2010 will be the year of stabilization. A year where, if you have a job, you will probably still be working at the beginning of 2011 and if you are not, you may find employment; one where if you are prudent (and by that I mean not-so-conservative but cautious), you will find the equity markets still performing better (but not better than expected); one where we have learned lessons that should not be soon forgotten.
Read the full article from Paul Petillo, Managing Editor of Target 2025.com here.
Showing posts with label savings. Show all posts
Showing posts with label savings. Show all posts
Wednesday, December 30, 2009
Tuesday, September 15, 2009
Retirement Planning: Fixing Wall Street with Moral Authority
Ask any cop on the street for their assessment of a drug bust. It goes, they will tell you something like this: “Sir, may I search you?” “Yes.” “There is crack in your pocket.” “Not my crack.” “But sir, it was in your pants.” “Not my pants.”
There are two key elements of success on Wall Street that President Obama overlooked when he addressed the financial crisis a year past. The first is the crisis itself.
To which the conversation would proceed something like this: “Sure. Go ahead and try to figure out where we took risks, what those risks were and why those risks were not our fault. Search all you want.” “You took those risks because there was no real regulation governing what you did.” “Not my problem.” “Then we should begin to look for these problems so it doesn’t happen again.” “Not at my financial institution.”
Ask any cop on the street and they will tell you that the drug busts they often make are due to stupidity and ironically, bad driving habits. Ask Wall Street and they will tell you the appetite for risk drove them to do what they did. Ask any cop on the street and they will tell you that the more felony laws you break, the less misdemeanors matter.
The second reason we still have lingering effects from what happened last year is reckless behavior. Had the appetite for increased risk not been laid on the doorsteps of our financial institutions (by the Bush administration in the form of ridiculously low interest rates, lax regulations and tax-based, incentive-based rewards for bad behavior), the address at Federal Hall would have been far different.
Wall Street bankers choose not to attend the meeting on the anniversary of the collapse of Lehman Brothers. Much like maligned athletes who do as they please, these CEOs do not want to be role models. The president was seeking what he refers to as “a broader sense of responsibility” when it comes to how they act, prodding them to lead the financial markets in the right direction. Knowing that the cameras would be trained on every facial tick, every sigh and every uncomfortable shift in their chairs, much the way the CEOs of the big three car companies were scrutinized, they stayed away.
Where Mr. Obama missed the mark was in taking the strength of his general popularity into the den of thieves, where his championing of the worker is often met with open derision. Suggesting that these financial titans should be beholden to the average citizen means the shareholder should be relegated to a lesser role in terms of consideration. To do that, the public sector would need to step in. And this is where the divide begins to widen.
Risk has never been adequately defined. For the small investor, it is a soul-searching exercise that is often fraught with anxiety and overtly quixotic. Unable to hedge their stance the way more savvy investors do, they simply take risk at face value, not as a mechanism designed to grow investments. The confusion starts for this group when they refer to their interaction with Wall Street (largely through their retirement plans and even though many were unaware, home ownership) as savings.
For the large investor, risk is the only reason they do what they do. Exotic products make the experience much more interesting and profitable. Lack of oversight makes the thrill doubly enticing. Using the government as a hedge against losses (not only of share value and assets but bonuses) made the process even more appealing. Is it any wonder that the headwind facing the president has picked up speed?
The main issue is how to regulate and protect. Currently the government does not have a single agency that can act in advance of such a storm. Having knowledge of an impending crisis would require you to have the ability to evacuate the innocent. Having that knowledge would require a federal agency to have much more private access to information than any publicly elected official would want, even the president.
We rely on the ability to learn lessons instead. Yet Wall Street uses another mechanism to understand the way markets work: forgetfulness. Understanding that politicians come and go suggests to these top financial folks that regulations should be either more fluid, able to evolve with the markets, or simply non-existent, employing a buyer beware sticker on each new product that makes its way to market.
Sen. Bob Corker (R., Tenn.), a member of the Senate Banking Committee suggested more introspection in the process: "Financial regulation needs to be done in an atmosphere of thoughtfulness." In other words, not at all. But reform does need to come in some shape or form. Doubts remain whether the president’s proposal of creating a consumer oversight committee to provide this sort of thoughtfulness will ever make it into law.
The ripple effect that spread in the aftermath of September 2008 still lingers in most of America. Billions of taxpayer dollars disappeared in an effort to bailout a system that few outside of Wall Street understood. Now we understand that the methodology employed by these brokers/traders/dealers/bankers offered no projection or even entertained the possibility of a fallout turns this into a politically charged topic. The moral authority of the president and his insistence that this will not happen again will turn this kind of regulation into a turf war with conservatives and financial interest groups.
Those that were instrumental in creating lax regulation will need to find a common ground with those that seek retributions for the market loses that followed the near-collapse of the financial system. The problem is determining which agency is best equipped to handle the new responsibility?
The Fed may not be the best choice. Their inability to see the crisis coming and possibly their own accommodative stance make them a poor candidate. The FDIC, which oversees the nation’s banking system doesn’t see their role as protector expanding to include all of the financial markets. Their grasp of regulation is still, even in the aftermath rather weak.
The Treasury would be an attempt to control by committee. Although Treasury Secretary Timothy Geithner pointed out that the Fed is both incremental and essential in the president’s plan, the markets, Wall Street is quick to point out, have begun to recover without any new oversight. Forget economists.
The bailout should not be cure enough. In many instances, it came without ties or questions and has even been offered back to the government. Doing so, often before it was clear that the bad times were ending suggests that Wall Street is aware that regulation would hamper their efforts at delving into new and more complicated methods for making a profit.
The cycle of dramatic financial events is shortening. While some suggest that this type of regulation will protect us ten years from now, there is a greater likelihood that another similar event will shake out in a matter of years. This also suggests that regulation is needed yesterday more than ever.
As the president searched Wall Street for answers to why they did what they did, they simply replied: “Not my pants.”
There are two key elements of success on Wall Street that President Obama overlooked when he addressed the financial crisis a year past. The first is the crisis itself.
