This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. Vice President and Publisher: Cynthia A. Zigmund Acquisitions Editor: Mary B. Good Senior Project Editor: Trey Thoelcke Interior Design: Lucy Jenkins Cover Design: Jody Billert Typesetting: Elizabeth Pitts
2003 by James A. Barry, Jr. Published by Dearborn Trade Publishing, a Kaplan Professional Company All rights reserved. The text of this publication, or any part thereof, may not be reproduced in any manner whatsoever without written permission from the publisher. Printed in the United States of America 02 03 04 10 9 8 7 6 5 4 3 2 1
Library of Congress Cataloging-in-Publication Data Barry, Jim, 1935– Let’s talk money : Jim Barry’s life strategies to attain and grow your wealth / James A. Barry, Jr. p. cm. Includes index. ISBN 0-7931-6504-0 1. Finance, Personal. 2. Investments. 3. Estate planning. I. Title. HG179.B3373 2003 332.024′01-- dc21 2003008151
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DEDICATION Dedicated to my loving wife, confidant, and life partner, Rosemarie Barry, who has been my inspiration to live life to the fullest, and without whom this book could not have become a reality. A very special thanks to my son, Jim, for just being my son, and for following in his dad’s footsteps, and exceeding them.
Contents
Preface
xi
Acknowledgments
xv PA RT
ONE
SHAPING YOUR VIEWS AND ATTITUDES 1. MAKING THE COMMITMENT Values and Attitudes It’s Up to You 6 What Is Money? 9 More Wasting Assets 13 The Bottom Line 14
3
2. TAKING CHARGE Know Your Strengths and Weaknesses The “No Decision” Dilemma 15 Chart Your Flight Plan 16 Identify Your Weaknesses 17 Take Control 19 Get Rid of the Noise 20 The Bottom Line 24 3. EMBRACING CHANGE It’s Opportunity It Can Happen to You 47 Benefiting from Tax Changes 51 Tax Relief 53 General Tax-Saving Tips 60 The Bottom Line 63
47
4. PLANNING FOR SUCCESS You Don’t Learn It in School The Money Equation 65 Setting Your Goals 67 Secrets to Financial Success 72 The Bottom Line 78
vii
15
65
viii
Contents
PA RT
TWO
ESTABLISH YOUR OWN TRADITION OF WEALTH MANAGEMENT 5. THINK CASH FLOW VERSUS INCOME Where’s the Cash Flow? 81 Coping with Down Markets 86 The Role of Family Relationships 89 The Bottom Line 93
81
6. UNDERSTANDING RISK 111 Principles to Follow 113 Measuring Risk: The Investment Pyramid 114 Reality Check 118 Your Risk Tolerance 119 The Bottom Line 119 7. THINKING LONG TERM 121 Understanding the Equation 122 Stay the Course 123 Pay Yourself First 125 The Exit Plan 130 The Achilles Heel of Financial and Estate Planning 133 The Bottom Line 141 8. INVESTING Strategies and Options Ground Rules and Strategies 143 Doing It Right 151 Investment Vehicles 152 The Bottom Line 160
143
9. STOCK MARKET BARGAINS The Sale Is On Forget the Herd 162 How Good Are You at Picking Stocks? 166 Some of the Basics 170 The Bottom Line 173
161
10. ESTATE PLANNING WITH YOUR HEIRS IN MIND Uncle Sam’s Take 176 Estate Planning Issues and Tools 179 Trust Options 183 The Bottom Line 192
175
Contents
11. HIRING THE RIGHT ADVISORS 193 The Big Gamble 194 What to Look for in an Advisor 196 Beyond the Credentials 199 The Bottom Line 202 12. PUTTING IT ALL TOGETHER Wealth-Building Basics 204 More Secrets to Success 205 The Time Line 207 Rules of the Road 209 The Bottom Line 211 Glossary 215 References 231 Index
243
About the Author
251
203
ix
Preface
A
merica is the land of opportunity. You don’t have to be wealthy to become wealthy. If in 1967 you began to put away $2,000 a year in an IRA invested in a mutual fund, today that investment would be worth more than $1.6 million! That’s no small chunk of change as a retirement nest egg. The road to financial success starts with your wisest investment, learning about wealth, and it’s an essential one. Our educational system does a reasonable job teaching us how to make money, but a lousy job teaching us how to manage it. In fact, often those who are the most successful at making money have the most trouble managing it. Why? They just don’t have the time, the knowledge, or the patience. This book will open your mind to what you can accomplish financially with the right mind-set. We will look at the wealth of investment and money-management possibilities available to all Americans—no matter who you are or where you come from. It doesn’t matter if you, your parents, or your grandparents came from South Philadelphia, South Africa, South America, or South Bronx. You can do it. In America, it’s not how much money you make, it’s what you do with that money that counts. I’m proof the American Dream works. I was raised in a six-family tenement house outside of Boston. I never had two nickels to rub together. My father never owned a home or a new car. I went to work at age 14 and have been going strong ever since. As a teenager, I worked behind the soda fountain at the corner drugstore, I delivered groceries, I delivered booze, and I worked in a cemetery digging graves my first year of college. You can’t psyche me out or come up with a struggle I haven’t had to deal with, or adversity I haven’t had to overcome somewhere along the line. xi
xii
Preface
Yet I believed in the American Dream. I believed I could accomplish anything I set out to do as long as I made a commitment to my goals. I certainly don’t believe that everything in life is perfect, but as long as you are willing to work hard and smart, and look at defeats along the way as stepping stones to a better future, you will attain your goals. Today I am founder and CEO of Barry Financial, one of the oldest and largest independent financial advisor groups in South Florida managing hundreds of millions of dollars for national and international clients. I’ve written three books on financial planning and wealth management, and am a nationally recognized motivational speaker and television personality. With my son, James Michael Barry, I host two weekly financial television shows, one airing nationally on public broadcasting stations to more than 55 million households. My business association with my son extends far beyond our work on television. James Michael Barry, CFP , has been president of Barry Financial since 1998, leading a full staff of top-notch professionals who handle day-to-day operations. Instead of a tenement house, today I live in a 20,000-square-foot villa on the Atlantic Ocean, Villa Clasani, named after my wife, and yes, I drive new cars, including a Rolls Royce. But I also understand that there is more to life than making money. I’ve been married to the same woman, Rosemarie, for 48 years and have three children, seven grandchildren, and two great-grandchildren with whom to share my good fortune. If you are proactive and think outside the box, you can win, too. But you can’t hit a home run from the dugout. You have to get to the plate. This book will take you there. With the help of my son and the experts from Barry Financial and beyond, I will share a wealth of financial knowledge, give you choices, and help guide you to develop your own plan to grow your wealth. No one can make the decisions for you. All I can do is show you what it takes. I hope this book will give you the inspiration to elevate your thinking from where you are today to where you should be despite all the negative things that can happen in your life. It’s not a how-to encyclopedia. It is intended to be an awakening session that can help you take charge, explore, and learn more about the information and material available to you.
Preface
xiii
Throughout this book, I mention various insurance companies, mutual funds, and other investments to illustrate my points. These are used as examples, not endorsements. Everyone’s financial situation is different, and there are literally thousands of options that may or may not fit into your personal financial plans. We are traveling a path together. We may encounter detours like premature death, disability, or even simple procrastination. Some of these you cannot control, such as the Federal Reserve, short-term interest rates, and stock markets. I’m going to teach you not to worry about those things, instead concerning yourself with things you can control. You are going to take charge of your life over the long term. I will show you what it takes to plan for your future and for future generations. But don’t expect to accomplish great things overnight. Building and managing wealth is a long-haul proposition. It’s about learning to be the marathon runner in life, not the sprinter, and it’s about balancing your quest for wealth with the truly important things in life—family, friends, and loved ones. The name of the game is getting off dead center and taking charge of your financial well-being. This book is not a blueprint for your life, but it will help you develop a positive mind-set, an upbeat attitude, and change how you look at yourself every day in the mirror. Instead of focusing on why something can’t be done, just do it. So, what are we waiting for? Let’s get started building your personal road to wealth. James A. Barry Jr., CFP
Acknowledgments
I
would like to express my sincerest gratitude to the many individuals with whom I’ve worked to present the ideas and information in this book. I am especially appreciative of: • Sir John Templeton, for being my mentor and showing me how important it is to use common sense, which is not so common today. • Richard Karas, president, NFS Distributors, Inc., Nationwide Financial, who over the years has shared with me his wisdom and insight on the financial services industry. • The Honorable Philip M. Crane, member of Congress, 8th Congressional District, state of Illinois; vice-chairman, Committee on Ways and Means; chairman, Subcommittee on Trade; member, Subcommittee on Health; and member, Joint Committee on Taxation, who over the years has sharpened my perception and given me a better understanding of the inner workings of our government. More important, I am thankful to him for just being my friend. • Peter D. Jones, president, Franklin Templeton Distributors, Inc., an executive of the highest esteem and integrity, who excels in his positions and always is willing to offer assistance to those enlisting his guidance and help. He is a true gentleman and friend. I would like to express my sincerest gratitude to the many individuals with whom I’ve worked to present the ideas and information in this book. I am especially appreciative of: • Robert M. Arlen, J.D., LL.M., CPA, Board Certified—Wills, Trusts, Estates, and Taxation, Robert M. Arlen, P.A. xv
xvi
Acknowledgments
• David Pratt, J.D., LL.M., CPA, Board Certified—Wills, Trusts, Estates, and Taxation, David Pratt and Associates, P.A. Many thanks also to the following companies for their assistance and resource materials, which contributed greatly to the completion of this book: • • • • • • • • • • • •
The American Funds Group Nationwide Life Insurance Co. Franklin Templeton Investments Fidelity Group AIM Funds MFS Investment Management Oppenheimer Funds Hartford Life Insurance Co. Penn Mutual Life Insurance Co. General Electric Capital Assurance Co. Transamerica Lincoln Financial
A special thanks to my associates at The Barry Financial Group: Midge Novoth, vice president and my executive assistant, for her help in coordinating all the various aspects concerning completion of this book, and to the following, who provided review and research information: • • • • • • •
Rolf D. Neitzel, CFP , CPA, CMFC Joan DeSena, director of marketing Kristine Black, director of life insurance services Joe Fernandez, CLU, senior vice president Dan Robinson, CPA, CFO Helinka Mills, CFP Greg Henry, wealth management planning
Also thanks to writer Susan J. Marks for helping turn my thoughts into this book, and to my loyal TV viewers who every week ask the questions that challenge me to guide them on their financial journey.
Acknowledgments
xvii
I am also very grateful to my clients and friends, who encouraged me once again to share my life experiences relating to achieving financial independence. Finally, I want to express my appreciation to my daughters, Irene Barry Leicht and Rose Barry Wood, for their support and encouragement throughout this project.
P a r t
O n e
SHAPING YOUR VIEWS AND ATTITUDES
C h a p t e r
1 MAKING THE COMMITMENT Values and Attitudes
I
f you’re not willing to make the commitment, forget about growing your wealth and managing it for future generations. Instead of reading this book, buy some lottery tickets because the odds of growing your wealth without this commitment are about the same as winning the lottery. Growing wealth takes a positive attitude, unwavering commitment, and a long-range plan to manage it for the future. Growing wealth requires knowledge of the right kind of savings programs, investment vehicles, and tax breaks to make the most of the opportunities available to you. In this great country of America, you don’t have to be born rich to become wealthy. Anyone can retire a millionaire, and you don’t need to win the lottery. Let’s say that 35 years ago at age 30 you started putting $2,000 a year (about $5.50 a day) into an individual retirement account (IRA). If that IRA were invested in a middle-of-the-road growth mutual fund like the Franklin Templeton Growth Fund, today, at age 65, you would have an investment worth almost $1.7 million! But the necessity for managing your money doesn’t end at age 65. With an estimated lifespan of 80 to 85, you need to make that money last at least another 15 to 20 years. If you set up a systematic with3
4
Let’s Talk Money
FIGURE 1.1 The Growth of Money Invested in an IRA \
WANT TO BE A MILLIONAIRE? IT’S EASY WITH AN IRA If in 1967 you began to put $2,000 a year into an IRA, and invested it in a moderate growth mutual fund, 35 years later your investment would be worth more than $1.66 million. Using Templeton Growth Fund as the example, watch how your money grows*: $2,000,000 $1,750,000
TOTAL INVESTED: $70,000 TOTAL ENDING AMOUNT: $1,662,658 AVERAGE ANNUAL RETURN: 14.24%
$1,500,000
$1,662,658
$1,250,000
Dec. 31, 2002
$1,000,000 $750,000 $500,000
$2,000 Dec. 31, 1967
$250,000 $0 12/31/67
12/31/77
12/31/87
12/31/97
12/31/02
*Investments not subject to sales charge, effects of income and capital gains taxes not demonstrated. Source: Thomson Financial
drawal plan for your $1.7 million—perhaps 8 percent a year—you could end up with $133,000 a year for the rest of your life. That’s no small chunk of change, and not bad for starting with only $2,000. Figure 1.1 illustrates the growth of your money in an IRA. But what happens if you start your investment plan today? I can’t prove to you that in six months, one year, or five years your investment’s value will increase. No one can predict the future, but if you look at the past 35 years, the stock market is up over the long haul. Over the next 35 years the same thing will happen unless the world goes to hell in a hand basket, and then it won’t matter. Time is on your side if you invest long term. Since 1900, the Dow’s 69 up years far outweigh its 34 down years. Figure 1.2 tracks the performance of the Dow Jones, S&P 500, and Nasdaq over time. Still have your doubts? Consider that if someone had invested just $1 in the Standard & Poor’s 500 Composite Index on Jan. 1, 1934, by the end of 2002 that investment would have been worth $1,459. If that
5
Making the Commitment
FIGURE 1.2 Dow, S&P, Nasdaq
TRACKING THE MARKETS OVER TIME 10,940.50
DOW JONES INDUSTRIAL AVERAGE
Jan. 3, 2000
Monthy closings January 1930 to January 2003 11,000
8,053.81 Jan. 3, 2003
10,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000
$267.10 Jan. 2, 1930
2,000 1,000 0 1930
1940
1950
1960
1970
1980
1990
2003
S&P 500 Monthy closings January 1950 to January 2003 1,400
1,394.46
1,300
Jan. 3, 2000
1,200 1,100 1,000 900 800 700
855.70
600
Jan. 3, 2003
500 400 300
17.05 Jan. 3, 1950
200 100 0 1950
1960
1970
1980
1990
2003
NASDAQ Monthy closings January 1984 to January 2003 4,000
3,940.35 Jan. 3, 2000
3,500
1,320.91 Jan. Jan.2,3,2003 2003
3,000 2,500 2,000 1,500
278.70 Jan. 2, 1985
1,000 500 0 1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
6
Let’s Talk Money
$1 had not been invested at all, today it would be worth just 7 cents, thanks to inf lation. (Figures courtesy of American Funds Distributors, Inc.; used with permission.)
IT’S UP TO YOU I’m sure you’ve heard the old expression “The worst enemy I have is the one I face in the mirror each morning.” Well, you have met the enemy of your success and it’s you. It’s not the economy, the Republicans, the Democrats, the neighbors, your mother, or your father. It’s not being born at the wrong time or on the wrong side of the tracks. It’s not the color of your skin or anything else for that matter. You may not want to hear it, but the buck stops with you. You are the one who has to take charge and understand what it takes to build personal wealth. You must recognize that you—as the moneymaking machine—will wear out somewhere along the line, and you must plan for the future. To build wealth, you have to get off dead center, forget about blaming everything and everyone else, and take charge of your financial wellbeing.
Your Value System How you look at yourself and your value system plays a big role in what you do with your life, whether it’s lifestyle, job, career, day-to-day finances, retirement, or estate planning. We are all, to some degree, a product of our environment: where we grew up, the times in which we grew up, and our education. All these factors inf luence how we think and how we act. I was born and raised in an Irish Catholic family. We lived in a sixfamily tenement house outside Boston. I never had two nickels to rub together. My father never owned a home. My parents assumed that my future was in the hands of my family and the Catholic nuns who made it their business to make sure I followed the guidelines set down in the Bible. I was stereotyped into believing that my financial security lay in becoming a policeman, postman, or fireman. Back then, that’s the way it was. My uncles were full-time policemen, but they also had to work parttime jobs on the side to make ends meet.
Making the Commitment
7
I remember how negatively my father regarded someone who had accumulated wealth, lived in a big home, and drove an expensive car. One of my high school friends was Cliffy Austin. I used to spend weekends with Cliffy at his big house on a lake. His family had a sailboat and a fancy car. His father and mine were about the same age, but Cliffy’s dad was a successful entrepreneur who owned several liquor stores. He was always happy and enthusiastic. At the end of each weekend, as Mr. Austin would drive me home, I would always ask myself, “What is this guy doing that my father is not?” Back home at the tenement house, I would be full of excitement after enjoying the fruits of Cliffy’s dad’s success. But that excitement was dashed when my dad would say to me in a derogatory tone, “But you don’t know how he made his money.” I later realized that, like every one of us, my dad had to give himself an excuse for where he was in life. The difference between my father and Mr. Austin was attitude. Cliffy’s dad was positive and believed he could achieve things. I loved my dad, but his negative attitude got in the way of his success, financially and personally. I easily could have followed my preset civil servant path. Someone recently asked me why I didn’t. “You took a big risk,” he said, “leaving a secure future and heading out on your own.” But what was the risk of getting out of a tenement house? What kind of security lies in needing a part-time job on top of a full-time one to make ends meet? You make your own security. You have that opportunity in America. With the right attitude, you have that chance.
The Herd Mentality As human beings it is only natural for us to want to be accepted, to belong to the group. But being a part of the group also can be detrimental to personal growth—mentally, physically, and financially. Consider two men who work side by side on a General Motors assembly line. Both have been doing the same thing at the same speed for 20 years. Along comes a new hire with new values and goals that prompt him to work much faster. The result is that assembly line productivity increases 20 percent. What would these old-timers say to the new guy? I think their comments would go something like this: “What are you doing? You’re making the rest of us look bad, so slow down.”
8
Let’s Talk Money
At that point, the new guy no longer is part of the group and is not accepted for his gung-ho attitude. What should he do? Back down? No! He should tell those people that he is not trying to make things difficult for them, but he does not intend to be on the assembly line the rest of his life. He has made a conscious decision to follow his goals and his values, and he is willing to risk exclusion from the group to succeed. He has decided to f ly like an eagle. That’s what I did when I decided to go to college to open my mind and change my financial lot in life. I didn’t know what I wanted to do; all I knew was that my brain was going to get it, and that financially I could accomplish anything I set out to do as long as I made the commitment to my goals, was willing to work hard and smart, and viewed defeats along the way as stepping stones to a better future.
The Role of Values When I set off on my quest, my values didn’t change. Years later, despite my many successes, I still value money based on the fact that I grew up without it. To this day, if I see a penny on the street, I pick it up. I still turn off lights in our 20,000-square-foot home, and turn off the air-conditioner in our office building. It’s an automatic process that is the outgrowth of a value system learned long ago. For my children, as is typical with succeeding generations, it’s different. Like most parents, I wanted my kids to have what I didn’t have, and I gave it to them. But there’s a problem with that. By giving our children so much, often we take away from them the very incentives that made us successful—the drive and the fire in the belly to succeed. It becomes a balancing act to instill the right values, yet give your children and grandchildren those things which you did not have.
Making Them Understand How do you do it? Here’s one way. My son, James Michael, grew up in a privileged environment. He attended private schools and, like his friends, had the newest and hottest of everything. When he turned 16, he got his driver’s license. Naturally, he came to me and asked for a car. “Do you really want one?” I asked. “If you really and truly do, you make the first $1,000, then we’ll be partners on the rest.”
Making the Commitment
9
Instantly, that kid who had never worked in his life had two jobs. It didn’t take him long to come up with the $1,000. Why did I make him do that when I easily could have bought him a car? I wanted him to understand the value of a dollar and that to achieve a certain goal, you must have that fire in your belly. You must want it badly enough to be willing to sacrifice. I was trying to instill in my son a value system. It worked. Today James Michael Barry, CFP , is president of our company, Barry Financial.
WHAT IS MONEY? Money itself doesn’t make you happy. In those days when I didn’t have it, I thought it would. But it doesn’t. Money has only one purpose. It is a bartering tool that buys the ability to trade for goods and services. It should not be the main priority in your life. All the material goods in the world won’t fill the emptiness in your life if you are alone. Money doesn’t greet you with a smile in the morning. It doesn’t care how old you are. What really matters is family, loved ones, friends, and their comfort and well-being. I always wanted to own a Rolls Royce. To me it was the symbol of success. After I bought one, I realized it’s not what I thought it would be. It’s always in the shop for repairs. The point is that possessions do not make us truly happy. But we’re hooked on the chase to get those material goods that are so much a part of our lifestyles. True happiness is having a wife who still loves me after 48 years as well as children, grandchildren, great-grandchildren, and friends. If your goal is solely to accumulate wealth and have no one else with whom to share it, yours is going to be a lonely and unsatisfying life. Don’t forget, too, that you don’t really own a single thing in life. You are simply the custodian. You came into the world with nothing, and when you cross the great divide, you leave with nothing. That’s the great equalizer. When you die, you go with a tag on your toe and that’s it. I’ve never seen a U-Haul behind a hearse. The ancient Egyptians thought they could take the fruits of their labors with them to the afterlife. They built fabulous pyramids with burial chambers filled with material signs of their wealth. But reality is that 3,000 years later, the fragments of those worldly possessions litter the sand-blown deserts.
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Let’s Talk Money
FIGURE 1.3 The Real Cost of Inflation
Half-Gallon of Milk: +895% Automobile: +1,714% A Day in the Hospital: +25,608%
1934
1980
2003
20 cents
$1.08
$1.99
$1,436
$7,530
$26,043
$12
$344
$3,085
Sources: Mutual of Omaha’s Current Trends in Health Care and Dental Costs Utilization 2002; National Automobile Dealers Association; Royal Crest Dairy; The Denver Post.
The Inflation Culprit Neither is money an antique never to be touched except to look at once a year. The dollar is constantly losing its purchasing power because of inf lation—an average 4 percent a year for the past 60 years. That means a dollar from 20 years ago is worth just 38 cents today. The cost to mail a letter 20 years ago was 15 cents. As this book goes to press, it’s 37 cents and rising fast. A new automobile on average was $7,500 in 1980; today it’s $26,000. A single day in the hospital on average was $345 a day. Now it’s almost $3,100. To buy what $10,000 bought 69 years ago, you would need $131,314 today, according to the U.S. Bureau of Labor statistics. You get the idea. What’s going to happen to the price of a loaf of bread in five years, the price of a car, your real estate taxes, or that college education for your children or grandchildren? The cost of almost everything is going up, so it’s essential that your dollars grow too. That’s one reason financial planning is so important. Without it, you can sit back and watch inf lation gobble up your purchasing power. Figure 1.3 details the cost of inf lation for some common expenses. But, if you plan right so your money keeps working for you, it’s possible to face inf lation without f linching. The reason is the Rule of 72— the time it takes to double an investment at various rates of return compounded annually. Simply divide 72 by the annual return on an investment to calculate how many years it will take your money to double in value. A 10 percent annual return, for example, will double your invest-
Making the Commitment
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FIGURE 1.4 The Rule of 72
The Rule of 72 refers to the time required for an investment to double in value at various rates of return compounded annually. To determine how long it will take for an investment to double in value, simply divide the annual return into 72. Annual return (%) 3 4 5 6 8 10 12 14 16 18 20
Years to Double Investment 24.4 18.4 14.4 12.4 19.4 17.2 16.4 15.1 14.5 14.4 13.6
ment in 7.2 years because 72 divided by 10 equals 7.2. That means if you have a $10,000 investment, in 7.2 years it becomes $20,000. The table in Figure 1.4 displays some examples of the Rule of 72. If you’re thinking that an investment today can’t possibly have a 10 percent return, you’re wrong. The average rate of return on the S&P 500 since 1925 has been 10.2 percent per year. That’s despite wars, recessions, catastrophes, and everything else that’s happened over the past 77 years! Opportunities exist there for the average investor, especially when you factor in legal tax avoidance or deferral features of certain investments. (See Chapter 8 for more information about investing.) The Rule of 72 applies to what things cost, too. For example, if your rent costs $1,000 a month and inf lation is 4 percent a year, the cost of your housing will double in 18 years.
Savers Lose The answer, however, is not to put all your money in savings accounts, tax-free bonds, corporate bonds, or even Christmas accounts or certificates of deposit, despite the feeling of security they may give you. I call the latter certificates of depreciation. These are all wasting assets because the principal does not grow. Historically these have been con-
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Let’s Talk Money
sidered low risk, but, over time, playing it safe can mean the risk of losing out to inf lation, and don’t forget taxation. Savers lose. Investors win.
Shift in Attitude Growing your wealth starts with a fundamental shift in your thinking. Look at your brain as a computer. It’s the hardware. Now take an imaginary screwdriver and open up your brain to get inside your mind, which is the software. The software package that makes your brain work consists of all your past experiences including admonitions from your childhood. For me it was things like: Catholics don’t eat meat on Friday; nuns can read your mind; always own your home free and clear; always wear clean underwear. (If I’m in a car wreck, does it really matter to the emergency room doctor that I’m wearing clean underwear?) This is the stuff programmed in your mind. Get rid of those outdated programs that don’t work under today’s circumstances and replace them with updated versions of the software. If you don’t, it’s like my doing your tax return today with the Tax Reform Bill of 1944. It doesn’t work.
Renting Out Your Money It’s the same with those perceived “safe” investments like CDs, bonds, and other similar nonappreciating, inf lation-ravaged options. First, the interest you perceive to be income really isn’t. It’s rental income. When you put your money in a savings account, a tax-free bond, or a CD, you are actually lending that money to an institution. You are saying, “Here is my money for a certain length of time.” In exchange, you receive rental income. With the exception of tax-free bond income, you then must belly up to the bar and pay income taxes on that rental income unless it is held within a qualified retirement program. So what’s left for you? If you make 5 percent rental income on your money and are in the 30 percent tax bracket, 30 percent of 5 percent means you pay 1.5 percent of that income to the federal government in taxes. If you don’t count the additional state income taxes that may be due, that leaves only 3.5 percent in your hands. But the average annual rate of inf lation in this country for the last 68 years, has been 3.9 per-
Making the Commitment
13
cent. The principal dollars that you get back at the end of the rental period may be $100,000, but what’s 3.9 percent of $100,000? You actually get back about $4,000 less for every year you rent out your money. That $100,000 principal no longer buys $100,000 in goods and services when you go to pay your real estate taxes or your children’s or grandchildren’s education. Your money depreciates every single year and has since 1954. That doesn’t mean I’m against CDs, tax-free bonds, or money-market funds. The questions instead are: in what amounts, for what purpose, and where do they fit into your overall personal financial plan? Let’s assume, for example, that you have a college tuition bill due in three months. A short-term CD or money market might be just the place to stash the money if you didn’t take advantage of other education savings programs or a 529 Plan (more on that in Chapter 3).
MORE WASTING ASSETS Collecting wasting assets is a big habit all of us have learned thanks to this credit-card-crazy world. Whether a card carries an interest rate of 8 percent, 12 percent, 18 percent, or higher, that interest is not tax deductible. If you go to any store and f lip out your card to buy a stereo, its real cost is the sales price plus the credit card’s interest payment. The day you buy that stereo system, take it home, and open the box, you cannot sell it to your neighbor for the same price. That stereo, like a car, is a wasting asset that you pay for over perhaps 18 months at 18 percent interest that you cannot deduct on your tax return. A year later if you decide to replace the wasting asset with something that’s newer and better, you’re still paying the interest on that wasting asset and you still can’t recover what you paid for it. Consider an alternative shift in attitude toward buying wasting assets. What about buying an increasing asset, holding it for a time, then liquidating a portion of it to buy the wasting asset with the profits? What does that mean? Instead of the herd mentality that says go to Circuit City and charge the stereo system, perhaps you buy some shares of a quality stock. Over a reasonable period of time, if the selection is right, the stock or equity in the company increases in value. If you buy the stock at $50 a share and it climbs to $100 a share, that’s an increasing
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asset. Now liquidate some of the appreciated shares, take the profits to the store, and buy the wasting asset—the stereo. It’s so simple.
THE BOTTOM LINE • Accumulating wealth is up to you. It takes commitment. • Take a positive attitude. Blaming others for where you are in life isn’t the answer. • Forget the traditional attitude that dictates putting your money in CDs, money-market accounts, and other “safe” fixed-principal investments. They’re not safe from inf lation! • Accumulating money and material possessions is not enough. Life planning is a balancing act that must combine finances with family and companionship. Money alone cannot make you happy. • Learn to buy appreciating assets, not wasting ones.
C h a p t e r
2 TAKING CHARGE Know Your Strengths and Weaknesses
T
he road to building your wealth begins with independent thinking. Your mind is a resource, a think tank, so take control, use it, and forget the herd mentality. Get outside the box. Plug the right software program into your brain to allow you to be productive, enthusiastic, knowledgeable, and positive, then f ly like the eagle. When I decided at age 22 to buy my first home—a two-family house outside Boston—for $21,000, I borrowed all of the money. My dad, who had never owned a home, thought I was crazy. “How much money do you have to borrow?” he asked, horrified. When I told him, he said to me, “Do you know that I could have bought that same home for half that amount 15 years ago?” I looked at him and replied, “Why didn’t you?” Ten years later I sold the home for $38,000.
THE “NO DECISION” DILEMMA Not making a decision is a decision itself. It’s a choice to do nothing. When my dad didn’t buy the two-family home years before, that was a conscious decision to do nothing. 15
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All of us have been there. We have put our heads in the sand and ignored our responsibility for our future and the futures of our families, our loved ones, and future generations. For some of us, it’s happened more than once. I always wanted to start my own business. Twice I stepped up to the plate to do so, and both times I backed down. It was tough for me to leave the Putnam Group where I was a senior vice president. At the time I was married and had kids, family responsibilities, and college education bills. The corporate job represented shelter and security. I suppose I had to go through the equivalent of a training program—the various stages in my life—until I was ready to be that eagle and f ly. The third time I toyed with going out on my own, my wife, Rosemarie, said to me, “Jim, do you remember when we first got married and lived in a one-bedroom apartment and didn’t have two nickels to rub together? What’s the worst that can happen if you start your own company and fail? You can always go back to the corporate world. I’m tired of hearing you talk about it. Either do it or don’t, but I don’t want to end up with a 70-year-old husband always saying ‘What if ?’” I broke out of the fold, started the business, and the rest is history. Remember the slogan for athletic goods giant Nike: Just do it. Most people don’t.
