Key to Financial Success is Understanding and Managing Your Spending

Jane Young, CFP, EA

Jane Young, CFP, EA

Sometimes the simple things can make the biggest impact on our lives.  One of the most important steps toward achieving financial success is to fully understand where you spend money.   Increasing your awareness of how much you have available to spend and where you spend this money helps you become more intentional in your spending.

Studies have found that many of our actions are based on habit rather than conscientious decisions.  This is true with the food we eat, our daily routines and our spending habits.  By tracking your expenses you may discover spending patterns that are preventing you from achieving your financial goals.

This may seem obvious, but if it’s been a while since you took a serious look at your spending habits, it may be time to track and evaluate your spending.  You don’t need an expensive software package, just a pen, paper, and a calculator.  Review your credit card statements and bank statements over the last 6 months and track your monthly expenses.  If you spend a lot with cash you may need to keep a journal, for a month, to monitor where you are spending your cash.  Don’t leave out the quarterly and annual expenses in your review.  Compare your expenses to your net income to determine how much is left at the end of each month.

This exercise should be enlightening and you will probably be surprised at the amount you spend in certain areas.  Think about your financial goals and evaluate how you are actually spending money in the context of your goals.  Are you maintaining an emergency fund and saving money to meet long term goals such as retirement, a new home, a new car or college education for your children?  Create a spending plan that supports your financial goals.

You may find it helpful to systematically set aside or invest money to build an emergency fund, invest for retirement or save for college tuition.  If this money is put aside, it may be easier to become accustomed to living on the remaining funds.

Regardless of your income level, the secret is truly understanding how much you can spend and being intentional about how and why you spend your money.   Budgeting is about setting financial goals and priorities, not keeping you from doing what you love.   If it’s a priority to spend a lot of money on eating out, taking a vacation or buying a new car and it fits within your financial plan, then enjoy yourself.   Alternatively, if you are spending too much in one area consider enjoyable alternatives.   For example, meet friends for happy hour rather than dinner at an expensive restaurant.

Being aware of your spending helps you spend more intentionally and weigh the trade-offs of every purchase.  The simple act of reviewing your past spending habits will make you stop and think before making spending decisions in the future.

Financial Mistakes to Avoid as You Approach Retirement

Jane Young, CFP, EA

Jane Young, CFP, EA

As you enter your 50s it becomes increasingly important to incorporate retirement planning into the management of your finances.  Your 50s and 60s will probably be your highest earning years at a time when expenses associated with raising children and home ownership may be tapering off.  It’s crucial to take advantage of the opportunities during this time to shore up your retirement nest egg.

One significant retirement mistake is the failure to assess your current financial situation and understand how much is needed to meet your retirement goals.  Many underestimate the amount of money required to cover retirement expenses which may result in delaying retirement.   Consider hiring an advisor to do some retirement planning and help you understand your options, how much money is needed, and what trade-offs may be required to meet your goals.

Another common mistake is to move all of your retirement funds into extremely conservative options, as you approach retirement.  With the potential of spending 30 to 40 years in retirement, it’s advisable to keep a long term perspective.  Consider keeping your short term money in more conservative options and investing your long term money in a well-diversified portfolio that can continue to grow and stay ahead of inflation.  As you approach retirement, it’s also important to avoid making emotional decisions in response to short term swings in the stock market.   Emotional reactions frequently result in selling low and buying high which can be harmful to your portfolio.

Many in their 50s and 60s have more disposable income than at any other stage of life.  Avoid temptation and be very intentional about your spending.   Avoid increasing your cost of living with fancy cars and toys or an expensive new house as you approach retirement.  Instead, consider using your disposable income to pay down your mortgage or pay off consumer debt to reduce your retirement expenses.

Another common pitfall is spending too much on adult children including your child’s college education.  The desire to help your children is natural and admirable but you need to understand what you can afford and how it will impact your long term financial situation.  Place a cap on how much you are willing to contribute for college and encourage your kids to consider less expensive options like attending a community college or living at home during their first few years of college.   They have a lifetime to pay-off reasonable student loans but you have limited time to replenish your retirement funds.

Finally, a failure to care for your health can be financially devastating.  If you are healthy you will probably be more productive and energetic.   This can result in improved job performance with more opportunities and higher income.  If you are in poor health, you may be forced to retire early, before you are financially ready.   You also may face significant medical expenses that could erode your retirement funds.

Defending Yourself Against a Market Correction

Jane Young, CFP, EA

Jane Young, CFP, EA

The recent increase in the stock market is making a lot of investors nervous about the possibility of a significant correction.  I am frequently asked what the market will do over the next few months.  In reality, no one can predict market performance, especially in the short term. Your best defense against a volatile stock market is to create a financial plan and an asset allocation that is appropriate for your financial situation and time horizon.

If your current asset allocation is in line with your financial goals, there’s probably no need to make major adjustments to your current portfolio.  Your asset allocation defines the percentage of different types of investments such as U.S. stock mutual funds, international funds, bond funds and CDs that are held in your portfolio.  You should establish an asset allocation that corresponds with the timeframe of when your money will be needed.   Investments in the stock market should be limited to money that isn’t needed for at least 5 to 10 years.  Keep money that may be needed for emergencies and short term expenses in safe, fixed income investments like bank accounts, CDs or short term bond funds.

The stock market is inherently volatile and there will be years with negative returns.  However, over long periods of time the market has trended upward with average annual returns on the S&P 500 exceeding 9% (approximately 7% when adjusted for inflation).  It’s important to consider your emotional risk tolerance in establishing your asset allocation.   You may have the time horizon to have a significant portion of your portfolio in stocks but you may not have the emotional tolerance.  Your asset allocation may be too risky if you are tempted to sell whenever the market goes down or you are continually worried about your investments in the stock market.