To which the conversation would proceed something like this: “Sure. Go ahead and try to figure out where we took risks, what those risks were and why those risks were not our fault. Search all you want.” “You took those risks because there was no real regulation governing what you did.” “Not my problem.” “Then we should begin to look for these problems so it doesn’t happen again.” “Not at my financial institution.”Ask any cop on the street and they will tell you that the drug busts they often make are due to stupidity and ironically, bad driving habits. Ask Wall Street and they will tell you the appetite for risk drove them to do what they did. Ask any cop on the street and they will tell you that the more felony laws you break, the less misdemeanors matter.
The second reason we still have lingering effects from what happened last year is reckless behavior. Had the appetite for increased risk not been laid on the doorsteps of our financial institutions (by the Bush administration in the form of ridiculously low interest rates, lax regulations and tax-based, incentive-based rewards for bad behavior), the address at Federal Hall would have been far different.
Wall Street bankers choose not to attend the meeting on the anniversary of the collapse of Lehman Brothers. Much like maligned athletes who do as they please, these CEOs do not want to be role models. The president was seeking what he refers to as “a broader sense of responsibility” when it comes to how they act, prodding them to lead the financial markets in the right direction. Knowing that the cameras would be trained on every facial tick, every sigh and every uncomfortable shift in their chairs, much the way the CEOs of the big three car companies were scrutinized, they stayed away.
Where Mr. Obama missed the mark was in taking the strength of his general popularity into the den of thieves, where his championing of the worker is often met with open derision. Suggesting that these financial titans should be beholden to the average citizen means the shareholder should be relegated to a lesser role in terms of consideration. To do that, the public sector would need to step in. And this is where the divide begins to widen.
Risk has never been adequately defined. For the small investor, it is a soul-searching exercise that is often fraught with anxiety and overtly quixotic. Unable to hedge their stance the way more savvy investors do, they simply take risk at face value, not as a mechanism designed to grow investments. The confusion starts for this group when they refer to their interaction with Wall Street (largely through their retirement plans and even though many were unaware, home ownership) as savings.
For the large investor, risk is the only reason they do what they do. Exotic products make the experience much more interesting and profitable. Lack of oversight makes the thrill doubly enticing. Using the government as a hedge against losses (not only of share value and assets but bonuses) made the process even more appealing. Is it any wonder that the headwind facing the president has picked up speed?
The main issue is how to regulate and protect. Currently the government does not have a single agency that can act in advance of such a storm. Having knowledge of an impending crisis would require you to have the ability to evacuate the innocent. Having that knowledge would require a federal agency to have much more private access to information than any publicly elected official would want, even the president.
We rely on the ability to learn lessons instead. Yet Wall Street uses another mechanism to understand the way markets work: forgetfulness. Understanding that politicians come and go suggests to these top financial folks that regulations should be either more fluid, able to evolve with the markets, or simply non-existent, employing a buyer beware sticker on each new product that makes its way to market.
Sen. Bob Corker (R., Tenn.), a member of the Senate Banking Committee suggested more introspection in the process: "Financial regulation needs to be done in an atmosphere of thoughtfulness." In other words, not at all. But reform does need to come in some shape or form. Doubts remain whether the president’s proposal of creating a consumer oversight committee to provide this sort of thoughtfulness will ever make it into law.
The ripple effect that spread in the aftermath of September 2008 still lingers in most of America. Billions of taxpayer dollars disappeared in an effort to bailout a system that few outside of Wall Street understood. Now we understand that the methodology employed by these brokers/traders/dealers/bankers offered no projection or even entertained the possibility of a fallout turns this into a politically charged topic. The moral authority of the president and his insistence that this will not happen again will turn this kind of regulation into a turf war with conservatives and financial interest groups.
Those that were instrumental in creating lax regulation will need to find a common ground with those that seek retributions for the market loses that followed the near-collapse of the financial system. The problem is determining which agency is best equipped to handle the new responsibility?
The Fed may not be the best choice. Their inability to see the crisis coming and possibly their own accommodative stance make them a poor candidate. The FDIC, which oversees the nation’s banking system doesn’t see their role as protector expanding to include all of the financial markets. Their grasp of regulation is still, even in the aftermath rather weak.
The Treasury would be an attempt to control by committee. Although Treasury Secretary Timothy Geithner pointed out that the Fed is both incremental and essential in the president’s plan, the markets, Wall Street is quick to point out, have begun to recover without any new oversight. Forget economists.
The bailout should not be cure enough. In many instances, it came without ties or questions and has even been offered back to the government. Doing so, often before it was clear that the bad times were ending suggests that Wall Street is aware that regulation would hamper their efforts at delving into new and more complicated methods for making a profit.
The cycle of dramatic financial events is shortening. While some suggest that this type of regulation will protect us ten years from now, there is a greater likelihood that another similar event will shake out in a matter of years. This also suggests that regulation is needed yesterday more than ever.
As the president searched Wall Street for answers to why they did what they did, they simply replied: “Not my pants.”
Friday, June 19, 2009
Why Investors Do What They Do: Anchoring
So far, we have discussed loss aversion and narrow framing, trouble spots in any investors view of what they are trying to do. They may be investing in their retirement plan or simply making an economic (better yet, one with financial implications) decisions, but we often, as studies have shown, begin from some point of what we know. This is referred to as anchoring.
Unfortunately, anchoring is a bias. It is often included among other similar cognitive biases such as memory bias (which effects how we recall a situation after the fact) and confirmation bias (depends largely of what you already know and uses this information to skew your perception of what really is). Each alters what we see with something we already know and this drives businesses, who want to anticipate what you will do and more importantly, what you will buy and confounds psychologists, who have twisted the lab questions done on test subjects in every conceivable way only to find out that we have numerous cognitive influences mucking up the works.
But anchoring is particularly dangerous when it comes to investor reaction. An anchor is basically an expectation. We are not the kind of shoppers who go into a store, find a good and before we flip the price tag, try and determine what we will pay for it. But it is a good experiment that you can conduct on yourself. Time after time, you will find your expectations of the cost of the good, be it a television or a dress will be altered by what you perceive.
