Inflation and the Rising Tide: Protecting Your Assets

For individuals in retirement living on a fixed income, it can devastate one’s savings and lifestyle.

As a bond or CD-holder, the purchasing power of regular interest income gets hit.  As a stock investor, stock prices can suffer as profit margins and earnings of your equity holdings are hurt by the higher costs for inputs like energy, precious metals and labor.

Right now, Wall Street is in a good mood.  For the quarter just ended, the Dow has gained about 14%, the S&P increased 14.5% and the NASDAQ was up 15%.  In fact the last time the Dow saw such a large quarterly surge was back in the fourth quarter of 1998 when it rose more than 17% as the dot-com bubble was forming.

This quarter’s rally continued a trajectory that began in mid-March 2009.  It has been primarily propelled by glimmers of light at the end of the tunnel.  A variety of positive statements from Federal Reserve Chairman Ben Bernanke contributed to a more optimistic view.  Residential real estate sales continued to come back mostly prompted by a first-time homebuyer tax credit.  Corporate earnings have been up.  The popular “cash for clunkers” program spurred auto sales and by some measures consumer spending increased marginally even without the impact from auto sales.

Despite the Wall Street rally, Main Street is still hurting: unemployment continues to rise, business and personal bankruptcies have increased, bank failures are at their highest level and the dollar continues to weaken fueling fears of inflation down the road.

Signs of future higher inflation are on the radar screen:  All the government economic stimulus here and abroad coupled with mounting public debt; the Fed’s projected end of a program in March 2010 that will likely lead to higher mortgage rates; a Fed interest rate policy which has no place to go but up and rumblings that foreign governments and investors may not want to continue at their current pace of supporting our debt habit. 

So how do you position yourself to profit whichever way the tide turns?

Now, more than ever, it is important to have a risk-controlled approach to investing.  This is centered on an age-based allocation that includes exposure to multiple assets.

This is why we will continue to manage portfolios with an allocation to bonds and fixed income but there are ways to protect from the impact of inflation and still allow for growth.

1.)    Include dividend-paying equities:  Using either mutual funds or ETFs that have a focus on dividend-paying stocks will help boost income as well as return.   Stocks that pay dividends have averaged near a 10% annual return compared to a total return less than half of that for stocks that rely solely on capital appreciation.  Better yet, consider stock mutual funds or ETFs that focus on stocks that have a record of rising dividends.

2.)    Stay short:  By owning bonds, ETFs or bond mutual funds that have a shorter average maturity, you reduce the risk of being locked into less valuable bonds when higher inflation pushes future interest rates up.

3.)    Hedge your bets with inflation-linked bonds: Fixed-rate bonds offer no protection against inflation. A bond that has changes linked to an inflation index (like the Consumer Price Index) like TIPS issued by the US-government or ETFs that own TIPS (like iShares TIPS Bond ETF – symbol TIP) offer an opportunity for a bond investor to get periodically compensated for higher inflation.

4.)    Float your boat with Floating-Rate Notes: These medium-term notes are issued by corporations and reset their interest rates every three or six months.  So if inflation heats up, the interest rate offered will likely increase.  Yields in general are higher than those offered by government bonds typically because of the higher credit risk of the issuer.

5.)    Add Junk to the Trunk: Hi-yield bonds are issued by companies that have suffered down-grades – sort of like homeowners with dinged credit getting a mortgage.  Yields are set higher than most other bonds because of the higher risk.  Yet, as inflation heats up with a growing economy, the prospects of firms that issue junk improve and the perceived risk of default may drop. So as the yield difference narrows between these “junk” bonds and Treasuries, these bonds offer a “pop” to investors.

6.)    Own Gold and Other Commodities:  Whether as a store of value or hedge against inflation, precious metals have a long history with investors seeking protection from inflation.  It’s usually best to focus on owning the physical gold or an ETF that is tied directly to the physical gold. Tax treatment of precious metals is higher because of its status as a “collectible” but this is a minor price to pay for some inflation protection.  And because the demand for commodities in general increases with an expanding economy or a weakening dollar (in the specific case with oil), owning funds which hold these commodities will help hedge against the inflationary impact of an expanding economy.

Flexible Spending Accounts Help Lower Care Costs

Both dependent care and medical flexible spending accounts are funded with pre-tax deductions from your paycheck. Both have a “use or lose” policy if the funds deducted are not used in the calendar year for which the election was made.

Typically, a person can only make the election to have these deductions taken at the time of their hiring or during the annual enrollment period every company offers for their employees to make changes to their health and welfare benefits. (There are other times as well during certain “life events” such as marraige or birth of a child when benefit elections can also be changed.)

Since the election to make these deductions are made for a full year, one must be very cautious about the amount chosen. If you don’t use the funds towards eligible expenses in the time period allowed, you cannot get the money back.

For those with young children or elder parents needing day care, the dependent care FSA can be useful.  The maximum amount that can be set aside is pegged at $5,000 each year. With the costs of child care and adult day care being what they are, it is not likely that an employee will end up not using the full amount set aside so maxing out makes sense.

However, the dependent care program only allows a person to receive funds already in their FSA account, regardless of how much the person has already paid out in dependent care expenses. For example, if a person elects the $5,000 maximum to be withdrawn over the course of the year, after 3 months there is only $1,250 in the account. Even though the person has already paid more than that to the child care provider, they can only receive the balance.