Establishing an asset allocation that meets your situation can help your ride out fluctuations in the stock market more effectively than trying to anticipate movements in the market.  It’s impossible to time the market and a short term increase is just as likely to occur as a drop in the market.   Although you want to avoid timing the market, you should rebalance your portfolio on an annual basis to maintain your target asset allocation.  Additionally, you will want to adjust your target allocation over time as your financial situation changes and you move through different phases of life.

Keeping other areas of your financial life in order can also help you through a major market adjustment.   It’s essential to maintain an emergency fund of at least 3 to 6 months of expenses,  make a habit of spending less than you earn, and  save at least 10 -15% of your income.

Rather than focusing on where the market is headed and what the financial pundits are predicting, maintain an appropriate asset allocation and keep your financial affairs in order.

Understanding Stock Market Indexes

Jane Young, CFP, EA

Jane Young, CFP, EA

A stock market index provides a benchmark from which you can measure the performance of the stock portion of your portfolio.  An index statistically tracks the movement of a specific grouping of stocks.  There are numerous indexes that range from monitoring performance of the entire market to specific sectors of the market.  When referencing an index it’s important to understand what comprises the index and how the stocks are weighted.

The oldest and most widely followed index is the Dow Jones Industrial Average (DJIA), founded on May 26, 1896 by Charles Dow.  It is comprised of 30 stocks from a wide range of industries with the exception to transportation and utilities.  The 30 stocks comprising the index are selected by editors of the Wall Street Journal with the goal to show a true reflection of the market by focusing on relevance, longevity and market representation.

The DJIA isn’t actually an index but a price weighted average where more expensive stocks represent a higher proportion of the index and have more influence on the movement of the index than lower priced stock.  Originally, the DJIA was an average of the sum of the prices on all stocks in the index divided by the total number of stocks.  However, over time the calculation has been adjusted to account for stock splits and dividends.

Currently the DJIA represents about 25% of the total value of the U.S. stock market.  Although it only represents 30 widely known companies, over the long term it tracks well with the S&P 500 and can be a good measure of large company stock performance.

The S&P 500, another widely known index, was created on March 4, 1957 by Standard and Poor’s and is now part of McGraw Hill Financial.  It is comprised of 500 U.S. companies chosen by a committee at Standard and Poor’s with an objective to represent the U.S. stock market based on “market size, liquidity and group representation”.  It excludes companies that invest in real estate and companies that primarily hold stock in other companies.  Currently the index is solely comprised of U.S. companies, primarily but not limited to large companies.  The S&P represents about 75% of the value of the U.S. Stock Market, providing a much broader picture than the DJIA.

The S&P 500 is a market-cap weighted index where the weight in the index is based on the total value of all outstanding stock in the company.  As a result, large companies have much greater influence on movement in the index than do small companies.  About 50 of the 500 stocks in the index represent half of the total market capitalization within the index.

There are numerous other indexes available to monitor performance on specific sectors, smaller company stock and international stock.  For example, the Wilshire 5000 Index is a total U.S.  market index covering almost all publicly traded U.S. companies and the Russell 2000 Index covers the 2000 smallest publicly traded U.S. companies – both of which are capitalization weighted.

Words of Wisdom from Planners Around the Country

Jane Young, CFP, EA

Jane Young, CFP, EA

While recently attending the national conference of the Alliance of Comprehensive Planners, I interviewed dozens of fee-only, Certified Financial Planners.  I asked them to share the most important piece of advice that they can give to their clients.  The answers were not exciting or complicated but practical, common sense recommendations that are useful to most everyone.   The most common piece of advice, by an overwhelming margin, was to save more and spend less.  Below are the top ten most important financial steps you should take according to some of the finest financial planners in the industry.

  1. Live Below Your Means – Establish good spending habits early. Monitor your expenses for about three months and create a realistic spending plan that you can stick with.  Make intentional decisions to keep your spending well below your income and always maintain an emergency fund.
  2. Save at Least 10% of your Gross Income – Start saving as early as possible. Everyone should save at least 10% of their income.  If you are getting started later you may need to save closer to 15% to 20% of your income
  3. Look at the Big Picture – Take an integrated approach to your finances. Your financial life is a big puzzle with a lot of interlocking pieces.   Don’t make decisions in isolation.  Create a financial plan that serves as a roadmap to integrate all areas of your financial life including investments, taxes, insurance, retirement planning and estate planning.
  4. Be True to Yourself – Live, spend, and invest in accordance to your values and goals, not to impress or compete with others.
  5. Create a Realistic Investment Plan – Create a diversified investment plan that you will stick with during significant market fluctuations. Your portfolio needs to support your investment time horizon and the level of risk that you are comfortable with.
  6. Hire a Good Financial Planner – Managing your finances can be more complicated and time consuming than you realize. A financial planner can help you integrate all aspects of your financial life and can provide an objective perspective on your situation.
  7. Don’t Invest in Complex Insurance and Investment Products – Avoid insurance and investment vehicles that require a team of attorneys to understand. The words in small print are probably not in your best interest.
  8. Maximize Contributions to your 401k and Roth IRA – Fully utilize tax advantaged retirement plans and take advantage of an employer match where available.
  9. Don’t Let Family Members Derail Your Financial Plan – Don’t sabotage your financial security by paying for all of your child’s college education or by supporting adult children, parents, or siblings. You need to help yourself before you can be of assistance to others.
  10. Leverage Your Real Estate – Don’t be in a hurry to pay off a low interest mortgage on your personal residence. You can benefit from appreciation on your home with as little as 10% to 20% down.