CHART YOUR FLIGHT PLAN Building wealth starts with a plan. Without one, you’re lost. Imagine boarding a f light from Florida to New York City and asking the captain how long the f light will be, to which he responds, “Maybe two to five hours.” What if you also asked him what route he is taking to avoid the hurricane offshore and he replied, “What hurricane?” I don’t know about you, but I would get off that plane pronto. I wouldn’t want to f ly with a captain who doesn’t know where he’s going or what’s happening around him. Well, you are the captain of your financial destiny. What is your life plan? Beyond your investment plan, do you have a will, durable power of attorney, a living trust, and other estate-planning tools? Would I want to travel with you at the controls based on your plan today? The answer probably is a resounding no.
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IDENTIFY YOUR WEAKNESSES To put together a successful life financial plan, you also have to recognize your weaknesses. Then, learn to tap OPB—other people’s brains—to make up for your shortcomings. Successful investors, like successful athletes, have coaches—impartial OPBs to steer them in the right direction. I didn’t build my car or my house; chances are you didn’t build yours or the components in them either. You relied on other individuals, experts in those fields, to do that for you. The same thing holds true with money management. Use professionals in money management whose job it is day in and day out to get the best possible return on an investment objective.
Your Advisor Is Your Coach Your financial planner is your coach, the big-picture person who analyzes the first phase of what’s going on, helps devise strategies, then aligns with OPBs—specialists—elsewhere in the industry to help get the rest of the job done. This orchestrator of your financial plan also should be there if you have questions about an investment, a strategy, or even the wording in a prospectus. Unfortunately, many people don’t use the experts, and that’s wrong. Did quarterback great John Elway achieve football success on his own? What about home run king Barry Bonds, figure-skating champion Michelle Kwan, or basketball powerhouse Michael Jordan? All these pros had coaches, experts to identify objectively their weaknesses and help them orchestrate a solution. When it comes to financial planning, that’s what you have to do too. Forget the excuse that you don’t have enough money to hire a “coach.” When you buy a shirt, you have plenty of price options—from Target to Neiman Marcus and everything in between. The same is true of financial planners. They come in all price ranges. (See Chapter 11 for more information about hiring the right advisors.) Once you hire a coach, he or she needn’t be with you for the rest of your life. Great athletes change coaches. So should you if you did your homework before you hired that person, truly gave him or her the authority and responsibility to do a good job for you over time, and you’re still not satisfied. If, for example, long-term returns—five to seven years—on your portfolio are down while markets are up, look for
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a new advisor. Also, don’t be afraid to ask your advisor for justification if you disagree with an investment. The only dumb questions are the ones you don’t ask. My mother died of cancer at age 63. She had the same doctor for 30 years, but he never diagnosed the problem, and she never challenged him or asked the important questions. At Barry Financial, the first thing a new client does with the help of a Barry wealth manager is fill out a fact-finding questionnaire that asks those important questions. The document covers everything from personal data on you and your spouse—basics like name, address, occupation, and assets and liabilities—to important details, like prenuptial agreements, chronic illnesses in the family, sibling or other family issues, estate-planning documents, and your philosophies on life, money, family, and retirement. (Check out the complete questionnaire at the end of this chapter.) I’ve found over the years that people usually have several brokerage accounts at discount and full-service companies; their will, if they have one, was drawn up years ago and never looked at since; their tax return is handled by a CPA who never looks at their investments; and they own lots of different stocks or mutual funds in an IRA but have no idea whether the holdings duplicate. Disorganization is the rule because there is no plan and no one at the controls. Just as you need a f light plan to get from point A to point B on your financial journey, you need a pilot to f ly your plane to its destination. How can you achieve your financial and personal goals without that bigpicture person at the helm?
T-Square Approach Choosing the right coach or pilot depends on your strengths and weaknesses. You want someone who excels in the areas of your weaknesses. To help identify your strengths and weaknesses, it’s useful to write them down. Try the T-square approach. Draw a T-square with strengths on one side and weaknesses on the other as shown in figure 2.1. Then list the talents, skills, and abilities at which you excel and have nurtured on the side of strengths. Next, consider your shortcomings and list them on the other side of the T-square. Be painfully honest because the sole purpose of this exercise is to help you understand yourself.
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FIGURE 2.1 The T-Square Approach
STRENGTHS
WEAKNESSES
If you’re married or in a relationship, your spouse or significant other also should fill out a T-square. Then, look for advisors who excel in the areas in which you and your spouse have weaknesses. The end result is more likely to be a harmonious, holistic approach to building and managing your wealth.
TAKE CONTROL After you know your strengths and weaknesses, it’s time to take control of your financial life. That doesn’t mean drawing up an elaborate budget. That’s not the way to achieve success and build wealth because budgets are like diets; people don’t like them and they don’t work. What does work is understanding the big picture—your total financial situation, what has to be accomplished, and how it can be done. While this includes putting together some kind of a budget, it does not have to be so specific as to account for every cent you pay for postage stamps. This is not supposed to be punishment. It is to help identify a problem and turn it into an opportunity to achieve your objectives.
Set Goals Think of your objectives as goals to accomplish over the short term, intermediate term, and long term. The latter includes funding your
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IRA. An intermediate goal could be a plan to buy a home in three to five years. A short-term objective could be the college tuition bill due in three months. Whether you’re single or married, the best approach to achieve your goals is to think of your finances as a business. You are the chairman of the board or co-chairman with your spouse if it’s a “family business.” Within that business is a written business plan: where are you, where have you been, where you propose to go, and how are you going to meet those objectives.
The “Nut” Any business also has what’s known as the “nut,” the expenses of doing business. Your imaginary business has that nut which is your expenses, such as rent or mortgage payments, groceries, education, automobile repairs, home repairs, real estate taxes, life insurance premiums, and so on. The next step to running your family business is to determine your current cash f low, which is the money coming in the door to pay the nut. If the nut is greater than the cash f low, the problem down the line is bankruptcy. That is why it is important to identify the nut, which is where your money goes, and then the sources of cash f low. Also, keep in mind that as a business, your nut keeps growing every year. The heating bill, the college expenses, the food on the table, the real estate taxes, the clothing on your back all increase in cost every year, so your cash f low needs to go up, too. Once your business plan is on paper, you may be able to find areas to pare down expenses or grow cash f low. These decisions are up to you. Make them with the ultimate short-term, intermediate-term, or longterm goals in mind. And remember to think of problems as opportunities waiting to be solved.
GET RID OF THE NOISE Once you take off on your investment journey, for sanity’s sake, follow a few cardinal rules including: • Don’t be overwhelmed by all the information that bombards you daily. It’s just noise, so tune it out.
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• Always consider the source of information. Sound bites or a tip from your neighbor don’t constitute the whole story. If you’re relying on “hot tips” in some financial publication to make your investment decisions on a given day, you could be making the wrong decisions because the information could be out of context, short-sighted, or even inaccurate. • Do your homework on an investment or strategy. Look to impartial reports from regulatory agencies like the Securities and Exchange Commission or the National Association of Securities Dealers. Read a stock’s annual report instead of listening to what the financial pundits say. Stock picking is about focusing on the fundamentals of each company, not about trying to predict what will happen with interest rates, elections, the direction of the yen or Euro, or where the Nasdaq is headed. • Think long term (more on this in Chapter 7). Before buying a mutual fund, make sure you understand the stated objective of the fund. It’s spelled out in the prospectus and material provided to you. If that fund’s manager deviates from the stated objective even though the fund’s performance may have improved, fire him! Why? He is deviating from the stated objective of the fund and could be adding more risk than is acceptable. Look at the turnover of holdings in a fund and the expense ratio. There is no set acceptable number for either. The Vanguard Group, a leader in investment management that offers competitive investment performance, has a broad array of funds and the lowest average expense ratios among families of retail mutual funds. However, just because a fund has a high expense ratio doesn’t mean it should be eliminated. Find out why. For certain types of funds, higher-than-average expense ratios may be justified. If you’re running a technology fund, for example, there could be tremendous turnover of assets—perhaps 200 percent in one year—compared with a balanced fund. Also look at a fund’s management. Some funds like Putnam or Fidelity are managed by recognized experts. Others, like American Fund Group’s ICA Fund, rely on a committee. One form of management is not necessarily better than another. But do your homework. What is the fund’s track record? Is the performance based on recommendations from the existing fund manager or one who left three years ago?
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• Keep in mind that fund managers today generally are in their mid-30s, and until the Internet bubble burst in 2000, the last bear market occurred during 1973 and 1974. That means we have a generation of very bright and well-educated fund managers. But the skills of most have barely been tested by a real bear market, one in which stock prices have a prolonged drop of 20 percent or more. That’s why it’s also important to consider a fund’s culture and long-term outlook.
Forget the Uncontrollable Don’t stay glued to CNBC or CNN all day. You can’t let yourself be bombarded with information overload. Forget daily market swings. If you spend time worrying about things over which you have no immediate control, when are you going to have time to worry about the things you can control? Can you control the weather, or whether Fed chairman Alan Greenspan will cut interest rates, or who the next CEO of General Electric will be? Of course not. Don’t worry about it. If the Dow Jones Industrial Average tanks because the president of the United States steps down, as happened with Richard Nixon in 1974, or there are record bank failures amid S&L scandals, as happened in 1988, or even if the United States is under terrorist attack on home soil, as happened on September 11, 2001, understand these are events beyond your control. Realize that people still drink Coca-Cola, drive cars, heat their homes, go to Disney World, attend college, buy clothes, purchase homes, and more. That’s what makes the system work. It’s not the federal government. People somehow believe that the federal government is the great provider of all our services. That’s a falsehood. What supports the federal government is the funding that comes from the public in the form of taxes. The individual, the small business, and the big corporation all pay taxes and make the system work. If an investment like a U.S. savings bond says, “Backed by the full faith and credit of the United States of America,” it doesn’t mean that Uncle Sam is guaranteeing it. It’s you and I who guarantee the guarantee. We are the people who pay the taxes. If Coca-Cola goes out of business, if IBM tanks, if Microsoft, Walt Disney, and dozens more companies fold, the “guarantee” won’t mean much. With our system—one
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that’s stable and allows private enterprise to thrive—markets go up over time, period. Recognize that. Look back in Chapter 1 to where I talked about how the Dow, the S&P 500, and the Nasdaq have gone up over the long haul, despite tumultuous events. What seemed like devastating blows to the markets at the time, are barely blips in the long term. Yes, the market is volatile, but the longer the time period the less volatility. Zero in on October 1987 when the Dow Jones Industrial Average plummeted. I’m sure on that day or in subsequent weeks, investors felt as if they were on a roller coaster. Long term, it’s a smoother ride.
The Caveat: Diversification What I’ve said is true with one caveat. Diversification. Don’t put all your money in a single company or country. We’ve all seen what happened to people’s life investments with the bankruptcies of Enron, Tyco, and Global Crossing. You wake up one morning and the company is in trouble, bankrupt, or out of business, and the money is gone. Diversify, diversify, diversify. Consider how diversification can limit losses by looking again at the ICA Fund. If you had invested $10,000 in ICA in December 2002, and, hypothetically, Philip Morris Cos. went out of business, you would lose only $344 of your $10,000; if IBM tanked, your loss would be just $112; PepsiCo, only $80; General Motors, $109; General Mills, $57; Bank One, $54, and so on (figures American Funds Distributors, Inc.; used with permission). Proper diversification is your hedge. Use it.
My Fact-Finding Questionnaire: Beyond the Facts Why bother with the detailed questionnaire at the end of this chapter? Remember the pilot who needs a f light plan to get from point A to point B? Well, this data sheet is the starting point for your life’s financial plan. This is a tool to use to collate your assets, delve into your feelings toward money and investing, understand your goals, and then chart the right course to get there. That’s what we at Barry Financial do. From this questionnaire that a client fills out with the help of a professional planner, we develop an actual written blueprint of a financial plan. With the client, we determine his or her short-term, intermediate-term, and long-term goals, and the best way to achieve those goals given his or her attitudes, feelings, and circumstances.
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Lots of financial planners have data sheets. My 7-year-old grandchild could fill them out because they’re just basic data-gathering questions. But most of these questionnaires miss the point. They fail to probe your mind-set, attitudes, feelings, and aspirations—all of which are so essential to creating an achievable and successful financial plan. Instead of tackling this questionnaire on your own, do it with the right financial planner for you. (See Chapter 11 to learn about hiring an advisor.) That’s sound advice no matter what your financial stage in life. If he or she is a good planner, some of the questions on the data sheet will provoke more questions, and your answers provide that planner a greater insight and understanding into you. If you decide to try this couch psychology on your own without someone else guiding or interpreting for you, a word of warning: Be very honest with yourself about your feelings, emotions, and concerns. After all, this is a tool to help you organize your finances and your thinking toward your financial situation today, tomorrow, and for your heirs. It’s a guide that says: Where have I been? Where am I? Where am I going? How do I propose to get there?
THE BOTTOM LINE • Think out of the box; forget the herd mentality. It doesn’t matter what your neighbor thinks of your work ethic, only what you think. • Honestly evaluate your strengths and weaknesses, then capitalize on OPB (other people’s brains) that complement your shortcomings. • Approach managing your personal finances like a business. You are the CEO, your expenses are the cost of doing business, and your income is the cash f low. • Tune out the noise. With less noise, you can concentrate on the important things. Daily market f luctuations don’t matter. Investing is a long-term process. • Use the fact-finding questionnaire that follows.
Taking Charge
FIGURE 2.2 Fact-Finding Questionnaire
Confidential First Appointment Questionnaire Barry Financial Group 40 S.E. 5th Street, Suite 600 Boca Raton, FL 33432 Phone: 561-368-9120 or 800-366-9120 Fax: 561-395-4855 Web site: <www.talkmoney.com> Personal Data Name: ______________________________________________________________________________ Gender: ________ Date of Birth: __________ Age: _______ Social Security #: ___________________ Address: ___________________________________________________________________________ _____________________________________________________________________________________ Phone: _____________________ Fax: _____________________ E-mail: ________________________ Alternate Address: ___________________________________________________________________ Alternate Phone: ___________________________ Alternate Fax: _____________________________ State of Residence: ____________ Citizenship: ____________ Birthplace: _______________________ Occupation: _____________________________ (If retired, former occupation and date of retirement) Employer’s Name: __________________________ Client’s Position: ___________________________ Employer’s Address: __________________________________________________________________ Work Phone: _____________________________ Work Fax: _________________________________ Cell Phone: _______________________________ Marital Status: _________________________ (If applicable) Number of Years Married? ____________ Any Prenuptial or Postnuptial Agreement? ❏ Yes ❏ No Any Prior Marriages? __________________ If yes, how did they end? ___________________________ When? _________________________________________ If yes, are there any current obligations? __________________________________________________ Do you smoke? _______________ Any major or chronic illnesses: _____________________________ _____________________________________________________________________________________ Medications: ________________________________________________________________________ Spouse Name: ________________________________________________________________________ Gender: ______ Date of Birth: _____________ Age: _______ Social Security #: ___________________ State of Residence: ____________ Citizenship: ____________ Birthplace: _______________________ Occupation: _______________________________________________ (If retired, former occupation) Employer’s Name: __________________________ Client’s Position: ___________________________ Employer’s Address: __________________________________________________________________ Work Phone: _____________________________ Work Fax: _________________________________ Cell Phone: _______________________________ E-mail: _____________________________________________________________________________
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FIGURE 2.2 Fact-Finding Questionnaire (continued)
Any Prior Marriages? __________________ If yes, how did they end? ___________________________ When? _________________________________________ If yes, are there any current obligations? __________________________________________________ Do you smoke? _______________ Any major or chronic illnesses: _____________________________ _____________________________________________________________________________________ Medications: ________________________________________________________________________
Children Son: ______ Daughter: ______ First Name: ___________________ Last Name: ____________________ Birth Date: ________________ Age: ________ Marital Status: _________ # Years Married: __________ Occupation: _____________________________ Employer: ____________________________________ Spouse (if applicable) First Name: ______________________ Last Name: ________________________ Occupation: _______________________________ Employer: __________________________________ Birth Date: _____________________ Age: _______________ Any children? (How many) ____________ Street Address: _______________________________________________________________________ City: _____________________________________________ State: _________ Zip: ________________ Phone: _____________________________________ Financially Independent? _____________________ Names of Children Birth Dates Special Issues, Health Concerns, etc. _______________________________________________________________________________________ _______________________________________________________________________________________ _______________________________________________________________________________________ _______________________________________________________________________________________ Any additional family issues of which we should be aware: _____________________________________ Son: ______ Daughter: ______ First Name: ___________________ Last Name: ____________________ Birth Date: ________________ Age: ________ Marital Status: _________ # Years Married: __________ Occupation: _____________________________ Employer: ____________________________________ Spouse (if applicable) First Name: ______________________ Last Name: ________________________ Occupation: _______________________________ Employer: __________________________________ Birth Date: _____________________ Age: _______________ Any children? (How many) ____________ Street Address: _______________________________________________________________________ City: _____________________________________________ State: _________ Zip: ________________ Phone: _____________________________________ Financially Independent? _____________________ Names of Children Birth Dates Special Issues, Health Concerns, etc. _______________________________________________________________________________________ _______________________________________________________________________________________ _______________________________________________________________________________________ _______________________________________________________________________________________ Any additional family issues of which we should be aware: _____________________________________
Taking Charge
FIGURE 2.2 Fact-Finding Questionnaire (continued)
Children (continued) Son: ______ Daughter: ______ First Name: ___________________ Last Name: ____________________ Birth Date: ________________ Age: ________ Marital Status: _________ # Years Married: __________ Occupation: _____________________________ Employer: ____________________________________ Spouse (if applicable) First Name: ______________________ Last Name: ________________________ Occupation: _______________________________ Employer: __________________________________ Birth Date: _____________________ Age: _______________ Any children? (How many) ____________ Street Address: _______________________________________________________________________ City: _____________________________________________ State: _________ Zip: ________________ Phone: _____________________________________ Financially Independent? _____________________ Names of Children Birth Dates Special Issues, Health Concerns, etc. _______________________________________________________________________________________ _______________________________________________________________________________________ _______________________________________________________________________________________ _______________________________________________________________________________________ Any additional family issues of which we should be aware: _____________________________________ Son: ______ Daughter: ______ First Name: ___________________ Last Name: ____________________ Birth Date: ________________ Age: ________ Marital Status: _________ # Years Married: __________ Occupation: _____________________________ Employer: ____________________________________ Spouse (if applicable) First Name: ______________________ Last Name: ________________________ Occupation: _______________________________ Employer: __________________________________ Birth Date: _____________________ Age: _______________ Any children? (How many) ____________ Street Address: _______________________________________________________________________ City: _____________________________________________ State: _________ Zip: ________________ Phone: _____________________________________ Financially Independent? _____________________ Names of Children Birth Dates Special Issues, Health Concerns, etc. _______________________________________________________________________________________ _______________________________________________________________________________________ _______________________________________________________________________________________ _______________________________________________________________________________________ Any additional family issues of which we should be aware: _____________________________________ Son: ______ Daughter: ______ First Name: ___________________ Last Name: ____________________ Birth Date: ________________ Age: ________ Marital Status: _________ # Years Married: __________ Occupation: _____________________________ Employer: ____________________________________ Spouse (if applicable) First Name: ______________________ Last Name: ________________________ Occupation: _______________________________ Employer: __________________________________ Birth Date: _____________________ Age: _______________ Any children? (How many) ____________
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FIGURE 2.2 Fact-Finding Questionnaire (continued)
Street Address: _______________________________________________________________________ City: _____________________________________________ State: _________ Zip: ________________ Phone: _____________________________________ Financially Independent? _____________________ Names of Children Birth Dates Special Issues, Health Concerns, etc. _______________________________________________________________________________________ _______________________________________________________________________________________ _______________________________________________________________________________________ _______________________________________________________________________________________ Any additional family issues of which we should be aware: _____________________________________ Son: ______ Daughter: ______ First Name: ___________________ Last Name: ____________________ Birth Date: ________________ Age: ________ Marital Status: _________ # Years Married: __________ Occupation: _____________________________ Employer: ____________________________________ Spouse (if applicable) First Name: ______________________ Last Name: ________________________ Occupation: _______________________________ Employer: __________________________________ Birth Date: _____________________ Age: _______________ Any children? (How many) ____________ Street Address: _______________________________________________________________________ City: _____________________________________________ State: _________ Zip: ________________ Phone: _____________________________________ Financially Independent? _____________________ Names of Children Birth Dates Special Issues, Health Concerns, etc. _______________________________________________________________________________________ _______________________________________________________________________________________ _______________________________________________________________________________________ _______________________________________________________________________________________ Any additional family issues of which we should be aware: _____________________________________
Family Discussion Please list any living parents, their ages, where they live and any issues that affect your situation (health concerns, financial dependence on you, etc.). Client’s Parents: ______________________________________________________________________ _______________________________________________________________________________________ _______________________________________________________________________________________ _______________________________________________________________________________________ Spouse’s Parents: ______________________________________________________________________ _______________________________________________________________________________________ _______________________________________________________________________________________ _______________________________________________________________________________________ Are any of your relatives (parents, siblings, adult children, others) dependent on you for financial support? ❏ Yes ❏ No If yes, please describe: _________________________________________________________________ _______________________________________________________________________________________
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FIGURE 2.2 Fact-Finding Questionnaire (continued)
Financial Assets Nonretirement Accounts Cash Equivalents at Banks/Credit Unions (not held at brokerage firms) Please list name of institution under each account category. Checking Accounts
Owner
$ Amount
Owner
$ Amount
Owner
$ Amount
Owner
$ Amount
Owner
$ Amount
1) 2) 3) Savings Accounts 1) 2) 3) Money Market Accounts 1) 2) 3) Certificates of Deposit (include maturity dates) 1) 2) 3) Treasury Bills/Notes/Bonds 1) 2) 3) Total Cash Equivalents
*Note: Ownership should specify trust ownership if applicable, along with name of trust.
$
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FIGURE 2.2 Fact-Finding Questionnaire (continued)
Nonretirement Accounts Investment Accounts Brokerage Company Name: Account Holdings
Account Owner: Quantity
Date Bought
$ Current Value
$ Cost Basis
Cash/Cash Equivalents Bonds Stocks Mutual Funds Other Total Account Value:
Brokerage Company Name: Account Holdings
Account Owner: Quantity
Date Bought
$ Current Value
$ Cost Basis
Cash/Cash Equivalents Bonds Stocks Mutual Funds Other Total Account Value:
Brokerage Company Name: Account Holdings
Account Owner: Quantity
Cash/Cash Equivalents Bonds Stocks Mutual Funds Other Total Account Value:
Date Bought
$ Current Value
$ Cost Basis
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FIGURE 2.2 Fact-Finding Questionnaire (continued)
Retirement Accounts Client Accounts Type of Account
Institution
Current Value
(IRA, 401(k), pension, etc.)
Beneficiaries Primary and Contingent
______________________
___________
_______________
___________________
______________________
___________
_______________
___________________
______________________
___________
_______________
___________________
______________________
___________
_______________
___________________
Are you taking required minimum distributions from your IRA?
❏ Yes ❏ No ❏ N/A
If yes, who is making the calculations for your required minimum distributions? ____________________ ______________________________________________________________________________________ ______________________________________________________________________________________ ______________________________________________________________________________________
Type of Account
Institution
Current Value
(IRA, 401(k), Pension, Etc.)
Beneficiaries Primary and Contingent
______________________
___________
_______________
___________________
______________________
___________
_______________
___________________
______________________
___________
_______________
___________________
______________________
___________
_______________
___________________
Are you taking required minimum distributions from your IRA?
❏ Yes ❏ No ❏ N/A
If yes, who is making the calculations for your required minimum distributions? ____________________ ______________________________________________________________________________________ ______________________________________________________________________________________ ______________________________________________________________________________________
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FIGURE 2.2 Fact-Finding Questionnaire (continued)
Directly Owned Investments (not held at a brokerage firm) Do you own investments that are not shown on a statement (kept in your safe deposit box, filing cabinet, etc.)? Stocks: name of co. & symbol
# Shares
Owner
Current Value
Date Bought
Cost Basis
# Bonds
Owner
Current Value
Date Bought
Cost Basis
# Shares
Owner
Current Value
Date Bought
Cost Basis
11) 12) 13) 14) 15) 16) 17) 18) 19) 10) Bonds: include maturity, coupon % 11) 12) 13) 14) 15) 16) 17) 18) Mutual Funds: specific names 11) 12) 13) 14) 15) Stock options: Co. Name ______________ # Shares ____ Exercise Price ____ Expiration Date _____
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FIGURE 2.2 Fact-Finding Questionnaire (continued)
Notes/Mortgages Receivable Debtor
Amount
Term (Years) Interest Rate Balloon Date
Owner
___________________
_________
_________
_________
_________
_________
___________________
_________
_________
_________
_________
_________
Investment Real Estate (Please note interest rate pertaining to each mortgage balance.) Type of Property
Location
Current Value
Cost Basis
Owner
Mortgage
1) ___________________
_________
$ ________
$ ________
_________
$ ________
2) ___________________
_________
$ ________
$ ________
_________
$ ________
3) ___________________
_________
$ ________
$ ________
_________
$ ________
4) ___________________
_________
$ ________
$ ________
_________
$ ________
Location
Current Value
Cost Basis
Owner
Mortgage
Principal residence: __________________
$ ________
$ ________
_________
$ ________
Second residence: ___________________
$ ________
$ ________
_________
$ ________
Third residence: ____________________
$ ________
$ ________
_________
$ ________
Personal Real Estate
Personal Property $_________________ (Including household furnishings, jewelry, furs, precious metals, art, antiques, collections, RVs, boats, motor vehicles, etc.) Annuities Please note if fixed or variable. Please attach statements, including subaccount investments and surrender charges. Company & Type
Policy #
Contract Date
Owner
Beneficiary
Current Value
______________________________________________________________________________________ ______________________________________________________________________________________ ______________________________________________________________________________________ Other Assets (Limited Partnerships, etc.) Company & Type
Purchase Date
Cost Basis
Ownership
Current Value
______________________________________________________________________________________ ______________________________________________________________________________________ ______________________________________________________________________________________
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Let’s Talk Money
FIGURE 2.2 Fact-Finding Questionnaire (continued)
Liabilities (not including mortgages listed on previous page) Creditor
Amount
Interest Rate
Credit Cards
__________________
$ __________
___________
Automobile Loans
__________________
$ __________
___________
__________________
$ __________
___________
Home Equity Loan
__________________
$ __________
___________
Margin Debt
__________________
$ __________
___________
Other
$
1) ______________________________________
$ __________
___________
2) ______________________________________
$ __________
___________
Total Liabilities (excluding mortgage debt)
$ __________
35
Taking Charge
FIGURE 2.2 Fact-Finding Questionnaire (continued)
Life Insurance Total Face Amount of All Life Policies: $ ____________________________________ Policy One: Face Amount:
Policy Two: $
Face Amount:
Insured:
Insured:
Owner:
Owner:
Beneficiary:
Beneficiary:
Contingent Beneficiary:
Contingent Beneficiary:
Carrier:
Carrier:
Type:
Type:
Purchase Date:
Purchase Date:
$
Premium:
$
Premium:
$
Policy Loans:
$
Policy Loans:
$
Cash Surrender Value:
$
Cash Surrender Value:
$
Policy Three: Face Amount:
Policy Four: $
Face Amount:
Insured:
Insured:
Owner:
Owner:
Beneficiary:
Beneficiary:
Contingent Beneficiary:
Contingent Beneficiary:
Carrier:
Carrier:
Type:
Type:
Purchase Date:
Purchase Date:
$
Premium:
$
Premium:
$
Policy Loans:
$
Policy Loans:
$
Cash Surrender Value:
$
Cash Surrender Value:
$
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Let’s Talk Money
FIGURE 2.2 Fact-Finding Questionnaire (continued)
Other Insurance Do you have Long-Term Care Insurance?
❏ Yes ❏ No Carrier: __________________________
Purchase Date: _____________________________ Annual Premium: ________________________ Benefit Period: _____________Waiting Period: ____________ Daily Benefit: $__________________ Do you have adequate coverage of the following types of insurance? Medical
❏ Yes ❏ No
Automobile
Liability
❏ Yes ❏ No
Homeowners
Disability
❏ Yes ❏ No ❏ Yes ❏ No
❏ Yes ❏ No ❏ N/A Cash Flow Analysis
Annual Income / Cash In-Flow
Client
Spouse
Total
Wages, Salaries, Bonuses
$
$
$
$
$
$
Monthly
Annual
$
$
Self-Employment Business Income Social Security Benefits Other Government Benefits Taxable Investment Income Nontaxable Investment Income Pension (describe) Pension (describe) Other Other Annual Income / Cash In-Flow
Total Living Expenses See worksheet if necessary. Include income tax and property tax.
Cash Flow Surplus / (Deficit) What is your current tax bracket
$
?10% ___ 15% ___ 27% ___ 30% ___ 35% ___ 38.6% ___
(Please attach past two years’ income tax returns. )
37
Taking Charge
FIGURE 2.2 Fact-Finding Questionnaire (continued)
Household Expenses Worksheet Name: ________________________________________ $ Annually Mortgage and/or rent payments
$ ______________
Utilities (power company, water, phone, garbage, cable TV)
$ ______________
Insurance premiums (life, homeowners, auto, medical)
$ ______________
Groceries, household supplies, cigarettes, liquor
$ ______________
Auto (gas, loan payments, repairs )
$ ______________
Charitable/political/religious contributions
$ ______________
Cleaners, personal care (barber, salon)
$ ______________
Homeowners/condo association fees
$ ______________
Country club dues, recreational expenses, vacations
$ ______________
Entertainment/dining out/sporting events
$ ______________
Clothing
$ ______________
Home repairs, yard/pool maintenance
$ ______________
Security system monitoring/pest control
$ ______________
Legal/accounting/financial services fees
$ ______________
Household help (include Social Security taxes)
$ ______________
Medical, dental, drugs (not reimbursed)
$ ______________
Gifts (birthdays, holidays, weddings)
$ ______________
Subscriptions, books, postage
$ ______________
Furniture/appliance purchases
$ ______________
Education expenses
$ ______________
Career expenses (dues, seminars, meetings)
$ ______________
Boats, horses, airplanes
$ ______________
Federal and state income taxes
$ ______________
FICA (Social Security taxes)
$ ______________
Property taxes
$ ______________
Child support/alimony
$ ______________
Other
$ ______________
Total estimated expenses
$ ______________
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FIGURE 2.2 Fact-Finding Questionnaire (continued)
Estate Planning Documents Do you (and spouse, if applicable) have any of the following? Last Will & Testament:
❏ Yes ❏ No
State in which drawn: _________ Dated: __________
Living Will:
❏ Yes ❏ No
State in which drawn: _________ Dated: __________
Durable Power of Attorney:
❏ Yes ❏ No
State in which drawn: _________ Dated: __________
Health Care Surrogate:
❏ Yes ❏ No
State in which drawn: _________ Dated: __________
Revocable Living Trust:
❏ Yes ❏ No
State in which drawn: _________ Dated: __________
Individual or Joint Trust:
____________
Funded? ____________________________________
Irrevocable/Family Trust:
❏ Yes ❏ No
State in which drawn: _________ Dated: __________
Assets in the Irrevocable Trust: ___________________________________________________________ Have you incorporated generation skipping into your planning? _________________________________ Have guardians been named for your minor children?