With the medical flexible spending account, however, a person can be reimbursed at any time during the year up to the annual
amount elected to have withdrawn.  Thus, the person can receive funds from the FSA prior to the funds actually having been withdrawn from their paycheck.

Let’s assume you know you are going to have a surgical procedure in January and your cost will be about $5,000, so you elect to have $5,000 deducted towards the medical FSA during the open enrollment period. In February, you pay your $5,000 portion. Even though you have only about $800+ in your FSA account, you can submit a reimbursement claim for the full $5,000 that you paid out.

It is prudent to review what your expected medical expenses may be in the upcoming year, verify that they are eligible FSA expenses with your employer’s FSA administrator, and then make the election. It can’t hurt to underestimate, so you may have to pay some expenses with after tax dollars, but that’s still much better than giving away money because you overestimated and you lose what you had deducted and not used.

Some examples for using a medical FSA are when you incur orthodontia expenses and dental procedures for which you have a high deductible and/or co-pay. Regular doctor office visit co-pays, which are not usually exceptionally expensive, are eligible for FSA reimbursement. If you go often enough, even saving a few tax dollars can be beneficial.

Using the FSA is a great tool to enforce a disciplined savings program to cover expenses that are expected to be incurred anyway during the year.  And by doing it through a tax-deferred program at work, you’re ultimately reducing the cost by your marginal income tax rate so that your savings stretch out to buy you more services. (For someone in the 20% marginal tax bracket, for example, one would have to earn $1.25 to have enough cash to pay for $1.00 of services after the impact of taxes.)

By taking some time to project your personal expenses, you can ultimately benefit with Uncle Sam’s help.

Beware the Siren Call

Like the mythical siren’s call, the pitch is enticing – a seemingly perfect investment.

Investors can buy into a contract offering a minimum return with the potential to capture the upside of increases in the stock market while avoiding portfolio value declines if – and when – the market goes down.

This blend of promises can be found in ‘equity-indexed annuities” or EIAs offered by insurance companies.

And these offerings have become popular given the steep declines in the stock market.  According to a report in the WSJ (9/02/09), sales of EIAs during the first half of 2009 rose 20% compared to a year ago to $15.2 billion.

As compelling as these products may sound, they are anything but simple.  There are many complicated moving parts to each EIA contract. So buyer beware!

Think of investing as finding the route to your destination (a goal) and matching that with the appropriate mode of transportation (or investment vehicle) to get you there.  You may be traveling from Boston to New York and can choose highways or back roads. You can choose hi-speed rail, a car, a bus, a bike or even a plane.  You can drive or fly yourself or hire someone else to drive. All will get you to where you want to go but it’s a question of what kind of comfort level you want on the ride, how much time you have to get there and at what cost – in fees or simply mental health.

For those who may not have the stomach for the gyrations of the stock market but are looking to be more venturesome, the EIA may be a suitable compromise. It’s sort of like someone hiring a driver for the trip but traveling on main roads while avoiding highways.

First, understand that an annuity is offered by an insurance company and backed by the credit-worthiness and deep pockets of the insurer.  There is no FDIC backing. This is not a bank product (although you may find them sold by brokers with desks in banks).

Next, understand that an index can be any benchmark for any asset class or market.  The most common benchmarks include the Dow Jones Industrial Average (DJIA), the S&P 500 and NASDAQ in the US.  Overseas, indexes include the NIKKEI in Japan for instance.

An equity-indexed annuity (EIA) ties the amount that will be credited to an investor’s account to the performance of a particular index. 

But don’t expect to receive a one-for-one increase in your account value based on the index’s increase.  Instead, these contracts include a “participation rate” that sets a percentage of the index gain that is used.

The index-based interest credit may be further limited by “caps” that set a maximum amount of gain.

For anyone who has ever had an Adjustable Rate Mortgage, the process is very similar to how loan rates are recalculated.

Calculating the interest credit is further complicated by the method of measuring the change in the index value.  For instance, the insurer can determine the index change based on the “Annual Reset” – the difference between the index value at the beginning and end of each contract annual anniversary date.  Or a “point-to-point” method may be chosen that compares the index value at the beginning date with some future date like the fifth anniversary. Or the insurer will use “index averaging” taking multiple index returns and averaging them.

By the way, the index value won’t include changes resulting from dividends. While total return on the S&P 500 averaged 9.5% between 1969 and 2008, more than one-third of the return was attributed to dividends.  So these EIA market participation formulas will be calculated on a lower base when dividends are not considered part of the index return.

Typically but not always, there is a minimum amount of interest that is credited. But be aware that this minimum interest credit may not apply to 100% of the contract value.  It may apply an interest rate of 3% to only 90% of the value.  It may apply 1.5% interest to 85% of the total value.  It all depends on the terms of the contract.

EIA contracts have dual values:  the one based on the index value, participation rate and cap; the other based on the minimum interest credit.  And if you get out of the contract before the full term, you may be forfeiting the index-based account value. The insurer would then pay out the amount based on the minimum guaranteed portion which may be lower than what you expected compared to the index formula.

And how many football fans would be happy if their favorite team was on the 1-yard line and the referees moved the goal post?  Well, most EIA contracts reserve the right to unilaterally change terms reducing the participation rate or using stiffer lower, caps for example.