Value Provided by Financial Advisor Can Exceed Fee

Jane Young, CFP, EA

Jane Young, CFP, EA

Many things can trigger the decision to hire a financial planner.  You may need some direction on how to prioritize your spending and saving to better prepare for the future.  You may be too busy or uninterested in managing your own finances.   You may experience a sudden life change such as a marriage, divorce, inheritance or retirement.   Your situation may be getting complicated and you want a professional opinion or you lack the technical expertise to continue managing things on your own.

Although, you may need a financial planner you may be hesitant to pay the fee.   Fee-only planners can be compensated using a flat fee, a percentage of assets or an hourly rate.   The fee will typically be around 1% of assets for on-ongoing advice.   A recent Vanguard study may help put your mind at ease.   The study found that the added value provided by a fee-only planner can far exceed the cost.

In 2014 Vanguard published the results of a study they conducted on the value added by advisors.  The study found that financial advisors can add up to about 3% in net returns for their clients by focusing on a wealth management framework they refer to as Advisor’s Alpha©.  The study found that an advisor can add to a client’s net returns if their approach includes the following five principles: being an effective behavioral coach, applying an asset location strategy, employing cost effective investments, maintaining the proper allocation through rebalancing and implementing a spending strategy.  These are just a few of the practices and principles followed by most comprehensive fee-only planners.

The exact amount of added return will vary based on client circumstances and implementation.  It should not be viewed as an annual return but as an average over time.  The opportunity for the greatest value comes during periods of extreme market duress or euphoria.  Additionally, Vanguard found that paying a fee for advice using this framework can add significant value in comparison to what the investor had previously experienced with or without an advisor.

Vanguard’s framework places emphasis on relationship oriented services that encourage discipline and reason, in working with clients who may otherwise be undisciplined and reactionary.  Rather than focusing on short term performance there is a focus on sticking to the plan and avoiding emotional overreaction. Advisors, acting as behavior coaches, can help discourage clients from chasing returns and focus instead on asset allocation, rebalancing, cash flow management and tax-efficient investment strategies.

The study found that when advisors place emphasis on stewardship and a strong relationship with the client, investors were less likely to make decisions that hurt their returns and negatively impacted their ability to reach long term financial goals.  According to Vanguard “Although this wealth creation will not show up on any client statement, it is real and represents the difference in clients’ performance if they stay invested according to their plan as opposed to abandoning it.”

Financially Get a Jump Start on 2017

office pictures may 2012 002The beginning of a new year is a good time to evaluate your finances and take steps to improve your financial situation.  Start by reviewing your living expenses and comparing them to your income.  Are you living within your means and spending money in areas that are important to you?  Look for opportunities to prioritize your spending where you will get the most benefit and joy.

This is also a good time to calculate your net worth to see if it has increased over the previous year and evaluate progress toward your goals.  To calculate your net worth, add up the value of all of your assets including real estate, bank accounts, vehicles and investment accounts and subtract all outstanding debts including mortgages, credit card balances, car loans and student loans.

With a better understanding of your net worth and cash flow you are ready to set some financial goals.  Start with the low hanging fruit including paying off outstanding credit card balances and establishing an emergency fund.  Maintain an emergency fund equal to at least three months of expenses.   Once your credit cards are paid off you may want to focus on paying off other high interest debt.

After paying off debt and creating an emergency fund, it’s advisable to get in the habit of saving at least 10% of your income.   Saving 20% may be a better goal if you are running behind on saving for retirement.

Take advantage of opportunities to defer taxes by contributing to your company’s 401k.  If you are self- employed create a retirement plan or contribute to an IRA.  Take advantage of any match that your employer may provide for contributing to your retirement plan.  If you are already making retirement contributions, evaluate your ability to increase your contributions.  If you have recently turned 50 you may want to increase your contribution to take advantage catch-up provisions that raise the contribution limits for individuals over 50.

As the new year begins you also may want to evaluate your career situation.  Saving and investing is just part of the equation, your financial security is largely dependent on career choices.  Look for opportunities to enhance your career that may result in a higher salary or improved job satisfaction.  It may be time to ask for a raise or a promotion or to explore opportunities in a new field.  Consider taking some classes to sharpen your skills for your current job or to prepare you for a new more exciting career.

You may have additional goals such as buying a new home, contributing to your children’s college fund, remodeling your house, or taking a big vacation.  Strategically think about your priorities and what will bring you satisfaction.  Start the year with intention, identify some impactful financial goals and create a plan.  Formulate an action plan with specific steps to help you meet your goals.

Working Part Time in Retirement Becoming the Norm

Jane Young, CFP, EA

Jane Young, CFP, EA

With the possibility of living another 20 to 30 years in retirement, many baby boomers are considering part time work in retirement.  According to a report by the Transamerica Center for Retirement studies, 82% of people in their 60’s either expect to work past 65, already are doing so or don’t plan to retire.   Likewise, a 2013 Gallop poll found that 61% of people currently employed said they plan to work part time in retirement.  While many seek part time work for financial reasons, working in retirement can also provide tremendous psychological and health benefits.

With the loss of traditional pension benefits many retirees need an extra cushion to cover retirement expenses.   Working part time can provide many financial benefits including the reduction of distributions from your retirement account.  Part time work can also help you avoid drawing from your portfolio when the market is down and the additional income can make you more comfortable increasing the risk in your portfolio, with the potential for higher returns.   Another benefit of working part time is the opportunity to delay Social Security benefits till age 70, when you can earn a larger benefit.  Additionally, part time earnings can be used to improve your future cash flow by paying off your mortgage, credit card debt, vehicle loans, and proactively address household maintenance and repairs.

Aside from the financial benefits, numerous studies have found that people who work in retirement are happier and healthier.  Part time work can give you a sense of purpose, identity and relevance.   It can also replace the social interaction that is lost when you retire.  A 2009 study in the Journal of occupational Health Psychology found that those who worked in retirement experienced better health.   Additionally, a study reported by the American Psychological Association in 2014 found that working in retirement can delay cognitive deterioration.