❏ Yes ❏ No ❏ N/A
Do you or your spouse anticipate any inheritance(s)?
❏ Yes ❏ No
If yes, please describe how much, from whom, and when: ______________________________________ _____________________________________________________________________________________ When did you last have your estate planning documents reviewed or updated? _____________________
Is your attorney a Board Certified Estate Planning Attorney? ____________________________________
Attorney’s Name:
__________________________________________________________________
Company: _________________________________________________________________________ Address: __________________________________________________________________________
Taking Charge
FIGURE 2.2 Fact-Finding Questionnaire (continued)
Document Checklist Please provide the following documents along with your completed questionnaire. In order for us to design your financial plan, it is necessary for us to refer to these documents. ________ Latest Federal Tax Return (plus prior year, if possible) ________ Latest State Tax Return ________ Gift Tax Returns ________ Bank / Brokerage Statements ________ Retirement Account Statements (including 401(k), 403(b), SEP, profit sharing, etc.) ________ Last Will & Testament (client and spouse, if applicable) ________ Trust Documents (client and spouse, if applicable) ________ Prenuptial or Postnuptial Agreements ________ Annuity Contracts and Statements ________ Life Insurance Policies (declaration and application pages only) ________ Disability Insurance Policies (declaration pages only) ________ Long-Term Health Care Policies (declaration pages only) ________ Other documents unique to your situation: _______________________________________
39
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Let’s Talk Money
FIGURE 2.2 Fact-Finding Questionnaire (continued)
General Discussion What motivated you to make this first appointment with our company? What are your life goals (i.e., charitable work, artistic pursuits, new career, save the environment, family business, activist for social causes, etc.)?
How do you like to spend your free time?
What does money mean to you?
Who makes investment decisions for your portfolio?
If client is decision maker: Do you have a plan for the transition of managing your investment portfolio in case of your incapacity?
What is your investment philosophy and do you have an asset allocation program?
What motivated you to put your money into CDs or Treasuries?
What are your feelings about your portfolio’s performance over the past three to five years? Are there any specific types of investments in which you would not be willing to invest (i.e., individual stocks, mutual funds, bonds, annuities)?
Is protection from stock market fluctuation important to you?
What is your current relationship with your broker?
If applicable: Broker’s Name: Company: Address:
Have you ever been so dissatisfied with a broker that you have gone to arbitration or filed a lawsuit?
Taking Charge
FIGURE 2.2 Fact-Finding Questionnaire (continued)
General Discussion (continued) Please indicate whether the following are issues for you and share with us your specific concerns. Yes
No
___ ___ Reducing estate taxes ___ ___ Reducing income taxes ___ ___ Protection from inflation ___ ___ Maximum investment growth potential ___ ___ Current spendable cash flow from assets ___ ___ College funding for children / grandchildren ___ ___ Retirement planning or current retirement lifestyle issues ___ ___ Make gifts to family (for home down payments, grandchildren’s education, etc. ) ___ ___ Liquidity (assets easily converted to cash) ___ ___ Ensure financial independence over your lifetime ___ ___ Maximize the inheritance for children and heirs ___ ___ Make charitable contributions How do you think your current spending habits will affect your ability to reach your goals?
Please indicate the number of years experience you have with investing in the following: Stocks _____ Mutual Funds _____ Bonds _____ Options _____ Margin _____ Limited Partnerships _____
41
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FIGURE 2.2 Fact-Finding Questionnaire (continued)
Business Information Business Name: _______________________________________________________________________ Business Address: ______________________________________________________________________ Business Phone: _______________________________ Business Fax: _____________________________ Type of Business: ______________________________________________________________________ What are your responsibilities and what do you enjoy most about your work? _____________________ _____________________________________________________________________________________ How did your company begin? Who founded it? _____________________________________________ _____________________________________________________________________________________ What other members of your family are involved in the business? _______________________________ _____________________________________________________________________________________ Form of Business: ❏ Sole Proprietorship
❏ Partnership ❏ Professional Corporation or Association
❏ S Corporation ❏ C Corporation ❏ Limited Liability Company State of Incorporation: _____ Owners/Percentage Interest: __________________________________________________________ Fiscal Year End: ____________ Number of Employees: __________ Annual Revenues: ____________ If you could sell the business to me today, what would be your asking price? Business Valuation: $______ Benefit Plans Group Health:
❏ Yes ❏ No
Disability Insurance:
❏ Yes ❏ No
Business Continuation:
❏ Yes ❏ No
What do you want to have happen to the business when you’re no longer involved? ______________ ___________________________________________________________________________________ Key Employee Insurance:
❏ Yes ❏ No
Life Insurance:
❏ Yes ❏ No
If no, what is the source of money for a buyout? ___________________________________________ Retirement Plan:
❏ Yes ❏ No
Plan Type: ________________________________
Plan Assets: $ __________________________ Number of Participants: _________ Current Concerns or Issues to Discuss: Where do you see the business going in the next few years (strengths, weaknesses)? _____________________________________________________________________________________ _____________________________________________________________________________________
Taking Charge
FIGURE 2.2 Fact-Finding Questionnaire (continued)
General Discussion Client: If employed, do you feel that your income and job status are secure, or are you planning any career changes?
When do you plan to retire?
Spouse: If employed, do you feel that your income and job status are secure, or are you planning any career changes?
When do you plan to retire?
Do you expect your annual income or expenses to change within the foreseeable future? Please explain.
How is your relationship with your accountant and how often do you communicate?
Accountant’s Name: _________________________________________________________________ Company: _________________________________________________________________________ Address: __________________________________________________________________________
What is your relationship with your insurance agent and how often do you communicate?
Agent’s Name: _____________________________________________________________________ Company: _________________________________________________________________________ Address: __________________________________________________________________________
43
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Let’s Talk Money
FIGURE 2.2 Fact-Finding Questionnaire (continued)
Estate Planning Discussion 1. Which of the following most accurately describes the sources of your wealth? Check all that apply. ____ Earnings from employment
____ Spouse
____ Running your own business
____ Gifts from relatives/friends
____ Successful investing
____ Inheritance
____ Teamwork/partnership with person other than spouse
____ Other _________________ (please specify)
2. Check one: Do you feel that you have reached ______ or exceeded ______ your needs for financial independence? 3. Rank the following financial and estate planning goals in order of importance to you. 1 = most important
5 = least important
____ Ensure financial independence over your own lifetime ____ Maximize the legacy (inheritance) for surviving spouse, children, and heirs ____ Decrease potential estate taxes on your estate ____ Make charitable contributions ____ Build exit plan for retirement assets (401(k), IRA, etc.) 4. List beneficiaries of your estate (surviving spouse, children, grandchildren, other relatives, friends, charities, business associates, etc.)? __________________________________________________________________________________ __________________________________________________________________________________ 5. Any favorite charities? _______________________________________________________________ 6. Do you feel that your current estate planning documents are up to date with regard to the way you wish to distribute your wealth (allocations to family members, charitable organizations, etc.)? __________________________________________________________________________________ __________________________________________________________________________________ 7. Do you feel comfortable with your understanding of the documents that you have created? __________________________________________________________________________________ __________________________________________________________________________________ 8. Have you discussed (or do you plan to discuss) your family financial assets with your children or other relatives? __________________________________________________________________________________ __________________________________________________________________________________
Taking Charge
FIGURE 2.2 Fact-Finding Questionnaire (continued)
Estate Planning Discussion (continued) 9. Do you feel that your children, spouses of married children, or heirs have the necessary skills to manage wealth properly? __________________________________________________________________________________ __________________________________________________________________________________ 10. How do you feel about transferring assets to children, heirs, or charitable causes while you are still living? __________________________________________________________________________________ __________________________________________________________________________________ 11. Have you made any gifts over $10,000 annually (now $11,000) to any one entity? __________________________________________________________________________________ __________________________________________________________________________________ If yes, have you ever filed any gift tax returns, and how much of the Unified Tax Credit have you used? __________________________________________________________________________________ __________________________________________________________________________________ 12. Does the idea of a personal or family foundation through which you would manage charitable contributions appeal to you? __________________________________________________________________________________ __________________________________________________________________________________ 13. Have you made arrangements with someone you trust to know the location of your important papers or whom to contact should something unexpected prevent you from handling your own affairs? __________________________________________________________________________________ __________________________________________________________________________________ 14. If you own any collections, have you indicated specific instructions in your will or trust for the transfer of these items to your heirs? __________________________________________________________________________________ __________________________________________________________________________________ 15. Are there any of your siblings or other relatives that we should discuss with regard to your planning issues? __________________________________________________________________________________ __________________________________________________________________________________
45
C h a p t e r
3 EMBRACING CHANGE It’s Opportunity
P
eople by their very nature resist change. We have a tremendous way of avoiding it by procrastinating and thinking it will go away. But change is inevitable, and it’s happening every day. When I wake up every morning, there is less of me on this Earth. I can take vitamins, I can exercise, I can watch my diet, but somewhere along the line I will meet my maker.
IT CAN HAPPEN TO YOU For some people, that end happens earlier than for others. Look at the horrific events of September 11, 2001, the terrorist attacks that changed all our lives. Consider the young woman or man who left home that morning to work at the World Trade Center in New York City, or the grandmother or loved one who headed off to work at the Pentagon in Washington, D.C. Many never made it home. More than 10,000 children were left without a parent that day. The surviving parent now is responsible for the mortgage payments, the BMW payments, and the children’s education. What planning do you think he or she did prior to 9-11? Most did not have wills, probably didn’t have a durable power 47
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of attorney, and may not have named guardians for their minor children in case something happened. Look at it another way: Four friends, each 65, are playing bridge. Statistics show that one of those four will end up in a nursing home or require skilled home health care. Both types of care carry financially crippling price tags. If I were one of the four, I would be looking around thinking, “Which of those other three is going to end up in the nursing home?” It’s always something that happens to the other guy. But you better believe it can happen to you, so plan for it.
Face Up, Fess Up, and Get Ahead A 56-year-old woman and mother of three came to me for financial advice in the middle of a heated divorce from her husband of 25 years who came home one day and “out of the blue” asked for a divorce. My first question to the woman was whether she knew ahead of time that something was wrong with the marriage. She finally admitted that she had known for the past six years something was amiss. I asked her why she had stayed in the marriage. Her response: “I had the kids and I’m Catholic.” In other words, she knew about the problem but didn’t acknowledge it. Instead, she tried to rationalize her position, just like my dad always questioned the ethics of anyone who had money. If decisions must be made in life, you need to make them. Don’t sit tight and think the problem will go away. It won’t, and you can’t go through life sweeping problems under the rug. Instead, embrace change, plan for it, and profit from it. I live by the philosophy that problems are opportunities waiting to be solved, and I use change as a path to improvement. Instead of ignoring a problem, grow and learn from it. Don’t run from down markets. Use them as buying opportunities. (See Chapter 9 for strategies to find stock market bargains.) Wouldn’t it have been great to have had a crystal ball in late 1999 and to have known ahead of time that the Internet bubble would burst and markets would plummet? I didn’t have a crystal ball then, and I still don’t. No one does. But America will survive. Just as our ancestors faced wars, turmoil, chaos, and uncertainty, we too have faced traumas
Embracing Change
49
and will continue to do so, as will our children and grandchildren. What we can do is plan for the unexpected—whether in investing, estate planning, or life planning—and figure out how to turn problems into positive opportunities, monetary and otherwise. Don’t forget that inf lation shrinks your money’s buying power every year, so it’s essential to come up with a game plan that meets your needs and keeps your money working as hard as it can. Past performance is not a clear indication of what will happen in the future, but history has a tremendous habit of repeating itself. “It’s different this time” is not a valid excuse for doing nothing.
How Emotion Derails Logic In an economic storm, the wrong thing to do is panic. That goes for the 75-year-old widower, the recent retiree, and the young worker just starting out on his or her wealth-building journey. Bear markets are perfectly normal and part of the process of building and maintaining wealth. History shows that markets go up, markets go down, and markets go up again. Instead of panicking in a bear, ride out the storm and focus on your long-term goals. When the value of your investments is falling, don’t think about selling unless there is a major change in the world. Buy instead. In many cases, the more an investment falls, the more you should buy because the most direct cause of a fall in the market or an investment’s price is that frightened people are selling their holdings. When a mutual fund suddenly loses ground, it doesn’t mean that the intrinsic value of that fund plummeted. It means there are more sellers than buyers, and that’s usually due to millions of frightened people selling out instead of holding on or even buying more. Look at the stock market crash of 1987. From an August 25 high of 2,722 to an October 19 low of 1,739, the Dow Jones Industrial Average plummeted 36 percent. Investors lost big—or did they? Let’s see what happened to a hypothetical investment in one mutual fund from AIM, one of the nation’s largest investment-management companies. AIM is a good example to prove my point because its funds emphasize longterm, disciplined investing. If you had put $10,000 in the AIM Constellation Fund at the August high, after the crash you would have had just $5,928, a 40.72 percent loss. The choices you had on October 19 included: sell; wait to regain
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your losses, then sell; hold and let time work for you; or hold and buy more shares at the lower price. Here’s what would have happened to your investment based on what you did that day. • If you had sold and placed the $5,928 in a CD (remember it’s a certificate of depreciation), as of December 31, 2002, your investment would be worth $14,767 with a 6 percent rate, $17,186 with a 7 percent rate, or $19,999 with an 8 percent rate. • If you had waited to regain your losses then sold on August 10, 1989, and put the money in a CD, as of December 31, 2002, your investment would have been worth $22,321 at 6 percent, $25,509 at 7 percent, or $29,146 at 8 percent. • If you held on to your mutual fund shares, as of December 31, 2002, your initial investment of $10,000 would have been worth $35,971 on December 31, 2002. • If you held on and invested an additional $10,000 on October 19, 1987, as of December 31, 2002, your total investment would have hit $94,957. • If you held on, but could only afford to start putting an additional $100 a month into that same AIM fund, as of December 31, 2002, your total $28,300 investment would have amounted to $69,408. Need more convincing to tune out the noise and sit tight? Let’s take a typical $10,000 investment, this time in Investment Company of America (ICA), a growth and income mutual fund from American Funds, and see what happens to it after some of history’s tumultuous events ( American Funds Distributors, Inc.; used with permission ) . • Ten years after the December 7, 1941, attack on Pearl Harbor that drew the United States into World War II, your $10,000 investment would have been worth $34,728, and by year-end 2002, $15,042,680. • Ten years after the 1957 launch of Sputnik, the first satellite in space, by the then–Soviet Union, your $10,000 would have been worth $38,083, and by the end of 2002, $1,749,059. • Ten years after the 1963 assassination of President John F. Kennedy, your $10,000 would have grown to $22,945, which in turn became $862,188 as of December 31, 2002.
Embracing Change
51
• Ten years after President Richard Nixon’s resignation in 1974, your $10,000 would have been worth $40,343, and $395,001 as of year-end 2002. The key is to develop a game plan based on growth of the marketplace with diversification in mind. If you lost heavily when the Internet bubble burst, the real problem is not the technology sector. Technology is here to stay. The problem is that you were invested too heavily in technology. Reallocate your portfolio based on your objectives and diversification. Remember, it’s not a Mack truck coming at you from the opposite end of the tunnel, it’s sunlight. But you have to get the right game plan going for your particular state in life. Don’t try to time the market, either. First, you must be in the market to participate in the market. If by some quirk of luck you get in and out at the right time, chances are you will have to pay Uncle Sam short-term capital gains tax (treated as ordinary income) if you bought and sold within a 12-month period. Getting out of a bear market is easy. Just sell. A common mistake investors make is to lose patience and sell at or near the bottom of a downturn. If you get out early in a decline, you still have to figure out when to get back in, and therein lies the problem. Bear markets usually are not characterized by a straight-line decline in stock prices. Instead, the market’s downward trend is jagged, with bursts of price increases or “sucker rallies,” and then more declines. A much easier path to wealth building is long-term investing. Lots of great fund choices exist, but for our purposes, let’s look again at just one, ICA, and its performance record. Long-term investors have been rewarded for their long-haul attitude since January 1, 1934, as shown in Figure 3.1.
BENEFITING FROM TAX CHANGES The only guarantees in life are death and taxes. The latter, though, seems to continually change with the whims of Congress and presidential administrations. Taxes never go away, but they can be reduced considerably if you make the right financial planning moves. Even as I write this book, tax laws are changing. For the sake of that life business you’re running, you need to keep up with those ongoing changes in the
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FIGURE 3.1 The Benefit of Time on Investments
Long-term investors historically have been rewarded for their patience. Here is Investment Company of America’s record of positive results over calendar periods as indicated since January 1, 1934.
2002 American Funds Distributors, Inc. Used with permission.
laws and understand the implications for tomorrow of what you do today. Without proper planning, you can end up paying Uncle Sam a big chunk of your savings or earnings while you’re alive and after you die. That’s why you need to surround yourself with OPB (other people’s brains) such as tax experts who are up-to-date on tax laws. That’s also
Embracing Change
53
why everyone needs an annual financial examination just as they need an annual physical exam. The time to learn about and plan for various tax implications is before tax problems arise. That’s especially true with retirement vehicles that allow your money to grow tax-free or tax-deferred. (More on that later in this chapter and in Chapter 10.) Tax planning does not begin just before your taxes for the previous year are due, when you hurriedly gather up the shoebox and rush it to the accountant. It’s not just one shot with the CPA or tax preparer once a year. It begins 16 months earlier, on January 1 every year!
TAX RELIEF In 2001, the federal government enacted the Economic Growth and Tax Relief Reconciliation Act, a $1.35 trillion federal tax cut to be phased in over the next decade. In 2002, more cuts followed, and then additional changes were made with the passage of the Jobs and Growth Tax Relief Reconciliation Act of 2003. Some phase-in provisions may be accelerated, others eliminated or expanded. Some of the changes deal with tax-rate reductions, child-credit increases, marriage-penalty relief, education incentives, estate taxes, retirement-plan provisions, alternative minimum tax relief, and lots more. Many of the existing rules are complex and their impact may not be felt for years—if they are carried out at all—so it’s essential to continually work with your tax expert and to carefully plan ahead to capitalize on the full benefits of the changes. All this further complicates tax, estate, and long-term retirement planning. As I write this book, so many new tax-law changes are under consideration that for the sake of your sanity and accuracy, I won’t go into much detail. Following is an overview of some areas of change, especially those that relate to estate planning and long-term financial planning. As I’ve said, no tax changes are set in stone. This information should not be used to do your taxes; that’s for you and your tax preparer. What the information should do is open your mind to issues, the importance of planning, and capitalizing on change.
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FIGURE 3.2 Tax Rate Reductions*
2000 Rate 28% cut to: 31% cut to: 36% cut to: 39.6% cut to:
2003 and beyond 25% 28% 33% 35%
*At time of publication
Individual Rate Reductions Individual taxpayers determine their federal income-tax liability for the year by applying graduated tax rates to their taxable income depending on the amount of their income and their taxpayer category (single, head of household, married filing jointly and surviving spouses, and married filing separately). Rates rise with the amount of income. The 2001 changes included a reduction in tax rates to be phased in by 2006. During May 2003, Congress accelerated the phase-ins. The previous rates of 28 percent, 31 percent, 36 percent, and 39.6 percent were replaced by 25 percent, 28 percent, 33 percent, and 35 percent respectively (see Figure 3.2). The 10 percent and 15 percent rates remain as they were.
Gift and Estate Taxes It gets more complicated. Current law imposes three federal taxes on lifetime or “at death” transfers of assets from one person to another, with variations and exemptions on each. You may give $11,000 ($22,000 for a married couple) annually to any individual tax free. For any amount over that, a gift tax potentially is payable by the giver unless it’s credited against the lifetime estate and gift exclusion ($1 million for 2002-2003). That exclusion, also known as the unified credit, means that estate and gift taxes that normally would be owed on that amount are forgiven. When you die, tax is imposed on your estate based on the value of its assets. A generation-skipping transfer (GST) tax applies to lifetime or death-time transfers to a member of a generation more than one generation younger—a grandfather to a granddaughter, for example. The gen-
Embracing Change
55
eration skipping transfer tax has a separate exemption for cumulative generation-skipping transfers that is adjusted for inf lation. Under the Tax Relief Act of 2001, the top estate-tax and gift-tax rates will be reduced, and the unified credit effective exemption amount and the generation-skipping transfer tax exemption will increase in steps. The top tax rate for the largest estates is 49 percent in 2003, scheduled to drop by one percentage point a year until it hits 45 percent in 2007. It will remain at 45 percent until 2010 when the estate tax, along with the GST tax, is repealed. Without further congressional action, the estate tax returns in 2011 with a top rate of 55 percent. However in 2010, when the estate tax is repealed, the gift tax remains and the rate will be equal to the highest income tax rate, which is scheduled to be 35 percent. Got that? Don’t worry if you don’t. The timing and numbers may change more than once before those dates actually arrive, so talk to your tax advisor before making any decisions. Here’s a look at the estate exclusion amounts through 2010, though these are subject to change (the gift tax exclusion amount remains at $1 million). • • • • •
2002 through 2003: $1 million 2004 through 2005: $1.5 million 2006 through 2008: $2 million 2009: $3.5 million 2010: Estate tax repealed
Here’s one example of the advantages of estate tax planning today. Under the current gifting tax laws in America, an individual can give up to $11,000 a year tax free to anyone and to as many people as he or she desires. It can be the garbage collector, if you want. The gift’s recipient doesn’t pay any taxes on the money, and you don’t owe any gift tax either. Gifting, therefore, becomes a tool to reduce the size of your estate and subsequent federal estate taxes when you die. In my case, that means my wife, Rosemarie, and I each can give $11,000 to any one person and to as many people as we wish tax-free in the same calendar year. As a couple, we can gift $22,000 a year to each of our three children, seven grandchildren, and two great grandchildren for a total of $264,000 a year transferred to our heirs tax free! But if I plan to wait until the end of the year to make the gift, what happens if I die in June? I
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lose the right to make my gift and only Rosemarie would be able to gift her share tax free. That’s $132,000 that cannot be gifted, thus losing a big estate-reduction opportunity. Tax planning is not just putting together a Form 1040 at tax time. It is estate planning and other planning year round. Don’t procrastinate and lose the savings available to you. You get the picture. It’s complicated and forever changing. That’s just more reason to make use of tax-advantaged vehicles like trusts and life insurance to avoid estate taxes altogether. (More on estate planning and taxes in Chapter 10.)
Education Provisions Recent tax changes add to the education funding incentives. Here’s a look at a few. (More on funding an education in Chapter 4.) • Coverdell education savings accounts (formerly education IRAs). An individual, corporation, or other entity now may contribute a nondeductible $2,000 per year to a designated beneficiary to be used for qualified education expenses. Those expenses can be for grades K through 12 and postsecondary education, and can include tuition, fees, books, supplies, equipment, room and board, uniforms, computers, and extended-day programs. The contribution limit is phased out if a taxpayer’s adjusted gross income (AGI) exceeds certain inf lation-adjusted amounts. Distributions are excluded from income. • Qualified tuition programs (also known as Section 529 plans). These state-sponsored investment programs offer a tax-favored means of funding a child’s future qualified higher-education expenses. Distributions or education benefits received from qualified state-sponsored programs are not subject to federal income tax. Recent tax law changes now permit higher education institutions to offer their own 529 prepaid programs. • Student loan interest deduction. With limits, interest paid on qualified education loans is tax deductible up to $2,500 a year whether the taxpayer itemizes or not. Eligibility for the deduction is phased out depending on the taxpayer’s AGI. The Tax Relief Act no longer limits the interest deduction to the first 60 months that payments are required.
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• Deduction for higher education expenses. Up to $3,000 a year in higher education expenses is deductible in addition to the standard deduction. Eligibility for the deduction, however, is phased out depending on the taxpayer’s AGI.
Capital Gains and Losses and Investment Dividends Short-term capital gains generate substantial income taxes that can take more than one-third of your profits, depending on your tax bracket. Long-term capital gains (on assets held more than 12 months) are taxed at lower rates. When it comes to dividends, Uncle Sam has been double dipping for years by taxing corporations for their earnings, then taxing shareholders for the dividends they receive on those same earnings. That’s not fair, and was addressed in part with legislation passed in 2003. Dividends, which for many years were taxed at ordinary income tax rates, are now taxed at the same rates as long-term capital gains. Also there may be some changes in the area of loss carry-forwards. As of 2003, you are allowed to deduct up to $3,000 in capital losses (a loss on the sale of a business or investment asset) in excess of your gains, dollar for dollar in a calendar year, and can carry forward any additional unused losses. It’s been that same dollar amount for many years, never indexed for inf lation. Maybe by the time you read this book that will have changed. For example, if you have $15,000 in capital gains, you can utilize up to $18,000 of capital losses, thereby giving you a net $3,000 loss to be used against ordinary income. Any excess losses over the $18,000 can be carried forward to future years.
IRAs and Pension Plans Changes regarding tax rules on individual retirement accounts and pensions are numerous. Here are just a few, with the caveat that they likely will change even further, so again look to OPBs for up-to-date help. • Maximum IRA contributions. In general, there are two types of individual retirement accounts: the traditional IRA, which provides for tax-deductible contributions and taxable distributions, and the Roth IRA, which calls for after-tax contributions and nontaxable distributions. There are taxpayer qualifications associated
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FIGURE 3.3 Limits on Contributions to 401(k) and Other Plans
Year 2002 2003 2004 2005 2006
401(k)/403(b) Plans $11,000 $12,000 $13,000 $14,000 $15,000
SIMPLE Plans $7,000 $8,000 $9,000 $10,000 $10,000
457 Plans $11,000 $12,000 $13,000 $14,000 $15,000
with both. Tax changes increase the maximum contributions to each—$3,000 for tax years 2002 to 2004; $4,000 for tax years 2005 to 2007; and $5,000 for 2008 and beyond, adjusted for inf lation. In addition, those over age 50 can make annual “catch-up” IRA or Roth IRA contributions of $500 through 2005 and $1,000 a year after that. Contributions to a Roth IRA are subject to AGI limits, depending on your filing status. • Maximum contributions to 401(k) and other plans. The law also increases the maximum allowable contribution to salary deferral 401(k) plans, tax-sheltered annuity 403(b) plans, simplified employee pensions (SEPs), SIMPLE retirement plans, and 457 deferred compensation plans. Contributors who are 50 and older also can make additional “catch-up” contributions. See Figure 3.3 for details on the contribution limits of those plans. • Portability of benefits. New laws contain rules that apply when rolling over eligible distributions from one tax-favored retirement plan to another with the purpose of retaining the tax-favored treatment of the money distributed. Taxable IRA distributions can be rolled over to a tax-qualified plan, 403(b) annuity, or 457 plan. Surviving spouses who participate in their own tax-qualified plan, 403(b) program, or 457 plan will be able to roll over distributions from a deceased spouse into their own plan. After-tax employee contributions to a tax-qualified plan can roll over to another qualified plan or traditional IRA. The IRS can extend the 60-day rollover period when failure to comply is due to casualty, disaster, or events beyond the reasonable control of the taxpayer. Figure 3.4 brief ly compares aspects of various retirement plans.
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FIGURE 3.4 Retirement Plan Comparison
Defined-Benefit Pensions
Money-Purchase Pensions
Profit-Sharing Plan
How Company’s Contribution Is Determined
Mathematically determined in advance; must be adequate to fund benefit.
Established by plan formula; can utilize up to 25 percent of covered compensation. Contribution must be made with or without profits.
Set by formula and action of board of directors; can utilize up to 15 percent of covered compensation. Contributions are made only in profitable years.
Where Company’s Contribution Goes
Larger shares to owner and longer service, more highly paid employees.
Distributed proportionately according to salary and length of service.
Distributed proportionately according to salary and length of service.
Effect of Investment Gains and Losses
Above assumed rate: reduces company deposit Below assumed rate: increases company deposit.
Benefits increase or decrease accordingly.
Benefits increase or decrease accordingly.
Effect of Forfeitures
Above assumed rate: reduces company deposit Below assumed rate: increases company deposit.
Reduces company deposit
Reallocated proportionately to remaining participants.
How Plan Pays Benefits
Each participant’s benefit predetermined mathematically. (Benefit is generally lower than in defined contribution plans.)
Vested funds due participants upon termination of employment.
Vested fund due participants upon termination of employment.
Benefit a Function of:
Plan-stipulated percentage of final average salary; related to pay level/length of service.
Years of participation. Contributions. Investment results.
Years of participation. Contributions. Investment results. Forfeitures.
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Alternative Minimum Tax The alternative minimum tax (AMT) is imposed on individuals with significant income-tax deductions or credits to ensure that a minimum amount of tax is paid. The amount of income exempted from the AMT has been increased.
GENERAL TAX-SAVING TIPS One way to save on taxes is to cut down on your taxable income. That doesn’t change your tax bracket, but it does generally cut down on the amount you owe in taxes. Typically, ways to do this include accelerating deductions, slowing receipt of income, and giving to charity. Here are a few general tips that can help you.
Personal Debt Interest on personal debt like credit cards, auto loans, and personal loans is not tax deductible. But interest on up to a $100,000 home equity loan is, so using a home equity line of credit to pay down your personal debt or buy that car you need has its advantages. Remember, it’s about making your money work for you all the time. It should not be allowed to idle, as is usually the case with the equity in your home.