And most contracts have very steep surrender charges that can start at 10% to 15% of the contract value in the first year and declining from there for up to 10 years.

And be aware of the financial incentives that are part of these contracts.  Some EIAs offer “bonuses” to investors – an extra 5% or 10% added to the initial deposit.  But there is no free lunch.  In exchange for such a bonus, the insurer will likely increase the surrender penalty.  So as much as the bonus is an incentive to open the contract, the penalty is an incentive to not move the money out.

Follow the money, too.  Many EIAs pay out commissions to brokers between 6% and 10% and sometimes more.  An investor should be aware that there may be an incentive by a salesperson to offer this as a catch-all solution whether or not it fits the investor’s particular situation. 

The advantages to an EIA include the opportunity to participate in the upside of a market index as an alternative to investing directly through mutual funds for instance.  When an investor opens up an annual statement, there may be less apparent volatility because the account balances aren’t fluctuating wildly.  So this may help a conservative investor dip a toe in the market and sleep better.  And like most annuity products, investors have free access to a portion of their money without surrender charge (usually 10%). And like any other insurance product, it provides a guaranteed death benefit.  Like other annuities, it offers an income stream that you cannot outlive.

The average return on such EIA contracts has been reported to be in the 5%-6% range.  Given the complexities of these contracts and the average returns, it may be a costly way to limit your market exposure but it may make sense for those looking for a principal-protected CD alternative for the cash portion of their portfolios as well as a source of income to supplement retirement.

Sit On It and Rotate

The market’s are jumpy to say the least right now.  As I post this the market has ended four days down in a row after finishing August up 3.5% and up 45% since March. 

Despite signs of ‘green shoots’ and glimmers of positive economic activity, the US stock markets have ended the summer rally with a selloff of over 2% (on the DJIA Index).  Fears of a stock market correction or a “W”-shaped recovery loom large after several months of impressive gains.

Manufacturing activity in the US and Europe are mostly up.  Large money-center banks have been paying back the US Treasury for the money borrowed as part of their bailout.  US auto manufacturers are rehiring.

Yet fears that the mighty economic engine of China may slow coupled with worries about the commercial real estate sector in the US have lead investors to take cover.

What’s an investor to do?  Buy and Hold. Or is buy and hold dead as some commentators say?  What about diversification which really seemed to not protect anyone from the steep dive in all markets and all asset classes?

I personally believe that it’s important to follow the time-tested wisdom of grandma:  Don’t put all your eggs in one basket.

But diversifying doesn’t mean “set it and forget it” either which is typical among investors.

To all things there is a season.  And farmers planting crops and fisherman at sea all know that there are cycles in nature.  (El Nino, anyone?)

So why wouldn’t you expect there to be cycles in markets as well?

Considering that stock and bond markets reflect the collective expectations and emotions of millions of investors, it’s an easy leap to expect markets to be governed by cycles in the cumulative raw emotions as well as considered opinions of its many participants.

Example: Right now small-cap stocks have paid off big time this year.  According to the WSJ, stocks in the S&P Small Cap 600 index have leaped over 66% and midcap stocks are up nearly 62%, far outpacing the S&P 500 large cap index which gained “only” 51%.

What a typical investor will do upon hearing such performance will be to move money into this hot sector of the market. And of course that has been exactly what investors have done as more than $7.5 Billion of all fund flows have been to small-cap mutual funds versus outflows of $18.5 Billion from large-cap funds. What’s that saying about “when fool’s rush in?” 

This being said, there are ways to combine investment approaches.

Instead of “buy and hold” it’s time to consider “sit on it and rotate.” 

Ideally, we all want to a perfect investment that always goes up and never goes down.  But a look at one of those “periodic table” of investment returns shows, rarely does the same sector that was a top performer one year do a repeat the following year.

There is a way to get off the wild roller coaster ride between “gloom and doom” and “irrational exuberance.”

This is what I refer to as a “skill-weighted” portfolio.  Essentially, this approach combines various investments in different assets with different investment approaches to help reduce the roller coaster ride.

Even a nesting hen that is sitting on its eggs will rotate positions every once in a while.  And through this approach, too, an investor will maintain a watchful eye on his portfolio being positioned for opportunities by rotating between and among investments, sectors and trends.

Think of a house: a foundation, a frame and then all the visually appealing touches.

In this approach, an investor will have a core foundation comprised of index type investments (mutual funds or Exchange Traded Funds) with a frame consisting of actively managed mutual funds and topped off with a trend-following program for stocks and/or other Exchange Traded Funds to accent the portfolio.  The combination of all these elements will provide balance which helps reduce overall volatility while still positioning for opportunities.

Consider this:  If an investor owns and holds onto an index, he’ll get 100% of the upside … and 100% of the downside.  If an investor owns all actively managed mutual funds, more than 80% do not beat their benchmark.  And those who “market time” need to be right two times:  when they sell and then when they buy.

Not all approaches work all the time but by combining them (rotating between them) an investor may have a better opportunity to preserve, protect and ultimately profit.

What should matter most to any investor is not beating an individual benchmark but getting where they want to go with as few bumps as possible.

Gone Phishing

During these last lazy days of summer, a fishing trip might seem like a great idea as a favorite past time for many.

But beware of other types of ‘phishermen’ on ‘phishing expeditions.’