If you are considering part time work during retirement, start developing a plan before leaving your current position.  Leverage and expand your existing network while you are still working.   Your current employer may be interested in retaining you on a part time basis or may be aware of other opportunities for you.

Think of creative ways to utilize your skills, experience and passion to find or create a job that you will enjoy.  You may want to start your own business doing free-lance work or consulting.  Consider turning your hobbies or interests into a business such as tutoring, handyman services, party planning, programming or working for a golf course.  If you have management experience you may be able to fill a gap as a temporary executive while an organization is going through a transition.

Keep an open mind, be flexible and stay connected with your network.  Here are a few sites that can be helpful in finding part time work; Retirementjobs.com, Flexjobs.com and Coolworks.com.  Please use extreme caution when using internet job sites; many are scams that look legitimate.

Managing a Sudden Windfall

Jane Young, CFP, EA

Jane Young, CFP, EA

If you are fortunate enough to receive a significant windfall give yourself some time before making any major decisions.   A sudden influx of cash from an inheritance, winning the lottery, life insurance or the sale of a business can cause a major disruption in your life.    Over 50% of all windfalls are lost in a short period of time.  NBC news reported that more than 70% of all lottery winners exhausted their fortunes within 3 years.   You need some time to emotionally adjust to your situation and to create a plan.

You may experience a variety of new emotions and it’s important to avoid making decisions for the wrong reasons.  Some common emotions include guilt, loss of identity, isolation, anxiety, unworthiness, fear, intimidation and a lack of confidence.  It’s crucial to recognize and deal with these emotions before making big spending decisions that may hamper your long term financial security.  You also may feel pressure from friends and family.  Stand your ground and take the time needed to develop a well thought out plan.

You also want to carefully select a team of trusted advisors to help manage your windfall.  Most people will need a Certified Financial Planner, a Certified Public Accountant and an Estate Planning Attorney.  It’s essential to develop a financial plan, fully understand the tax implications of your windfall and put a new estate plan in place.

Initially your financial plan should include establishing an emergency fund equal to about one year of expenses, paying off your high interest debt, and making sure your new found wealth is adequately protected.  A significant windfall will probably necessitate the purchase of more liability insurance.  Additionally, you should address any health concerns that you or your immediate family may have been neglecting.  Also consider reducing your overhead by purchasing a home or paying off your mortgage.  This is also a good time to take care of any maintenance and repairs that you have been putting off.

Once your immediate concerns are addressed, think about the future.  If you were unable to cover your living expenses prior to the windfall, make a plan to cover your monthly cash flow needs.  Next develop a retirement plan to make sure your expenses in retirement are covered.  Consider saving for your children’s college and setting aside money for major necessary expenditures such as vehicles and appliances.   If you are in an unrewarding career, consider going back to school to transition into something more fulfilling.

Once you have addressed all of your current and future financial needs feel free to spend on some discretionary items.  You may want to help a friend or family member who is in need, make a charitable contribution, start a business, or plan some vacations.   At this point you can spend some money on having fun.  Unfortunately too many people start with fun and quickly spend through their entire fortune.

Tips from the Wealthy on How to Get Rich

Jane Young, CFP, EA

Jane Young, CFP, EA

You don’t have to be incredibly intelligent and born into the Rockefeller family to attain wealth.   Below are some pointers commonly shared by wealthy people on how to manage your life and your money to reach financial independence.  There is no magic, achieving financial security involves straight forward, common sense actions to gradually build your net worth.

  1. Write Down Your Goals: It’s great to dream about what you want to achieve but to accomplish something you need to put your goals into writing and create an action plan to attain them.
  2. Control Your Expenses: Take the time to understand and manage your expenses and create a budget that supports your goals.   Spend less than you earn and develop good saving habits.  Keep your expenses in check when things are going well and avoid automatically increasing your expenses as your income grows.
  3. Don’t Buy Status: Don’t buy things to look rich or to impress your friends.  Most wealthy people drive older model used vehicles and live in modest homes.  Use your money to save for the future and spend on what really matters.
  4. Educate Yourself: Getting a good education and selecting the right career is a huge factor in attaining wealth.  A good education can result in a more rewarding job in a field you enjoy.  If you enjoy your work you are more likely to excel and earn more money.  If you are in a dead end job or a career you don’t enjoy consider going back to school to transition into a career for which you have more passion.
  5. Be Patient and Maintain a Long Term Perspective – The key to successful investing is having the patience to ride out fluctuations in the market. Resist the temptation to chase returns and time the market.  Invest for the long term and let your portfolio grow over time.  Stay the course and avoid making decisions triggered by emotions.
  6. Manage Risk and Return – Balance your desire for high return with the risk involved. Maintain a diversified portfolio with adequate short term liquidity to get you through rough spots in the market.   Rebalance on an annual basis to keep your portfolio diversified.  Take a disciplined approach to investing and avoid high risk investments that promise a return that may be too good to be true.
  7. Start your own business – According to Forbes nearly all of the people on their list of billionaires made their money through involvement with a business they or their family had started. Owning your own business may seem too risky but it can provide you with an opportunity for higher earnings and greater control over your financial future.
  8. Avoid Complex Investments – Avoid investing in anything that seems overly complicated or that you don’t fully understand. Complex investments often come with  greater risk, a lack of control, limited marketability, limited transparency and hidden fees.