Retirement Plan Contributions When do you fund your IRA? Not just before you pay taxes, I hope. The time to fund it is at the beginning of each calendar year so that your money works all year. You could earn up to an extra 15¹⁄₂ months of total return that’s not taxable until you withdraw the money. If on January 1 every year for the past 20 years, you had anted up $2,000 cash for your IRA and invested it in the Investment Company of America mutual fund, as of December 31, 2002, you would have had $194,000 socked away. That compares with the procrastinator who instead funded his IRA on April 1 of the following year just before taxes were due, and ended up with only $186,000. Easy extra money. (As of 2002, the maximum allowable IRA contribution climbed to $3,000 with provisions for catch-up contributions for those over age 50.) Saying that you do not have the cash is an excuse to do nothing. If you don’t have money available to contribute to your IRA and you own a home, consider taking out a home equity loan. The interest is tax de-
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ductible. If you take out a $3,000 home equity loan at a 5 percent interest rate and are in the 30 percent tax bracket, the cost of the loan is just 3.5 percent. The other 1.5 percent is your tax deduction. 30 percent (tax bracket) × 5% (interest rate) = 1.5% (tax deduction) 5 percent (interest rate) – 1.5% (tax deduction) = 3.5% (cost of loan) If your money earns an average 10 percent over time (the S&P’s average annual rate of return since 1925 is 10.2 percent), that gives you a 6.5 percent net return on your money! That’s using your money to your best advantage. Money should always, always be working for you. All kinds of alternatives like this can fund an IRA. What’s right for you depends on your individual circumstances. I want to open your mind to other possibilities instead of just saying, “No. I don’t have the money.” This is an Economics 101 lesson on what financial planning, tax planning, and investing are all about. It’s that software icon in your brain popping up to tell you that you have options. Explore them. Be proactive and manage your money.
Charitable Donations Donate to your favorite charity. It’s deductible and many charities even allow you to use a credit card to do so. Charge the donation in late December and then take the deduction in that calendar year even though the charge won’t appear on your credit card bill until January of the following year. Donations also needn’t be in the form of cash. Instead of having a garage sale or throwing away old clothes, furniture, appliances, even old cars that don’t run, consider giving them to a qualified charity and taking a tax deduction for the goods. The law allows you a deduction for the “thrift shop value” which in many cases is 10 percent to 20 percent of the original cost. The Salvation Army has a free valuation guide, or check out Bigwriteoff.com on the Internet. Be sure to always get a receipt for your donations. If you donate stock that has appreciated in value since you purchased it, you can take a deduction on your tax return based on the fair market value of the stock on the date you donated it. By donating the actual stock instead of selling it and then donating the cash from its sale, you are not subject to capital gains tax on the stock’s appreciation. If,
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on the other hand, you think the stock is worth less than you paid for it, you may want to first sell it, take the tax loss, then donate the money to the charity.
Volunteer Work If you do volunteer work for a charity, you can either deduct your actual driving expenses, or a mileage allowance plus parking and tolls. You also can deduct any out-of-pocket costs for materials, supplies, and phone calls. If you travel overnight while doing work for the charity, you can deduct the expenses of lodging and food, too.
Property Taxes Most counties bill for next year’s property taxes before the end of the current year. They also allow you to pay them currently or wait until next year. In most cases, it’s beneficial to pay them in the current year so you can take the tax deduction sooner rather than later.
State Taxes If you pay estimated state taxes, your fourth-quarter payment usually is due by mid-January of the following year. You should make your payment in late December of the current year so you can deduct it in the current year.
Medical and Dental Expenses As you probably know, medical and dental expenses are deductible to the extent that they exceed 7.5 percent of your adjusted gross income. But did you know that medical and dental expenses include more than just the cost of going to the doctor or dentist? Also included are: • • • •
The cost of prescription drugs Premiums for medical, dental, and long-term-care insurance Transportation to and from doctors and other medical facilities Lodging (with limitations) while away from home primarily for and essential for medical care and treatment. Meals, however, are not deductible. If your spouse has to accompany you on the trip to assist you, he or she also is entitled to the deduction.
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• The cost of smoking-cessation programs and prescription drugs to alleviate the symptoms of nicotine withdrawal • Nursing home care for you, your spouse, or dependent if he or she is in a nursing home because of a physical condition, and the availability of medical care is the principal reason for being there. All the costs—including lodging and meals—are deductible. However, if you are in a nursing home (or assisted-living facility) primarily to make your life or your family’s life less troublesome, you can deduct only the portion of the costs directly attributable to medical and nursing care. • The cost of special equipment prescribed by your doctor to mitigate the effects of a physical impairment or handicap, such as a doctor-prescribed whirlpool for an individual with severe arthritis or daily swimming therapy for someone with a chronic medical condition. With the latter, the cost of adding a pool to your home would be deductible less any appreciation added to the value of the home. If, for example, you spent $20,000 for the pool and the value of the home appreciated only $12,000, the $8,000 difference is deductible. This chapter’s brief look at some of our ever-changing tax laws is meant to show you just how complex this area of your financial life can be. Depending on your stage in life, any of the areas may or may not apply to your situation. The important thing is for you to be aware that getting professional help with your taxes can go a long way toward maximizing all the tax advantages available.
THE BOTTOM LINE • Change is inevitable. Plan for it and profit from it. • When the value of your investments is falling, don’t even think about selling unless a major change occurs in the world. Instead, you should think about buying. • Tax laws change all the time, especially those that relate to longterm investing, retirement savings, and estate planning. Choose the right advisors who can help you keep your tax strategies current with the laws. • Tax planning is a yearlong proposition that can cut your tax liability substantially and build your wealth at the same time.
C h a p t e r
4 PLANNING FOR SUCCESS You Don’t Learn It in School
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e have done a reasonably good job teaching people how to make a living, but a pretty miserable job teaching them what to do with the money they make. In fact, often those who are the best at making money have the most trouble managing it. That’s yet another reason why it’s important to count on OPBs (other people’s brains). Do your investing homework, but let the money manager do the managing. Part of money management, after all, is about doing the right thing now to enjoy life later when you (the money machine) wear out. It’s also about preserving the fruits of your labors for your heirs.
THE MONEY EQUATION In Chapter 1, I wrote about the importance of having family and loved ones with whom to share your success, and about understanding that money alone does not buy happiness or success. But let’s take a closer look at the vehicle of barter we call money. The name of the game is to grow money. Money does not die, it does not become disabled, and it does not stop to take vacations. Money 65
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doesn’t like you or dislike you. It’s an inanimate object, a piece of paper that doesn’t even recognize if it has changed hands. So don’t become emotional with a piece of paper that represents the value of real estate or stock or a mutual fund. Be logical with your decision making.
Two Kinds of Money Basically, there are two kinds of money: money from people at work and money from money at work. Determining which one has a longer earning potential is a no-brainer. The money machine—you—will wear out or decide to stop working long before that dollar will. So what happens after your “economic death,” when you stop producing income? When you stop bringing in cash, your money shouldn’t quit. In fact, when the money machine quits, the money has to work harder to keep up the cash f low to pay the bills and keep the collection wolves away from the door. At the beginning of the 20th century, the average life expectancy was 46 for a man and 47 for a woman. (That could be why they had great marriages. Husbands and wives didn’t live long enough to get bored with each other!) Today, the average man lives to 80 and the average woman to 85 plus. That means if you retire at age 65, chances are good that you will live—and need to support yourself and your family— another 20 years. That’s not including your responsibility to pass on the fruits of your labors to your children and grandchildren. If you want to enjoy your retirement years, you have to think long term; you have to plan for tomorrow.
The Road Map To achieve wealth takes personal commitment, self-discipline, and a plan. That plan is the road map to your destination, whether it involves long-term goals like buying a home, funding a college education, or retiring in style. You wouldn’t consider building a home without a blueprint, yet most people have no road map for their financial plan. Without a road map, problems arise because too many things are competing for the same dollar bill, and our credit card culture promotes an instant gratification mentality as opposed to long-range satisfaction.
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How many times have you opted for the latest and greatest in a disposable asset like a stereo, new outfit, or “toy” instead of paying off a bill, adding to savings, or bolstering your retirement fund?
SETTING YOUR GOALS Part of your plan is goal setting, which is a very personal thing. Each of us has our own definition of financial success. For one person, it could mean owning a home free and clear; for another, paying off the last college bill for the kids; still another might think the ultimate freedom is owning an 80-foot sailboat. It depends on an individual’s needs and desires.
Retirement One long-term goal that most everyone has in common is retirement. Somewhere along the line the moneymaking machine will retire, voluntarily or involuntarily. You no longer will be able to produce an income. If one of your goals is to retire at 55, 60, or even 65, you still face many years of life and paying bills after the money machine quits. From where will the cash f low come? Social Security? Pension? Will there be a deficit? Each of us has to answer those questions, and if your response is, “No problem. The government will take care of everything,” you’ve got a big problem waiting for you! Although Social Security is likely to be around in some form when you reach retirement age, it certainly won’t be enough on which to live. Why? Social Security isn’t a funded program. It’s the people paying taxes who support the system. You must create your own security system. That means putting together a package for your retirement well-being without giving the federal government a buck and expecting the same buck in return at some future date through Social Security, Medicare, or Medicaid. How much will you need to invest to retire comfortably? I can’t tell you exactly. No one really can. Most of those formulas with long-term projections that say it will take X amount of dollars to save Y amount in so many years usually are way off base. I can’t predict the future. Remember my crystal ball is cloudy. But, I can tell you that the amount you will need to invest is not overwhelming if you have time on your side, if
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FIGURE 4.1 The Results of Dollar Cost Investing over Time
HOW MUCH DO YOU NEED TO INVEST? No one can tell you exactly how much it takes invested today to retire comfortably tomorrow. But if in 1982 you began to put $2,000 a year into an IRA, and invested it in American Funds’ Investment Company of America Fund A, as of December 31, 2002, your investment would have grown to $186,061*: $225,000
TOTAL INVESTED: $42,000 TOTAL ENDING AMOUNT: $186,061 AVERAGE ANNUAL RETURN: 12.34%
$200,000 $175,000 $150,000
$186,061 Dec. 31, 2002
$125,000 $100,000 $75,000 $50,000
$2,000 March 3, 1982
$25,000 $0
12/31/82
12/31/87
12/31/92
12/31/97
12/31/02
*Investments not subject to sales charge, effects of income and capital gains taxes not demonstrated. Source: Thomson Financial
you have the discipline to save, and if you have picked the right type of investments. You can count on the Rule of 72 (described in Chapter 1) to tell you how long it will take to double your investment. We also can look to the past to see the savings needed for someone to retire comfortably today. Historically, the S&P 500 has averaged a 10.2 percent rate of return over time. If in 1982 you were age 40 and planned to retire at age 60 at the end of 2002, let’s look at what would happen to your investment with a typical money-management approach like dollar cost averaging. That’s regularly investing a set amount of money in the same investment over a period of time. By putting just $2,000 a year away in American Funds Investment Company of America Fund, at the end of 2002, your total $42,000 investment would be worth more than $186,000, with your money earning an average 12.34 percent annually, as shown in Figure 4.1.
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FIGURE 4.2 Projected College Costs
Your Child’s Age 10 11 12 13 14 15 16 17 18 19 10 11 12 13 14 15 16 17
Eventual College Expenses* $345,593 $326,031 $307,576 $290,166 $273,742 $258,247 $243,629 $229,839 $216,829 $204,556 $192,977 $182,054 $171,749 $162,027 $152,856 $144,204 $136,041 $128,341
No. of Years to Save 18 17 16 15 14 13 12 11 10 19 18 17 16 15 14 13 12 11
*Projected costs for a child entering college, based on a 6% annual rate of inflation applied to average total expenses of $27,677 for one year at a four-year private college (including tuition, fees, room and board, books and supplies, transportation, and personal expenses), according to the College Board for the 2002-2003 school year. Public college costs, of course, are typically lower. Source: © American Funds Distributors, Inc. Used with permission.
College Education: The Gift of a Lifetime You need to give your children two things: love—sometimes tough love—and the best education you can, because it’s a cold world out there. Love is the support they need and education is the foundation for their future. When you cut the umbilical cord and let them f ly out of the nest, hopefully they will be able to soar like an eagle. The mind is an absolutely wonderful thing that has to be cultivated. A college education opens the mind to endless possibilities. How many men and women have you met who went to college and actually ended up working in their major field of study? Very few.
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What the college education did for those same men and women, however, was open their minds to think outside the box and consider the possibilities. That’s what it did for me. College—in my case, Burdett College in Boston—opened my horizons and convinced me that I could do anything within reason. Because I also had the drive to succeed and the street sense to make it happen, I was unstoppable. If there was a brick wall in front of me, I just put my head down and went through it. On the other hand, a lot of kids with whom who I grew up also went to college, but they didn’t have the same drive to excel financially that propelled me forward. College education does not guarantee success; it opens doors. You guarantee your own success with your drive to achieve it and by applying what you learn. One big caveat with college, however, is that the price tag keeps going up. That four-year degree at a private college that cost close to $111,000 in 2002-2003 will more than double in 11 years. So it’s especially important to plan accordingly. The table in Figure 4.2 lists projected college costs based on your child’s age. As your children near college age and you worry about how to foot the bill, you may feel like you should cut down on your IRA contributions, at least until the kids are out of school. Big mistake! Remember, there are many ways to pay for college, but only you are responsible for your retirement. We talked about a few tax advantages of some college-funding options in Chapter 3. Let’s take a closer look at one of those options, college savings or 529 plans. Provisions for these plans are in section 529 of the IRS Code, hence its name. These are state-sponsored or educational-institution-sponsored prepaid tuition and education savings programs that offer an excellent strategy to save for higher education expenses. Programs are administered by a state agency or an organization designated by the state or institution, such as a for-profit company or an investment company. Plans differ, but withdrawals for all plans for qualified educational expenses are federal income tax free. (Some states levy income taxes on the qualified withdrawals.) Funds from the account can be used at most domestic private and public educational institutions and some foreign ones, too, if, for example, the beneficiary decides to attend college abroad.
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The IRS does have certain requirements for 529 plans. • All contributions must be made in cash. • Each beneficiary must have a separate account. • There is a penalty for using funds for other than educational expenses of the beneficiary. There are no penalties for withdrawal if the beneficiary receives a scholarship, dies, or is disabled. However, income taxes will be due on the earnings. • The investment cannot be used as security for a loan. • Federal tax law allows one individual a maximum contribution of $55,000 in the first year of a five-year period without exceeding the annual federal gift tax exclusion. If you make that maximum contribution, however, you are not allowed subsequent tax-free gift contributions until the sixth year. Each state sets the maximum amount that can be invested in a single account. There is no limit on how large the account value may grow. Some programs will allow a contribution of more than $268,000 per beneficiary, but there may be tax implications. Minimum contributions also vary with each 529 program. A 529 works like this: A contributor establishes an account for the beneficiary to pay for expected college expenses. There is no stipulation as to the account owner’s relationship to the beneficiary. You could set one up for yourself, your child, your grandchild, or even your neighbor’s kid. The contributor is the owner of the account and maintains control of it. Mutual fund companies chosen by a state generally manage most of the 529 plans. The account owner chooses a specific fund portfolio that matches his or her investment objectives, then contributes accordingly. Some 529 plan contribution programs operate almost like airline frequent-f lier programs through Web sites like Upromise.com. Shop at your favorite stores, go out to eat, take a trip, buy a house, and as long as it’s through one of the thousands of participating companies, a small portion of the money goes to your 529 plan. Following are some other advantages of a 529 plan for college savings. • Earnings grow federal income tax free. Withdrawals for qualified education expenses are federal income tax free. That’s an advantage over the Uniform Gift to Minors Act account, which is fully taxable.
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• Substantial amounts of money can be contributed to a 529 plan, much more than to other types of investments designed to finance higher education. • The account owner maintains control of the account regardless of the age of the beneficiary. This is another advantage over the Uniform Gift to Minors Act, which transfers control of the account to the beneficiary when he or she reaches legal age. • The account owner can change from one 529 plan to another without tax or penalty once every 12 months. • An account owner can change the beneficiary as long as the beneficiary is a member of the family of the original beneficiary. That includes siblings, first cousins, nieces, nephews, parents, and spouses. • Contributions of as much as $55,000 per beneficiary can be made in the first year with no gift tax liability to the contributor. There are also a few disadvantages of 529 plans. • If the student owns the account, that may affect his or her eligibility for financial aid. • Only cash can be contributed to the account, not stocks. • Assets in a 529 plan cannot be used as collateral for a loan. • You don’t control the investments in the plan. The only way to change the investment choices is to roll the account over into another state’s plan, which is allowed once a year without penalty. • Withdrawing the money for reasons other than qualified highereducation expenses incurs a 10 percent penalty plus the taxes due. Figure 4.3 offers a comparison of various education savings plans.
SECRETS TO FINANCIAL SUCCESS If you’re expecting hot stock tips, you’ve come to the wrong place. There are no new secrets for building wealth in the 21st century, only the same old secrets that smart people have used for centuries. Here is a look at a few of them.
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FIGURE 4.3 Comparing Education Savings Options
Features
529 Plans
UGMA/UTMA
Coverdell Education Savings Account (ESA) (Formerly known as Education IRA)
Taxable Account in Parent's Name
Investments and Control Who controls assets and withdrawals?
Account owner
Control transfers to child when child becomes of legal age
Account owner
Account owner
Qualifications Qualified expenses for use of assets at any accredited post-high-school institution. Includes vocational, technical, and community college.
Owner must use for benefit of minor, if used before minor reaches legal age; after child becomes of legal age, no restriction on use of assets.
Qualified expenses for K-12 plus any postsecondary school; must be used before beneficiary turns 30. (Age requirement not applicable for special needs beneficiary.)
None
Maximum contribution per beneficiary; can vary by state
Up to hundreds of thousands of dollars in some plans
Unlimited
$2,000 annually
Unlimited
Investment options
Defined by each state's plan.
Broad range of securities
Broad range of securities
Broad range of securities
Investment management style options
Professionally managed
Can be self-directed
Can be self-directed
Can be selfdirected
Can beneficiary be changed?
Yes, may change anytime, to a member of family of original beneficiary.
No
Yes, may change anytime
Not applicable
Financial Aid and Taxation Taxation of earnings
Federal tax-free. State tax advantages may vary by state.
Up to $1,500 is generally taxed at child's rate for federal and state tax purposes. Remaining income may be taxed at parent's rate.
Federal tax-free. State tax advantages may vary by state.
Taxable to owner
Federal tax deductible contributions
No
No
No
No
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FIGURE 4.3 Comparing Education Savings Options (continued)
Features
529 Plans
UGMA/UTMA
Coverdell Education Savings Account (ESA) (Formerly known as Education IRA)
Taxable Account in Parent's Name
State tax deduction contributions
Yes, for some states
No
No
No
Penalty for nonqualified use or early withdrawal
Earnings are subject to 10% penalty
Not applicable
Earnings are subject to 10% penalty
Not applicable
Income limitations for plan contributions
None
None
Max allowed contributions phased out as AGI exceeds thresholds. (single $95K-$110K, joint $190K-$220K)
None
Gift tax guidelines
Up to $55K per beneficiary ($110K with gift splitting) may be contributed without incurring gift tax.
Subject to normal gift tax exclusion of $11K per beneficiary, per year ($22K with gift splitting).
Subject to normal gift tax exclusion of $11K per beneficiary, per year ($22K with gift splitting).
Assets part of owner's estate.
Estate tax guidelines
Account balance is generally not included in the estate of the contributor or the estate of the minor. (A portion can be if the contributor dies in the five year averaging period.)
Value included in minor's estate.
Balance of account not included in estate. Usually, neither contributor nor beneficiary includes account in estate.
Assets part of owner's estate.
Who is regarded as the owner when evaluating eligibility for financial aid? (Private institutions may vary.)
Account owner
Student
Student
Account owner
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Work Smart, Not Just Hard A boat on the wrong course won’t reach its destination no matter how hard the crew rows. My parents and grandparents always felt that a man’s degree of success was based on how hard he worked. Not so, I have learned. It’s how smart he works. That doesn’t mean you shouldn’t work long hours or be committed to your path. But time is money and money is success, so spend time and money carefully, and stay focused on your goals. Every step wasted in the wrong direction takes an extra step to get back on course. That’s one reason why the captain of a ship spends most of his time on the ship’s bridge. A single day has 24 hours, it’s the same for everyone. Use your time effectively to increase productivity. Once again it’s about taking control of your life. Don’t waste time sifting through spam e-mail or answering your phone all the time. Take advantage of answering services, caller ID, and many other ways to filter out junk that bombards all of us daily and eats up valuable time.
Think Positive You have heard the words think positive so often that they tend to go in one ear and out the other. But the evidence shows time and again that positive thinking affects an outcome. People with debilitating illness or injury constantly are pushed to think positive. Look at the patterns of successful athletes. The marathon runner doesn’t cross the finish line because he thinks he can’t do it. What about the 5-foot-7-inch all-star football running back who squares off against refrigerator-size players? Or the Olympic athlete who competes for the gold? If you expect to be successful in your life, you need to think about success not failure. Distance yourself from those people who offer negative feedback. It’s harmful to your personal and financial well-being.
Write Down Your Goals Put your goals in writing. If a goal is worth pursuing, it’s worth putting on paper. Be specific, otherwise you can easily stray from your purpose. Under each goal write down what’s necessary to achieve that goal.
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Next to it write a target date for achievement. This is your plan of attack. You can add to it or change these steps whenever necessary because circumstances can change, for example, f luctuations in the economy or demands on your financial resources. There are many paths to the top of the mountain, but the view is always the same. — Chinese proverb
Keep an Open Mind Remember the analogy in Chapter 1 of your brain as the computer hardware and your experiences as the software program? Change that software program so you have a clean slate and no preconceived ideas of what you’re supposed to do or think. Don’t be afraid of your goals or failure. So what if you fail? Failure is a part of success. The key is to begin your quest and keep trying, whether you succeed or fail. One good success absorbs many failures. Failure is not the opposite of success; lack of trying is. No outcome at all is far worse than failure.
Forget the Herd Think outside the herd mentality. Just because domestic mail shipments took several days in 1965 didn’t stop Frederick W. Smith from coming up with a better idea. While an undergraduate at Yale, he wrote about a system designed to better accommodate the process of overnight delivery. Later he started Federal Express, and now overnight delivery is the standard. Flying like an eagle likely will be a lonely journey because few people choose this route. Many others will make excuses for your success or cast aspersions on your character or commitment. As my career was taking off, my father used to say, “Jim, you are going to be the youngest wealthy guy in the graveyard.” He related making money to stress. It’s not true. Stress is when you don’t have money to pay your bills. You have to be willing to think and act independently if you want to be successful.
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Educate Yourself Just because you hire someone with a specific area of expertise to help you, don’t think you’re off the hook. You are still the captain of your destiny. Educate yourself about investments, strategies, and philosophies so you can make informed decisions. Read journals and books, especially biographies of successful people. Take courses, but don’t rely on Internet chat rooms, your neighbor, magazines, radio, or TV as sources of sound information. Do make use of sources like the Securities and Exchange Commission (including their online database EDGAR), the National Association of Securities Dealers, educational Web sites, and more. Words of warning though: Be aware of hidden agendas with information from many sources, especially on the Web. Take into consideration the source of the information. (See the References section in the back of the book for a list of good sources of information.) Perhaps more than anything else, failure is a learning experience, and because many failures result from insufficient information, the lesson is to seek more information.
Don’t Blame the World for Your Failures The buck stops with you. Don’t blame the world and everyone else for your oversights or failures. That’s not the mind-set for success. Few successful athletes would claim credit for a victory, yet not accept responsibility for a defeat. Successful people are goal-oriented and don’t just drift. Part of being goal-oriented is recognizing that failure is part of success. Don’t be afraid to set goals. Be afraid of not having any. To achieve your goals or reach your destination takes a map or a plan. Put it down on paper and then get started. This is where many people freeze as if they were at the door of an airplane about to take their first parachute jump. Remember the Nike slogan: Just do it. Few people ever do.
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THE BOTTOM LINE • You must grow your money. Sooner or later the moneymaking machine stops producing and your money has to do the work for you. • To achieve wealth takes personal commitment, self-discipline, and a plan. The plan is a road map to your destination, whether it’s buying a home, funding a college education, or retiring in style. • Forget about the government taking care of you in retirement. It’s not going to happen that way! Put together a plan for your own social security. • Consider 529 college savings plans as an excellent tax-advantaged way to pay for higher education expenses. • There are no new secrets to building wealth in the 21st century, only the same methods that savvy people have used for centuries. They begin with working, thinking, and investing smart!
P a r t
T w o
ESTABLISH YOUR OWN TRADITION OF WEALTH MANAGEMENT
C h a p t e r
5 THINK CASH FLOW VERSUS INCOME
Y
ou are the money machine. You make X dollars based on your ability, your talents, and your instinct to understand your business life or profession. No matter what you think or plan, you will wear out or quit producing the money some day. Your nut, or living expenses, however, does not stop. So accept the facts and start investing wisely during your working and earning years so your money keeps working for you, your family, and heirs.
WHERE’S THE CASH FLOW? First, recondition yourself to think in terms of “cash f low,” not “income.” I know that’s counter to the software package in your brain that contains those traditional ideas like pay off your house free and clear, buy certificates of deposit, and bring in income. But replace that software now. No matter your age, you want cash f low—money coming in regularly to pay the rent, the utilities, and other living expenses. The idea is total return on your money in the form of dividends, appreciation, and capital gains or losses. Think again about the nut of running a business, in this case, your life. To pay for the nut, the cash f low must 81
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grow each year because of inf lation. Growing your money is even more important after the money machine wears out. If you take the traditional road and think in terms of income and interest, it’s all taxable at ordinary income tax rates, with the exception of tax-free bonds and tax-deferred retirement programs, and you end up in partnership with Uncle Sam. You do not want income because income does not allow growth of capital. You want cash flow.
Total Return Strategies Consider what happens if you have a $100,000 investment under the cash-f low scenario. Assume a growth mutual fund has an average 10 percent rate of return per year with 1 percent of that return from dividends. The other 9 percent return comes from capital appreciation over the long term. Let’s assume that you ask the fund to pay you 8 percent of your account’s value per year, or $8,000 the first year paid out over 12 months. Each year you will withdraw the same 8 percent value of the portfolio. It’s much like harvesting fruit from a tree each year. As the tree grows, so does the size of each harvest. You lower your taxes, get more cash f low, and your capital has a chance to grow over a period of time to offset that ever-increasing cost of the postage stamp, the hospital stay, the automobile, and most everything else. If that $100,000 investment is fixed in nature like a bond, CD, or Treasury securities, and the principal does not grow to offset inf lation, after just one year the real value of your $100,000 principal is only $96,000; after two years, $92,000, and so on because of an average 4 percent annual inf lation over time. You can make capital gains appreciation on bonds if you are a buyer and seller of bonds based on interest rates. But that’s not what the typical person does. Usually, someone buys a bond then holds it until maturity. Wrong tactic. That’s how you lose your shirt! Bonds have a place in your program, but nowhere near what people have preached over the years, especially when you retire. When your kids inherit those bonds 20 years later and go to pay for their kids’ college education, they will have a rude awakening. The cost of college will have gone up, but not the bond’s principal. Figure 5.1 demonstrates how bonds and CDs perform over time compared to equities. All this doesn’t mean I’m totally against CDs, Treasury securities, money-market funds, and other fixed-principal investments. The ques-
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FIGURE 5.1 Equities Compared with Fixed Investments
How Equities OutperformBONDS, Bonds and Time EQUITIES OUTPERFORM CDs CDs OVERover TIME Compare what happens to $100,000 in various investments over a 20-year period if 8% of the account’s value is Compare what happens to $100,000 in various investments over a 20-year period if 8% of the account’s value is withdrawn — a likely likely scenario scenarioininretirement.* retirement.* withdrawn annually annually—a STOCKS/EQUITY MUTUAL FUND
BOND FUND
CERTIFICATE OF DEPOSIT
$100,000 split among two funds ($50,000 in Investment Company of America A Fund and $50,000 in MFS Massachusetts Investors Growth Stock A**) WITHDRAWAL TOTAL: $306,586 TOTAL ENDING AMOUNT: $193,653 AVERAGE ANNUAL RETURN ON INVESTMENT: 14.22%
$100,000 in Franklin U.S. Government Securities A WITHDRAWAL TOTAL: $179,948 TOTAL ENDING AMOUNT: $102,458 AVERAGE ANNUAL RETURN ON INVESTMENT: 9.83%
$100,000 initially invested in 6-month CD; subsequent investments may decrease to account for 8% annual variable withdrawal. WITHDRAWAL TOTAL: $142,435 TOTAL ENDING AMOUNT: $62,980 AVERAGE ANNUAL RETURN ON INVESTMENT: 7.04%
$400,000 $350,000
$193,653 $300,000 $250,000 $200,000
$102,458 $150,000 $100,000 $50,000
$62,980
$0 12/31/82
12/31/92
12/31/02
*Not subject to sales charges; does not reflect effect of income and capital gains taxes. **Income and capital gains reinvested Source: Thomson Financial
WITHDRAWALS STOCKS/EQUITY MUTUAL FUND ’82 $ 0 ’93 $13,784 ’83 8,170 ’94 14,603 ’84 8,372 ’95 12,858 ’85 8,722 ’96 15,566 ’86 9,846 ’97 17,897 ’87 11,714 ’98 21,839 ’88 10,395 ’99 26,875 ’89 10,977 ’00 29,182 ’90 11,415 ’01 27,652 ’91 12,098 ’02 20,770 ’92 13,852
BOND FUND ’82 $ 0 ’83 8,260 ’84 8,196 ’85 8,514 ’86 9,276 ’87 9,508 ’88 9,298 ’89 9,028 ’90 9,230 ’91 9,581 ’92 9,820
’93 $9,901 ’94 9,696 ’95 8,777 ’96 9,292 ’97 8,944 ’98 9,041 ’99 8,840 ’00 8,075 ’01 8,402 ’02 8,270
CERTIFICATE OF DEPOSIT ’82 $ 0 ’93 $7,272 ’83 8,054 ’94 6,910 ’84 8,104 ’95 6,690 ’85 8,244 ’96 6,515 ’86 8,206 ’97 6,323 ’87 8,028 ’98 6,150 ’88 7,910 ’99 5,963 ’89 7,866 ’00 5,788 ’90 7,886 ’01 5,673 ’91 7,842 ’02 5,389 ’92 7,622
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tion instead is how much of your portfolio should be invested in these vehicles, why, and for what purpose in your overall long-term plan? Just keep in mind that your money has to work hard and grow for you, especially after you retire, but it does not work hard in CDs, Treasury bills, tax-free bonds, corporate bonds, high-yield funds, Ginnie Maes, Freddie Macs, and all the other fixed-principal traps out there! Again I will point out that we do a good job teaching people how to make a decent living, but a lousy job teaching them what the hell to do with money after they make it.