Phishing is the favorite process of scam artists to try to get consumers to divulge personal identification information like account numbers, Social Security Numbers or addresses.

Once a scamster has your personal information it can wreak havoc on your personal financial management.

Methods familiar to most include elaborate imitation websites combined with emails and some type of message that your account information needs to be reverified because of some sort of special offer or need to update the institution’s account database.

With the recent credit crisis and proliferation of special loan programs, homeowners have been favorite targets. One example: Email solicitations by a legitimate-sounding credit union advertising low rates for mortgage refinancing. Or emails offering loan modification programs or ways to stop foreclosure.

Other techniques are taking advantage of the trend toward the use of more social networking sites. With the advent of such resources like Linked In, Twitter or Facebook, some identity thieves will find enough personal information (i.e. employment, residence, education) to help them become you.

Remember that a government agency or financial institution will never ask you to provide your personal identifying information in an unsolicited email. One way to check the authenticity of any such email is to scroll over any visible links in the email to see the website suffix. Anything other than ‘.com,’ or ‘.gov’ or ‘.org’ might be indicating a non-US-based computer server and a likely scam source. Also consider scrolling across the bottom of the subject email. Sometimes there are hidden links which may also provide an indication of the foreign origin of the email.

If in doubt, call the agency or firm directly but use a phone number provided from one of your statements, not from the email. You can also check on the legitimacy of the source by checking with the Federal Trade Commission (www.ftc.gov) or trade organizations.

For instance, a visit to the National Credit Union Association (www.ncua.gov) determined that the credit union refinance offer was phony. Banks, financial services firms and insurers all have regulators and industry trade groups that can verify the legitimate existence of an organization.

Not all ‘phishing’ expeditions are hi-tech. Some are as low-tech as rummaging through garbage cans and dumpsters for mail showing account numbers. Others include phone calls using the same message of ‘updating account information’ as noted in the email version above.

So what can you do to protect yourself? Be careful about leaving information lying around. When on line, clear your ‘cookies’ often and avoid leaving your passwords or credit card information pre-filled at financial websites you visit. Make sure that your computer is protected with updated versions of anti-spyware, anti-malware and pop-up blockers. Check your credit report to make sure it is accurate and that no new unauthorized accounts have been opened in your name. Get your free copy of your credit report from www.annualcreditreport.com.

Off-line you can protect yourself by shredding old financial records as well as credit card offers since these are prime sources for dumpster divers.

Don’t just throw away old computers, hard drives or cell phones. There is too much information on them that can be retrieved by a tech savvy ID thief. Hard drives should be shredded or use a baseball bat. You’ll protect yourself and be able to vent a little to get even with all the frustration that technology may have caused you.

With a little effort, you can protect yourself and not become bait for an unwanted ‘phisherman.’

Increasing Your Chances for Student Financial Aid

In the initial article of this series, I mentioned ten specific ways to lower college costs.  These included such ideas as taking Advanced Placement exams to earn college credit, considering an in-state college, using the American Opportunity Tax Credit  formerly known as the Hope Education Credit, employing your child in your business or investment real estate business and encouraging your child to use the proceeds to fund a Roth IRA.

But even if you haven’t stashed a lot aside for expected college costs, there are strategies you can take to maximize the financial aid that your child may be able to receive.

Many parents mistakenly believe that they “make too much money” to receive aid.  Or they look at the “sticker price” of a private school and think that it is way too expensive to afford.  In reality most people never pay the full sticker price and with some planning ahead of time many can find ways to make even such private schools within reach.

Yet many would be surprised to find out that by speaking with a knowledgeable professional they increase their chances for an aid package that makes college more affordable and less stressful to their personal retirement plans.

Remember that the more time you have before your child or children begin college, the more options you have.  But even if college tuition bills loom on the horizon, there are things that you can do to be better prepared.

Expected Family Contribution:

Everything depends on the Expected Family Contribution (EFC) calculated from a review of income and asset documentation and the Free Application for Federal Student Aid (FAFSA) completed after January 1 of your student’s senior year of high school.

A particular formula is applied to this information to determine what income and assets are eligible from the family (including the student) toward the total cost of a year at college for everything from tuition and fees to room and board, books, supplies and travel.

1. So this first year, called the “base year,” is the crucial one.

Ultimately then, your goal is to lower your EFC by employing strategies that lower your income or assets in the crucial base year.

Consider this:  If you own a business, you could increase your outflow for needed equipment that results in a lower net income.  You could delay your billings and collections to also lower your net income.  While a business owner needs to report the value of a business, the FAFSA form is not the place to brag.  The value of one’s business need only include actual cash on hand and tangible assets but not intangibles like “goodwill.”  This may help lower the value of your business and increase the amount your student may ultimately be eligible to receive.

On the other hand, maybe you’ve always considered starting a business or because of your job prospects this has become a necessity.  Don’t wait until the children have started or finished school.  By launching the business in the base year, you will incur expenses (including possibly depreciation on equipment) that will lower your reported income.

Even if you don’t own a business, you may have some control over the income and assets you report.

If your child will need a car, a computer or other school supplies, consider buying them in the year before completing the FAFSA.  Since credit card debt is not taken into account in the FAFSA, use extra cash instead to pay off these debts.  Another option might be to prepay property taxes or your mortgage which also provides you with an added tax deduction. All of these strategies will lower the cash on hand.