Take Care of Your Family with a Good Estate Plan

Jane Young, CFP, EA

Jane Young, CFP, EA

Most of you put tremendous effort into saving and investing for the future.  It’s common to routinely monitor our budgets, portfolios and progress toward retirement but neglect our estate plans.  It can be uncomfortable and awkward to work on your estate plan but the failure to plan for the thoughtful distribution of your assets can be disastrous for your loved ones.  Your estate plan is a significant part of your financial plan and needs to be accurate and thorough to cover most contingencies.

I encourage most individuals to work with an estate planning attorney to develop or maintain a plan.  To select an attorney ask friends, colleagues and professionals you know or work with for a referral.  Have a brief phone call with at least three attorneys to find one you feel comfortable with, who provides the services you need and whose fee structure seems reasonable.   If you have a complicated situation select an attorney who is proficient with complex estate planning.   If your situation is straight forward, you’ll want to guard against an unnecessarily complicated and expensive estate plan.

Prior to seeing an attorney think about how you want your assets distributed and who should serve as your personal representative to manage the distribution of your assets.  Also consider how your plan will change if one or more of your heirs predeceases you.

Your estate plan should address and coordinate assets that are distributed using a will and those to be distributed using a beneficiary designation, transfer upon death or other automatic transfer.  Give beneficiary designations serious consideration as they may impact a large portion of your estate. Beneficiary designations, accounts transferable upon death, accounts held in Joint Tenancy, beneficiary deeds on real estate and assets held in a trust all supersede a will.  A will provides instructions on the distribution of your residual estate or those assets that are not distributed via other legal transfers.

Assets in retirement accounts, annuities and life insurance policies are generally distributed using beneficiary designations.  Be especially careful to name an individual rather than an estate or trust as beneficiary on a retirement account. This will make it easier for your beneficiaries to spread out distributions from the account over time and avoid a substantial tax bill if the entire balance is distributed all at once. Additionally, don’t leave the beneficiary designation blank on the assumption it will be distributed in accordance with the will.  Many financial institutions distribute retirement accounts, without beneficiary designations, in accordance with “intestacy guidelines”.  These are rules your state uses to distribute assets when no will or beneficiary designation is in place.

In addition to the distribution of assets your estate plan should include a durable power of attorney, health power of attorney, advance health care directive or living will and a HIPPA authorization.  Most attorneys provide these as part of a complete estate planning package.

Selecting the Right Asset Allocation – Part 2

Jane Young, CFP, EA

Jane Young, CFP, EA

Your asset allocation is the basic structure of your investment portfolio defining the target percentage you want to hold in different categories of assets.   Start creating your asset allocation by deciding how much you want to invest in the two major categories, stock mutual funds and interest earning assets.  Next break your allocation down into more specific categories including cash, CDs, bonds, large cap stock, mid-cap stock, small cap stock, international stock, emerging markets stock and real estate.  Setting an appropriate, well diversified asset allocation helps you balance risk and return within your portfolio.  Your asset allocation may change over time as your financial circumstances change.  However, avoid changing your allocation too frequently based on short term fluctuations in the market.

The appropriate allocation depends on several factors including your age and investment time horizon, your financial goals, other risk factors in your life, your experience with investing and your emotional risk tolerance.  Regardless of your investment goals, you need to maintain an emergency fund of readily available funds equal to at least four months of expenses.

Your financial goals are a major determinant in setting your allocation.  Identify your major financial goals and when money is needed to support these goals.  Design an asset allocation to meet these goals.  Money needed in the short term should be held in safer, interest earning investments. The stock market should only be used for long term needs – generally at least five to seven years out.

You may be able to assume more risk in your portfolio if the timetable for your goals is flexible.  The timeframe for money to cover things like college education or your emergency fund may be firm but there may be some flexibility on when you take a major vacation, remodel your home or plan to retire.   Money needed for retirement is generally spent over twenty or thirty years.  You won’t need your entire nest egg on the first day.

Your allocation is also dependent on risks taken in other areas of your life.  For example, if you work in a volatile career with unpredictable earnings, own a small business or own rental property, you may want to reduce the risk in your investment portfolio. On the other hand, if you have a secure job and anticipate a generous pension, you may be comfortable taking more risk.

Regardless of your situation you need to feel emotionally comfortable with your allocation. If you are constantly worried about market fluctuations you may need a more conservative allocation.   Historically the stock market has trended upward, but there will be years with negative returns.  Create an allocation that gives you adequate emotional security to ride out swings in the stock market and helps you avoid selling when the market is down. If you are new to investing, start out slowly and test the water to see how you will react in a volatile market.

Risk and Your Investment Portfolio – Part 1

 

Jane Young, CFP, EA

Jane Young, CFP, EA

Deciding upon an asset allocation is one of the first and most significant decisions to be made when you start investing.  Your asset allocation is the percentage of different types of investments such as cash, bonds, stock or real estate that make up your investment portfolio.  Probably one of the most important allocations is that between investments in the stock market and investments in interest earning vehicles such as bank accounts, CDs and bonds.  An ideal asset allocation provides a balance between risk and return that helps you meet your goals but doesn’t keep you awake at night.

There is a trade-off between risk and return.  Generally, if you want a higher return you need to assume a higher level of risk.  Investment risk comes in many different forms with the most common being stock market risk.  Historically, over long periods of time, the stock market has out-performed most other investments.  However, in the short term it can be extremely volatile, including years with negative returns.  In the extreme case you could lose your entire investment in an individual stock.  To reduce risk in the stock portion of your portfolio, consider buying diversified stock mutual funds. You will still experience swings in the market but fluctuations in any one stock will have less impact.

On the other hand, interest earning investments such as bank accounts, CDs, bonds and bond funds are generally less risky and are not subject to stock market fluctuations.  Unfortunately, in exchange for this lower level of risk you may earn a much lower rate of return.