Down Markets All this sounds great, but how do you get cash f low in a down market? That’s easy. Even if you start in a down market, your capital appreciates over time. Wealth building isn’t about instant gratification. It isn’t about timing the market. It’s about having time on your side. I’m not talking about today, tomorrow, or a year from now. The objective is long-term gain, and we define that as five to seven years. You get cash f low in a down market if you tie your investments to long-term objectives. If you’re 30 years old and living paycheck to paycheck, and set aside just $20 a month, after 35 years you would have a substantial stash of cash. (See Figure 5.2.) If you’re 70 years old, your investment objective still is long term. You still have a life expectancy of perhaps 15 years or more. And I’ve never seen a hearse with a U-Haul behind it. You can’t take the money with you, so you’re growing it for both you and the next generation, whether you like it or not.
Liquidity and Your Reserve The degree of liquidity of an asset determines how quickly and easily it can be converted to cash without a significant loss. A liquid asset like a money-market fund is fast cash. It’s very different from an illiquid asset like real estate, the sale and value of which is subject to the whims of the market. Cash-equivalent financial instruments like money-market accounts or even short-term CDs and Treasury bills can be a good, relatively liq-
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FIGURE 5.2 How Investing Just $20 a Month Can Make a Difference See how a small $20 investment per month ($240 a year) grows over time when invested in Investment Company of $20 A MONTH America Fund.
See how just $20/month ($240 a year) invested in Investment Company of America Fund grows over time – 1968-2002* 1968-2002* $150,000
TOTAL CASH INVESTMENT: $8,400 TOTAL ENDING AMOUNT: $130,925 AVERAGE ANNUAL RETURN ON INVESTMENT: 12.76%
$125,000
$100,000
$130,925 Dec. 31, 2002 $75,000
$50,000
$240 Dec. 31, 1968 $25,000
$0 12/31/’67 12/31/67
12/31/’78 12/31/78
12/31/’88 12/31/88
12/31/’98 12/31/98 12/31/’02 12/31/02
*Not subject to sales charges; effect of income and capital gains taxes not included.
Source: Thomson Financial Source: Thompson Financial
uid tool that provides reasonable return with little risk when used properly. They might be used to meet a short-term goal like a college tuition bill due in three months. Your cash reserve, on the other hand, should be in a money-market account. A cash reserve is just that, extra money stashed away for emergencies. Don’t put your cash reserve in something that penalizes you for withdrawal. You want instant liquidity of your reserve, check-writing abilities against it, and the availability of overnight wire transfers to your local bank. If you want, hide it under the mattress. It is not an investment. How much reserve do you need? That depends. I always hear that you need enough reserve to cover six months’ worth of expenses, but how many people have put away enough money to live on for six months in the event they lose their job? The reality is that the size of your reserve depends on what you do, where you work, and your financial circumstances.
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If you’re a self-employed house painter, for example, your reserve needs are much greater than those of a 25-year General Electric executive or an autoworker on the assembly line in Detroit, both of whom have access to benefits ranging from health, disability, and life insurance to 401(k) and various retirement plan options. You should base your reserve amount on your actual cash f low needs, the amount of benefits available to you, and your stage in life—whether you’re just starting out, supporting a young family, midway through your earning years, or nearing retirement.
COPING WITH DOWN MARKETS Remember the analogy of running your financial plan like a business and having a nut, or expense, associated with running that business? To pay for the nut, you need cash f low. Sounds simple enough, but the big problem is that the cost of the nut keeps going up. How can you assure you’ll have enough cash f low when the market f luctuates? That’s a big retirement dilemma. Without the right financial planning, you could outlive your money and come up short.
Short on Cash? Retired or not, you may think you don’t have enough money to get ahead or even keep up. But think again. It could be that you just aren’t making the right use of the cash you already have. Look around. How many people do you know living paycheck to paycheck, hoping nothing ever disturbs the routine? Those people live in mortal fear of a healthcare crisis or a major auto or home repair. Chances are these people also drive relatively new cars or even a big SUV. If they’re not yet retired, I will bet that few participate in an employer’s matching 401(k) program either. That’s turning down free and easy money! My company, Barry Financial, has a matching 401(k) program for our employees. The company contributes 10 percent in addition to the employee’s contribution up to the maximum amount allowed by law, no strings attached. That’s cash free and clear. Easy money? You bet! All the employee has to do is sign up for the plan and put away a few dollars a year. Still, some employees don’t participate because they think they don’t have the financial means to do so. They need every penny from
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their paycheck to meet cash f low needs. Yet I see the same people driving new cars with big car payments. You need to change that software in your brain that’s programmed to think of instant gratification and wasting assets. The other day I was in the elevator of Barry Financial Plaza when the doors opened. In walked three men, each intently talking on their cell phones. Suddenly my tiny space was invaded by three different phone conversations! How in the world did we function before cell phones? Is it really necessary to talk on the phone in the middle of the grocery, movie, restaurant, business meeting, theater, or elevator? It’s the herd mentality again. Turn off the cell phone for mundane matters. That’s what I did, and look what I’ve accomplished. I go back to the philosophy that it’s not what you make, it’s what you do with the dollars you make. Life is not fair at times. But you can’t cry over spilled beer or the fact that you grew up on the wrong side of the tracks or have an ex-spouse that left you with bills and no child support. You must learn to take charge of your financial life. Even if you can only rustle up $10 a month toward a matching 401(k) or $500 a year toward an IRA or similar retirement plan, with time on your side, the money will mount up. If your employer doesn’t match your 401(k) contributions, so what? Your money still grows tax-deferred. This time the federal government is on your side! Max out all your opportunities on qualified retirement programs like 401(k)s and IRAs because anytime you can deduct an investment as an expense on your tax return and have it grow tax-deferred until you retire, you will end up with a hell of a lot more money than someone who didn’t take advantage of Uncle Sam’s generosity. A big difference between a wealthy client and a not-so-wealthy one is their level of knowledge and control of their financial life. It doesn’t take a lot of brainpower; it takes learning to use the brain you have. It’s not very difficult, but the average person just isn’t willing to make the effort. Stop someone on the street and ask, “What’s a Roth IRA?” He or she probably won’t know the answer. The Roth IRA allows you to invest up to $3,000 a year that grows tax-free. For those unwilling to make the effort, that’s more free money out the window. The wealthy don’t have an edge on you. But they are proactive and they take charge of their wealth-building plan. They have a positive attitude and know what they need to do to accomplish their goals.
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How would you like to get a $121,000 bill for the real estate taxes on your home, or a $54,000 bill for your homeowners insurance? I received both recently. Do you think I ever thought I would be in that position? But I am spending less money in proportion to my financial situation today than back when I bought my first two-family home. I didn’t get where I am with a negative attitude. I got there by having a very positive attitude despite my problems. At times, I felt as if I was going backwards and wasn’t going to make it. But I stayed with it through all the challenges along the way. Today, I easily have the ability to pay my bills. I didn’t when I was struggling to make ends meet at age 18, 19, 20, or even 25. But when I started learning about stock options, 401(k)s, profit-sharing, and tax-deferred compounding, and then applied this knowledge, my financial situation improved. It works. It’s as simple as that. You can start anytime. If a hard-working 50-year-old looks ahead to retirement at 65, he still sees a long-term goal. He may not have 35 years to sock away $2,000 a year and watch his money grow, but he can put away $5,000 a year in tax-advantaged retirement vehicles, get rid of some credit cards, and pay himself first. It’s never too late to start investing. Forget the excuses. Just do it.
Portfolio Options Designing your investment portfolio requires the right combination of growth and cash f low within your risk-tolerance levels to give you enough dollars coming in each month to pay the expenses of the nut and offset inf lation. (More on risk in Chapter 6.) Don’t forget that not making a decision is a decision to do nothing. Let’s look at the investment decisions, right and wrong, of one investor. It’s 1980. Joan is 65, newly widowed, and has a life expectancy of another 20 years. She never has had to make a financial decision, and is especially uncomfortable to do so now because she’s afraid of the unknown. She takes the $100,000 from her deceased husband’s life insurance and puts it into a certificate of deposit that pays 6 percent interest. Joan sleeps well at night because she knows her investment is safe, it’s liquid, and Uncle Sam guarantees it. But wait. We talked about that in Chapter 2. Uncle Sam doesn’t really guarantee anything at all. Taxpayers guarantee the guarantee.
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No one can predict the future ups and downs of interest rates, but I can tell you that Joan and millions of others like her will lose money on this type of investment because the principal isn’t growing, and inf lation is eating up her buying power to the tune of almost 4 percent per year. At the end of 20 years, Joan’s $100,000 has the buying power of only $38,000! What would have happened if Joan instead had invested her $100,000 with two money managers through two mutual funds? Let’s say she put $50,000 in American Funds’ ICA Fund and $50,000 with MFS Massachusetts Investors Growth Fund. The result: Her investment instantly is diversified. Through the mutual funds she now owns a part of more than 400 different companies. Over 20 years, Joan could get an 8 percent cash f low, drawing out $8,000 a year for a total $160,000 paid out to her, ending up with $444,375 left in the investment—a 1,081.76 percent cumulative gain. (See Figure 5.3.) That’s an average annual return of 13.14 percent. Not bad. But, what about factoring in inf lation? Here’s a better approach with long-term planning in mind that helps Joan retain her purchasing power and get better cash f low. She starts with the same $100,000, but her withdrawals are based on 8 percent of the portfolio’s value every year, so they vary. The first year Joan’s 8 percent is $8,170. By the 20th year, it’s up to $29,182. Joan gets an average annual return of 14.22 percent and a 1,328.8 percent cumulative gain, and she ends ups with $193,653 in the investment. But she also has built in a hedge against inf lation. (See Figure 5.4; figures do not include tax liabilities associated with cash f low.) But, you say, the numbers worked out so favorably only because this 20-year period included the longest bull market in history. The markets went down during Joan’s time frame, too, but historically, markets go up over the long term.
THE ROLE OF FAMILY RELATIONSHIPS Let’s look at your family again as a business. You’re the CEO or president, your spouse might be the CFO, and your kids the board of directors. You have a responsibility to convey to that board your values as well as an understanding of what’s going on in the family’s financial framework. If you don’t teach them how to handle money and investments,
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FIGURE 5.3 Investing for Cash Flow
Period End 12/31/82 12/31/83 12/31/84 12/31/85 12/31/86 12/31/87 12/31/88 12/31/89 12/31/90 12/31/91 12/31/92 12/31/93 12/31/94 12/31/95 12/31/96 12/31/97 12/31/98 12/31/99 12/31/00 12/31/01 12/31/02 Total
Withdrawal $ 0.00 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 8,000 $160,000
Income $ 0.00 3,166 3,463 3,329 3,275 4,008 4,102 4,363 4,286 2,987 3,224 3,269 3,455 7,885 3,863 12,842 4,614 4,997 5,632 6,026 6,169 $94,954
Total Cash Investment: $100,000 Withdrawal Total: $160,000
Capital Gain $ 0.00 9,586 6,043 8,668 26,392 11,567 9,840 13,225 5,030 7,800 7,267 19,395 13,013 16,311 37,146 39,264 45,566 54,117 50,255 6,837 5,480 $392,800
Reinvest $ 0.00 12,751 9,505 11,996 29,666 15,575 13,943 17,588 9,316 10,787 10,491 22,664 16,468 24,197 41,009 52,106 50,180 59,114 55,887 12,863 11,649 $487,754
Value $100,000 108,598 101,666 122,368 134,750 134,788 139,059 173,562 162,442 208,495 213,997 232,334 218,609 273,375 320,457 428,072 546,099 680,399 661,836 563,636 $444,375
Total Ending Amount: $444,375 Total Return on Investment: 13.14%
Source: Thomson Financial
where will they get this knowledge? Certainly not from our educational system. I’ve proved that. What if something happens to you and your earning capacity ceases permanently? Have you planned for that? What will happen to your family and its finances?
The Essential Contingency Plan Do you have life insurance to take care of your loved ones if you die prematurely? I don’t care how young you are, you need it! A 52-year-old woman recently called in to one of my weekly financial-advice television shows. She had been widowed suddenly and her late husband had no life
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FIGURE 5.4 Investing with Purchasing Power in Mind
Period End 12/31/82 12/31/83 12/31/84 12/31/85 12/31/86 12/31/87 12/31/88 12/31/89 12/31/90 12/31/91 12/31/92 12/31/93 12/31/94 12/31/95 12/31/96 12/31/97 12/31/98 12/31/99 12/31/00 12/31/01 12/31/02 Total
Withdrawal $ 0.00 8,170 8,372 8,722 9,846 11,714 10,395 10,977 11,415 12,098 13,852 13,784 14,603 12,858 15,566 17,897 21,839 26,875 29,182 27,652 20,770 $306,586
Total Cash Investment: $100,000 Withdrawal Total: $306,586
Income $ 0.00 3,160 3,440 3,278 3,158 3,743 3,710 3,802 3,570 2,354 2,418 2,328 2,330 5,634 2,325 8,519 2,446 2,458 2,579 2,566 2,447 $66,266
Capital Gain $ 0.00 9,572 6,029 8,616 25,819 10,994 9,118 12,020 4,515 6,765 6,080 15,670 9,946 11,777 26,583 24,787 26,718 29,782 26,395 2,912 2,173 $276,272
Reinvest $ 0.00 12,732 9,470 11,894 28,977 14,737 12,828 15,822 8,085 9,119 8,498 17,998 12,276 17,412 28,908 33,307 29,164 32,239 28,974 5,479 4,620 $342,538
Value $100,000 108,402 101,067 120,684 130,558 126,853 127,633 154,989 140,308 174,485 171,350 177,948 158,892 189,505 210,687 267,093 321,716 377,876 340,061 265,873 $193,653
Total Ending Amount: $193,653 Total Return on Investment: 14.22%
Source: Thomson Financial
insurance. Though her husband may have told her he loved her while he was alive, his lack of planning didn’t ref lect that. He left her in a terrible position. His earning capacity ceased permanently when he died and his widow couldn’t pay the mortgage, educate the kids, or afford a new car. His family lived in poverty, not dignity, because he didn’t take proper advantage of life insurance. He probably never considered the possibility he could die unexpectedly. The odds of your house burning down are 1 in 250 in the United States, while one in four men age 45 to 65 will die prematurely. Yet the bank requires homeowners to have insurance and state law requires drivers to have insurance. But no one requires you to insure your most
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valuable asset—you and your earning capacity. If you are supporting a family and don’t buy life insurance, that’s just plain stupid. It doesn’t make sense. The events of September 11, 2001, left more than 10,000 children without a parent. None of those parents left home that morning expecting to die. It’s essential that all of us take a proactive approach to managing our lives and our financial security, without procrastination or excuses. Recognize the “what ifs” and take action. Just do it!
Discuss Money It’s also important that family or loved ones are made aware of your financial situation as you age. It’s as much planning and being prepared for the possibility that you may become frail or disabled, as it is about structuring the logical transfer of wealth after you die. It’s about your financial well-being and that of your family. That’s extremely important. Children often worry about their parents’ state of affairs, and whether their wills are in order and their powers of attorney and other various estate planning tools are in place. But don’t be afraid to turn that around. It’s should be the responsibility of the older generation that built the wealth to know about their children’s and heirs’ finances as well. Most people who have built up substantial wealth don’t even talk to their kids about their potential inheritance. They don’t know if their kids have wills or trust agreements, or whether they have the necessary documents to facilitate the transfer of inheritance money. Don’t make a game of your estate. Bring your heirs in and let them know what’s going on so they don’t face unpleasant surprises. I learned that lesson the hard way. My divorced brother contracted disabling multiple sclerosis, then one day fell into a coma as a result of another health problem. At that point, I was named the successor trustee of his trust and headed to Boston from my South Florida home to “take care of things.” Once I got there, though, I faced estate management questions that I hadn’t imagined, let alone planned for. • • • • • •
Where are his car keys? Who has access to his safe-deposit boxes? Who has access to his condominium? What bills need to be paid? Who is his attorney? Where are his financial records?
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Fortunately, my brother survived, but at the time he could not assist me with the answers to these questions. It was a traumatic experience that taught me the importance of sharing with family, loved ones, and trusted advisors the details of how your life is organized—from the location of the car keys to how your obituary should read. At Barry Financial, we have an Asset Organizer form that we ask all our clients to fill out. It covers everything from the basics—such as the location of your keys and your will, insurance contacts, and burial and funeral wishes—to specific lists of assets and liabilities, and even an estate organizer. I’ve included this Asset Organizer at the end of this chapter for you to use as a way to outline these details for someone in your life in case you become incapacitated or die unexpectedly. It’s a way for you to tell your loved ones the specifics about condo keys, safe-deposit boxes, life insurance, and so on. Don’t forget to review your Asset Organizer at least once a year, or any time there is a major change in your life or financial situation. For example, if you get married or divorced, be sure to update your assets, advisors, and contact information.
THE BOTTOM LINE • Think cash f low, not income. • Your money has to work for you all the time. CDs, Treasury securities, money-market funds, tax-free bonds, corporate bonds, Ginnie Maes, and Freddie Macs have only a limited place in your portfolio because your principal in those investments is fixed—it does not grow. • Building wealth is not timing the market. It’s investing over time. You get cash f low in a down market by linking your investments to long-term objectives. • Don’t turn away free money. Invest in your employer’s 401(k) or qualified retirement plan. • Factor in your family or loved ones when it comes to financial planning and decision making.
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FIGURE 5.5 Asset Organization
Asset Organizer Letter Date: _______________________ Dear _______________________ , Please allow this letter to be a final hello and an eternal good-bye. I have compiled a list of all my assets, my will, etc. in an Asset Organizer. The locations of the associated paperwork, documents, and other items that may be of importance are also included. I have done this in an effort to facilitate the smoothest transition of my earthly possessions and responsibilities. The purpose of this letter is to let you know where I have placed this Asset Organizer. You will find it: _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________ Please make proper use of this information and/or inform the executor of my estate. I ( ❏ have,
❏ have not) made copies of this Asset Organizer. They are located:
_____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________ Thank you very much,
________________________________________________ Signature Printed name: ________________________________________________________________________ Address: _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________
Think Cash Flow versus Income
FIGURE 5.5 Asset Organization (continued)
Asset Organizer General Information For the Successor Trustee(s) 1. Miscellaneous: a. The key to my home is located at: _______________________________________________________________________________ b. The key to my second home is located at: _______________________________________________________________________________ c. The extra key to my car is located at: _______________________________________________________________________________ d. My original will, trust, living will, and durable power of attorney are located at: _______________________________________________________________________________ e. My safety-deposit box is located at: _______________________________________________________________________________ f. The key to the safety-deposit box is located at: _______________________________________________________________________________ g. Someone else’s property is in my safety-deposit box. _______________________’s property is identifiable as _________________________________ _______________________________________________________________________________ h. My personal safe is located at: _______________________________________________________________________________ i. My tax records are located at: _______________________________________________________________________________ j. Other: _______________________________________________________________________________
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FIGURE 5.5 Asset Organization (continued)
2. Advisors: We suggest you complete this section in pencil so that changes can be made as necessary. Personal Representative (Other than husband or wife): NAME
ADDRESS
PHONE
NAME
ADDRESS
PHONE
NAME
ADDRESS
PHONE
NAME
ADDRESS
PHONE
NAME
ADDRESS
PHONE
NAME
ADDRESS
PHONE
ADDRESS
PHONE
ADDRESS
PHONE
ADDRESS
PHONE
Trustee (Other than husband or wife):
Attorney:
Doctor:
Religious Advisor:
Guardian:
CPA/Accountant: NAME
Insurance Agent: NAME
Financial Advisor: NAME
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FIGURE 5.5 Asset Organization (continued)
3. Personal Information Medical Insurance
Company
ID Number
a. My original birth certificate is located at: _______________________________________________________________________________ b. My original marriage license is located at: _______________________________________________________________________________ c. My original military records are located at: _______________________________________________________________________________ d. My original Social Security card is located at: _______________________________________________________________________________ e. Judgments from any court cases affecting me (e.g., divorce, judgment against someone still owing me money, etc.) are located at: _______________________________________________________________________________ 4. Burial: a. My body should be buried in: _______________________________________________________________________________ b. The cemetery is located in: _______________________________________________________________________________ c. My body should be cremated and the ashes buried in: _______________________________________________________________________________ d. The cemetery is located in: _______________________________________________________________________________ e. My body should be donated to: _______________________________________________________________________________ f. Other information: _______________________________________________________________________________ _______________________________________________________________________________ _______________________________________________________________________________
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FIGURE 5.5 Asset Organization (continued)
5. Specific Comments, Wishes, Thoughts: __________________________________________________________________________________ __________________________________________________________________________________ __________________________________________________________________________________ __________________________________________________________________________________ a. Miscellaneous papers of personal interest are located at: _______________________________________________________________________________ _______________________________________________________________________________ b. My latest income tax return is located at: _______________________________________________________________________________ _______________________________________________________________________________
Notify
Name
Telephone Number
Newspaper Service Pool Service Lawn Service Domestic Service Other Information about pets: Type
Veterinarian
Telephone Number
My specific last instructions include: _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________
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FIGURE 5.5 Asset Organization (continued)
Specific List of Assets It would be very helpful to the successor trustee(s) if this list is kept up-to-date. These original documents are located at: _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________ Include checking, savings, certificates of deposit, etc.
All Bank Accounts Name & Address of Institution
Type of Account
Account Number
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FIGURE 5.5 Asset Organization (continued)
Specific List of Assets It would be very helpful to the successor trustee(s) if this list is kept up-to-date. These original documents are located at: _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________
All Stocks Name of Corporation
Name & Address of Broker/Transfer Agent
Account or Certificate Number
Think Cash Flow versus Income
FIGURE 5.5 Asset Organization (continued)
Specific List of Assets It would be very helpful to the successor trustee(s) if this list is kept up-to-date. These original documents are located at: _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________
All Bonds Type of Bond
Name & Address of Agent to Contact
Bond or Account Number
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FIGURE 5.5 Asset Organization (continued)
Specific List of Assets It would be very helpful to the successor trustee(s) if this list is kept up-to-date. These original documents are located at: _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________
Mutual Funds Name of Fund Company
Name of Fund
Account Number
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FIGURE 5.5 Asset Organization (continued)
Specific List of Assets It would be very helpful to the successor trustee(s) if this list is kept up-to-date. These original documents are located at: _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________
All Accounts Receivable Name & Address of Debtor
Due Date of Payment(s)
Security for Debt
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FIGURE 5.5 Asset Organization (continued)
Specific List of Assets It would be very helpful to the successor trustee(s) if this list is kept up-to-date. Keep copies of evidence of any business assets and business agreements (e.g., partnership agreements, buy-sell agreements, close corporation stock certificates, and miscellaneous business agreements). These original documents are located at: _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________
All Business Assets Type of Asset
Location of Asset
Account Number or ID Number
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FIGURE 5.5 Asset Organization (continued)
Specific List of Assets It would be very helpful to the successor trustee(s) if this list is kept up-to-date. These original documents are located at: _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________
All Titled Property Include cars, trucks, campers, boats, motorcycle, mobile homes, etc. Year
Make
Model
State Titled
These original documents are located at: _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________
All Real Estate Address
Type of Property
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FIGURE 5.5 Asset Organization (continued)
Specific List of Assets It would be very helpful to the successor trustee(s) if this list is kept up-to-date. These original documents are located at: _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________
All Other Assets (List Individually) Asset
Location
Furnishings Jewelry Heirlooms Antiques Works of Art Stamps or Coins Precious Metals Hobby Equipment Sports Equipment Furs China Glassware Silverware Include special considerations or specific instructions. _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________
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FIGURE 5.5 Asset Organization (continued)
Estate Organizer Schedule of Life Insurance/Tax-Deferred Annuities Include copies of the face page of insurance policies. These original documents are located at: _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________ Life Insurance (include accidental death policies )
Company Policy Number
Owner of Contract
Person Insured
Tax-Deferred Annuities
Company Policy Number
Owner of Contract
Person Insured
Beneficiary Designations Primary
Contingent
Beneficiary Designations Primary
Contingent
Face Value or Amount
Face Value or Amount
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FIGURE 5.5 Asset Organization (continued)
Estate Organizer Schedule of All Other Types of Insurance These original documents are located at: _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________
Type
Company
Amount and Type of Benefits
Disability Medical Long-Term Health Care Auto Homeowners Other Liability Other
Schedule of Tax-Deferred Investments These original documents are located at: _____________________________________________________________________________________ _____________________________________________________________________________________ _____________________________________________________________________________________ Beneficiary Designations Type Pension Profit Sharing IRAs Keoghs Tax-Deferred Annuities Other
Company
Primary
Contingent
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FIGURE 5.5 Asset Organization (continued)
Outstanding Obligations Retail Charge Accounts Name
Account Number
Short-Term Loans Family Loans Securities Margin Loans Bank Loans Federal Income Tax Liability State Income Tax Liability Property Taxes Investment Liabilities Mortgages Liability Judgment Family Member Support Obligation(s) Child Support Alimony Other (specify)
Number of Cards
Year Issued
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FIGURE 5.5 Asset Organization (continued)
Notes
C h a p t e r
6 UNDERSTANDING RISK
I
f you’re looking for a guarantee of success, wealth, or happiness, forget it. There is none. One thing you can count on, however, is that rich people know how to use the money they have to increase their wealth, while others tend to hold onto what they have and don’t plan long term. I made my first million by age 30 with the help of something I didn’t quite understand at the time—stock options. This equity ownership in my employer, Putnam Funds, seemed rather insignificant. In fact, I didn’t have the cash to exercise the stock options until Putnam arranged with a bank to lend me the money. When a public company purchased Putnam, I received stock in that company and suddenly I was a millionaire on paper. That was when I began to consciously understand the importance of utilizing OPM (other people’s money) and equity ownership to build wealth. The calculated risk I took borrowing the money paid off with a handsome reward. (Incidentally, today global money-management giant Putnam has $245 billion in assets under management for more than 700 institutional clients and more than 13 million shareholders and retirement plan participants! Its investment products range from institutional portfolios to IRAs, 401(k)s, mutual funds, annuities, and alternative investments for institutions and highnet-worth investors.) 111
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Of course, you should never speculate wildly with your assets however great or small they might be, but you should consider taking carefully selected, reasonable, and controlled risks with the aid of an advisor you trust and whose judgment you respect. No fortune has ever been made by a person who followed a policy of total risk avoidance, even during down markets and unsteady world events. Start by asking yourself two questions: 1. Is the United States going to survive? 2. Is the world going to survive? If you answered yes to both questions, then start investing. If you answered no, I don’t know where the hell you can put your money. Everything in life is risk/reward. Taking a shower in the morning is risk; you could fall and crack your skull open. Sitting next to someone who is smoking a cigarette is a risk; secondhand smoke causes cancer. The key is to analyze the risk for its reward potential, then ask yourself if you are willing to accept the risk for the potential reward. Think of the great entrepreneurs of our time. Steve Jobs, cofounder of Apple Computer and inventor of the Mac, didn’t know the meaning of no. Ted Turner, founder of CNN, didn’t care if people around him laughed at the idea of a full-time news television station based in Atlanta. What about Bill Gates? In 1973, he entered Harvard only to quit his junior year to devote his energies to his then f ledgling start-up, Microsoft. Go back further in history to John D. Rockefeller, who started Standard Oil, steel magnate Andrew Carnegie, and financier giant J.P. Morgan to name a few. If you read the stories of each of those men’s lives, you will find that they did not turn away from calculated risk. (Incidentally, reading biographies of wealthy, self-made individuals is an excellent idea for those who aspire to reach financial success.) These people and other men and women like them sought opportunities to take risks that would enable them to increase their holdings. They recognized that the person who refuses to venture into the competitive arena makes very little progress in life.
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PRINCIPLES TO FOLLOW There are some basic principles to follow on your journey to building your wealth. • A dream stays a dream until you create a plan to make it come true. Only then does it become a reachable goal. • Don’t be unduly afraid of risk. Evaluate the threat it poses to you, calculate the rewards you stand to reap if you face it, and make your decision accordingly. That’s what I did when, for the third time, I seriously thought about starting my own business and finally did it. Thankfully at the time, Rosemarie pointed out the actual risk was minimal compared with the times when our family struggled to put food on the table. • Do not allow a fear of risk to paralyze you into inactivity. The courage to make investment decisions even when an element of risk is involved is a quality that you must develop. If you cultivate the courage, you won’t be sorry because it will help you act wisely in a variety of situations, both in and out of the investment arena. Years ago when the Dow Jones Industrial Average hit 1,000, people would ask me, “How high is high?” I heard the same thing when the Dow hit 5,000, then 8,000, then 10,000, and so on. You get the picture. When Rosemarie and I got married at 18, we bought a two-family home in Arlington, Massachusetts. I was working two jobs—digging graves during the day and delivering booze on the weekends. We couldn’t afford the $21,000 asking price, but I realized the importance of buying a home as a first step to building wealth. So I approached Jim McGuiness, then the vice president of Arlington Five-Cent Savings Bank. I knew him from my years of working at the Liggett’s Drug Store soda fountain where he was a regular. I asked him for the bank’s help. He didn’t laugh or mock or cast doubt on the aspirations of a young kid. Instead, he worked with me to make the deal. We both took a calculated risk. Rosemarie and I borrowed $2,000 for a down payment from Mrs. Ethel Cokely, an elderly widow in my neighborhood who also knew me growing up. We put that $2,000 down on the house, rented out the upstairs for $110 a month, and then added $44 a month from our pockets
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to make the $154 monthly mortgage payment. Every week Rosemarie would bring Mrs. Cokely $10 to pay down the $2,000 loan. Ten years later we sold that home for what we thought at the time was the unbelievable price of $38,000. That was $17,000 more than we paid for the house with $2,000 of borrowed money. I told Rosemarie at the time, “That guy’s crazy to pay this much for this home.” The last time I was in Boston, I visited that home’s owners—the same couple who bought it from us years earlier—and asked them what they would sell the house for today. The answer: a quarter of a million dollars! The rent upstairs was $1,400! How high is high? I don’t know. Just enjoy the ride.