You will try and narrow down your choices to one that seems to be what you think something is worth. But that narrowing of thought, trying to get closer to the price tag (and feeling very smug if your bias towards the cost is exactly what the cost is) will not work across a broad spectrum of goods. In lab tests, subjects merely get "a good" and know little about what it is. But as soon as the item is revealed, adjustments are automatically made.
We generally have no real anchor when we begin investing except for the money we begin the process with. This becomes the anchor if you have nothing in the account. But in a upwardly moving market, an investor can quickly get swept up in a constantly readjusting balance. Once money is made, a new anchor is created in your view of that portfolio.
Investing however is never quite that simple. While we all enjoy growth, we tend to lose focus on the fickleness of the markets and the underlying worth of whatever it is we are buying. If a stock or a mutual fund has had a great run of it, even topping the top ten lists, investors will not see this as the top but the new value on which to anchor their expectations.
Consider what cognitive abilities (or biases) you may have used or borrowed from someone else. You watch the business news channels hoping for a tidbit of relevant information about which security you would like to buy. You peruse the web looking for confirmation of what you would like to believe is true. But what you are really doing is looking for an anchor using someone else's anchor to support your decision.
If analysts make forecasts or predictions based on past performance and then offer the disclaimer that future results are not guaranteed. They have used past results to anchor their bias as to whether things look rosy or the future is bleak for the stock.
Anchoring is tougher on a retirement account largely due to the set and go approach that most investors use in these types of accounts. Unless severe market downturns capture our attention in the news, we tend to leave these accounts to their own devices, channeling a portion of our earnings into them each week.
But when we do look at those quarterly statements, and many of us have for the first time in a while, we have an idea of where we should be. And it will be much higher than is probably reported. That's because we aren't so good at making predictions or estimates.
Look at it this way. Suppose you invested a thousand dollars in an IRA account and added $100 a week to that account. Over the course of 25 years you would have put $114,429 (adjusted for inflation at 3% on the real value of $131,000 actually contributed) in the account. If the money grew over that period at a modest 5%, which for that stretch of time is below average even with last year calculated into the mix, you would have added almost $135,000 in earnings (also adjusted for inflation).
Now suppose your portfolio balance of $249,402 dropped 30% or $74,802. Wouldn't you still be in the black? With an inflation adjusted contribution of $114k, haven't you protected your money and even grew it by $40k. Because you constantly shift your anchor or readjust your estimates higher, your expectations follow.
This is due in large part to a small target. Your balance may have grown substantially since you began investing but what occurred caused you to miss the target. I am not a shooter but I know that when a person does aim and fire, they are often narrowly focused on the target when in fact we should be making broad sight adjustments.
Next up: Mental Accounting
Unfortunately, anchoring is a bias. It is often included among other similar cognitive biases such as memory bias (which effects how we recall a situation after the fact) and confirmation bias (depends largely of what you already know and uses this information to skew your perception of what really is). Each alters what we see with something we already know and this drives businesses, who want to anticipate what you will do and more importantly, what you will buy and confounds psychologists, who have twisted the lab questions done on test subjects in every conceivable way only to find out that we have numerous cognitive influences mucking up the works.But anchoring is particularly dangerous when it comes to investor reaction. An anchor is basically an expectation. We are not the kind of shoppers who go into a store, find a good and before we flip the price tag, try and determine what we will pay for it. But it is a good experiment that you can conduct on yourself. Time after time, you will find your expectations of the cost of the good, be it a television or a dress will be altered by what you perceive.
You will try and narrow down your choices to one that seems to be what you think something is worth. But that narrowing of thought, trying to get closer to the price tag (and feeling very smug if your bias towards the cost is exactly what the cost is) will not work across a broad spectrum of goods. In lab tests, subjects merely get "a good" and know little about what it is. But as soon as the item is revealed, adjustments are automatically made.
We generally have no real anchor when we begin investing except for the money we begin the process with. This becomes the anchor if you have nothing in the account. But in a upwardly moving market, an investor can quickly get swept up in a constantly readjusting balance. Once money is made, a new anchor is created in your view of that portfolio.
Investing however is never quite that simple. While we all enjoy growth, we tend to lose focus on the fickleness of the markets and the underlying worth of whatever it is we are buying. If a stock or a mutual fund has had a great run of it, even topping the top ten lists, investors will not see this as the top but the new value on which to anchor their expectations.
Consider what cognitive abilities (or biases) you may have used or borrowed from someone else. You watch the business news channels hoping for a tidbit of relevant information about which security you would like to buy. You peruse the web looking for confirmation of what you would like to believe is true. But what you are really doing is looking for an anchor using someone else's anchor to support your decision.
If analysts make forecasts or predictions based on past performance and then offer the disclaimer that future results are not guaranteed. They have used past results to anchor their bias as to whether things look rosy or the future is bleak for the stock.
Anchoring is tougher on a retirement account largely due to the set and go approach that most investors use in these types of accounts. Unless severe market downturns capture our attention in the news, we tend to leave these accounts to their own devices, channeling a portion of our earnings into them each week.
But when we do look at those quarterly statements, and many of us have for the first time in a while, we have an idea of where we should be. And it will be much higher than is probably reported. That's because we aren't so good at making predictions or estimates.
Look at it this way. Suppose you invested a thousand dollars in an IRA account and added $100 a week to that account. Over the course of 25 years you would have put $114,429 (adjusted for inflation at 3% on the real value of $131,000 actually contributed) in the account. If the money grew over that period at a modest 5%, which for that stretch of time is below average even with last year calculated into the mix, you would have added almost $135,000 in earnings (also adjusted for inflation).
Now suppose your portfolio balance of $249,402 dropped 30% or $74,802. Wouldn't you still be in the black? With an inflation adjusted contribution of $114k, haven't you protected your money and even grew it by $40k. Because you constantly shift your anchor or readjust your estimates higher, your expectations follow.
This is due in large part to a small target. Your balance may have grown substantially since you began investing but what occurred caused you to miss the target. I am not a shooter but I know that when a person does aim and fire, they are often narrowly focused on the target when in fact we should be making broad sight adjustments.
Next up: Mental Accounting
Sunday, May 10, 2009
Happy Mother's Day: Do You Know Where Your Retirement Plan Is?