If you’re expecting a year-end bonus, then try to negotiate with your employer to defer receipt of the bonus into a non-base year.  By doing so, you’ll avoid having the colleges count this twice: once as income in the base year and then again possibly as an asset in your savings accounts.

It’s important to minimize assets held by the student.  So consider using savings or investment accounts held in the student’s name to acquire a car or computers or other needed supplies.  It’s also a good idea to dissuade grandparents and family members from giving cash gifts to the child.  In lieu of a gift to the student, a grandparent could direct the same amount of cash to pay toward the college tuition or fees.

Working With A Pro: Preparing for Your First Planner Visit

If you’ve never met with a financial planner before or if it’s been years since you’ve visited one, you need to find a planner and then prepare for your visit.

 

Generally, you should research individual financial advisers or firms, and you should look to trusted friends and family for advice.  But don’t stop there.  Your due diligence should include checking the background of the advisor, understanding the services offered and how they are compensated. You can use industry trade groups like the CFP Board of Standards (www.cfp.com) or investor education websites like those offered by the industry regulator FINRA (www.finra.org/Investors/) or independent advisor rating services like the Paladin Registry (www.paladinregistry.com/external/general/). You should interview two or three advisers by phone before you sit down and commit to a planning engagement. 

 

It’s also important to discuss your overall goals with the planner you’re interviewing so you can gauge their ability to help you meet those targets. It’s imperative that you and your financial advisor have clear and open communication.  And it’s equally important to understand each other’s roles and expectations from the relationship to avoid any future misunderstandings. 

 

Here are some questions you should ask a prospective financial planner:

 

What training do you have?  Find out how long the planner has been in practice and what kind of certifications they hold. A CERTIFIED FINANCIAL PLANNER™ professional is someone with a minimum experience of three years who has completed a comprehensive course of study through a degree or certificate program offering a financial planning curriculum approved by The CFP Board of Standards, Inc. CFP® practitioners must pass a comprehensive two-day, 10-hour Certification Examination that tests their ability to apply financial planning knowledge in an integrated format. Based on regular research of what planners do, the exam covers the financial planning process, tax planning, employee benefits, retirement planning, estate planning, investment management and insurance.  In addition, CFP ® practitioners must complete a minimum of 30 hours every two years of continuing education in these topics to keep abreast of changes that may impact clients. 

 

What services do you offer? What a financial planner offers is based on credentials, licenses and areas of expertise. Generally, financial planners cannot sell insurance or securities products such as mutual funds or stocks without the proper licenses, or give investment advice unless they are registered with state or Federal authorities. Some planners offer financial planning advice on a range of topics but do not sell financial products. Others may provide advice only in specific areas such as estate planning or taxes.

 

How do you charge for your services? Professional planners will provide you with a financial planning agreement that spells out the services they provide and how they’ll be compensated. Payment can happen in one of several ways:

• Salaried planners are actually employees of a firm, and you help pay their salaries through fees or commissions you agree to pay.
• Direct fees to the planner through an hourly rate, a flat rate, or on a percentage of your assets and/or income.
• Commissions paid by a third party from the products sold to you based on the planner’s recommendations. Commissions are typically a percentage of the amount you invest based on those recommendations.
• A hybrid of fees and commissions based on services. A planner may charge a fee for designing a comprehensive financial plan and occasional visits and calls to review it, while commissions might come from products they sell that you invest in.

 

Do you have any potential conflicts of interest? It may seem like a rude question, but the best planners expect this one and are prepared to make disclosure. Obviously, if a planner profits from the sale of investment products to you, she must spell that out. Some may receive indirect fees from the mutual funds selected (called 12-b-1 fees).  Others may receive a commission for placing certain business with a provider of a financial product as in the case of insurance or alternate investments like limited partnerships.  The method of compensation may be an inherent conflict of interest since a financial salesperson may be motivated to steer you toward a product purchase that pays the highest compensation for the sale.  Fee-only financial professionals do not receive any compensation from investment product sales which may result in more objective advice not tied to a particular product.

 

How do you feel about teaching and training? One of the primary benefits of having a financial planner is education about the moves you are making or may potentially make. Don’t view a planning relationship as tossing someone your finances so you won’t have to deal with them anymore. You will still need to be involved in this relationship and a good planner will help educate you.  While you’re not expected to be an expert in all financial matters, you will at least be able to make informed decisions with a base of knowledge. As long as you’re paying for their services, make sure you get a long-term education out of it.

 

(For a more detailed list, there is a useful brochure located at the investor education portion of the CFP Board’s website with ten questions you should consider asking any prospective planner).