MEASURING RISK: THE INVESTMENT PYRAMID Of course there is no such thing as a risk-free investment, despite anyone’s claims. All investments are subject either to the risk of the actual loss of money or the loss of the purchasing power of the money due to inf lation. When I borrowed the money to exercise my stock options with Putnam, the company could have run into financial or regulatory trouble; I could have lost my job; the company might not have been purchased. Any number of risks were possible, but I felt the reward would be worth the risks. I compared the risk with the potential reward and made a decision based on my risk tolerance at that time. You have to do the same thing when it comes to your investment decisions.
Simple to See A simple way to visualize the risk/reward potential of any investment is to build an imaginary pyramid. At the broad base are investments with the greatest security, the least risk to your principal, and the lowest potential for return on your money. Keep in mind, though, that the principal is not guaranteed against inf lation. The base therefore would include investments like savings accounts, life insurance (cash value), CDs, Treasury bills, commercial paper, and checking accounts. (See the glossary at the back of this book for explanations of each.) As you move up the pyramid, there is increased risk of losing capital but also greater potential for reward through appreciation. (See Figure 6.1.)
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FIGURE 6.1 The Investment Pyramid
ART STAMPS RARE COINS PRECIOUS STONES STRATEGIC METALS SALE OF CALL OPTIONS (UNCOVERED)
l
hro
api ta
rd t
fC
ew a
ss o
RAW LAND
COMMERCIAL & RESIDENTIAL REAL ESTATE OBTAINED FOR INVESTMENT PURPOSES OIL & GAS INCOME PROGRAMS MUTUAL FUNDS MANAGED ACCOUNTS VARIABLE ANNUITIES
BLUE CHIP STOCKS SALE OF CALL OPTIONS (COVERED)
lR
f Lo
ntia
ko
Pot e
Ris
COMMODITY POOLS
FIXED ANNUITIES
MUNICIPAL BONDS CORPORATE BONDS
INSURED MUNICIPALS
SAVINGS ACCOUNTS
TREASURY NOTES & BILLS
RESIDENCE PERSONAL PROPERTY
ed
ed
OIL & GAS EXPLORATION
rea s
rea s
Inc
Inc
SPECULATIVE STOCKS (INCLUDING PENNY STOCKS)
ugh
Ap
pre
cia
tio
n
PURCHASE OF CALL AND PUT OPTIONS
er ow al gP cip asin rin rch of P f Pu ety Saf ss o sed f Lo rea ko Inc Ris sed rea Inc
GOLD & SILVER
MONEY MARKET ACCOUNTS SAVINGS BONDS
LIFE INSURANCE (CASH VALUES)
CERTIFICATES OF DEPOSIT COMMERCIAL PAPER CHECKING ACCOUNTS
Note: Bonds traditionally have been situated low on the pyramid, but these investments are no longer entirely safe harbors for principal preservation. Be sure you’re aware of the recent history of the bond market before buying them.
But even the pyramid is not a sure thing. Municipal and corporate bonds are near the bottom of the risk pyramid, yet they still default. According to Moody’s Investors Services figures, 18 out of 28,000 bond issuers defaulted from 1970 to 2000. Not bad odds, but tell that to the thousands of people and corporations that lost money when Orange County, California, defaulted on its bonds in the 1980s. What about the holders of bonds from the 89 corporations that defaulted on almost $77 billion in obligations in the first half of 2002? Of those defaults, 21 issuers defaulted on more than $1 billion each!
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Don’t Forget Inflation If you’re still a bond holdout, have you thought about the effects of inf lation? In Chapter 1, I discussed the fact that the interest you earn on the bond is really rent for the use of your money. If you buy a 20year, $100,000 tax-free municipal bond, for example, you actually are lending your money to that municipality. It’s tax-free and you get back the amount you put in if you hold the bond to maturity, but what happens if you have to cash in the bond before maturity? If the bond carries a low interest rate and current rates are much higher, you will have to sell it for less than what you initially paid. Meanwhile, the taxes on your home, the cost of a new car, and most everything else keeps going up. When you add in the effects of inf lation, the $100,000 you get back in 20 years will probably only buy about $38,000 in goods and services! Where did you go wrong? To build wealth, your money has to grow at least at the rate of inf lation with taxation factored in. If it doesn’t, you are guaranteeing a losing proposition. Without realizing it, you are a risk taker because your purchasing power is at risk.
High Risk, Big Reward At the top of the risk pyramid are investments like art, stamps, rare coins, gold and silver, precious stones, strategic metals, sale of uncovered call options, and the purchase of call and put options. Just below these are commodity pools, raw land, oil and gas exploration, and penny stocks. If you sink $25,000 into a deal to drill for oil, is the potential for making money great? You bet. But what happens if it’s a dry hole? I hope you didn’t need that money. If I buy commodity futures on cocoa beans, is that guaranteed? No way. Could I make big dollars? You bet. But I also can lose everything. With every investment, you can measure fairly accurately its degree of risk and potential reward with the help of the pyramid, but you must also determine your risk-tolerance level. Everyone’s risk tolerance is different. A 70-year-old widow with no investment experience isn’t a likely candidate for a South African gold-mining deal even though it looks like a good investment. On the other hand, this investment might fit the risk tolerance of a wealthy 45-year-old who is single and has few responsibilities.
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The Low-Risk Lie Often potential clients will come to me with lots of different mutual funds in their portfolio, consequently thinking they are diversified and have safe investments. But lo and behold! Six out of their ten mutual funds have the same stated objectives. Further analysis of the portfolio shows it to be overweighted in certain areas and they don’t even know it. One man came to me proudly announcing that he had $8 million in tax-free bonds. I discovered a big problem: 93 percent of those bonds were in three states. What happens if 30 percent of those bonds were in California and there was a catastrophic earthquake, deficit financing, or some similar negative event? Good-bye money! Most people don’t think about these things when they put together a portfolio. Think about it. Be proactive with your money. Pay attention to what’s going on and capitalize on OPB!
The Free and Clear Lie Own your home free and clear. We’ve all had that philosophy drummed into our brains over the years. Once again it’s time to update that software in your brain. Free and clear is not the way to go if you want to build your wealth. It’s a guaranteed way to lose money because of inf lation. Don’t do it unless it’s the only way you can sleep at night! If your home is worth $400,000 and it’s paid off or close to it, do you want your money sitting there doing nothing? Make your home and your money work for you. Take out a $200,000 mortgage, and invest it wisely and with diversification. Pay the monthly mortgage from the total return on your investments. If you have to dip into principal every once in a while, big deal! It doesn’t matter long term. Dividends and capital gains will replace what you take out over the long term. There is little doubt that in 20 years the value of your house will increase and so will the $200,000 you borrowed if you invest wisely.
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REALITY CHECK Still doubt what seems like my contrarian approach? Look again at a little bit of market history. Each of these adverse events sent the Dow plummeting at the time, and each time the market recovered. • • • • • • • • • •
1973: Arab oil embargo 1974: Resignation of then-President Richard Nixon 1981, 1984, and 1986: Recessions 1987: Stock sell-off in the wake of the October crash 1990: Persian Gulf War 1992: Recession 1994: The Fed raises interest rates six times 1998: Asian banking crisis 2000: Dot-com debacle, the Internet bubble bursts 2001: World Trade Center and Pentagon attacks
It’s all about time in the market, not market timing. Look at a $10,000 investment in the mutual fund ICA, and what would have happened to it had you invested in the market on the day any of these events occurred. • Ten years after the Berlin Wall was erected, August 13,1961, your investment was worth $23,180, and by the end of 2002, it was worth $925,705. • Ten years after the March 28, 1979, Three Mile Island nuclear disaster, your investment was worth $45,658, and at the end of 2002, it was worth $209,401. • Ten years after October 19, 1987, a record 22 percent one-day drop in the Dow, your investment was worth $44,269, and at the end of 2002, it was worth $54,698. Don’t let emotions or short-term issues affect the logic of your longterm plan. It’s not easy, but it can be done. It takes a plan based on the facts. Facts do not change. Facts are emotionless. Facts are hard evidence. It takes practice to continually make investments that will grow over time and it takes a commitment.
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YOUR RISK TOLERANCE Risk tolerance is a personal thing. The investment that keeps that 75-year-old widow up at night could be the perfect vehicle for the 35year-old, dual-wage-earning couple. Like so much with investing, it depends on you, your circumstances, and where you are in life. That’s why before anyone becomes my client, they first complete a risk tolerance questionnaire to give me an idea of their value systems, attitudes toward money, family relationships, and what level of risk might be right for their personal circumstances. Other financial and investment organizations offer similar questionnaires. Typical questions include: • Do you feel comfortable allowing other people to manage your investments? • Do you feel the need to closely monitor your investments? • Do you ever panic and sell an investment if the price drops shortly after you purchase it? • Do you get upset if your investments underperform the S&P 500 Index? • How secure do you feel with your current job situation and the stability of your income? • Do you feel it’s necessary to totally understand every investment you make? • Would you ever be willing to make an investment that could risk loss of all your capital? Use these questions and others like them to help guide you when making investment decisions. Keep in mind, though, your risk tolerance and hence your investments will change as you go through life. Also, your responses can differ as the market f luctuates.
THE BOTTOM LINE • No fortune has ever been made with a policy of total risk avoidance, no matter how volatile the markets or how much global instability we face.
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• The key is to evaluate the risks versus the potential for reward and decide what’s right for you. • With every investment, you can measure its degree of risk and potential reward with the help of the investment pyramid. • Risk tolerance is a personal thing. Everyone’s risk tolerance differs. • Building wealth is about equity and time in the market, not market timing.
C h a p t e r
7 THINKING LONG TERM
W
e have a short-term mentality in America today. Instant gratification is the norm, and credit the mode of purchase. Think about it; most of those credit cards you carry have interest rates of 18 percent or more, and the interest isn’t tax deductible. Change that software program in your brain again! To build wealth takes a different kind of thinking. Forget the herd mentality— gotta have it now. The it is made up of wasting assets that cripple your wealth-building potential. Think instead about the long haul. You’re the marathon runner, not the sprinter. You’re training for the race, and like investing to build wealth, it’s not an overnight thing. It takes strength, conditioning, and time. Get with it for the long term. All it takes is the right mind-set. What discretionary money do you have? If you look at your nut, you probably have a hell of a lot more than you think. Are you buying wasting assets and paying for them on credit cards over time at 18 percent interest rates? There’s something basically wrong with a system that promotes that. What would you say if I told you I could guarantee you an 18 percent return on your money right now? How can I do that? Cut up the credit cards! Why are you buying food at the grocery on a credit card or charging that stereo you can’t even sell the same day to your 121
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neighbor for the same price? Unless you pay off the balance every month, you’re setting yourself up for a bad deal. Where are your priorities? Instead of driving an expensive new car, can you settle for a used car? Every car does the same thing. It gets you from point A to point B to point C. It doesn’t matter if it’s a Rolls Royce or a Chevy. Go for the Chevy, then later in life pay for the Rolls with money you’ve made as a result of investing that discretionary income. It’s attitude again; it’s priorities. I don’t mean you should hoard money, storing it in a safe-deposit box and having to swat the moth that f lies out when you open it once a year. There’s nothing wrong with using your money properly. It buys a good education for your kids. It sometimes can buy good health. For me, it bought a much better environment in which to raise my kids than a tenement house. It does a lot of bad things, too. It can buy lifestyles out of control that mix drug overdoses and more. This is where that balancing act that I talked about in Chapter 1 comes into play. You have to understand the value of money and what role it serves in your life. If you’re young or changing jobs, resist the temptation to cash in your 401(k) for the short-term gratification of buying that fancy car or taking an expensive vacation. Think about the real purpose of a 401(k). Where’s your commitment and conviction to the long-term goal of taking care of yourself and your family in later life? Roll the money over into a self-directed IRA program and keep it working for your future. A lot of young people don’t do that today, and that’s tragic.
UNDERSTANDING THE EQUATION What exactly is long term? It’s different things to different people. To my 7-year-old grandson it probably means 15 minutes from now. To a commodity trader on the Chicago Board of Trade it’s perhaps 30 minutes. Ask a 75-year-old man what long term means to him, and he’ll say he doesn’t even buy green bananas because he’s not sure they’ll ripen by the time he dies. Building wealth requires a different kind of thinking. To build your financial well-being, you must clearly define what long-term investing means to you. What are your long-term goals?
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My mentor in this business is Sir John Templeton, a pioneer in the concept of global investing. He’s in his 90s and still likes to point out that a normal business cycle is five to seven years. But when it comes to your financial plan, long term is really the rest of your natural life, and then, the money has to be managed for the next generation. Today, the fund company that bears his name, Franklin Templeton Investments, is part of a worldwide group, Franklin Resources, which is one of the world’s largest investment groups with more than 9 million shareholder accounts. Since 1950, both Franklin and Templeton have shown that thoughtful investing can bring real long-term rewards. Another of Sir John Templeton’s timeless wisdoms: I never ask if the market is going to go up or down because I don’t know, and besides it doesn’t matter. I search nation after nation for stocks, asking: “Where is the one that is the lowest priced in relation to what I believe it’s worth? —November 1978
When you buy your first home, do you think in terms of holding that real estate asset for a few months, then turning it over for a big profit? No. Instead you think of the purchase as a long journey. But the minute you buy a stock or mutual fund, you check the price daily, and the market f luctuations will drive you to drink. A good marriage is long term; mine has lasted 48 years. Building a business is long term; Barry Financial has been around more than a quarter-century. Building investments is long term. You must clearly define what long term means to you, set up your plan, and then stick with it. The most costly errors in selecting stocks are made by people whose thinking is dominated by the question of the temporary short-term trend of earnings. —Sir John Templeton, June 1949
STAY THE COURSE Assume that you came to me December 31, 1972, at the height of the bull market prior to 1973’s market collapse. You were 65, retired, and no longer producing dollars. You had worked for 40 years and ac-
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FIGURE 7.1 Winning through Long-Term Investing
Winning through Long-Term Investing
THE WINNER IfLONG you had TERM invested INVESTING a total of $1 million December 31, 1972 in two moderate mutual funds—$500,000 in Investment If you had invested a total of $1 million Dec. 31, 1972 in two moderate mutual funds – $500,000 in Investment Company Company of America and $500,000 in Massachusetts Investors Growth—see how your money multiplied after 30 of America and $500,000 in Massachusetts Investors Growth – see how your money multiplies after 30 years.* That’s after years.* That’s withdrawing of theevery valuemonth of theevery account withdrawing 8%after of the value of the8% account year. each year, taken systematically on a monthly basis. $10,000,000
TOTAL CASH INVESTMENT: $1,000,000 TOTAL ENDING AMOUNT: $5,012,413 TOTAL WITHDRAWAL: $8,690,619 AVERAGE ANNUAL RETURN ON INVESTMENT: 14.17%
$9,000,000 $8,000,000 $7,000,000 $6,000,000 $5,000,000 $4,000,000 $3,000,000
$1,000,000
$5,012,413
Dec. 31, 1972
Dec. 31, 2002
$2,000,000 $1,000,000 $0 12/31/’72 12/31/72
12/31/’82 12/31/82
12/31/’92 12/31/92
12/31/’02 12/31/02
*Sales charges not included; effects of income and capital gains taxes not included. Source:Source: Thomson Financial Thompson Financial
WITHDRAWLS ’72 $ 0 ’73 61,170 ’74 44,026 ’75 47,603 ’76 56,418 ’77 56,195 ’78 63,018 ’79 73,127 ’80 91,637 ’81 113,394 ’82 117,056 ’83 177,452 ’84 165,848 ’85 195,995 ’86 256,012 ’87 285,070 ’88 258,265 ’89 307,835 ’90 298,854 ’91 339,341 ’92 357,471 ’93 392,406 ’94 386,472 ’95 430,911 ’96 463,713 ’97 534,522 ’98 610,969 ’99 719,597 ’00 733,517 ’01 588,638 ’02 464,086
cumulated $1 million in various retirement accounts and savings. At the time, your life expectancy was another 20 years. As your advisor, I put $500,000 into each of two mutual funds; Investment Company of America, a value-driven fund, and Massachusetts Investors Growth Fund. The latter is a growth-driven fund that’s among the dozens of offerings from MFS Investment Management, which in 1924 established America’s first mutual fund. Because you needed cash f low to pay your nut, you decided to withdraw 8 percent of the account’s value each year. On January 31, 1973, you received the first check for $6,211. By the end of 1974, following two years of the worst bear market since the 1930s, your account’s value had plummeted to $467,416. You were in a panic because more than half your money was gone. Everyone around you was screaming, “Sell, sell, sell.” I kept saying, “Buy, buy, buy.”
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Why buy? Think about when you can get the best deals on Christmas decorations. It’s during the after-Christmas sales! As Templeton said back in August 1958: To buy when others are despondently selling and to sell when others are avidly buying requires the greatest fortitude and pays the greatest ultimate rewards. By the end of 1974, you wanted to hit me over the head with a twoby-four. But I kept telling you to stay the course.Yours is a long-term investment for the next 20 years, and even if you die in the short term, you can’t take the money with you. Market timing doesn’t work, but you have to be in the market to reap the benefits. Because you did not sell, almost 30 years later on December 31, 2002, that $467,416 was worth $5,012,413 after you had withdrawn $8,690,619 to live on over the years. The account’s average rate of return was 14.17 percent per year, despite the Dow’s ups and downs during the bull market. (See Figure 7.1.) Living with market declines isn’t easy, but if you understand the lessons of history, you’ll be a more intelligent investor.
PAY YOURSELF FIRST Think of the money you put away annually into your IRA, 401(k), or other retirement vehicle as the most important “bill” you owe. Pay it first instead of heading to Best Buy for that hot new stereo—a wasting asset you will want to replace before it’s paid off. Pay yourself first. Invest regularly and systematically using a technique called dollar cost averaging that helps soften the pain of market ups and downs. The strategy calls for investing the same amount at consistent intervals, such as once a month or every quarter. It doesn’t matter which way the market is going at a given point in time because you aren’t waiting for the perfect time to buy. Neither do you risk the possibility of investing all your money at the top of the market.
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The Tax Equation Long term is the name of the game. So is managing your investments with the tax consequences of your actions in mind. This applies whether you’re funding qualified retirement plans, putting money in other types of investments, drawing down those accounts, funding your kid’s education, donating to charity, or cashing in a stock. First, contribute as much as possible to qualified retirement programs. These include 401(k), 403(b), profit-sharing, or IRA programs. If your employer offers a matching-funds program, even better—it’s free money. All these programs help minimize the tax obligations of growing your wealth because any time you can take a dollar, deduct it on your tax return, and invest it to grow tax-free or tax-deferred, you will end up with substantial capital over the long term. It will be a lot bigger nest egg than that of someone who takes that dollar, pays 30 percent taxes on it— leaving just 70 cents to invest—then buys the same investment on which taxes have to be paid every year because of dividends and capital gains. Next, look at maximizing investments that generate only long-term capital gains tax, which is always lower than regular income tax rates. If you’re in the 38 percent tax bracket, don’t whip your money around from investment to investment, taking profits every six months, because those short-term capital gains will be taxed as ordinary income. That puts you back in partnership with Uncle Sam. The next type of tax-advantaged investment to consider is a nonqualified tax deferral like a fixed, variable, or indexed annuity. In this case, an annuity in a nonqualified account can be purchased with aftertax dollars from literally dozens of organizations, including Nationwide Mutual Insurance of Columbus, Ohio, one of the original creators of variable annuities. Among the many other solid, long-standing providers are The Hartford, which is backed by 190 years of experience, General Electric Financial Assurance, part of General Electric Co., which has been around since 1871, and Transamerica, founded in 1928. If your money is left alone in an annuity, it grows tax-deferred similar to a 401(k). Keep in mind, though, as with a 401(k), tax is due at the time of withdrawal. Also, do your homework and look to your financial advisor for guidance. (See Chapter 8 for more on annuities.)
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Qualified Retirement Programs IRAs, SEP-IRAs, and Roth IRAs are popular investment options today, as are defined-contribution plans like the 401(k), 403(b), SEP (Simplified Employee Pension), SIMPLE (Savings Incentive Match Plan for Employee), Money Purchase Pension Plan, and profit sharing. A Keogh is a qualified retirement program for self-employed individuals. These are all known as defined-contribution plans because there are limits on the amount of money that can be contributed annually. The ultimate benefit to the employee, however, is not defined and depends entirely on the plan’s investment returns. If investments do well, you’ll be wellequipped to handle retirement. If they bomb, you’re out of luck. Consider what happened to employees of companies like Enron and Global Crossing who did not diversify their retirement holdings, instead putting all their eggs in the company basket. One morning they woke up with only pennies left. If you have a 401(k) or similar qualified retirement plan and you leave an employer or the company downsizes, you may be able to receive your retirement benefits in a lump sum payment, in installment payments, through the purchase of an annuity, or by rolling them into a self-directed IRA. The best option will depend on many factors so it’s important to check with your financial advisor before making the decision. Strict rules also are associated with withdrawals. Defined-benefit plans, which were once the standard, are becoming dinosaurs among large corporations today. Through these plans, participants receive a certain percentage of their preretirement salaries in the form of retirement benefits, depending on how many years the employee has been with a company. Employers fund the plans and the monies are invested, but portfolio performance rarely has any effect on the amount of income retirees receive. Also, employees must be fully vested to receive this retirement benefit. If you leave the company prior to the minimum required years of employment, you could forfeit substantial benefits. These plans, however, are making a comeback among small employers with highly compensated employees because they allow larger contributions.
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Here are a few questions that may help you evaluate the real value of any company-offered pension or profit-sharing plan. • What are the eligibility provisions of the company’s retirement plan? • Are loans to participants permitted? If so, how much? • What is the vesting schedule? • Do you have plenty of investments from which to choose? • Can employee participants make voluntary contributions to the plan? • Does the employer offer any kind of fund-matching program?
Retirement: How Much Is Enough? When planning for retirement, you need to determine, with the help of OPB (other people’s brains), your nut, or expenses, and then factor in inf lation to figure out how much money you will need and what to do with your retirement nest egg. Keep in mind the Rule of 72 from Chapter 1 that determines how long it will take for an investment to double. Don’t gravitate to lots of fixed-income vehicles because a dollar loses, on average, about 4 percent of its buying power per year to inf lation. In ten years, that means your dollar is worth only about 60 cents. Also remember that inf lation is a very personal thing that depends on your nut—the costs you face at that point in your life. If you’re 65 with grown children and live in Louisville, Kentucky, your nut could be substantially less than that of someone the same age with two kids in college who lives in Carmel, California, where real estate prices and taxes are higher. Be careful not to project numbers too far out without using actual benchmarks, because your projections could be way off. How much will you need to retire comfortably? I can’t tell you exactly. Most of those formulas that use long-term projections claiming you will need X amount of dollars to live 20 years down the road usually are way off base. I can’t predict the future, but I can tell you that the amount you need to invest is not overwhelming if you have time on your side, the discipline to invest, and the ability to make the right investment choices.
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FIGURE 7.2 Looking to the Past to Determine How Much You Should Invest for Retirement
How HOW Much MUCHShould SHOULDYou YOUInvest? INVEST? ($1,200 ) in American you put put$100 $100a amonth month ($1,200 a year) in American Growth of America A beginning 31, 1977, If you a year FundsFunds Growth Fund Fund of America A shares beginningDec. December 31, 1977, as December of Dec. 31,31,2002, have been beenworth valued at $219,513.* by 2002,your youraccount account would would have $219,513.* $400,000
TOTAL CASH INVESTMENT: $30,000 TOTAL ENDING AMOUNT: $219,513 AVERAGE ANNUAL RETURN ON INVESTMENT: 13.66%
$350,000 $300,000 $250,000 $200,000 $150,000
$219,513 Dec. 31, 2002
$1,200
$100,000
Dec. 31, 1977 $50,000 $0 12/31/’77 12/31/77
12/31/’87 12/31/87
12/31/’97 12/31/97
12/31/’02 12/31/02
*Includes sales charges; effects of income and capital gains taxes not included. Source:Thompson Thomson Financial Financial Source:
While predicting the future is difficult, it is easy to look back to see what it has taken in the past to retire comfortably. Historically, the S&P 500 has averaged a 10.2 percent rate of return over time. For example, we can look at a typical money-management approach for someone who was age 40 in 1977 and planned to retire at 65 at the end of 2002. By dollar cost averaging—adding $1,200 a year to the account—and purchasing American Funds Growth Fund of America and reinvesting the dividends, by December 31, 2002, this investor would have $219,513 (See Figure 7.2.). If he or she expected to live another 20 years, taking an 8 percent withdrawal per year, this amount would provide $17,561 a year or $1,463 a month for the rest of that person’s life. (For more on your investing options, see Chapter 8, “Investing: Strategies and Options.”)
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THE EXIT PLAN Let’s say you’re 65 and have been socking away enough money in a retirement plan for 35 years that the plan is now worth $1 million. Your discipline to invest for the long haul is admirable. Now you, your family, and your heirs can reap the $1 million reward, right? Wrong! Is the money subject to federal and state income taxes? Is it subject to federal estate taxes? The answer to these questions is a resounding yes. Why? Because your retirement plan was a tax-deferral program, not a tax-free one, unless it was a Roth IRA. If you think your kids or grandkids are the primary beneficiaries of that $1 million when you die, you’re mistaken. If you don’t plan ahead, the biggest beneficiary will be the federal government. Why work so hard and save for 35 years only to let Uncle Sam get in excess of 70 cents of every dollar you accumulated? It doesn’t make sense. To prevent this from happening, proper planning is a must. While you are putting money into tax-deferred investment accounts, you also need to devise a plan to withdraw it. Otherwise, you create an unwitting partnership with Uncle Sam, unless you invested in a Roth IRA. Again, operate your family finances like a small business. As a business owner, you plan for what will happen to the business after you die. The same holds true for your retirement accounts.
Draw Down Your Accounts One of the biggest mistakes people make when they reach age 70¹⁄₂ is how they do or don’t draw down their retirement accounts. Clients tell me they want to take only the minimum distributions because they don’t need the income and they hate paying federal and state income taxes on the money. If you hate the thought of these taxes now, wait until you die and the federal government wants to double or even triple the taxation for your heirs! Take control. Consider taking out more than just the minimum dollar amount from your retirement plans and drawing down other investments as well. Look long and hard at the future gains possible across all your investments. Remember, it’s not what you have in your estate when you die, it’s what you don’t have that counts. The more you have in your taxable estate, the more taxes will be due.You want a program in place
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that reduces the amount of money in your estate as you go along, but you don’t want to give anything away that you might need to maintain the lifestyle to which you’re accustomed.
Stretch IRA If you don’t need all the money in your retirement investments to fund your living expenses, you might consider implementing a Stretch IRA, and designating your grandchildren as beneficiaries. Federal estate tax on this IRA is due after your death, but the income tax liability can be stretched out over the life expectancy of each beneficiary. Because your grandchild’s life expectancy obviously is longer than that of your child, it allows even more time for the money to grow before taxable withdrawals are required.
Life Insurance Life insurance is one of the most overlooked and underappreciated areas in the retirement planning process. It offers much more than just cash to leave to your heirs when you die. If structured properly, life insurance can provide any number of living benefits to you and your family. It can provide liquidity to help defray the cost of federal estate taxes in a large estate. It can be used as wealth replacement on IRA monies subject to income and/or estate taxes when you die. Through loan programs, it can generate income to take care of you and your family as needed. When annuitized, it can take care of a mortgage and can create wealth for future generations. Though variations are many, the basic types of life insurance are whole life, term insurance, universal life, and variable universal life. There are all kinds of policies, but they normally fall into one or a combination of these four categories. For example, let’s say you have young children and know you will have a financial obligation for a certain number of years based on their ages. You might opt for permanent life insurance as a base with a term rider to take care of short-term financial obligations associated with raising the kids, and perhaps a clause that amortizes the life insurance to pay off your mortgage should you die prematurely.
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Here’s another way to use life insurance. Spouses can leave any size estate to each other free of federal estate taxes. But when the second spouse dies with a large estate, taxes come due with a vengeance unless the couple planned ahead. Heirs could be forced to cash in or draw down retirement plans to meet the tax obligations. However, if life insurance is set up properly it can provide the necessary cash at exactly the right time without disrupting the principal in an IRA. While you’re alive, you and your spouse can set up an irrevocable life insurance trust. The trust buys a last survivor life policy that pays only on the death of the second spouse. To save even more on estate taxes, you can get creative with a Crummey Letter. (More on that in Chapter 10.) Using the annual gift tax exclusion, you can gift each of the beneficiaries of that trust $11,000 ($22,000 per couple), which the beneficiaries in turn forfeit (in writing). The money then goes into the trust to pay for the cost of the life insurance policy. After the second spouse’s death, the policy proceeds are not subject to estate tax because you didn’t actually own the policy, and the gifting reduced the value of your present estate while at the same time funding a future value gift. Got that? As you can see, it gets complicated and definitely takes the expertise of an estate planning professional. Here’s another way to look at it. Assume a couple, both age 65, have $2 million. The couple establishes an irrevocable life insurance trust, which then purchases a last survivor life insurance policy. This insures both spouses under one contract, but only pays the benefit on the second person’s death. What’s so important about the timing? That’s exactly when you want the payoff because that’s when the estate taxes come due. What’s the cost for such advanced planning? At the writing of this book, the annual premium for a $1 million standard nonsmoker last survivor life policy from Penn Mutual Insurance Company (Horsham, Pennsylvania) is $12,685 a year, hardly a stretch for the couple with $2 million socked away. Incidentally, Penn Mutual is one of the nation’s oldest mutual life insurers with more than a century of experience and financial strength.
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THE ACHILLES HEEL OF FINANCIAL AND ESTATE PLANNING Do you know what the Achilles Heel of financial and estate planning is? It’s your health and the costs associated with health care and long-term care.