Additionally, bonds and bond funds are subject to interest rate risk and default risk.  If you purchase a bond or bond fund and interest rates increase, the value of your investment will decrease.  To make matters worse, when interest rates rise bond funds commonly experience a flood of redemptions forcing them to sell bonds within the fund at a loss.  Even if you hold on to your shares you can experience a drop in value. However, if you purchase an individual bond and hold it till maturity you will receive the full value upon redemption.   Use caution when buying low quality bonds or bond funds; you may get a higher return but you are subject to a much greater risk of default.

Many investors don’t consider inflation risk.  This results from taking too little risk with a conservative portfolio containing little or no stock.  Over time inflation has averaged about 3% annually, if you are only earning 2% on your portfolio your real return after inflation will be negative.  This is compounded if inflation rates rise significantly.  Consider increasing your allocation in the stock market to hedge against inflation risk.

In the current environment of low interest rates and high volatility it’s crucial to build a portfolio that balances risk and return to support your financial goals and provide you with peace of mind.

Smart Financial Moves for College Graduates

Jane Young, CFP, EA

Jane Young, CFP, EA

After finishing school and hopefully landing a rewarding job, college graduates face a myriad of financial obligations and opportunities.   Here are some steps for graduates to get started in the right direction.

Create a Budget and Live Below Your Means – Based on your income, create a spending plan that leaves you with a little extra money at the end of the month.  Your budget should include saving at least 10% of your gross income.  Spend less than you earn so you are prepared for unexpected bumps in the road.  Initially this may involve renting a smaller apartment, living with roommates or driving an older car.  As your career progresses, avoid increasing expenses in lock step with earnings increases.

Establish an Emergency Fund – With the money you are saving, build and maintain an emergency fund equivalent to 4 to 6 months of expenses.

Avoid Credit Card and Consumer Debt – Pay your credit card bill in full at the end of every month.  If you can’t afford to pay for your purchases when the bill arrives then postpone or re-evaluate the purchase.   Avoid or minimize debt on vehicles and other consumer purchases.

Payoff Student Loans – Devise a plan to payoff your student loans.  Consider consolidating or refinancing your loans if it will save you money.  Consider both the interest rate and the duration when evaluating loans.  Generally, you want to pay off student loans in less than ten years.

Buy Adequate Insurance – It’s essential to have good health insurance coverage; if you aren’t covered by your employer you may be eligible for continued coverage on your parents plan.  You will also need good car insurance and renters insurance on your apartment.  Additionally, consider long term disability insurance and an umbrella liability policy.

Contribute to Your Employers Retirement Plan – Many employers offer a 401k or 403b plan to help you   save for retirement using before tax dollars.  At the very minimum contribute up to the match that your employer may provide.

Contribute to a Roth IRA – Once you start earning money you can also save for retirement by contributing to a Roth IRA.  The benefit of a Roth is since you initially invest with after tax dollars, you don’t pay taxes when the money is withdrawn in retirement.   This is a tremendous opportunity for recent college graduates because your money can grow tax free for forty or fifty years.

Travel and Have Some Fun – While you’re young and relatively independent, set aside some money to explore the world or do something adventurous.  Once you buy a house, start a family or assume more job responsibilities it’s harder to get away.

Educate Yourself on Finances – Start reading personal finance books and articles.  Here are a few books to consider; “The Money Book for the Young, Fabulous and Broke” by Suze Orman, “Personal Finance for Dummies” by Eric Tyson, and “The Millionaire Next Door “ by Thomas J. Stanley and William Danko.

Things to Consider Before Filing for Social Security

Jane Young, CFP, EA

Jane Young, CFP, EA

Social Security seems straight forward but it can be quite complex, there are many opportunities and pitfalls to watch out for.  Before filing for Social Security, research your options to maximize your benefit, minimize taxes and avoid errors in your benefit calculation.  It’s important to meet with a Social Security Representative prior to filing but don’t solely rely on this information.   Due to the complexity of various options, they may overlook something that could impact your situation

You can file for Social Security benefits as early as 62 but you will receive a reduced benefit.  Most healthy individuals should hold off on taking Social Security as long as possible.  If possible, delay taking Social Security until age 70.  Your benefit will increase 8% a year from your full retirement age to age 70.  The full retirement age for individuals born before 1954 is 66 gradually increasing to age 67 for anyone born in 1960 or later.

Upon reaching full retirement you may be eligible to take 50% of your spouse’s benefit or 100% of your own benefit if you are currently married, were born before 1954 and your spouse has started taking benefits.  While taking spousal benefits, your benefit can continue growing until you reach age 70 at which time you can switch to 100% of your own benefit if it’s higher.  There is no advantage to delaying benefits beyond age 70.

If you have been divorced for two years or more, were married for at least 10 years and are currently unmarried, you are eligible to receive 50% of your ex-spouses benefit or 100% of your own benefit.  If you were born before 1954, at full retirement you have the option to start taking 50% of your ex-spouses benefit and switch to your own retirement benefit at a later date. If you are a widow and you were married for at least 10 years you are eligible to take the highest of 100% of your deceased spouses benefit or your own.

If you take benefits before your full retirement age you are limited on how much you can earn before your benefit is reduced. In 2016, your benefits would be reduced by $1 for every $2 earned over $15,720.  Benefits lost due to work will result in a higher benefit later.  There is no income limit if you wait to take benefits at full retirement. If you take Social Security while working a larger portion of your benefit will be taxable, so you may want to consider delaying Social Security until you stop working or reach age 70.

If you held jobs where you paid into Social Security and you receive a pension from working in a job where you did not pay Social Security, your Social Security benefit may be reduced.  Be sure to notify the Social Security Administration of your pension.

More information on your Social Security benefits is available at www.ssa.gov.