 

When you select a planner, they’ll give you a list of documents and information to bring in for your first meeting, and generally, it will be detailed on a checklist that may include:

 

An income and expenditure checklist: This is a summary of current and projected income.  You’ll need to bring or detail:

 

Income

• A current pay slip
• Profit and loss statements for business income
• Pension income statements
• Statements of non-investment income
• Family trust distribution documents
• Tax returns
• Annuity, maintenance agreement statements

         

Expenses

• Home: Mortgage, rent statements, utilities, household repairs, insurance, appliance purchases, landscaping or house cleaning
• Transportation: Gasoline, car loan, public transit expenses and parking
• Food: Grocery and restaurants
• Medical: Doctor, dentist and prescription bills
• Education: Tuition, school fees
• Child care: In-home our outside-the-home care
• Personal grooming: Clothing, shoes and accessories, hair, makeup
• Pet care: veterinarian, food and grooming bills
• Insurance: Health, life, auto, disability

 

An asset and liability checklist: This is a summary of what you own and what you currently owe. You’ll need to bring or detail:

 

Assets:

• Principal residence
• Vacation home
• Investment property
• Bank accounts
• Investments
• Collectibles and personal property
• Automobiles, other vehicles

 

Liabilities:

• Mortgages
• Credit card debt
• Auto loans
• College loans
• Business loans

 

You should also be prepared to engage in a detailed and wide-ranging conversation that covers matters related to your attitude and experiences with money and financial decision-making.  Questions like how you choose investments or what kinds of information resources you consult or what risk means to you will be important to provide the planner with insight into your decision-making process and behavior type.  Armed with this information, a good planner will then be better able to make appropriate recommendations for your situation.

 

Cash Is King … Some Ways to Increase the Size of Your Kingdom

Here are some suggestions for saving money.  While “cash is king” now with the high level of consumer anxiety, these tips can and should be used any time.

 

1.) Pay Yourself First:  This is the best advice that any consumer can take to heart. It works through any and all environments.  Set aside a certain dollar amount each pay period to savings and investment.  When you receive a pay raise, increase the amount going to savings, investment or your 401k to include a good portion of the raise.  Money is like water.  It fills up the space provided and the more available cash someone has, then the more likely it will be spent.  By directing it to savings (or an auto investment like a 401k) the less temptation there is for someone to use it on “wants” versus “needs.”

 

2.) Start an auto-investment savings and investment plan:  This is related to the first step.  Direct a portion of your savings into a separate savings account for your emergency fund.  Direct a portion into your company-sponsored retirement plan. 

 

3.) Bring Your Own:  Whether it’s bagging your own lunch or brewing your own cup of java, this will add up.  Eliminating just one cup of special mocha grande latte (or whatever they call it), you can save nearly $5 per cup.  Add that up:  Over the course of a year, eliminating just one cup per day on your way to work can save at least $1,200.  Over the course of five years, that money put in a FDIC-insured account might be worth $5,000 to $6,000 – a tidy sum for some other more worthwhile endeavor (maybe a vacation, maybe a home improvement, maybe college savings).

 

4.) Use Cash:  When buying gifts or even a night on the town, use cash instead of credit cards.  Cash seems more real.  It is more immediate.  When the amount in your wallet drops by the cost of four movie tickets and jumbo drinks, it stings a little more than putting it on plastic. 

 

5.) Avoid Unneeded Insurance:  Don’t skip needed coverage on your auto, home, income or life.  And review these types of policies at least annually (or when there is a life-changing event like a birth) to make sure that adequate coverage is in place.  But skip the extended warranty coverages on small ticket items.  For instance, a cordless phone that costs $20 at Radio Shack may offer a 2-year extended warranty for replacement at $5 but that’s just increased your cost now by 25%. And it is more than likely that if and when the phone gets fried, you’ll be able to simply replace it at the same current cost with even more fancy features anyway.

For big ticket items, it may make sense to have some type of insurance in place:  a computer used for work, an expensive plasma TV.

 

Speaking of insurance.  Deal with a reputable Property & Casualty insurance agent who has access to many carriers.  Be sure to call and review your coverage.  Going for the lowest premium is not a way to save money.  Example:  Owning a home with a replacement cost of $400,000 and having outdated coverage up to only $300,000 exposes you to all sorts of risks and out of pocket costs if there is a damage claim since you’ll only get a proportion of the loss covered by the insurance.  Why?  Because you did not have full replacement cost coverage.

And it’s a good idea to insure only that portion of the risk that you are not willing or able to bear.  So consider increasing your deductibles on things like your auto and home insurance policies.  A policy with a $1,000 deductible will cost less per year overall than one with a $250 deductible.  And with the savings you’ve established from Step 1 above, you’ll have the deductible covered.

 

Example of being penny wise (i.e. annual premium) but pound foolish (i.e. larger out-of-pocket outlay).

 

6.) Save the Planet – Reduce, Reuse, Recyle: There is a bumber sticker out there that says “Think Globally, Act Locally.”  Here you can do your part to make the world a little more green while putting some green in your pocket as well.   There are a host of ways that one can cut back without too much impact on lifestyle.  Your mom’s advice here works: Shut off the lights when not in a room, don’t keep the refrigerator door open so long that you could paint a picture, wash your clothes in cold water instead of hot, unplug battery charges when not in use.   To reduce water consumption consider shorter showers (a challenge with teenagers, I’m sure) and don’t let the water run constantly while shaving or brushing teeth. And consider reusing plastic packages for other storage instead of simply tossing them.  And if your community has a recycling program, use it.  The more your community recycles, the lower the garbage collection tipping fees.  And that may mean one less excuse to raise your property taxes.

 

Hope that this helps.

5 Sure-Fire Strategies to Lower College Costs

When your salary stops at retirement, will you have enough to pay your bills, travel and live the lifestyle that you want in your Golden Years?

 

Sure, you may be one of the lucky ones with a pension.  Social Security may even still be around. But if you want to live your vision of retirement, then saving and investing properly is important.

 

And how you pay for college for your kids will impact your own retirement.