Long-Term Care If I asked you to paint a verbal picture of what long-term care is, could you? Would you describe an elder shivering in bed with the blankets pulled up to his or her nose? Perhaps it would be a vision of a thin parent lost on a bed staring at the ceiling of a dimly lit nursing home while surrounded by stainless steel trays. Could you envision a spouse, brother, sister, best friend, or even yourself lost in this kind of hopelessness? Supporting a loved one with a chronic illness has become one of the most serious and possibly disruptive issues for modern families. It can be one of the most emotionally and financially devastating periods for an individual or family. Long-term care can mean many services ranging from a little extra help with daily living in the home to adult day care, home health care, or chronic nursing home care. Let’s say your parents call one evening, upset because the doctor just told them your dad is suffering from the onset of a cognitive impairment. Your father has just joined the nearly half of those 85 and older who suffer from Alzheimer’s disease. Alzheimer’s sufferers cannot be left alone safely and often require around-theclock care. Your father and mother are scared and turning to you for support. Their world and yours as you’ve always known it is over. How much time is there? What is going to happen? What type of care will be necessary to keep your father at home? Conjuring up what this will cost is a sobering reality. The annual cost of nursing home care can be crippling. I have one client with Alzheimer’s who has been in a nursing home for eight years at $75,000 a year! Further, he will be there a long time because the illness isn’t affecting his life expectancy. Can you, your spouse, or your family afford bills like that if one of your loved ones faces the same future? Consider a few realities from the nonprofit National Family Caregivers Association (reprinted from 2002 statistics with permission of the
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National Family Caregivers Association, Kensington, Maryland, the nation’s only organization for all family caregivers; 800-896-3650; <www.nf cacares.org>). • More than one-fourth (26.6 percent) of the adult population has provided care for a chronically ill, disabled, or aged family member or friend during the past year. That’s more than 50 million people. • Men now make up 44 percent of the caregiving population. • Almost two-thirds (61 percent) of those family caregivers who provide at least 21 hours of care a week suffer from depression. • Heavy-duty caregivers, especially spousal caregivers, do not get consistent help from other family members. One study has shown that as many as three-fourths of these caregivers go it alone. • 59 percent of the adult population either is or expects to be a family caregiver.
Long-Term Care Insurance What’s your excuse for not having long-term care insurance? It won’t happen to you? You don’t need it? You can’t afford it? Better think again. You insure your automobiles, your life, your jewelry, yet from a health and risk point of view, you ignore the most valuable asset you have. Remember the four guys playing bridge, one of whom will end up in a nursing home or long-term health care setting? Who is going to pay for that? In the old days, kids took care of elderly parents. But today, because both partners in many couples work, that’s not possible. Even if you think it is possible, do you really want to place that responsibility and financial and emotional drain on a loved one? The government’s health care plan isn’t the answer either. Medicare, Medicare supplemental insurance, and major medical health insurance usually will not pay for long-term care. Medicaid programs pay for nursing home care only when the patient has reached the poverty level. That means the government says you have to spend down all you’ve worked hard to earn before it will pick up the cost. That doesn’t make any sense and can be avoided if you plan in advance. Instead of paying perhaps $75,000 a year out of pocket for nursing home care, a couple at age 65 can pay about $3,000
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a year to buy a long-term health care insurance policy through GE Financial Assurance Company, an arm of General Electric. Be pragmatic and unemotional about it. Compare the one-in-four odds that you’ll end up in a nursing home with the miniscule odds that your house will burn down or that you’ll be in an auto accident. Yet you have insurance for your car and your home, but often overlook the benefits of a long-term health care policy. Even if you are extremely wealthy and can afford to self-insure, it may not be a sound business decision. Money alone will not protect your family from the injuries, anxieties, and often-overwhelming burden of caregiving. Also, self-insuring is based on the assumption that your family will be physically, emotionally, and geographically able to step up to the plate at the future point of need. “I can’t afford it” is a lousy excuse for not having long-term care insurance. You can’t afford not to have it! The longer you wait to buy a policy, the higher the rates. At age 65, the premiums are more than double the cost had you bought coverage at age 50. Currently, the cost at age 50 for $150 a day in benefits with inf lation protection, lifetime protection, and a couple’s discount is about $1,400 annually for a policy through GE. At age 65, the same policy would cost the couple $3,200 a year. The cost of your long-term care premiums also may be fully or partially treated as a deductible medical expense on your taxes with some limitations, and benefits can be tax-free. The government will probably allow more incentives too, because it can’t afford the cost of health care. It must find ways to encourage you to do it yourself. That’s what Uncle Sam already does with funding for retirement through IRA and 401 (k) programs. There’s a good chance that you or your spouse will need long-term care at some point as you get older. Is paying for that out of pocket a gamble you’re willing to take? If you recognize the need for long-term care insurance but truly aren’t sure how to pay for it, you might want to look for a life insurance policy with what’s known as a living needs benefit or one with a longterm care rider. These policies can be tapped to pay for long-term care if you are deemed terminally ill. The following points can help you determine if long-term care insurance is right for you.
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Do not buy long-term care insurance if: • You have limited assets. • Your only source of income is a Social Security benefit or Supplemental Security Income. • You often have trouble paying for utilities, food, medicine, or other important needs. Buy long-term care insurance if: • • • •
You have significant assets and income. You want to protect some of your assets and income. You want to stay financially independent. You want the freedom to choose your care provider.
Long-term care policies are not standardized like Medicare supplemental insurance, so shop carefully. A few things to keep in mind: • Be sure you understand what services are covered and any limitations on who can provide those services. • Know what types of facilities are covered. If you’re in a facility that’s not covered, the insurer can refuse to pay for eligible services. • Find out if an insurer in your state can refuse to pay covered services for an illness that develops after a policy is issued. • Be aware of the benefit limits. Are they in line with the cost of the service in your state? • Know what triggers benefit payments and when. • Does your policy protect you in terms of cost of services and the effects of inf lation? Inf lation protection increases the premium, but if you don’t have it you may find that nursing home costs far surpass your benefits years from now. Obviously, the younger you are when you buy a policy, the more important it is for you to think about adding inf lation protection. • Keep in mind that this type of insurance can be purchased only while you are still healthy. If you already have a serious condition or have signs of Alzheimer’s, it’s too late.
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In Case of Disability On the subject of preparing for the unexpected, what would happen to your family, loved ones, or even yourself if you suddenly had an accident or came down with a serious illness and lost your earning capacity for several months or years? Could you continue to pay the mortgage, foot the college bills, and fund your retirement? That’s what disability insurance is all about. In fact, statistics show that during your working years, the likelihood of you becoming disabled is far greater than that of dying prematurely. That is why this type of insurance is so important for the breadwinner of any family. Chances are if you work for a big corporation, it’s an employee benefit. But if you are self-employed or if your employer doesn’t offer this coverage, look into buying an individual policy. Disability coverage generally pays you a portion of your income when you become disabled and the benefits are not taxable. Policies don’t, however, usually cover 100 percent of your lost wages. The amount of coverage you need depends on what it would take to maintain your lifestyle in case of a disability that prevents you from working. Other questions to ask when considering disability policies are: • How long will a policy pay benefits? It should be until at least age 65. • How does a policy define “disabled”? It should be along the lines of being unable to perform the duties of your occupation. • What is the elimination period on the policy? It’s the time lapsed between when you become disabled and when the policy’s benefits kick in. It’s much like a deductible on a car or home insurance policy.
The Big Variable: Health Insurance The cost of health care today is measured in trillions of dollars and is climbing fast. According to the U.S. Centers for Medicare and Medicaid Services, by 2011, Americans will be spending a total $2.8 trillion on health care. To most of us, those numbers are almost incomprehensible. What does register though is that no matter your age, every year health care costs take a bigger chunk of your money. If you’re self-employed or retired and don’t qualify for a group health policy, the costs
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can be especially staggering. More than 13 million Americans don’t even have health insurance. Here are a few more sobering numbers from the Centers for Medicare and Medicaid Services for 2001. • Spending on private health insurance premiums increased 10.5 percent in 2001, the fourth consecutive year of increases. • Hospital spending was up 8.3 percent. • Prescription drug expenditures climbed 15.7 percent. • Nursing homes and home health care were a relative bargain with increases of only 5.5 percent and 4.5 percent, respectively. How can the average person plan for and cope with these skyrocketing costs? Knowledge. When you buy a car, you don’t just go to the nearest dealership, pick out a color, plunk down the cash, and drive off. You do your homework first. You figure out the best car for your needs, then check out prices, gas mileage, financing options, warranties, and more. You probably also go to a couple of different dealers. The point is that you invest time and effort before making the major economic outlay. These days you probably will spend more money on health insurance over your lifetime than on cars. How much time do you actually spend researching and selecting health insurance? Do you simply sign up for your employer’s offering? With all the managed-care plans as well as the more traditional insurance plans, it takes time to wade through the sea of options to find what’s best for you, your family, and your budget. Don’t just pick the cheapest premium. You could regret it. Generally, health care plans fall into one of three categories: 1. HMO or health maintenance organization. This kind of a plan usually provides you the highest level of benefits for the lowest premium. You, the insured, are a member of the plan, and the participating doctors and hospitals are referred to as the network. You must receive your medical care from within the network. The only time the plan will pay for out-of-network benefits generally is in an emergency situation. Preventive care like routine physicals usually is fully covered. The insured generally has a copayment for services and is required to have a primary care
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physician (PCP). Doctors in an HMO generally are paid by a system known as capitation—your primary care physician receives a certain amount of money for every patient assigned to him or her whether they visit the doctor or not. Some plans require that PCPs share capitation fees with specialists if they refer patients to them, thus discouraging what can be necessary referrals. This sharing of the capitation fee, however, is not done by all HMOs, so don’t be afraid to ask. A point of service or POS plan combines the low out-of-pocket charges and preventive-care coverage of an HMO with the freedom to choose providers like a PPO. Out-of-network services with the POS, however, will cost the patient more than in-network services. 2. PPO or preferred provider organization. Like an HMO, a PPO offers a network to provide services. However, the member can go outside the network and still receive some benefit coverage. A PPO does not require a patient to see a primary care physician, and may limit the maximum benefits over the life of the policy. It’s a more expensive option because you are paying for the f lexibility of choosing your health care providers. 3. Standard indemnity plan. This was the standard in the industry before managed care. With this plan, there is no reimbursement until you have met your deductible, at which time it usually pays up to 80 percent of covered services. You pay the remaining 20 percent. Usually after a maximum out-of-pocket expense, the plan covers 100 percent of the cost. This type of plan can become expensive. It’s recommended for those who need the f lexibility, can afford the convenience, or really don’t have any other choices. What type of plan is right for you? There is no clear-cut answer. Each of us has different needs and limitations. HMOs can be less expensive than PPOs. You also could be paying for some benefits that you’re less likely to use. A plan with small payments for office visits may cost more initially, but if you and your family go to the doctor often, you may actually save money in the long run. If you don’t have a plan through an employer, look for group policies through associations. Some HMOs also allow individuals to join at group rates. One of the simplest moneysaving steps you can take is to choose a high deductible that could knock
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20 percent off your premium. This is often a good idea for people who are usually healthy. Put a small amount of your savings in a money-market account each month to pay the deductible and copays. If not spent, at least it will earn a little interest. If you are self-employed, consider a medical savings account (MSA) that allows you to buy a high-deductible policy and then set aside money in a tax-free savings account to pay the deductible costs or other out-of-pocket health care expenses. If your employer offers it, take advantage of a f lexible spending account (FSA) that allows an employer to deduct a pretax set amount monthly from your paycheck. That money goes into an account that can be used for medical and other qualified expenses like child care. But consider yourself forewarned. With an FSA, your employer gets to keep whatever you don’t spend by the end of the year. If you are married and both spouses work as employees, be mindful of the costs of dual coverage. If you have children and both you and your spouse can get coverage from your employers, it usually makes sense to enroll in only one plan. Investigate what each plan offers and choose the one that makes the most sense for your family’s needs. Like it or not, you’re going to have an ongoing relationship with your health insurer, so make sure you’re comfortable with it. Don’t be afraid to ask questions. That’s what you and/or your employer pay for. Some other considerations: • Know and understand the preventive care provisions, if any, in a plan. • Be confident with the level of medical care available through a plan and the company that underwrites it. • Keep in mind that many individual plans require you and family members who will be covered under the plan to be relatively healthy before they will insure you. • Find out if a plan accepts and provides treatment for preexisting conditions. Some do, others do not. Can you afford care for a preexisting condition that’s not covered? • Know your rights and fully understand cost factors. Just as you would get a medical checkup periodically, give your insurance plan a checkup too. It can be solid preventive medicine for your future.
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THE BOTTOM LINE • Building wealth is a long-term proposition that takes commitment (as in forget those credit cards) and training (as in hard work) over the long haul. • Pay yourself first. The money you regularly put away annually into an IRA, 401(k) or other retirement vehicle is the most important bill you owe. • When you put money into something long term, figure out an exit plan so you don’t get socked with withdrawal penalties or excessive taxes when it’s time to draw the money out. • Don’t overlook the importance, financially and emotionally, of long-term care insurance. The younger you are when you buy the original policy, the less expensive it is. • Don’t jump at the first and most convenient health insurance policy. Do your homework to figure out which plan is best for the needs of you and your family, and your finances.
C h a p t e r
8 INVESTING Strategies and Options
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always cringe when people tell me they “play” the market. Investing is serious business, not some crapshoot in a casino. With the help of OPB (other people’s brains, as in your financial advisors), it’s important to make your money work hard. Money doesn’t get a vacation, it doesn’t retire, and it always should be working for you.
GROUND RULES AND STRATEGIES Your principal has to grow to offset the effects of inf lation. That’s why debt ownership—loaning your money via fixed-income investments like CDs, bonds, and money markets—doesn’t work long term. Equity ownership, such as investing in stocks, works because your principal has a chance to grow. Remember, inf lation eats away at your savings every year so you must take that into consideration as you plan for the future.
Take a Holistic Approach Just as you take a total-body approach to your health, so should you with investing. With your health, you pay attention to drug interactions 143
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and take precautions not to strengthen one set of muscles at the expense of others when you work out. It’s the same with investing. Look at the big picture, not just one single investment. What happened to all those people heavily invested in technology when the Internet bubble burst? Even if they held smaller amounts of well-established technology stocks, chances are their value plummeted too. What about the Enron retiree with an entire 401(k) in company stock? It’s not a pretty picture, but it’s one that can be avoided with one simple word: diversification. I’m reminded of another nugget of wisdom from Sir John Templeton, this one dated July 1949. Diversification should be the cornerstone of your investment programs. If you have your wealth in one company, unexpected troubles may cause a serious loss; but if you own the stocks of 12 companies in different industries, the one which turns out badly will probably be offset by some other which turns out better than expected. — Sir John Templeton
Let’s look at General Electric, a real battleship of a stock holding because it’s difficult to sink. First, each of us would be hard-pressed to identify a home that does not contain a GE product. It could be a light bulb, dishwasher, or stove. GE also builds many of today’s jet aircraft engines. If you get an X-ray at the hospital, GE probably manufactured the equipment. If you want to buy life or health insurance or finance a business, chances are you may turn to GE for that too. It’s a great company, but if you are buying only GE stock, you’re putting all your eggs in a single basket and violating one of the cardinal rules of investing serious monies—diversification. Why not buy just GE? Look at the following numbers on the company as of December 31, 2002: • One-year total return: –37.71 percent • Three-year total return: –50.27 (–20.77 percent per year) • Five-year total return: 7.68 percent (1.49 percent per year) If you had put all your money in GE over the past few years, where would you be now? And GE is a solid company! On the other hand, if you had invested your money in two growth mutual funds, Fidelity Magellan and Investment Company of America, your losses would be min-
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imal over the same time period. At most, GE stock makes up only 2.4 percent of those funds’ portfolios. That means even if Battleship GE went out of business, you would lose only 2.4 cents of every dollar you put into the mutual fund. Diversify, diversify, and diversify.
Keep Your Emotions Out of It Your emotions have no place in investing. Save your emotions for art. Investing is a discipline. Most people understand theoretically that it’s wiser to deal with a problem logically, but they generally do the opposite. As your emotions rise, your sense of concern becomes warped. Decisions are made based on emotions and often cause more damage than what was feared in the first place. It’s the herd mentality again. Ignore what everyone else does! One animal gets frightened, they all start running, and that creates a stampede. The spark that ignited the stampede may have been valid, like a hungry lion, but the intrinsic value of that rich grass the herd was feeding on has not changed. So imagine being one of the smarter animals. Before you run, look around to see if a lion really threatens the herd. When the herd stampedes, the wisest investors not only stay, they buy more of the quality investments. The more the herd runs, the lower the prices go. As the market drops further, the wise investor buys more because he or she knows the herd will return. When it does, those smart investors already will own—bought at discounted prices—the very stocks the herd will once again clamor to buy. Look at the market history we discussed in Chapter 7. Did the bombing of Pearl Harbor destroy the stock market? For people who bought into the market that day, ten years later their investment was up 350 percent. Those who invested in the market in October 1987, when the market dropped 23 percent in a single day, saw the Dow up more than 440 percent ten years later. Wise investors never see any threatening lions because there are no lions in long-term investing. No one knows exactly what the future will bring, but we can look at the past for a hint of the future. The best strategy for investing success in good times and bad: Think long term; think diversification; think patience; think professional money management.
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Tune Out the Daily Noise Remember that we are bombarded daily with information overload. Tune it out. Don’t let all the negative media noise get to you. Take a deep breath. Step back and look at the big picture. After Hurricane Andrew pummeled the eastern coast of Florida in 1992, real estate values on coastal properties plummeted. Was it a permanent decline? Of course not. If the prices of my houses were listed daily in the Wall Street Journal, I would go out of my skull. Forget daily market f luctuations. Tune out the noise. Be Rip Van Winkle and fall asleep under a tree for the next 20 years. Don’t get me wrong. You need to pay attention to your advisors and the world around you, but being a patient investor is an absolutely critical part of the success equation. Give your investments the time they need to grow. Take a hint from Rip. Your investments will be all right. This advice was not heeded by those would-be day traders who five years ago quit their real jobs, went online to gamble in the serious business of the markets, and one day woke up broke. My advice on market corrections: Don’t worry, be happy. To maximize performance with minimal risk, think long-term investing.
Other People’s Brains I didn’t build my car; you probably didn’t build yours either. I didn’t build the bridge across the intercoastal waterway near my ocean-front home, and chances are you probably didn’t build any of the bridges or roadways near your home either. We left that to OPBs—the experts who knew how to do it. The same goes for building wealth and financial planning. If I have a secret formula to successful long-term investing, it’s to surround yourself with the right people. It all sounds so simple, but most people just don’t understand. They’re too caught up in excuses, instant gratification, and all the noise.
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Tax-Efficient Investing This may sound like a contradiction, but you can become efficient at investing while remaining inefficient with your taxes. You would think that anyone actively investing would be managing his or her tax rate effectively as well. Not so. Did you know that many average investment portfolios lose a substantial amount of their earnings to taxes? That’s because much of the investment management industry focuses on buying and selling stocks, and that can create short-term capital gains. As an investor, it’s your responsibility to be aware of the tax consequences of any investment. Index mutual funds from companies like Vanguard Group are an investment option for taxable accounts because they generally have a lower turnover and therefore fewer taxes associated with the portfolio. Combined with other investments, buying index funds can be a tax-efficient strategy. Keep in mind that the day you buy into a mutual fund, you buy into its tax consequences, too—good or bad. If you buy shares of a fund in June and in November it declares capital gains and a dividend based on the buildup in the fund over the years, you will participate in that tax obligation. Even if the market may have gone down since you bought your shares or you have a loss in your account, you still have to pay the taxes. Conversely, if you buy a fund with loss carry-forwards and it’s a good fund, you might not pay much in taxes because any dividends the fund declares can be offset by past losses. Do your research and see what its current built-in capital gains or dividends are before you buy a mutual fund in a taxable account.
Think Big over the Long Haul Though they have their ups and downs, big or large-cap companies like AT&T, General Electric, Cisco, and Microsoft probably will be in business for years to come and generally provide good returns over the long haul. Don’t, however, overlook the little guys or small-cap companies or mutual funds. Keep in mind that most of today’s megacompanies started out small. Of course, predicting which small cap will make it is a risky business. You can lower your risk while optimizing your chance for gains by investing in large caps and small caps.
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Using Your Mortgage to Make Money Most people become emotionally attached to their homes, and that’s understandable considering a home is where the heart is. In doing so, however, you may be overlooking a valuable investment opportunity. Say you’ve managed to pay off your mortgage and now own the house free and clear. Some people may need that freedom from debt in order to sleep well at night. However, having all that equity tied up in a paidoff home is probably not to your best financial advantage. Why not take out a new low-rate mortgage, then use that money to invest wisely? I’m not talking about day trading or gambling on commodity futures. I’m talking about putting the money in stable mutual fund investments. If you took out a $50,000 mortgage on your home and invested it wisely, what do you think the chances are that it might show a good return in 20 to 30 years? Historically speaking, investing in mutual funds has proven to be a generally safe bet. If you need the cash f low, set up a systematic withdrawal plan from the mutual fund to cover the mortgage, and you likely still will show quite a good investment return. Of course, if you feel this is too risky, look for other opportunities. The most important thing you have to remember with building your financial future is that you have to be comfortable with the amount of risk you take on.
More Real Estate Realities I started my wealth-building path by owning that two-family home outside Boston. I bought it with borrowed money and ten years later sold it for a hefty profit. That wasn’t luck. I took a calculated risk and it paid me back with what at the time seemed a huge reward. That’s what buying the right real estate can do for you. I bought my first home on the Florida coast in 1984 for the ungodly price of $480,000. Rosemarie protested because it really was a beat-up house, but I told her we were buying the land, not the house. We rebuilt the home for another $300,000, then lived in it for 18 years. I then turned around and sold it for $3.1 million cash and bought the house next door from a retired dentist and his wife for the ungodly price of $1.175 million. That dentist had bought the home in 1972 for the ungodly price of $115,000. I suspect he made more on that one house than
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he did treating patients for 30 years. He probably said to his wife, “My God, this guy’s crazy.” It sounds crazy, but that’s the real world. The current rental on the home we sold for $3.1 million is $17,000 a month! The land alone today is going for $4 million. Calculated risks pay off if you do your homework.
Global Options Don’t discount international opportunities. When our markets are down, foreign markets often are up. When you add international securities to your portfolio, you open the door to greater investment opportunity because more than half the world’s market capitalization lies outside the United States. Because international markets periodically have done better than our markets in the past, why limit your investing to just one nation? Be aware, however, that international investing does come with certain risks related to f luctuations in the value of the U.S. dollar relative to other currencies, custody arrangements made for the fund’s or stock’s foreign holdings, differences in accounting, political instability, and the lesser degree of public disclosure provided by nonU.S. companies. Global mutual funds can be a good, diversified alternative. These funds can invest all over the world, including the United States. With a mutual fund, the responsibility of handling the global risks lies with the investment fund manager. Among the many companies that offer solid global funds is Oppenheimer, one of the largest and most respected mutual fund companies in the United States, managing more than $120 billion in assets. At this writing, Barry Financial has about 15 percent of its allocation on the global side, but those numbers constantly change. That money, however, is not in a country-specific sector fund like a Japan Fund, a German Fund, or a Singapore Fund. It’s about total diversification! One example of a global mutual fund is the New Perspective Fund, another of the many funds available from the American Funds family of funds. It’s a fund that looks for long-term growth of capital worldwide with a focus on taking advantage of changing trade patterns and economic and political relationships.
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In the investing world, it’s important to remember that global differs from international. Global includes investments in the United States. International investing does not. It’s also becoming less accurate to refer to many U.S. companies as domestic. Companies like Coca-Cola, Philip Morris, and McDonald’s are U.S. companies, but each does 50 percent or more of its business outside the United States. Do your homework before you buy to be sure you know exactly into which type of mutual fund you’re buying.
Dollar Cost Averaging Don’t let the fancy name fool you. Dollar cost averaging simply refers to investing a certain amount of dollars on a systematic basis over the long haul, whether the market is up, down, or in between. That could be every week, every month, every three months, or whatever fits your financial picture. If the herd screams sell when prices are falling, tune it out. With dollar cost averaging, it doesn’t matter. Sometimes you buy low, other times high. Over the long term, you come out a winner because you steadily have increased the number of shares in your investment. Consider Louie the Loser, a guy who for the past 20 years always invested his money on the worst day of the year, the day the market peaked. Now Louie is ready to retire and he’s smiling. Why? Because Louie’s annual $10,000 invested in Investment Company of America Fund (a total $200,000 investment) today is worth $653,939, and he’s averaged a 10.9 percent annual return. Even if Louie had invested every year at market lows—the best time to invest—his average annual return would have been only 12.2 percent. (Figures American Funds Distributors, Inc.; used with permission.)
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DOING IT RIGHT I keep coming back to Investment Company of America because it takes a solid approach to investing. The elements that go into an ICA investment decision include ( American Funds Distributors, Inc., used with permission.): • Long-term value-oriented approach. ICA wants stocks of well-managed companies bought at reasonable prices and held for the long term. In 2002, 70 percent of the stocks owned by a typical growthand-income fund at the beginning of the year had been sold by the end of the year. Yet ICA’s turnover rate was only 27 percent. Low portfolio turnover cuts transaction costs and helps shareholders control taxable capital gains. • Global research effort. ICA does its homework. That includes not only reading and analyzing documents, but on-site visits to plants, branch offices, suppliers, customers, competitors, and bankers which all provide insight into companies held or under consideration. In 2002, American Funds experts made more than 9,000 visits in more than 50 countries. • Portfolio management by committee. ICA calls it the “multiple portfolio counselor system.” Each portfolio is divided into portions and managed independently subject to a fund’s objective and overall guidelines. This blends teamwork with individual expertise and minimizes the impact on the total product if one counselor changes responsibilities or leaves. • Veteran investment professionals. ICA’s nine counselors have an average 24 years of industry expertise and have been through both bull and bear markets. • Low operating expenses. In 2002, shareholders in a typical growthand-income fund paid $129 in expenses for every $10,000 invested. ICA shareholders paid less than half that amount, only $59. Decision by committee, however, is not necessarily better than portfolio management by individuals. Fidelity Investments proves that. The company, which has the largest staff of portfolio managers, analysts, and traders in the fund industry, has a more-than-50-year track record
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of successful mutual fund management that emphasizes intensive market research and active portfolio management by individuals, not committees. That approach to money management has remained a hallmark since Edward C. Johnson II initiated it after becoming president and director of the then-small Boston-based Fidelity Fund in 1943.
INVESTMENT VEHICLES There’s an investment for every need, every taste, and most every tax break you can think of. Following is a brief look at just a few. I’m not recommending any specific investment or product because, as I keep saying, everyone’s needs, desires, risk tolerance, and goals are different. I can only get you on track and open your mind to the possibilities. The decisions are up to you. In investing, there are two types of money: equity and debt. Equity investments are those in which you own a piece of the business or action. The investment should provide the opportunity for your money to grow to offset inf lation. On the other hand, debt investments, like a bond, are static. You loan or rent your money to an entity for a set period of time, then get the same principal back with some interest. Because inf lation continually erodes the value of your dollar, you need to seriously consider whether the principal and interest you will collect down the road is in reality more than you lent. It’s not that I’m against all debt investments like certificates of deposit, bonds, and other fixed-income vehicles. As I’ve said before, the questions are how much of your money should be invested, for what purpose, and what role do these instruments play in your long-term financial strategy. They are appropriate bottom-of-the-pyramid holdings for people who can’t sleep at night with other kinds of investments. But perhaps those same people should think about updating the software program in their brains.
Stocks When anyone says “investment,” most people think of stocks or equities. When you purchase a stock, you actually are buying a tiny equity
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ownership in that company. If the company does well, the value of your stock goes up. If the company does poorly, so does your investment. Over the long term, equities substantially have outperformed fixedprincipal investments. There’s nothing wrong with buying a few individual stocks yourself. But don’t think you’re a professional money manager if you pick a few winners. It’s luck! Rely on investment professionals instead. That’s what mutual funds are all about.
Mutual Funds Who doesn’t own a mutual fund these days? They offer professional management, diversification, low cost, liquidity, and convenience, plus there’s a fund for every kind of investor. An equity mutual fund generally buys stock in many individual companies. Fixed-income mutual funds buy bonds, and money-market mutual funds buy short-term commercial paper or Treasury bills. Fund shareholders then own shares in a pool of investments. Did you know that the concept of a mutual fund originally was greeted with skepticism? It happened in 1924 when the founders of MFS® Family of Funds debuted Massachusetts Investors Trust, America’s first mutual fund. The rest, of course, is history. By nature, buying a fund is more diversified than buying a small equity interest in a single company. However, the kind of fund you purchase makes a big difference. A sector fund may target only one industry or segment of an industry, thus increasing your risk and possibly your reward. Technology sector funds buy stock only in technology companies; utility sector funds buy only utility-related companies, and so on. Just how risky are sector funds? When the Internet bubble burst, investors found out fast what can happen to a narrowly targeted investment sector. I personally don’t like sector funds because you need to know when to get in and when to get out. That’s timing the market, and we already know that doesn’t work. When you compare various funds, don’t overlook the fees that a fund charges because they can affect your returns over time. There can be front-end loads (sales charges), back-end loads, redemption fees, exchange fees, account maintenance fees, management fees, and 12b-1 fees. Some funds have only a few fees, while others are weighed down
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with charges to shareholders. In general, however, costs are substantially lower today than 20 years ago, according to the Investment Company Institute. A fund’s fee table can be found in its prospectus. Also keep in mind that higher fees do not mean better performance or vice versa. Talk to your financial advisor about fund fees. Sometimes fees perceived to be high are in place for a good reason.
Managed Accounts If you like the diversification of a mutual fund but want a more customized portfolio and have a minimum $50,000 to $100,000 to invest, perhaps an individual managed account is for you. Unlike a mutual fund in which shareholders own shares in a pool of securities, a managed account consists of shares of specific stocks you own. Companies like MFS Investment Management out of Boston design a portfolio based on your objectives, ideals, and interests. For example, you could specify that the account managers exclude tobacco stocks or include only companies that comply with clean-air policies, and so on.
Hedge Funds Hedge funds are private, mostly unregulated investment vehicles with high minimum investment requirements, usually $200,000 or more. Often they are set up as limited partnerships or limited liability companies. Unlike mutual funds, leveraging is a cornerstone of hedge funds’ investing style. Fees are high and the fund’s management or sponsor is not required to disclose fund holdings or performance. Typically, these funds use strategies other than the usual buy and hold of ordinary investors as a hedge on the direction the market will take. Often it involves short or long positions associated with an investment. A short position (selling borrowed securities) anticipates the market is going to go down; a long position (owning the securities) anticipates that it will go up. In other words, hedge funds carry high risk and potential big reward. But an awful lot of people out there have gambled big and lost just as big on these investments. Buyer beware.
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Closed-End Funds A closed-end fund is an investment company that offers a fixed number of shares and generally invests in equities or bonds. The fund’s assets are professionally managed in accordance with the stated fund objectives, and shares usually trade on a stock exchange or in the overthe-counter market. Because fund shares are openly traded on the stock market, prices vary depending on demand, so shares often are sold or bought at a discount or a premium to their net asset value.