Variable Annuity Not Magic Solution

office pictures may 2012 002While driving home recently I was disconcerted by another commercial spouting false information and preying on investor fear.  This commercial was exaggerating the danger and volatility of the stock market by implying most investors lost millions in the 2008 and 2009 market crash.  In reality if you were invested in the stock market from 2006 to 2016 you would have seen a 65% increase in your stock portfolio.  If you didn’t sell when the market dropped, you would have experienced a reasonable return rather than a loss on your investment.   Commercials like this stir up fear and anxiety then promise the perfect solution to market volatility – the magic to provide great returns without taking risk.

There is no miracle product that is going to provide you with high returns without risk.  If it sounds too good to be true, it is!  A basic concept of investing is the trade-off between risk and return.  If you want more return you will have to absorb greater risk.  If you want a risk free investment you will be limited to CD’s and US government bonds that pay very low interest rates.   If you want to earn higher returns you will need to take on some risk and invest part of your portfolio in the stock market.

The mystery product in commercials and ads that promise high returns with no risk is often a variable annuity.  While on occasion the use of an annuity may be appropriate for a portion of your portfolio, most variable annuities come with significant disadvantages.   A variable annuity is an insurance vehicle that invests your money into separate accounts similar to mutual funds.   Annuities are complex insurance contracts that are commonly sold on commission, with built-in fees and significant restrictions on when and how you can withdraw your money.    Earnings on money invested in a variable annuity grow tax deferred but are taxed at regular income tax rates when withdrawn.

Insurance salespeople influence you to buy annuities by promising protection from market volatility.  Basically, in addition to paying the typical fees and commissions, you can purchase an insurance rider to guard against a drop in the market.  However, this insurance usually only applies to a death benefit or the base amount used to calculate an annual income stream.   If you think a variable annuity is appropriate for your situation make sure you fully understand the product’s benefits and restrictions before investing.   Also consider an annuity with no or a low commission and without restrictions on when and how you can access your money.

A better option for managing market volatility may be to invest in a diversified portfolio that supports your time horizon.   Avoid the need or temptation to withdraw money from the stock market when it’s down.  Invest money needed in the short term in safe investments and limit your stock market investments to long term money.

Save on Travel by Making Wise Credit Card Choices and Eating with the Locals

office pictures may 2012 002Credit cards have become an excellent tool for saving money on travel. Many major credit card providers offer reward cards that provide 30,000 to 50,000 bonus airline miles after you charge as little as $3,000 to $4,000 over the first 3 months of opening the account.  They frequently waive the annual fee for the first year. If you don’t want to continue, and pay the annual fee for subsequent years, cancel the card before the end of the year when the fee is due.  Additionally, many travel cards have a generous rewards program that allows you to earn miles as you make purchases during the year.   Many travel cards also allow you to waive checked baggage fees and provide you with priority seating.

Some cards with an attractive introductory offer include Chase Sapphire Preferred, Capital One Venture Card and Citi/AAdvantage Platinum Select, among others.  A helpful website to compare the benefits and fees for various travel cards is creditcards.com/airline-miles.php.  Before selecting a new credit card make sure you fully read and understand the terms and conditions.  Credit cards opened to accumulate airline miles should only be used by those who pay off their entire balance every month.  This should not be considered by those who carry a balance from month to month.

When travelling overseas you should have at least one card that doesn’t charge foreign transaction fees.  Many credit cards assess a 3% foreign transaction fee on all international charges.  Some companies have begun waiving foreign transaction fees including Capital One Venture Card and Chase Sapphire Preferred, to mention a few.

When travelling abroad, a rewards card without foreign transaction fees is essential but there will be times when cash is required.  Use your ATM card to get foreign currency, it will provide you the best exchange rate.  Avoid exchanging U.S. dollars for foreign currency at exchange bureaus.  ATMs do charge a fee for every transaction so limit the number of transactions by getting as much money as possible each time you make a withdrawal.  Additionally, it’s prudent to carry at least two ATM cards, from different banks, in case there is a security concern and access to your account is blocked.

Once at your destination you can save money and enhance the authenticity of your visit by staying and dining off the beaten path.  Seek out family run hotels and restaurants that are local favorites. You can often save money by booking a Bed and Breakfast or vacation rental.  Booking a room at the last minute can also result in nice accommodations at a reduced price.  To find good restaurants, ask local residents for their recommendations.  Observe who is patronizing a restaurant and select one that is teaming with locals rather than tourists. Once you select a restaurant, stick with the local specialties and order food that is currently in season.

Flexibility is the Secret to Saving Money on Travel – Part I

office pictures may 2012 002

The demand for travel in 2016 is strong.  This has resulted in fewer deals and the need for extra planning if you want to save some money.   Flexibility on when and where you travel can have a huge impact on travel costs.  Try to avoid travel on major U.S. holidays and on major holidays in countries that you will be visiting.  If possible, avoid peak season and travel during the shoulder seasons which fall in September, January and April.  Generally, you can save money by flying in the middle of the week or on Saturday afternoon.   Additionally, it’s usually cheaper to fly very early in the morning or late at night.  Prices will vary based on supply and demand.

Booking your flight well in advance of your preferred departure date can also save money.   After analyzing over 3 million airline trips, CheapAir found that the best time to book domestic airfare is 54 days prior to your departure.  Similarly, Expedia’s Air Travel Outlook for 2016, found the best time to buy a domestic ticket is 57 days prior to departure and the best time to buy a ticket from North America to Europe is 176 days before departure.

To find the most cost effective combination of date and location use on-line sites such as Kayak Explore.  Kayak Explore allows you to interactively change the date to see how the airfare changes for cities throughout the U.S. or the world, all on one screen.