We all have mothers in common. And on this day, besides remembering her with flowers, candy or breakfast in bed, there is no better time to begin planning for her future. I mention in my book "Retirement Planning for the Utterly Confused" that women often play a very diverse role throughout their working career. The roles they play, the numerous hats they don, are often the reason Mom doesn't have the financial strength when her working years are done.
She often leaves work to have children (not always and if your are a stay-at-home Dad, you would be wise to pay attention as well) and this is first instance of retirement interruptus. Her efforts at saving for the future, at a time when every financial advice giver agrees, are the best years for saving for that far off distant future, are put on hold. That one move can have long-term damaging effects.
She may hit other bumps in the road as well. Later in life, statistics show that it is often the woman who leaves work to take care of a parent in their golden years. This creates a cycle of disaster as the lack of preparation of the parent leads to a continuance of the problem that must be avoided. Adding another work stoppage seems to make the previous break for children even worse.
There is also the issue of being single. They may wait longer to get married, but no one problem for s secure financial future looms larger than the possibility they they will face their retirement years without a spouse. While this independence might seem attractive at first glance, your Mom may be under severe financial stress, shortening her lifespan in the process.
Sons and Daughters need to unite. Today (and the next day and the next) are the best times to take all of this into account.
Sons should not only be looking at their own mothers and mothers-in-law but their wives and daughters as well. In many instances, these women default to your experience with money. In many instances this is a grave mistake. Men, as it has been shown, are more emotional about money, willing to take bigger risks, and are often not focused on the big picture.
Sons, you need to begin the conversation. Is your wife saving as much as you are? Is she adequately insured for potential disability or even long-term care? Is she assuming enough risk to make her retirement investment grow?
Is your mother's finances in the best place to ensure it will not outlast her time with you? Are you financially prepared to deal with a health problem (has she named an executor, made a will, or otherwise let her intentions be known) or a loss of property? Have you made a plan to determine all of the possible scenarios that might play out, as difficult as something like that might be to do?
Is your wife (and daughters, if they are at least twelve years old) involved in how your financial house is structured? Are you guilty of financial infidelity, an act of risky behavior that you hide from the family's finances and fail to admit? Have you saved enough for a rainy day?
These are all tough problems to deal with. But ignoring only puts off until tomorrow what you should have planned for today.
Today is the day that Sons need to help your mother, your wife and your daughters have a better future. Daughters: Today is the day you need to get involved, open the conversation and make a plan for your future.
Oh, and Happy Mother's Day!
She often leaves work to have children (not always and if your are a stay-at-home Dad, you would be wise to pay attention as well) and this is first instance of retirement interruptus. Her efforts at saving for the future, at a time when every financial advice giver agrees, are the best years for saving for that far off distant future, are put on hold. That one move can have long-term damaging effects.She may hit other bumps in the road as well. Later in life, statistics show that it is often the woman who leaves work to take care of a parent in their golden years. This creates a cycle of disaster as the lack of preparation of the parent leads to a continuance of the problem that must be avoided. Adding another work stoppage seems to make the previous break for children even worse.
There is also the issue of being single. They may wait longer to get married, but no one problem for s secure financial future looms larger than the possibility they they will face their retirement years without a spouse. While this independence might seem attractive at first glance, your Mom may be under severe financial stress, shortening her lifespan in the process.
Sons and Daughters need to unite. Today (and the next day and the next) are the best times to take all of this into account.
Sons should not only be looking at their own mothers and mothers-in-law but their wives and daughters as well. In many instances, these women default to your experience with money. In many instances this is a grave mistake. Men, as it has been shown, are more emotional about money, willing to take bigger risks, and are often not focused on the big picture.
Sons, you need to begin the conversation. Is your wife saving as much as you are? Is she adequately insured for potential disability or even long-term care? Is she assuming enough risk to make her retirement investment grow?
Is your mother's finances in the best place to ensure it will not outlast her time with you? Are you financially prepared to deal with a health problem (has she named an executor, made a will, or otherwise let her intentions be known) or a loss of property? Have you made a plan to determine all of the possible scenarios that might play out, as difficult as something like that might be to do?
Is your wife (and daughters, if they are at least twelve years old) involved in how your financial house is structured? Are you guilty of financial infidelity, an act of risky behavior that you hide from the family's finances and fail to admit? Have you saved enough for a rainy day?
These are all tough problems to deal with. But ignoring only puts off until tomorrow what you should have planned for today.
Today is the day that Sons need to help your mother, your wife and your daughters have a better future. Daughters: Today is the day you need to get involved, open the conversation and make a plan for your future.
Oh, and Happy Mother's Day!
Monday, June 2, 2008
Retirement Planning: At 30
Retirement planning at age 30 puts you in a unique position. You would have done better had you started saving years ago. And yet, you are still at an age where you can capture many of the same opportunities that you may have missed.
At age thirty, life begins to seem like a game of rock-paper-scissors. You are familiar with the game. Competitors face off against each other, pump their arms and reveal a fist (rock), an outstretched hand (paper) or two fingers (scissors). Best of three wins the contest.
The game is so simple; it has been used to decide court cases and even disputes over works of art. They played it recently on the television show Survivor to determine who would go to Exile Island. Some scientists even suggest that game may govern the equilibrium of the universe.
In your thirties, the wrong move could leave you facing financial set back, one that could take years to unravel. If you are just beginning your retirement journey, you will find yourself in one of three financial positions. You will either have no debt with no savings, no savings and debt, or a family, house, car, and everything that goes along with life at this stage in the game. (Ironically, even those that have started to save, possibly through their work, still fall more or less into one of the three categories.
While the situation is far from dire, you do need to get things together quickly.
If you have no debt and no savings, there are some simple solutions to your retirement plan. Begin to build an emergency account - $25 a week to a money market account with limited check writing abilities is often enough to get started.
- A money market account generally pays a higher interest rate than regular passbook savings and checking. Access to the account is often limited to a few checks a year. This limited access but immediate availability make these accounts ideal for creating an emergency savings account
Next, if you haven't done so already, look into beginning to save for retirement with a tax deferred retirement account.