Think about this:  College tuitions, books, fees and housing continue to increase at a rate faster than inflation in general.  Based on current trends, the cost of sending just two kids to a private or elite college for a total of eight years will cost more than $360,000 if paid after taxes.  This means that those in the 28 percent tax bracket need to earn more than $500,000 in order to meet the costs from cash flow.

 

Regardless of where you send your kids to school, the bottom-line fact is this:  How you pay for college impacts how much you save for retirement.  For every dollar that you save on college costs means more for your personal retirement down the road.

 

There are a number of strategies you can use to improve your chances at a better retirement and a solid education at a lower personal cost.

 

There are more than thirteen strategies for increasing needs-based aid.  There are at least a dozen cost-cutting ways that any family can use to improve their bottom line.

 

Ultimately, it depends on how well you know how to use the IRS code for your advantage to lower your own Expected Family Contribution (or EFC in financial aid parlance).

 

Regardless of whether you expect to qualify for needs-based aid or not, here are some examples of cost-cutting strategies available to you.

 

Strategy 1:  Get College Credit Through Exams

By taking Advanced Placement exams or even a “challenge” exam for basic college courses, a student can get through school quicker potentially saving thousands in tuition and fees.  Opportunities are available for Advanced Placement (AP), College-Level Examination Program (CLEP) or DSST exams for 37 different courses.  For more information on these, check out www.collegeboard.com or www.getcollegecredit.com.

 

 

Strategy 2: Stay Local

In-state tuition and fees at a public higher education institution is a bargain compared to the elites and even crossing the border to go to another state’s public college.  If you are considering going across the border or away, consider having your child establish residency in that state.  Find out what the residency requirement are ahead of time by contacting the admissions office.

 

Strategy 3:  Get the Credit You Deserve from the IRS

Use the Hope Education Credit, renamed the “American Opportunity Tax Credit.” This was recently increased to $2,500 (from $1,200) and now applies to all four years of college, not just the first two.  In addition, forty-percent of the credit is now refundable. Another helping-hand comes in the form of the Lifetime Learning Credit which is available for one family member and allows you to take up to 40% credit on educational expenses up to $10,000.  Income limits apply so be sure to consult a qualified tax professional or visit www.irs.gov.

 

Strategy 4: Employ Your Child

If you own a business, work as an independent contractor or own rental real estate, consider hiring your child to work for you. Maybe your child can provide administrative support or help with marketing or real estate related chores. By hiring a child and paying him or her, you will lower your own personal taxable income through a business expense deduction and provide income for your child.  In addition, the child can use the earnings to open a Roth IRA, a tax-favored retirement account which is not assessed as an asset for financial aid purposes.  And if needed, a child can withdraw a portion of the proceeds to pay for qualified educational expenses.  There are certain limits and time restrictions that apply.  

 

Strategy 5: Establish a Section 127 Educational Assistance Plan

As a business owner you can establish a Section 127 employer-paid tuition benefits program for your employees. This plan allows the business owner to pay up to $5,250 per year to employees (including employed children) as a qualified tax deductible expense.  This can be used for both undergraduate and graduate programs of study.  Assuming that Junior was going to work in the family business during the summer and throughout the year, Junior can earn a wage (deductible expense for the business) which he can use for his own support and Roth IRA contribution (which may be eligible for paying educational expenses) and earn a tuition benefit (another deductible business expense).  If you were going to give the child the money anyway, you may as well structure it to be tax deductible.

 

Consider this: There are more than 110 different other strategies for you to consider. All the more reason to have a coordinated plan in place by speaking with a professional advisor who can help evaluate these options with you.

 

Food for thought: 

 

• Encourage your pre-teen to open a Roth IRA with earnings from their paper route or other jobs.
• Consider hiring your child to work in your business or help with chores related to your investment property.
• Use a CollegeSure CD issued by an FDIC-insured bank to accumulate savings
• Think about using a fixed income annuity to hold a portion of money for college to avoid the potential loss in principal that can happen with a 529 plan invested in mutual funds.
• Pursue private and merit-based scholarships  (For more information on some of these options, check out www.fastweb.com, the CollegBoard and www.scholarshipexperts.com

Navigating thru Volatile Times – A Road Map & Resource Guide

On Wednesday, March 11, I launched the inaugural event of my Financial Road Map Series teleconferences.

I want to thank each of you who stopped by to listen in to my brief discussion on taking control of your financial future by controlling what you can.

To recap the important points we discussed:

1.) Control What You Can:  No sense in worrying about things that are beyond our individual control.  There’s plenty enough for us to handle and impact directly.  Things that you can control can include:  Your saving and spending habits, your health and exercise programs, your asset allocation, your investing costs, and most importantly, YOUR ATTITUDE.

2.) Have SMART Goals:  Begin with the end in mind.  Be Specific with Measurable goals that are Attainable and Realistic and tied to a specific Timeframe.  It’s one thing to say “someday I want to be rich” or “someday I want to own a boat.”  But if you can put a number to that vision, your mind’s eye can picture it as reality and it becomes a real target to shoot for.