Flexibility with regard to your destination can result in significant savings – costs vary dramatically depending on the country or region you are visiting.  In 2016 some of the most expensive countries to visit include Norway, Sweden, Switzerland and Japan while some of the least expensive countries include Slovakia, Croatia, Poland, Romania and Morocco.  Information on the comparative travel costs in various countries is available on Numbeo.com/travel-prices and fareness.com.   You can also reduce travel costs by flying into smaller cities or less popular cities.   When travelling to Europe consider flying into a less popular city on a major airline and connect to cities within Europe on small, inexpensive regional carriers like Air Berlin or EasyJet.

Once you have decided upon a date and destination use airfare search sites such as Cheaptickets.com, CheapAir.com and Expedia.com to shop and compare flights on different airlines.  However, keep in mind that several airlines, including Southwest, are not listed on aggregation sites.  Do some research and check fares on all major airlines with service to your destination.  Check both round trip and one way ticket prices.  Some airlines have recently begun offering two, one way segments for less than a round trip ticket.  Once you have selected a flight try to book directly with the airline you will be using.  The prices are usually comparable and it will be a lot easier to reschedule if any problems arise.

Taking the Mystery Out of Alternative Minimum Tax

office pictures may 2012 002This year many taxpayers were faced with the unwelcome surprise of Alternative Minimum Tax on their income tax return. Alternative Minimum Tax (AMT) is a complex, parallel income tax system to the standard income tax calculation.  AMT was started in 1969 in an attempt to prevent very wealthy people from using large deductions and exemptions to avoid paying income tax.  At that time it was discovered that 155 households with income over $200,000 were able to avoid paying any income tax.  AMT was originally aimed at the very rich but over the years it has come to impact millions of middle and upper income taxpayers.

Until you are hit with AMT, you may be unaware that behind the scenes your tax software runs two sets of numbers to determine how much income tax you will owe.  Your return is calculated using the standard income tax rules and it is calculated using the AMT rules.

AMT recalculates your taxable income by adding back many commonly used deductions and exemptions.  Some of the most common AMT add-backs include state and local taxes including real estate taxes, miscellaneous itemized deductions, home equity loan interest that isn’t used to buy or improve a home, and medical expenses.  AMT also adds back exemptions for dependents and the standard deduction, if you don’t itemize.  Tax-exempt interest from most private activity bonds becomes taxable under AMT and if you exercise Incentive Stock Options, the gain becomes taxable upon exercise. Under the standard income tax calculation, tax is due when the stock is sold.

If there is a possibility you will be subject to AMT, I recommend having your taxes professionally prepared or using tax preparation software.  Your software will calculate AMT by adding the items listed above to your adjusted gross income to arrive at your Alternative Minimum Tax Income (AMTI).  You are allowed to exempt some of your income from AMTI.  For 2016 the exemption for single filers is $53,900 and for joint filers is $83,800, the exemption is reduced for higher income taxpayers.  AMT is calculated by subtracting your exemption from your AMTI and multiplying your first $186,300 by 26% and anything over $186,300 by 28%, these figures are adjusted every year.  Your total income tax for the year will be the higher of your standard income tax calculation or AMT.

Taxpayers who are most likely to fall into AMT are those who live in a state with high income taxes, those with high deductions and those with large families. While there are limited opportunities to reduce the likelihood of paying AMT, one option is to reduce your adjusted gross income by maximizing tax deferred retirement plans such as 401k and 403b plans.  You also may be able to reduce AMT by moving to a state with no or low income tax or by managing the timing on when you pay state and local taxes.

Get Serious About Planning for Retirement in Your 50’s

Jane Young, CFP, EA

Jane Young, CFP, EA

In our 50’s we still have time to plan and save for retirement and it’s close enough that we can envision ourselves in retirement.  Below are some things to address as you plan for retirement.

  • Set some goals and make plans, what does your retirement look like? Consider your path to retirement and your timeframe – you can gradually transition by working fewer hours in your current job, work part time in a new career field or completely stop working.  Think about how you will spend your time in retirement.   Work usually provides us with mental stimulation, a sense of purpose and accomplishment, social interaction and a sense of identity.  How will you meet these needs in retirement?
  • Evaluate your current situation. Take a thorough look at current expenses and assets.  Analyze your spending habits and compare this to your earnings.   Look for opportunities to save money to invest and prepare for retirement.
  • Ramp up savings and maximize your retirement contributions – try to save at least 10% to 15% of your annual income. Increase contributions to your 401k and IRA to take advantage of catch-up provisions.  These are your highest earning years where you can really benefit from investing in tax deferred retirement plans.
  • Invest in a diversified portfolio that will grow and keep up with inflation. Your retirement savings is long term money that will need to last another 30 – 40 years.   A reasonable portion of this money should be invested in stock mutual funds to provide you the growth needed to carry you through retirement.
  • Take steps to reduce your retirement expenses – pay off high interest debt, credit cards and vehicle loans. Make extra payments on your mortgage to pay it off around the time you retire.
  • Think about where and how you want to live. Do you want to move to a lower cost area or downsize to a smaller home? Put plans in place to meet your goals.  Complete major remodeling, repairs and upgrades on appliances before you go into retirement.
  • Develop a retirement budget. Consider the impact of inflation and taxes on your monthly outflow.  Many retirees are more active and spend more early in retirement.   Include expenses for health care and long term care in your budget.
  • Evaluate your Social Security options. Delay taking Social Security benefits as long as possible, up to age 70.
  • Calculate how much you need to pull from your retirement savings by subtracting your monthly expenses from your Social Security and pension benefits. As a rule of thumb, avoid spending more than about 4% of your retirement savings per year.  This will vary with the amount of risk you are comfortable taking in your portfolio.  To get a more precise projection on when you can retire, how much you can spend and how much you should save, periodically work with a financial planner on some formal retirement planning.
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