the additional taxes.

When you use credit cards to buy things you can’t afford you are borrowing from your future to pay for your now.  If you cannot pay off credit cards monthly, by definition you are living beyond your means.  For example, paying interest of $700 – $1,000/year on a credit card balance of $6,000 equals to spending x% of your income.  As the goods or services you purchased with the credit card decline in value, the purchase price increases because of the interest.  After 5 years at 15% you paid twice the original sticker price.  Borrowing from your future to pay for your now is devastating to financial independence and peace of mind.

There’s an old saying that you can’t manage what you don’t measure.  The first step to controlling spending is to count it.  There’s an amazing benefit.  Forcing yourself to record every expenditure will automatically reduce your spending.  Use the Spending Plan / Cash Flow tool on our website to develop a budget for the next 6-months.

There is growing evidence that the primitive part of our brain called the amygdala triggers the impulse to consume now.  The urge to consume as much as possible probably helped us survive in a prehistoric world of scarcity.  But in modern times that survival mechanism may be just as harmful as the related mechanism that stores fat.  Today the urge to consume as much as possible harms financial, as well as physical health.

To override the urges of our primitive brain we must use our frontal cortex which gives us the unique ability to plan.  We can set ourselves up so that we become automatic savers instead of automatic spenders.  Many middle income millionaires achieved the status automatically.  Here’s how they did it:

a)      Set up automatic savings by having 10% (or more) of your paycheck automatically deposited into your 401(k) or IRA.

b)      Set up automatic bill paying from one checking account or credit card.

c)      Set up automatic tracking or accounting.  The monthly statement from the single account becomes your record of expenses.  To get a bigger and more detailed picture of your finances sign up for one of the FREE online automatic accounting services.  The most comprehensive is Yodlee MoneyCenter at www.yodlee.com.  The most user firendly and fastest growing is Mint at www.mint.com.  A relatively new service is Quizzle at www.quizzle.com.

d)      Finally, stop impulsive spending by cutting up all the credit cards except one.

 You can also use financial planning software such as Quicken or Microsoft Money.

The primary purpose of life insurance is to protect against the loss of income caused by the premature death the person who earns the income that supports dependents. If you do not have dependents, you probably do not need life insurance.  Life insurance provides the “instant portfolio” that the bread winner did not have time to build due to his or her premature death. 

Level premium term insurance that fits the time period needed to build the portfolio or estate is the best fit for this need.  Twenty year level term purchased after the birth of a child is often a good fit for a young family starting out in life.

Most people should not be purchasing cash value life insurance unless they have special estate planning or business needs.  Cash value life insurance is very expensive compared to level term and often causes young families to be underinsured.  It’s illegal to sell life insurance as a retirement vehicle or savings plan.  Because of the high expenses and commissions to the agent, it’s usually a terrible investment.

Most people should not be putting money into cash value life insurance until they are maximizing their contributions to the Qualified Retirement Plans (e.g., 401k, 403b) and IRAs and are in a very high tax bracket.  Premiums paid into cash value life insurance are not tax deductible.  Investment money in cash value life insurance is not protected from creditors by ERISA.

What to do?

• Call your insurance company and ask for the “cost basis” of your cash value policies.  Cost basis is the total amount of after-tax money that you have paid into the policy and which you can pull out without having to pay any taxes.
• If the cost basis is significantly more or less than the surrender value, consider the benefits of doing a 1035 tax free exchange into a Vanguard variable annuity.
• Purchase low cost term insurance that will provide a lump sum large enough to replace lost income for the period of time needed by dependents.

Low cost term insurance can be purchased online at www.insure.com or www.vanguard.com or www.tiaa-cref.com.

People who practice good health habits are more likely to enjoy physical independence than those who smoke, eat junk food and don’t get enough sleep or exercise.  Clients who implement The Five Fundamentals of Fiscal Fitness© achieve financial independence and move successfully through the financial stages of life. 

 The 1^st Fundamental is to save 10% of your income.

 Why?

 a)      Saving 10% is the simplest and easiest of all budgets.  If you are saving 10% of your income, by definition you are living within your means.

b)      The secret to Financial Independence is to Fund your Future First.  No matter how much or how little you earn, you should always save 10% of your income as “permanent” savings.  Most people pay their bills first and save what’s left.  Financially independent people pay themselves first and spend what’s left.  The only money you really keep for yourself is what you save.

 c)      Saving 10% of your income is evidence of your ability to defer gratification.  According to psychologists the ability to defer gratification is an indicator of emotional intelligence and perhaps the most powerful predictor of success for young toddlers.

d)      Nobel Laureate, Robert William Fogel, has calculated that if the average couple with one spouse working part time, saved 14.7% of their income from the day both spouses entered the work force, the couple could retire at age 55 with a retirement income that placed them among the top 20% of all US households (William Fogel, The Fourth Great Awakening, p. 196.).

e)      Saving 10% of your income to build wealth reduces your dependency on Social Security.  Social Security was meant to be a social safety net, not a universal retirement plan.  When Social Security started there were 40 workers contributing for every one beneficiary.  Today the ratio of workers to beneficiaries is 3/1 and soon it will be 2/1.  There is no doubt that social security benefits will have to be reduced for the program to remain solvent.

f)       Saving 10% of your income provides a cash flow cushion which allows you to take more risk in your portfolio.  During an emergency, you can reduce your savings rate instead of tapping your investments.

g)      Saving 10% of your income even after you retire provides some inflation protection during the withdrawal years.  In practice this means that when you retire, your taxes and living expenses should be about 90% of your total income.

h)      Saving 10% of your income even during retirement reduces the impact of portfolio losses during the withdrawal years.  The key to retirement is managing spending.  By never spending more than 90% of your gross income, you continue to fund your future first and greatly reduce the odds that you will outlive your money.