Using your employer's retirement plan, the most common being a 401(k) account (public employees often use a 403(b) account in the same way), you can begin building an account for your future. If your employer offers a match, lucky you.
- A match acts like an incentive to save. Offered by your employer, your contribution, up to a certain limit, is matched dollar for dollar.
You need to contribute at least that much to the account. This is free money that is put into your account with your contributions, and when invested and allowed to grow over time, will give you a sizable jump on where you need to be.
Even if your employer doesn't match your contribution, you should put away 5-10% of your pre-tax income. This money is withdrawn before the taxes are taken out and in some instances, this can actually lower your overall tax by licking you into a lower bracket. The upside to this: it may have very little effect on what you take home.
If you have no savings and debt, a much more common scenario, you can also be saved and surprisingly, without too much pain. It is obvious that you are living somewhat beyond your means. You have financed your lifestyle with money you didn't have.
The simplest way for you to get back on track is to build a spending framework. That's right: a budget.
- Budgets act like road maps. They simply give you an overview of where you are now assets (income) minus liabilities (what you owe and to whom) equals how much you have left to spend or save in a given period of time, usually over the course of a month.
Budgets can be like diets and New Year's resolutions. You start out with the best intentions but the changes you have promised yourself to make are often too drastic to achieve. But unlike diets and New Year's resolutions, they are incredibly important for two reasons.
It allows you to see where you are financially. Your money is not working for you if you are servicing debt. Debt comes with a cost and each time you pay interest on debt, you are paying for the use of that money. This exacts a toll on your savings.
Budgets also give you some idea of what it takes to get through the month real dollars. At this stage of life, it is no sin to live paycheck-to-paycheck. We have all done it. Many of us still do.
Paying off your credit cards is easier than you might think. I have developed a simple way called the sliding scale. Here's how it works.
If you have three cards this about average list the minimum payments of each on a sheet of paper. For the sake of example, let's assume that these minimums are $25, $35, and $50. Your plan of attack using the sliding scale is simple. Pay double the amount due on the lowest minimum until that card's balance is paid off.
- The payment schedule on the sliding scale would change from $25, $35 and $50 to $50 ($25 x 2), $35 and $50 for a total of $135
This increases your monthly credit card payments something you should make on time and without fail every month from $110 to $135.
Once that card is paid off, put it away for extreme emergencies and roll the $50 payment over to the next minimum. You are still paying the same amount but with one card paid off and the other card getting an $85 payment instead of $35 ($50 from the first plus $35 from the second), you are well on your way to satisfying that card's outstanding balance.
When that card is paid-off, put it away as well. Now, you are paying $135 to the card with the $50 minimum payment. Without taking too much from your budget (just $25 more a month), you have begun to tackle your credit card debt in a meaningful way.
At thirty, however, you might also have a car you have financed, college bills and possibly even a mortgage. A budget will give you the opportunity to see how much money goes where.
If you fall into the last category: family, a house, a car (possibly two) and no savings, it is time to change that. Now it becomes vitally important to begin to use your employer's retirement plan (see the thirty-year old with no savings and no debt), work on living within your means (see the thirty-year old with no savings and debt), and enjoy yourself.
The attitude you bring to life is more important at this stage than ever. You can see the future and have made tentative plans on how you will get there. You need to look forward to forty, and fifty, and even sixty as something worth achieving. Making the right retirement moves now will allow you to move forward with no regrets.
Monday, May 12, 2008
Retirement Planning - B is for Balance
As we continue our alphabetical look at the wide variety of investment terms that are thrown about - in such a way as to generally assume you know what is being spoken or written - we will look at balance.
There has been entirely too much emphasis placed on the need for balance. I firmly believe that in order for each part of your plan to work, it needs to have time to develop. Few people are willing to ride market unrest out, constantly tweaking their portfolio of mutual funds to get the same return, quarter over quarter, year over year.
Not only is this difficult for professional money managers, it is nearly impossible for the average investor to do.
There are far more important things to “waste” our time doing. If you follow some basic rules, you will be fine.
Among the first things you should ask yourself is “why did I buy this fund?” If it was because you found the long-term returns to be in line with your goals, then let the fund manager work out any kinks the market might throw his/her way. Check the fund each quarter but focus on the yearly prospectus. You should also keep those dollars invested. A down market is a buying opportunity for investors who use dollar cost averaging.
Dollar cost averaging or DCA is one of the single most important ways to build a retirement portfolio. The method invests money each month directed to your defined contribution plan in equal amounts. This allows you to buy more shares of your mutual fund when the price is low and less when the price is high. It employs one of the basic market principles better than most investors would and does it with no effort.
There are several reasons that this works. Suppose the mutual fund you purchased was selling shares for $5. For each $5 you invested, you received a share in the fund. The market, doing what it does best changes based on an innumerable amount of factors. In some instances, this makes the share appreciate, increasing the price and in others, the price goes down.
When the price increases to $7, your designated investment dollars does not see that as a buying opportunity. Your five dollars instead buys only a portion of a share, in this case, only about three quarter of a share. In this instance, it keeps you from buying shares that might be overpriced.
But if the market goes down and the share price decreases to $2.50, your five-dollar investment has bought a share and a half. Investors have a difficult time controlling the desire to buy more when the markets are on the way up and selling when they are declining in value. DCA solves this.
The idea behind it is simple and is employed with great success in your company-sponsored plan. In those plans, money is automatically taken from your paycheck. If you are using a traditional 401(k), it is done before taxes are taken from your paycheck. If you are participating in a Roth 401(k) it is taken from after-tax dollars.
In both plans, a steady stream of cash is invested for your future. IRA users have some different challenges facing their use of DCA to its best advantage. Often, IRA investors opt for sending their mutual funds a check each month. This allows them to act based on current headlines.
If this sounds like something you are doing, set-up your contribution to be done automatically and write that amount in your budget. This will give you the opportunity to take advantage of all of the magic the DCA offers.
Previously: A is for Asset Allocation
B is for Balance
There has been entirely too much emphasis placed on the need for balance. I firmly believe that in order for each part of your plan to work, it needs to have time to develop. Few people are willing to ride market unrest out, constantly tweaking their portfolio of mutual funds to get the same return, quarter over quarter, year over year.