3.) Understand Your Risk:  These past seventeen months have tested what it means to be an investor.  It has highlighted the reality that most individuals do not have a handle on their own risk appetite.  Understanding risk is more than simply answering a few questions on a form.  It involves an open and honest conversation with yourself, your spouse (significant other) and your advisor. Go beyond the standard form and consider what does money mean to you, how your family treated money, what has been your best and worst financial decision and how you came to those decisions.  Ask yourself (or your advisor should ask) how you feel about these risk attitudes.  You may even want to consider using an impartial tool located at www.riskprofiling.com to provide additional insight into your risk tolerance.

• NOTE: In my practice I utilize multiple risk profile formats to get a handle on how a client thinks and what motivates a decision.  This is helpful to be able to better communicate with a client. 

But having an honest conversation is also integral to proper investment planning.  For instance, I can use the standard risk profile tools, my questions and the website tool listed above and determine a Risk Capacity Measure for a client.

A person who has verifiable emergency reserves (3 to 12 months depending on their particular circumstances), has a positive cash flow and net worth, low debt ratio and adequate life insurance in place has a capacity for higher risk than someone not demonstrating these attributes.  For someone lacking these attributes, the financial plan will likely focus on improving these measures before investing in something risky.

4.) Have an Investment Road Map: Most people would not go on a trip without a map or GPS.  The same should be true about investing.  Having a road map (called an Investment Policy Statement) is something that professional investors like pension funds, insurance companies and endowments use all the time.  It outlines the end result desired (for instance, growth of capital with the investment generating $X in income per year), the types of investments that will be considered (i.e. no investment in nuclear power or tobacco), and the criteria for determining when to buy, when to sell and what to replace it with.  This helps take the emotion out of investing and avoids having a long-term plan sabotaged by the chatter of “talking heads” either in the media or at the office water cooler.

5.) Risk Allocation:  You don’t need a graduate degree in finance to understand that some things just make sense.  More than ever the old adage makes sense: Don’t Put All Your Eggs in One Basket.  While it is true that all asset classes have lost value from their peak nearly 18-months ago, that is no reason to give up on the wisdom of diversification. Just because someone doesn’t win a race the first time doesn’t mean you give up running ever again, does it?

But let’s be sensible about this.  Having a target risk allocation (based on investor age, timeframe until goal, risk capacity and risk tolerance) does not mean simply that you “buy and hold” or “set and forget.”  While academic literatute indicates that a buy and hold strategy will win out over time, in reality most investors do not have the stomach for the occasional and frightening roller coaster rides that happen like they have recently.  In which case in makes sense to buy, regularly and tactically rebalance while exploiting short-term trends and hold cash.  (Most investors do a poor job at following trends, implementing a disciplined trading strategy without emotion and sometimes having to go against the grain and do what seems uncomfortable like buying when everyone else is selling).

6.) Control Your Costs and Your Investment Vehicle: Invesment costs can weigh you down like an anchor.  And choosing the right investment vehicle helps you ride in comfort to your destination. 

Consider this:  Not all mutual funds are created equal.  Actively managed mutual funds have costs that detract from performance.  And typically more than 50% of active mutual funds do not match much less beat their benchmark index.  Does this mean that you give up on investing?  Heck, no. It just means you find another ride.  When a star football player gets hurt, does the team forfeit the remaining games?  No, they have a back up ready for replacement.  With a solid investment policy and using ETFs, you can make a quick switch, too.

This is why you should consider a strong core of index mutual funds and Exchange Traded Funds (ETFs) as part of your investment stratetgy (see “Top 8 Reasons to Use ETFs in Your Portfolio,” March 10 blog post).

7.) Estate Planning is for Everyone: Be prepared.  That’s the motto that every Boy Scout knows.  It’s good advice here as well.  Having the best investment strategy and record-breaking performance on investments will mean absolutely nothing if you’re not on a strong foundation.  This is what an estate plan will help do by laying the groundwork on how you want to control disposition of your assets and control your affairs.  Regardless of age or portfolio size, an estate plan is important throughout the various stages of life.  This goes for seniors and newly married couples.  If you have something or someone to protect, you need to talk with an attorney to draft a plan that includes at the very least: a Last Will, a durable Power of Attorney, a health care directive.  And if you have minor children it is imperative to have your guardianship issues addressed.

8.) Insurance: In uncertain times, it is even more important to make sure that you protect yourself from contingencies that can blow up your plans and get you off track.

Please review these items annually.  Consider putting it on your calendar to coincide with the seasonal change for clocks.

• Make sure you have full replacement coverage on your property
• Add an “umbrella liability” policy to your home and auto.  In a litigious world you don’t need to lose everything because of a lawsuit.
• Make sure you have filed a “homestead declaration” recorded at the Registry of Deeds on your primary residence.  This will protect you from creditors placing a lien on your property that could force you to sell to settle a suit.
• Review your employer-sponsored benefits and consider group Long-term Care Insurance, Short and Long-term Disability and Supplemental Accident coverages in addition to standard health/vision coverage.
• You really need to consider coordinating these coverages with individually owned policies because when you leave your employer you will lose these coverages. 
• Life Insurance:  Do speak with a financial planner who will do a detailed expense analysis to determine the appropriate level of insurance.  This approach is more likely to result in an appropriate level of insurance at a lower cost than rules of thumb based on income.  As with employer-benefits, consider having policies separate from your work.  A level-term policy is relatively inexpensive and offers cost-effective coverage during the peak years when you may have considerable debts and family responsibilities.

For specific advice on any of these matters, please consider speaking with an independent board-certified planner.