The primary focus of a Financial Plan is to help you build and manage your wealth more effectively.  Achieving that goal requires you to choose one of three core financial strategies:

1. Accumulation
2. Conservation
3. Distribution

If you select the Accumulation strategy, your #1 priority is to build your wealth.  Accumulation may be the most suitable strategy if you do not have much wealth to protect or you do not have sufficient wealth for your life expectancy.  While you never want to lose money, adopting an accumulation strategy means that growth trumps safety.  A higher return is often more important than lower risk.

If you select the Conservation strategy, your #1 priority is to preserve your wealth.  Conservation may be the most suitable strategy when you have significant wealth to lose.  You may be near retirement or you may possess sufficient wealth to match your life expectancy.  In either case, not losing wealth becomes more important than gaining more.  Why risk going backwards if you have already arrived at your destination?  While you always want your money to work hard, during the conservation stages, safety trumps return.  Lower risk is more important than a higher return.

If you select the Distribution strategy, your highest priorities are enjoying the use of your wealth and planning for its final disposition.  Establishing and updating a values-based estate plan becomes very important.

You can leverage the Cambridge Financial Life Cycle© to determine the most suitable strategy for your situation.

Asset Allocation is the process of dividing investments among different kinds of asset classes (such as stocks, bonds, cash, real estate, commodities, etc.) to try to meet specific financial goals.  Research shows (Brinson, Hood & Beebower, 1986) that over 90% of investment portfolio performance over time is explained by the asset allocation decision. Thus asset allocation is so important, way more than security selection.

Do not believe the myth that diversification can be achieved with 10-30 individual stocks.  Academic research indicates that it takes at least 60 randomly selected individual stocks to eliminate 88% of diversifiable (uncompensated) risk.  Build a $250,000 core portfolio with low cost index funds or at least 60 individual stocks from different industries and countries.

For this core portfolio, adopt a financial asset allocation target of equity mutual funds and interest earning vehicles.  The split between these groups is based on your risk profile.  As you build wealth with this proven strategy, you create the solid foundation which increases your risk capacity. Your asset allocation will also change to match your increased risk capacity as your overall financial position on the Financial Life Cycle improves.

Use Morningstar’s fund screener to find mutual funds under these categories.  We recommend passively managed or index funds with low expense ratios.

There are many strategies for changing your financial asset allocation to more closely proximate the model of middle income millionaires.  All the strategies accomplish the same goal, but differ in terms of:

• Transaction costs
• Tax consequences
• Complexity
• Time to implement
• Financial benefits ($$$) to you
• Your emotional resistance

These strategies include:

• Liquidating portfolio equity assets and reinvesting in interest earning assets
• Invest 100% of your new IRA contributions/salary deferrals into interest earning assets until you achieve the target.
• Purchasing  US Savings bonds with after-tax dollars
• Some combination of the above

The National Association of Personal Financial Advisors (NAPFA) wants you to become more knowledgeable about personal financial issues, like basic money management, investments, kids and money, and much more. That’s why they’re launching a series of FREE online seminars (webinars) over the next year. The Consumer Webinar Series is for everyone – no matter how in tune you are with personal financial issues.

Each session is led by a NAPFA-Registered Financial Advisor who commits to the highest of standards in the financial planning industry. Many of the instructors are authors, educators and leaders in the industry.

The Consumer Webinar Series is a year-long initiative beginning August 7 (2009) that will provide an opportunity for anyone in the country to learn about a wide range of financial issues.  Each month a new session will be conducted live online. Consumers can attend the live session after registering for free, or listen to an audio file after the program.

The series will include 12, one-hour sessions delivered via the internet.  The individual sessions will be conducted from 11:00am – 12:00 noon Colorado time and will include:

• August 7, 2009:  Money 101: Knowing the Basics
• September 4, 2009: Kids & Money
• October 2, 2009:  What is Financial Planning?
• November 6, 2009:  Protecting What You Have
• December 4, 2009:  Investments: The Basics
• January 8, 2010:  Investments: Advanced Concepts
• February 5, 2010:  Managing Your 401(k)
• March 5, 2010:  Leaving a Legacy
• April 2, 2010:  Women and Money
• May 6, 2010:  Financial Planning and Small Business Owners
• June 4, 2010: Your Retirement
• July 1, 2010:  Financial Windfalls

Learn more about the Consumer Webinar Series by visiting the webinar page on the NAPFA website.