Not only is this difficult for professional money managers, it is nearly impossible for the average investor to do.
There are far more important things to “waste” our time doing. If you follow some basic rules, you will be fine.
Ask The Right Questions
Among the first things you should ask yourself is “why did I buy this fund?” If it was because you found the long-term returns to be in line with your goals, then let the fund manager work out any kinks the market might throw his/her way. Check the fund each quarter but focus on the yearly prospectus. You should also keep those dollars invested. A down market is a buying opportunity for investors who use dollar cost averaging.
What is DCA?
Dollar cost averaging or DCA is one of the single most important ways to build a retirement portfolio. The method invests money each month directed to your defined contribution plan in equal amounts. This allows you to buy more shares of your mutual fund when the price is low and less when the price is high. It employs one of the basic market principles better than most investors would and does it with no effort.
There are several reasons that this works. Suppose the mutual fund you purchased was selling shares for $5. For each $5 you invested, you received a share in the fund. The market, doing what it does best changes based on an innumerable amount of factors. In some instances, this makes the share appreciate, increasing the price and in others, the price goes down.
When the price increases to $7, your designated investment dollars does not see that as a buying opportunity. Your five dollars instead buys only a portion of a share, in this case, only about three quarter of a share. In this instance, it keeps you from buying shares that might be overpriced.
But if the market goes down and the share price decreases to $2.50, your five-dollar investment has bought a share and a half. Investors have a difficult time controlling the desire to buy more when the markets are on the way up and selling when they are declining in value. DCA solves this.
In your Retirement Plan
The idea behind it is simple and is employed with great success in your company-sponsored plan. In those plans, money is automatically taken from your paycheck. If you are using a traditional 401(k), it is done before taxes are taken from your paycheck. If you are participating in a Roth 401(k) it is taken from after-tax dollars.
In both plans, a steady stream of cash is invested for your future. IRA users have some different challenges facing their use of DCA to its best advantage. Often, IRA investors opt for sending their mutual funds a check each month. This allows them to act based on current headlines.
If this sounds like something you are doing, set-up your contribution to be done automatically and write that amount in your budget. This will give you the opportunity to take advantage of all of the magic the DCA offers.
Previously: A is for Asset Allocation
Friday, May 9, 2008
Retirement Planning - A is for Asset Allocation
Today, we begin a look at the alphabet soup that has become investing and more importantly, retirement planning. For most people, the concept of saving is already understood, the downside effects of having debt has been completely drilled in - from every angle imaginable, and the importance of a retirement plan or planning strategy is absolutely necessary to prevent financial disaster when we hit or sixties or seventies.
When there is market turmoil, one of the first things you should examine is how well you have allocated the assets in your retirement portfolio. This is no easy task.
If your 401(k) was properly allocated a year ago, before the economy slowed down, with mutual funds that were focused on growing your money and with your risk tolerance in mind, you will be fine. Fundamentally, not that much has changed.
Smart investors know they need to give their portfolios twelve months to fully utilize the plan. History has shown that with time, many of the imbalances that have a stranglehold on the markets will loosen their grip and things will return to normal.
Hold tight, time will come to the rescue.
How those assets are positioned in your retirement portfolio however is a different matter.
In a retirement plan, asset allocation takes on a different meaning. In your portfolio, you should have basket of mutual funds that focus on different parts of the market. This method of investing protects you from swings in the market that is often specific to one group of investments. The markets rarely fail altogether.
The most recent example of this happened in early 2008 when the stocks of banks and other financial institutions began to falter. The most famous was the failure of technology stocks in 2000. Had you not allocated your assets properly, you would have felt a greater loss than the market as a whole did. Asset allocation protects you from this.
In order for asset allocation to work, you need to determine two things: your age and your risk tolerance. Age is not so much a reference to how old you are but how far off in the distant or near future your retirement is.
Your risk tolerance is a reference to how much of your investments you are willing to put to the test.
If you are in your twenties, it is generally assumed that you should be the most tolerant of risk, investing in growth mutual funds and able to overcome any short-term problems.
Allocation assets becomes much more important once you reach forty, beginning to temper your risk and protect some of your assets. By age sixty, you should be investing a conservative mix of stocks and bonds.
Perhaps the simplest way: invest in target funds that save for a future retirement date. These types of funds gradually change your assets over the years, essentially re-allocating for you.
A is for Asset Allocation
When there is market turmoil, one of the first things you should examine is how well you have allocated the assets in your retirement portfolio. This is no easy task.
If your 401(k) was properly allocated a year ago, before the economy slowed down, with mutual funds that were focused on growing your money and with your risk tolerance in mind, you will be fine. Fundamentally, not that much has changed.
Smart investors know they need to give their portfolios twelve months to fully utilize the plan. History has shown that with time, many of the imbalances that have a stranglehold on the markets will loosen their grip and things will return to normal.
Hold tight, time will come to the rescue.
What is asset allocation?
How those assets are positioned in your retirement portfolio however is a different matter.
In a retirement plan, asset allocation takes on a different meaning. In your portfolio, you should have basket of mutual funds that focus on different parts of the market. This method of investing protects you from swings in the market that is often specific to one group of investments. The markets rarely fail altogether.
The most recent example of this happened in early 2008 when the stocks of banks and other financial institutions began to falter. The most famous was the failure of technology stocks in 2000. Had you not allocated your assets properly, you would have felt a greater loss than the market as a whole did. Asset allocation protects you from this.
The Right Mix
In order for asset allocation to work, you need to determine two things: your age and your risk tolerance. Age is not so much a reference to how old you are but how far off in the distant or near future your retirement is.
Your risk tolerance is a reference to how much of your investments you are willing to put to the test.
If you are in your twenties, it is generally assumed that you should be the most tolerant of risk, investing in growth mutual funds and able to overcome any short-term problems.
Allocation assets becomes much more important once you reach forty, beginning to temper your risk and protect some of your assets. By age sixty, you should be investing a conservative mix of stocks and bonds.
How to get the Right Allocation
Perhaps the simplest way: invest in target funds that save for a future retirement date. These types of funds gradually change your assets over the years, essentially re-allocating for you.
Friday, January 4, 2008
Retirement Planning and Employee Stress
Along the same topic of stress, there is a mention in the book about financial education for employees. Some business leaders suggest that once employees grasp some basic financial ideas, those ideas become tools to eliminate stress and increase productivity.
"Our calls in general for mortgage-related issues are up over three times compared to last year," says Richard Chaifetz, CEO of ComPsych. "(Employees) become preoccupied with financial issues at work. You see absenteeism, lack of performance and turnover as people look for jobs that may pay more." ComPsych, for those interested is focused the business aspect of the equation and offers products and services to that end.
The not-for-profit company Personal Finance Employees Education Foundation, inc. led by the renowned Dr. E. Thomas Garmin, works to achieve three goals: (1) The lack of financial literacy--spending plans, credit management, and savings--is the major reason why employees do not save for retirement; (2) Money worries hinder employee job performance; and (3) Providing employees easy access to basic financial literacy education programs improves their personal financial behaviors and job performance as well as the employer's bottom line.
These folks act as an intermediary advisors, taking donations for its efforts with a volunteer board and recommending programs designed to further the education process. Those donations can run from as little as $500 to $100,000.
According to Dr. Thomas R. Watson, a leading expert on workplace financial education, employers who provide a “sound investment in employees, a quality financial education program would benefit your business for years to come. Workers become more tolerant of budget cuts that prevent expected increases in pay. Fewer employees work second jobs or seek higher paying jobs at the expense of their employer. Employees who are more cost-conscious at home should be more cost-conscious at work.”
In the end, this reduces absenteeism and, for the employer, that means increased profits. When a business focuses on human capital, something that has a reduced importance to employers as the worker ages, it can increase an employee’s financial capital. Their efforts may in the end be somewhat of a Sisyphean challenge. The hardest part is not in the education of employees, it is in the creation of a permanent change in attitude about a future that lies solely in their hands.
"Our calls in general for mortgage-related issues are up over three times compared to last year," says Richard Chaifetz, CEO of ComPsych. "(Employees) become preoccupied with financial issues at work. You see absenteeism, lack of performance and turnover as people look for jobs that may pay more." ComPsych, for those interested is focused the business aspect of the equation and offers products and services to that end.
The not-for-profit company Personal Finance Employees Education Foundation, inc. led by the renowned Dr. E. Thomas Garmin, works to achieve three goals: (1) The lack of financial literacy--spending plans, credit management, and savings--is the major reason why employees do not save for retirement; (2) Money worries hinder employee job performance; and (3) Providing employees easy access to basic financial literacy education programs improves their personal financial behaviors and job performance as well as the employer's bottom line.
These folks act as an intermediary advisors, taking donations for its efforts with a volunteer board and recommending programs designed to further the education process. Those donations can run from as little as $500 to $100,000.
According to Dr. Thomas R. Watson, a leading expert on workplace financial education, employers who provide a “sound investment in employees, a quality financial education program would benefit your business for years to come. Workers become more tolerant of budget cuts that prevent expected increases in pay. Fewer employees work second jobs or seek higher paying jobs at the expense of their employer. Employees who are more cost-conscious at home should be more cost-conscious at work.”
In the end, this reduces absenteeism and, for the employer, that means increased profits. When a business focuses on human capital, something that has a reduced importance to employers as the worker ages, it can increase an employee’s financial capital. Their efforts may in the end be somewhat of a Sisyphean challenge. The hardest part is not in the education of employees, it is in the creation of a permanent change in attitude about a future that lies solely in their hands.
Thursday, September 13, 2007
Retirement Planning and the College Loan
Retirement Planning and the College Loan
There are basically three types of college loans: the one you do not have, the one you are paying for or the one you are paying for your children.
I write the following in the book: "Yet the psychology of debt assumes that it (and this instance we are speaking about your ability to repay your collegiate debt) will soon turn bad."
There was a time in the not-so-distant past when college graduates and those who chose to enter into the workforce could expect to earn similar incomes. Thirty years have passed and, as we all know (or assume) this is no longer the case. In fact, when those two post-high school incomes met along that timeline in 1975, college was much cheaper.
According to the College Board, who recently stepped away from the loan business, the average student will leave college with about $20,000 of debt. (Realistically, the student who fully finances her or his education will often have as much as ten thousand dollars of additional debt above and beyond the cost of classes.) And that is just for undergraduate public school completed in four years. Many students extend their college years beyond this, attending graduate school and adding another $30-40,000 in loans.
Want to find out how much you are likely to make with that college education? Salary.com has compiled a list of entry-level incomes for a wide variety of careers.
How does college play itself out in your retirement plan? There are three basic concepts to understand.
The first: A thirty thousand dollar loan can quickly turn itself upside down if the student does not pay it off early. Letting it languish for the full ten-year payback period will add as much as a third more to the cost of the education.
Second: Because the student is not likely to prioritize those loan payments, they will be much more prone to roll the debt over into some sort of longer termed consolidation loan, extending the period of payback and because of that, paying additional interest charges, fees for loan origination and in the process, learn one of life's most frequently taught lesson – debt overload. Once this happens, and if the post-college income generated from those years racking up that debt fails to match the debt, young people just starting out will be well behind the best years for saving.
Third: Parents shouldn't pay. Okay, middle class parents shouldn't pay. Diverting money to your child’s education seems noble enough and might even make you feel better but it doesn’t work if you are not using that money for your own retirement.
I have suggested that a family with a household income of less that $80,000 devote any money to growing their child. Lessons, activities, sports and travel all eat up enormous amounts of cash from the average budget. But it will produce a much better (and more attractive, at least from a collegiate perspective) citizen/student. And that child is more likely to obtain scholarships and grant money because of it.
Parents at this income level have few good opportunities to save for their own retirements. Passing up even so much as single dollar directed towards a savings plan for those later years would be catastrophic.
Incomes above that amount will not be in much better shape to save for college but they will feel the pressure of their peer group to do so. With the recent credit crunch revealing some cracks in the accounting of many households who have kept their eye on prizes they could ill afford, saving for college may add to an already strained budget.
Retirement planning rule of thumb: If your total household debt exceeds 70%, you should focus on your future and not that of your child(ren). That debt will afford them better borrowing opportunities but, on the other hand, that same debt will be creating a negative momentum for your own future.
Thursday, August 2, 2007
Retirement Planning and Debt: Liquidity
Retirement Planning and Debt: Liquidity
No one can downplay the importance of debt in your financial plan. While I am guilty for frequently mentioning the concept as a negative influence on your plan, we are besieged with information offering us a contrary view.
We are encouraged to keep the economy going by spending. Savings on the other hand, is actually portrayed as a negative influence. An economy can slow the flow of goods if consumers keep their cash close.
While this may be true, it is overspending or buying on credit that has propelled these markets on a global scale. And that movement is based on the availability of money.
What motivates equity markets is liquidity. This is a financial terms that in its simplest form refers to the availability of cash to borrow. Let me explain how liquidity works, often differently depending on where and who you are.
On a corporate level, liquidity can be incredibly deceiving. It acts as a reward for savvy business acumen. And because of so many people are using their skills to find this excess capital where little to none exists, we have these stock market levels (over the month of July, the DJIA hit 14,000, then gyrated wildly downward in fits and starts losing five percent of its value).
Liquidity in its purest form comes from the banking system. The Federal Reserve Board fixes the overnight short-term interest rates for the best borrowers. When it does this, it is suggesting a rate at which it believes the marketplace has just enough cash at the right price to keep the corporate engines fueled. That rate is then passed on to each subsequent lender, who increases the rate in small increments right on down the line.
This gives the average borrower like you and I the impression that the Fed controls the economy with each pull of its purse strings. And you would be right, to a degree. The flip side of making money inexpensive to borrow is having enough available in adequate quantities to those willing to pay the price. But liquidity offers business and consumers different opportunities but similar punishments.
In order for the borrower to qualify for a sizable loan, whether it be business or consumer related they often need to have some sort of underlying asset that they are willing to “put on the line” for the amount of money they seek. With business, it is often money borrowed for reinvestment in production or to expand a product line. With the consumer, it is often their largest asset: their home.
Most of the time this borrowing is at the heart of how a business grows, tapping inexpensive money that gives them additional competitive opportunities.
Each asset the company owns acts as collateral. But what happens when the borrower wants money not for the usual and traditional purpose of expanding the business but to reinvest it? On the surface, it creates an illusion of economic health.
A business can borrow cash to buy back its own stock. The net effect of such a maneuver suggests two things: the company thinks its stock is fairly valued and is taking some of it off the table, making it unavailable for buyers and secondly, it believes that the markets will reward just such an action by increasing the share price. But what happens when the interest rates (called debt service) rise faster that the return on the stock? Nothing until someone begins to realize that this whole debt structure might be nothing more than a house of cards.
The housing analogy is not accidental. For well over three years, I have wondered how consumers would react if their ability to extract money from their homes dried up. For over two years I have been wondering what would happen if all of those creative mortgages, the ones done with adjustable rates and fancy, no-documentation paperwork, became too burdensome for the borrower.
As money becomes too expensive to borrow, opportunities to make money in market places like stocks begin to seem risky and after they calculate the debt service, not too affordable. Businesses, instead of growing and creating new markets find themselves facing the possibility that they may just have painted themselves into a corner.
Consumers, no longer feeling as though the cost of borrowing is worth it, will spend less. This of course has a domino effect disrupting economic growth.
That is the simple explanation. There are global forces at work as well but these will only have an effect on you if your liquidity has dried up. With debt, liquidity is based on your ability to borrow and pay the cost of that transaction and, most importantly, you feel as though the risk and the cost are worthwhile.
If you have no debt, your liquidity is based on your ability to tap cash when you need it. In the book, I fall back on the old stand-by, the emergency account as the base for a good retirement plan. Creating just such an account allows you to have more than just enough money to get you by during times of income disruptions, it gives you peace of mind knowing that the money comes without a cost if you need it and you were able to save it.
It also has the effect of immunizing you from any economic fallout as a result of nefarious corporate and marketplace shenanigans or because other consumers over-extended themselves in unwieldy loans.
Tuesday, June 26, 2007
Retirement Planning and Life Expectancy
Retirement Planning and Life Expectancy
No retirement planning book would be complete without a look at life expectancy. Trying to determine how long you might live, whether you will outlive your money and exactly how much money will be needed should you break all-time length of life records affects every plan.
In the book, I point to the work done by Wharton School of Business professors Dean P Foster, whose field is statistics and Lyle Unger, an expert in Genomics and computational biology. Their work on longevity based on how much walking one does was expanded into a full fledged calculator with the addition of Chua Choon Tze, who brought his finance background from the Lee Kong Chian School in Singapore.
The calculator was expanded to include numerous diseases and charts that will narrow your possibilities by ranking you among your peer group.
Included are references to fitness using a maximal treadmill exercise test as a measure of fitness with an initial speed set at 3.3mph, 0% grade for 1st minute, 2% grade for 2nd minute, an increase of 1% for each subsequent minute until 25 minutes thereafter, the speed is increased by 0.2mph each minute until test is terminated
To do this of course, you would need to compare what you think the maximum amount of time that you can stay on the treadmill with mean time for men of 16 minutes 52 seconds and a mean time for women of 11 minutes 28 seconds.
They also asked the user to judge their diet (Dairy, Meat, Grain, Fruit, Vegetable) and their stress level. The following list would have a negative effect on your overall life span:
- Serious Illness in a family member (excluding death)
- Serious concern about a family member (excluding illness)
- Death of a family member
- Divorce or separation
- Forced to move house
- Forced to change job
- Been made redundant
- Feelings of insecurity at work
- Serious financial trouble
- Been legally prosecuted
More fun can be had at NW Mutual's longevity game. As you input the information, your body changes shape and often not for the better. Starting out at the average life expectancy of 74, each question prompts an increase or a decrease in that anticipated age.
There is much more to creating enough wealth to weather a long lifetime. And these calculators and games only hope to illustrate the changes you can make to achieve a longer healthier life. My job is to help you get the money you need.
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