Unit Investment Trusts With a unit investment trust, the investment company buys a fixed portfolio of stocks, bonds, or other securities for a fixed length of time. Units of the portfolio are sold to investors. Unlike a mutual fund, there is generally no investment turnover during that period of time. At the end of the period, units often can be rolled over into a new offering. Because there is little management of the portfolio during the time period, fees are much lower than those of mutual funds.
Annuities Are you worried about outliving your money? If so, you’re not alone. It’s one of the biggest retirement fears people face. Properly setting up the right annuity can guarantee that won’t happen. But before you jump on the bandwagon, you better know what you’re getting into, and as with other tax deferral plans, you need an exit plan. Annuities are contracts usually issued by insurance companies. They come in two main varieties: fixed and variable. Variable annuities offer a choice of dozens of investments and personalized options that will blow your mind. You control which management companies will manage your money and you get to pick the investment options. You can split your money among offerings from companies like Fidelity, Franklin Templeton, Putnam, and other well-known names. You have additional options like locking in a hedge against inf lation on the annuity’s
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death benefits and whether to lock in profits (choosing a “watermark”). You can’t do the latter with an individual stock or a mutual fund. A fixed annuity offers a guaranteed and fixed interest rate for a certain period of time. It’s immune to stock market or interest rate ups and downs. The down side is you also lock in a fixed rate that doesn’t change even if interest rates go up. A variable annuity, on the other hand, is more complicated but has the potential for a much higher rate of return. Of course, I prefer the variable annuity. You already know what I think of “fixed” investments. Annuities can be deferred, which allows the money to be set aside and grow tax-deferred for future use. At retirement, you have the option of withdrawing the money as needed or turning the annuity’s value into a regular income stream guaranteed by the issuing company to last the rest of your life no matter how long that may be. An annuity that is chosen carefully, provided it is not your only investment, can enhance your financial plan. However, a fixed annuity has no real long-term hedge against inf lation. Also like all tax-deferred investments, withdrawals from annuities come with a price tag—tax liabilities. Make sure you talk with your financial advisor before you make any annuity investments, withdrawals, or annuitization plans. Think of an annuity as an umbrella. It’s raining taxes so you open the umbrella to seek shelter under it and defer those taxes. However, when you die, as much as 83 percent of every single dollar can go to the federal government if that annuity is part of a taxable estate. To avoid the tax trap, figure out an exit plan at the time you buy an annuity. The new generation of annuities offers a different game from those of the old school in which you gave the insurance company X dollars and they paid you for life, keeping what money was left if you dropped dead prematurely. The choices available today are like those on a restaurant menu: You decide what you want for breakfast, lunch, dinner, and all the courses in between. The Securities and Exchange Commission regulates variable annuities. Unlike fixed annuities, you’re not at the mercy of the insurance company if it runs into financial difficulties. As I mentioned in Chapter 7, you can buy annuities from dozens of organizations with solid track records. Nationwide Life Insurance Co., for example, offers The Best of America annuities and traditional life and health products. Lincoln National (Hartford, Connecticut), the
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stalwart f lagship of the Lincoln Financial Group of companies, is another major annuity, insurance, and financial services provider. (See the “References” section at the back of the book for the names of more of the nearly 6,000 insurance companies in the United States today.)
Life Insurance The main purpose of life insurance is to provide cash in the form of a death benefit to your family or loved ones after you die. The money is federal income tax free. How much life insurance you need is an individual decision based on your family’s ongoing expenses and needs. The rule of thumb is to buy a policy that is five to seven times your annual gross income. Life insurance falls into two basic categories with many variations on each. Term insurance provides protection for a specific period of time—from one to 30-plus years—and it pays the benefit only if you die during the term. Some term policies can be renewed when you reach the end of the term. Premiums increase at each renewal. The other category of life insurance is permanent insurance which provides lifelong protection. As long as you pay the premiums, the specified death benefit will be paid. Other names for these policies are whole, ordinary, guaranteed universal, and variable life. Most have a cash value or cash surrender feature that term insurance policies do not have. Depending on the type of policy you have, if you need to stop paying premiums, you may be able to use the cash value to continue your current insurance protection for a specified time or have the option to reduce the death benefit of the policy. See Figure 8.1 for a breakdown of the differences between term and permanent insurance. Variable universal life (VUL) is one of the most popular types of permanent insurance. It provides death benefits and cash values that vary with the performance of investments within your policy. It offers exceptional f lexibility in the choice of professionally managed investment options, tax-deferred accumulation, income-tax-free death benefit, tax-favored access to cash, and tax-free policy loans. Because of its f lexibility, VUL can help you plan for a lifetime of financial goals, from funding a child’s college education to supplemental retirement benefits and estate planning.
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FIGURE 8.1 Term Insurance versus Permanent Insurance
With Term Insurance . . .
With Permanent Insurance . . .
• Initial premiums generally are lower allowing the purchase of a higher level of coverage. • Premiums increase as you grow older. • Policy generally doesn’t offer cash value or paidup insurance. • Coverage may terminate at the end of the term or become too expensive to continue. • Excellent tool to cover needs that will disappear over time like car loans or mortgages.
• Required premium levels may make it hard to buy enough protection. • Premium costs can be fixed or flexible to meet personal financial needs. • Policy accumulates a cash value against which you can borrow. • With some policies, a provision or rider can be added that gives the option to purchase additional insurance without a medical exam or furnishing evidence of insurability. • Policy’s cash value can be surrendered in total or in part for cash or converted into an annuity.
Some tips to keep in mind about your life insurance purchase. • Take your time and do your research. On the other hand, don’t put off an important decision that could provide protection for your family. • Make your policy purchase check payable to the insurance company, not the financial advisor, and get a receipt. • Remember that after buying a policy you have a “free-look” period—usually ten days—during which you can change your mind. • Review the copy of your application contained in your policy and notify your advisor or the company of any errors or missing information. • If an advisor or company contacts you and wants you to cancel your current policy to buy a new one, contact your original advisor or company before making a decision. • If you have a complaint about your insurance advisor or company, contact the customer service division of your insurance company. If still dissatisfied, contact your state insurance department or division. • Review your policy periodically or when your situation changes to be sure coverage is adequate.
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Viatical Settlements I’m also compelled to mention viatical settlements, though my advice is to tread very carefully in this arena. A viatical settlement is the discounted sale of a life insurance policy to a third party so that a terminally or chronically ill patient—the policyholder—can use the cash they receive from the policy sale during his or her lifetime. The policy is purchased for a discounted cash value, then when the policyholder dies, the third party receives the full benefit. Viaticals surfaced as a way for AIDS patients to cash in their life insurance policies and handle some of their astronomical medical bills. This kind of a settlement might work in isolated circumstances, but be forewarned that this area is rife with fraud. Viatical settlements are out there as an alternative, but think twice before getting into one.
Bonds You already know where I stand on equity ownership versus fixedincome ownership—owning a piece of the action versus renting your money to someone for a set time at the end of which you get the principal back. With fixed-income investments inf lation will eat away your money’s purchasing power. Bonds are based on interest rates that f luctuate. If you buy when rates are at historic lows, you’re locked into that rate for the life of the bond. When your principal is returned at maturity, you get back only the same dollar amount, not the same purchasing power. I admit that bonds can provide some stability in times of volatility. Before you buy though, step back, take a deep breath, and look at how you have made your money up to now. Chances are it was in equity ownership, not renting out your money. I didn’t become wealthy by lending my money to some entity so it could invest in equity that grows. At one of my wealth-planning seminars, a woman proudly announced to me that she doesn’t pay any taxes at all. “I love those checks every month from my tax-free bonds,” she added. That woman needs an updated version of the software in her brain. She doesn’t realize that she can’t zero herself out with taxes in tax-free bonds because she is losing buying power every year. Also, she’s looking at those checks as income. What about the cash f low she will need to pay her nut in ten years? What will happen to the
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real estate taxes on her condominium or the cost of her health insurance, food, clothing, and a new car? The cost of living goes up, but the value of her fixed investments will go down an average 4 percent per year due to inf lation.
CDs, Treasuries, and More Certificates of Deposit, aka certificates of destruction or certificates of depreciation, and Treasuries—are more investments that do not allow your principal to grow, and generally are not for the long-term wealth builder. As I’ve mentioned over and over again in this book, your money must keep working for you to meet your nut and keep up with inf lation. If you buy a $10,000, ten-year CD, ten years later, when you get your principal back, that $10,000 will only buy around $6,000 worth of goods and services. In the meantime, what will happen to the costs of the food you buy, the rent or mortgage you pay, and the cost of your automobile? They will all go up. I’m not against fixed-income investments to meet short-term needs, but they don’t work over the long haul. It doesn’t make sense to lend your money to someone else, have them use it, and only receive back the same principal later while the cost of living has gone up.
THE BOTTOM LINE • Your principal has to grow to offset the effects of inf lation. That’s why fixed investments like CDs, bonds, and money markets don’t work long term. Equity ownership, like stocks and real estate, do work because your principal has a chance to grow. • Look at the big picture, not just a single investment. • Don’t be paralyzed by all the negative media noise. Take a deep breath, step back, then concentrate on the important things. • “Free and clear,” as in paying off your home, is not necessarily a wise choice when it comes to building wealth. • Life insurance can be an excellent tool to provide security for your loved ones, lessen tax liabilities, and create wealth for future generations. • Annuities can be solid sources of cash if they’re selected properly. Don’t buy without consulting your financial advisor first.
C h a p t e r
9 STOCK MARKET BARGAINS The Sale Is On
For those properly prepared in advance, a bear market in stocks is not a calamity but an opportunity. — Sir John Templeton, May 1962
E
verything in life is supply and demand. You don’t need a Harvard MBA to recognize that. With a limited supply and big demand, the value of something goes up; a big supply with limited demand decreases the price. It happens in the stock market at various times; it happens in real estate; and it happens with any goods and services. When few people are buying stocks, prices are low, which creates a buying opportunity. When everyone’s buying, equities cost more. It’s just common sense to buy low when the Microsofts, Wal-Marts, and Philip Morrises of the world are on sale. But few people buy into a sale on stocks. Instead they go out of their way for a sale on clothes, shoes, dishes, or whatever, and even try to negotiate lower prices. My son, James Michael Barry, compares the way people buy stocks with buying a car. It’s like deciding to buy a Mercedes with a $50,000 sticker price but insisting that the dealer take $60,000 for the car because you really like it. That’s crazy, yet that’s exactly what people do in the stock market. 161
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They wait for the price to go up before buying. The time you should buy is when the price is down. The time you should sell is when everyone wants to buy. That’s contrarian thinking, but that’s the way to build wealth! You have to learn to do exactly the opposite of what the average person does. That’s what makes people successful not just in money matters, but in vocations, attitudes, and raising a family too. How do you know the right stocks or mutual funds to buy at the equities sale? You don’t. You hire a professional. That’s their job. Remember OPB!
FORGET THE HERD Whenever you buy anything on sale, you must know the quality of the merchandise you are buying. With a stock sale, most people do not. They recognize quality clothing and the fact that Christmas decorations go on sale after the holidays, but when Microsoft, Wal-Mart, Intel, or Home Depot are on sale, they have a hard time appreciating the quality of these companies. They get scared, they run, and they sell off their stock, or, if they don’t own these shares, they don’t buy into the sale even though this is the time they should! Think differently. Don’t be part of the herd. Go to the sale and buy the bargains. They’re there for the taking, even in an extended declining market, as long as you recognize that no one has a crystal ball that can predict exactly when share prices will rise. The key is to tap OPB to help you identify the quality merchandise. Years ago if I had sat around sipping wine with ten friends and told them that I planned someday to have two live television shows—one on public broadcasting stations and the other on Fox—sponsored by some of the leading financial companies in the United States, that I would have a Web site with tons of free investment information, and that I would be known nationwide as a motivational speaker at conventions and organizations, what do you think my friends would have said? Most likely, it would have been something like: “Compete with Louis Rukeyser? Do all that? You’re crazy. How the hell are you going to do it?” Nine out of ten people would have given me reasons why it could not be done. But I just did it. I’m contrarian because the great majority
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of the time the current mentality is wrong. You cannot be part of the herd. More wisdom that I learned from Sir John Templeton: If all the money managers on Wall Street are breaking for lunch at noon and communicating with each other about what they’re looking at and buying, there’s no individuality. There’s no creativity. They’re all part of the herd, and that’s not what makes a winner. I buy a new car when demand is low and the dealer is clearing inventory. I follow the same principle with my investment strategies. I fund my retirement programs at the beginning of every year. I have certain disciplines, things that I know work but that the majority of people aren’t doing. Callers to my television shows always ask me where is the best place to put their money. That’s the wrong question. Instead they should ask: where is the worst place, the investment everyone thinks is no good. Why? Because that’s often where to find the real buying opportunities. Do you want to buy at wholesale or at retail prices? Wholesale, of course. With stocks you do that by buying stocks when the market is down. That’s just common sense. But the herd mentality doesn’t follow that system. How in the world am I able to live in an incredible 20,000-squarefoot house on the Atlantic Ocean? How did I do that when I was told to be a priest or fireman or mailman and get a second job if necessary to make ends meet? I didn’t do it by having a herd mentality. I didn’t do it by arriving at work at 8:30 AM, taking 45 minutes off at lunch, then heading to the gym at 5 PM. I did it by having a different thought process from the majority of people. Don’t make excuses for why something can’t be done. I’m telling you it can be done with the right attitude and approach, and it doesn’t just apply to making money, either. Mother Theresa certainly wasn’t part of the herd mentality and look what she has accomplished. Nelson Mandela wasn’t part of the herd. Neither was Abraham Lincoln. These people were eagles and not afraid to be different.
Seize the Opportunity Learn to live with what people perceive as bear markets and take advantage of them. Our nation has been there before; it will be there again. Forget the excuse that it’s different this time. It’s not. We had Sep-
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tember 11, 2001; we have the war on terrorism. But the world has lived through Attila the Hun, Roman conquerors, the Oklahoma City bombing. The list goes on. Maybe it looks like a different color or a different shade today, but it’s not. The opportunities are there despite the negative things going on in the world. You must believe that! If you don’t, your attitude is holding you back. There is no simple answer to the question of what to invest in. It constantly changes. A mutual fund’s manager could leave suddenly and drastically affect that fund as the investment of choice. A company could lose a key deal or run into regulatory hurdles that affect the value of that individual stock. See Figure 9.1 to see the f luctuations of the values of some large corporations. I can’t tell you what specific investments to make. I will, however, offer you some advice on what not to do.
Forget Market Timing Timing the market is a crapshoot. Let’s go back to December 31, 1972, and assume that as your investment advisor, I convince you to put $10,000 in the Fidelity Magellan Mutual Fund. Two years later following an oil embargo, President Nixon’s resignation, and a recession, your $10,000 investment has plummeted almost 60 percent, and is worth just $4,150 on December 31, 1974. Let’s look at your three options and what would happen to your investment in each case. 1. Move to fixed investment. Disgusted with the stock market and my recommendations, you pull what’s left of your money out of Fidelity Magellan, instead seeking the “safety” of Uncle Sam’s guarantee with a 6-month certificate of deposit (aka certificate of destruction/depreciation) that you renew every six months. 2. Stay the course. Instead of the take-the-money-and-run philosophy, you leave what’s left of your investment alone in Fidelity Magellan because you’re wise enough to think patience. After all, yours is a long-term investment.
HD IBM MCD MSFT MO S SBUX WMT WAG DIS
IBM
McDonald's
Microsoft
Philip Morris Companies
Sears Roebuck
Starbucks
Wal-Mart
Walgreens
Walt Disney
F
Ford Motor
Home Depot
COST
Costco Wholesale
HIG
CSCO
Cisco Systems
Hartford Financial Services Group
CC
Circuit City Stores
GE
BBBY
Bed Bath & Beyond
GM
T
AT&T
General Motors
AOL
AOL Time Warner
General Electric
Ticker
Company Name
Media
Consumer Services
Consumer Services
Consumer Services
Consumer Services
Consumer Goods
Software
Consumer Services
Hardware
Consumer Services
Financial Services
Consumer Goods
Industrial Materials
Consumer Goods
Consumer Services
Hardware
Consumer Services
Consumer Services
Telecommunications
Media
Sector
Media Conglomerate
Specialty Retail
Discount Stores
Restaurants
Department Stores
Tobacco
Business Applications
Restaurants
Computer Equipment
Home Supply
Insurance (Property)
Auto Maker
Electric Equipment
Auto Maker
Discount Stores
Data Networking
Electronics Stores
Furniture Retail
Telecom Services
Media Conglomerates
Industry
NYSE
NYSE
NYSE
NNM
NYSE
NYSE
NNM
NYSE
NYSE
NYSE
NYSE
NYSE
NYSE
NYSE
NNM
NNM
NYSE
NNM
NYSE
NYSE
Exchange
FIGURE 9.1 Performance Fluctuations of Some Individual Stocks (As of December 31, 2002)
-20.30
-12.93
-11.76
-26.98
-48.60
2-6.78
-21.99
-38.42
-35.47
-52.74
-26.33
-20.83
-37.71
-38.92
-36.77
-27.66
-56.61
-21.86
-27.70
-59.19
Total Return 1 Year
-16.90
0.33
2-9.46
18.90
-5.33
27.95
-23.78
-25.69
-9.94
-29.31
0.37
-17.29
-20.77
-31.58
-14.96
-37.46
-36.75
25.73
-27.90
-44.32
Annual Return 3 Year
-12.39
13.75
21.30
16.26
-9.92
3.14
9.86
-6.89
8.79
4.46
1.17
-2.66
1.49
-10.59
4.69
7.11
-8.37
29.11
-12.03
-18.29
Annual Return 5 Year
41.03
46.44
49.23
84.80
38.24
51.41
65.29
31.51
46.83
55.00
89.94
43.34
30.86
39.81
52.37
77.09
117.72
72.65
47.17
178.59
Best 3 Month Return
-35.55
-27.25
-18.17
-37.97
-44.05
-33.50
-30.00
-37.93
-30.64
-33.32
-32.55
-38.82
-23.10
-38.30
-39.77
-58.66
-60.97
-28.01
-42.60
-39.54
Worst 3 Month Return
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3. Buy more shares. Because I’m a good advisor and keep telling you that this is a buying opportunity, you decide to put another $10,000 into Fidelity Magellan on December 31, 1974. Let’s see what happened to your money 28 years later as of December 31, 2002. 1. If you went for the CD, it’s now worth $29,498, not counting any tax liabilities on the gains. That’s a 7.26 percent average annual return. End of discussion. 2. Your original investment now is worth $799,655. That’s a 15.73 percent annual rate of return, even factoring in the miserable markets of the past couple of years. 3. Your $4,150 plus the additional $10,000 you put in on December 31, 1974, has grown to $2,726,314, an 18.41 percent average annual rate of return! So much for market timing and safe CDs as long-term investments. Don’t think the fund gains are just because I chose Fidelity Magellan either. It’s the economy, the growth of our country that boosts the value of your investment. You can’t prove it short term, but you certainly can prove it on a long-term basis.
HOW GOOD ARE YOU AT PICKING STOCKS? Whether you think you have what it takes to pick market winners on your own or humbly admit you haven’t a clue when it comes to investing, try the challenge in Figure 9.2 to test your skill, courtesy of the Investment Company of America. How did you do? Not very well I’ll bet, and that’s with the benefit of hindsight. How do you think you would do pinning your long-term financial security on predicting the future? That’s why we all need specialized help in many areas of our lives from building a car or drafting a trust agreement to choosing the right investment to fit our needs, risk tolerance, and goals. Surround yourself with OPB.
Stock Market Bargains
FIGURE 9.2 You Pick the Stock Winners
The Dow Jones Industrial Average is made up of 30 stocks, though its composition has changed over the years. Let’s assume that 69 years ago you invested $10,000 each in any five stocks in the DJIA. (If a company in the index was replaced by another, proceeds from the sale of the original one were invested in the new one.) Circle your top five picks from the list below then check the results on the following page to see how well you did. • • • • • • • • • • • • • • • • • • • • • • • • • • • • • •
Alcoa (replaced National Steel in 1959, which replaced Coca-Cola in 1935) American Express (replaced Manville in 1982) AT&T (replaced IBM in 1939 ) Boeing (replaced Inco in 1987) Caterpillar (replaced Navistar International in 1991) Citigroup (previously known as Travelers, replaced Westinghouse in 1997) Coca-Cola (replaced Owens-Illinois in 1987, which replaced National Distillers in 1959, which replaced United Aircraft in 1934) Disney (replaced USX in 1991) DuPont (replaced Borden in 1935 ) Eastman Kodak Exxon Mobil General Electric General Motors Hewlett-Packard (replaced Texaco in 1997) Home Depot (replaced Sears, Roebuck in 1999) Honeywell International IBM (replaced Chrysler in 1979) Intel (replaced Chevron in 1999) International Paper (replaced Loew’s in 1956) Johnson & Johnson (replaced Bethlehem Steel in 1997) J.P. Morgan Chase (replaced Primerica in 1991, which replaced American Can in 1988) McDonald’s (replaced American Brands in 1985) Merck (replaced Esmark in 1979, which replaced Corn Products in 1959) Microsoft (replaced Union Carbide in 1999) Philip Morris (replaced General Foods in 1985) Procter & Gamble SBC Communications (replaced Goodyear in 1999) 3M (replaced Anaconda in 1976, which replaced American Smelting in 1959 United Technologies (replaced Nash-Kelvinator in 1939) Wal-Mart Stores (replaced Woolworth in 1997 )
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FIGURE 9.2 You Pick the Stock Winners (continued)
Company
Market value of $10,000 investment (excluding dividends) after 69 years*
Investment Co. of America Procter & Gamble Philip Morris General Electric Exxon Mobil Coca-Cola Merck Citigroup Eastman Kodak Alcoa Hewlett-Packard Intel DuPont Home Depot SBC Communications Microsoft McDonald’s United Technologies Wal-Mart 3M General Motors Disney Honeywell International Boeing American Express International Paper IBM J.P. Morgan Chase Johnson & Johnson AT&T Caterpillar Inc.
$4,616,859 4,265,769 3,895,949 3,596,311 1,739,690 1,307,005 1,300,371 860,544 786,558 672,688 605,886 453,627 433,618 401,447 330,269 303,209 291,103 276,151 220,832 194,976 166,401 100,539 98,576 98,309 95,620 88,385 59,072 53,342 51,167 36,864 19,789
*It was assumed that the initial $10,000 was invested in each stock and that fractional shares were purchased where required to use up the full amount. No brokerage charges were included in the cost. Adjustments were made for stock splits and stock dividends. ©2002 American Funds Distributors, Inc. Used with permission.
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Picking Mutual Funds Remember, a mutual fund is nothing more than a package of investments pooled together and managed by professionals. As you can see from the challenge in Figure 9.2, none of the stocks of the DJIA outpaced the investment in a solid mutual fund like Investment Company of America. The mutual fund outpaced the single stocks over the long term and with a lot less risk because the fund is diversified. But how do you decide on the right mutual fund for the long haul? Here are a few suggestions. • As long as your money can stay invested at least five years, stock funds are a good option. Historically, they have provided higher returns than other investments. If you choose this option, though, take my advice to heart: Tune out the noise. It takes a strong stomach to handle the daily ups and downs of these funds. • Think big—as in company size. Though bigger doesn’t always mean better, over the long haul big companies like Philip Morris, ExxonMobil, and General Electric likely will be in business. They also generally provide good returns over time. • Don’t set your expectations on return too high. The S&P 500 has averaged a 10.2 percent return over the long haul. That means there’s a high probability that a well-diversified portfolio of common stocks of average risk should continue to return about the same amount. The bull markets of the 1980s and 1990s have spoiled investors. Remember, investment returns are closely tied to investment risks. • Think about an index fund like the S&P 500. It’s made up of some of America’s top companies from various industries and despite market f luctuations, it can provide consistent opportunity for growth. Also fees often are lower than those of other types of funds because money managers don’t pick the individual stocks. • Consider asset allocation funds. These are mutual funds with the stated objective of allocating monies between sectors and asset classes. It’s a good bet for diversification as long as you avoid bond funds. Bond funds are perceived as “safe,” but in reality they can be quite volatile and returns are not usually as high as stock funds over the long term.
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• Don’t invest blindly. You do your research before you buy a car or a house or even take a vacation. So do it before you buy a mutual fund or any investment. Study the prospectus, investment objectives, performance, and even whether the stocks in a fund are ones you would choose if buying separately. • Don’t forget to consult your financial advisor for information, recommendations, and direction.
SOME OF THE BASICS Don’t shy away from investing because you don’t understand the lingo. Learn about it. Knowledge is power. If you do your homework, you can make better decisions for your future and that of your family and loved ones. Take the mystery out of the jargon by reviewing the glossary at the back of this book and the concepts below.
The Prospectus When you’re thinking about a mutual fund investment, read the prospectus before you invest. It’s a financial report card to let you know how a mutual fund is doing. Learn how to read it. You will receive one regularly from your mutual fund company. The prospectus should address at least three main topics: 1. Expenses. This details how much it costs for someone to manage the fund. This section includes sales commissions, management fees, and operating charges. No matter how boring you think it is, read the data meticulously and make sure you understand all charges. 2. Financial history. This is an encapsulated view of how the fund has performed over the years. Check each year to determine the investment’s stability. As a mutual fund grows, expenses should come down. Also check fund turnover. If you see a 50 percent turnover rate, that means your fund manager turned over half of the investment portfolio that year. If one year’s turnover is 37 percent and the next year it’s 137 percent, find out why.
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3. Investment objective. This explains how a fund’s manager expects to increase earnings. For example, the plan could include boosting foreign or domestic investments or investing in options. If your fund invests in bonds, you also can find out whether the main holdings are investment grade or junk bonds. Use the prospectus to see if the fund manager’s goals and objectives are in keeping with your own. If not, ask questions, express your concerns, and don’t invest if it’s not the right fit for you.
Large Cap, Mid Cap, and Small Cap Funds These are stock funds made up of companies grouped together based on size. They can be considered large, medium, or small. Size doesn’t refer to the number of employees or offices, but instead to the company’s value on the stock market. That value is figured by taking the number of outstanding shares and multiplying it by the share price. The result is the market capitalization or “cap.” Number of Outstanding Shares × Share Price = Market Capitalization Corporations valued at about $12 billion and higher generally are considered large cap companies. Mutual funds that have portfolios of large cap holdings usually are considered quite stable with a consistent rate of return. Most investors will tell you this is a good place to hold a long-term investment like a retirement fund. Small cap usually refers to companies valued at less than $1.5 billion. Those smaller companies often are considered higher risk, but because of that risk they can generate higher returns. Small cap funds usually invest in growth industries like technology. In between those funds are the mid caps. Whatever fund you choose, keep in mind that the greater the potential for gain, the greater the risk. A portfolio that includes large, mid, and small cap funds will provide the most potential with the least amount of risk over the long term. Diversification is the key!
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Beta and PE Ratio Both of these are tools that measure performance. Beta is a measure of risk. A stock’s beta is a measure of its volatility in relation to the market. A 0.7 beta, for example, means a stock price is likely to move up or down 70 percent of the market change; 1.3 means the stock is likely to move up or down 30 percent more than the market. A beta of less than one indicates lower risk than the market; a beta of more than one indicates higher risk than the market. A company’s price-earnings ratio or PE Ratio shows the multiple of earnings at which a stock sells. It’s figured by dividing the stock’s current price by earnings per share (adjusted for stock splits) for the past 12 months. A high multiple means investors have higher expectations for future growth and have bid up the stock’s price.
Some More Don’ts Sometimes the best advice is to let you know what not to do when it comes to your investments. I’ve already cautioned you about the pitfalls of market timing and the fallacy of trying to predict what markets will do on a daily basis. I don’t care what happens to the Dow from day to day. It doesn’t matter. The market will go up over time. Here are a few other don’ts. Repeat them, remember them, and practice them. • Don’t listen to your next door neighbor, your doctor, or a friend who has a tip on a great stock buy. • Don’t panic just because the Dow tanks for a day, a month, or even a year or two. • Don’t concentrate your wealth in single stocks. • Don’t time the stock market. • Don’t invest in something that’s more risk than you are prepared to handle.
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THE BOTTOM LINE When the market is down, it’s an equities sale. Don’t miss it! Think outside the herd mentality. Timing the market does not work. A prospectus is your window into an investment. Check it out, look at what’s going on, and take action accordingly. • Forget daily market ups and downs. They don’t matter over the long haul. • • • •
C h a p t e r
10 ESTATE PLANNING WITH YOUR HEIRS IN MIND
I
have the perfect plan set up for my family. I will live to age 90 and then die while making love to my wife, Rosemarie, who then dies instantly from pure excitement. When the kids get there, a big sign above the bed will say: I love you kids, but all the money has been spent so don’t go looking for it. That’s my ideal estate plan, but is it reality? The answer is probably not. But I still need to try my best to come up with a reasonable plan, despite all the detours that crop up in life. I love this great country of ours. There’s nothing better than to be an American. But if you don’t plan ahead, Uncle Sam may get more than half your estate. That’s money you worked hard for all your life to ensure that your spouse, children, and grandchildren are comfortable. It’s your obligation to preserve the wealth you have worked to build, or, if you’re young, are in the process of building. Few people like to think about their mortality, but you need to face it, deal with it, and build wealth for your heirs. Anyone who has substantial assets should look at estate planning as a way to pass on and protect existing assets, protect loved ones, eliminate huge tax liabilities, create wealth for future generations, and lessen the delays of probate. It’s also a parent’s responsibility. There’s no ex175
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cuse for a parent not to have a will that at least designates a guardian for minor children in case of premature death. That’s the word from David Pratt, a Boca Raton, Florida–based estate planning attorney and my OPB on these matters. It doesn’t matter whether you’re in the early years of your work life, nearing retirement, or facing pending mortality, you must plan for the unexpected.
UNCLE SAM’S TAKE To understand the difference that estate planning can make, you first have to understand how far-reaching Uncle Sam’s tax bite can be. If you procrastinate and do nothing, Uncle Sam could take to the bank well over half of all you have worked for in life. In 2003, the highest federal estate tax rate is 49 percent. That means if you don’t make the right moves today, when you die, up to 49 cents of every dollar in your estate that exceeds the exemption amount goes to the federal government for estate taxes, and that doesn’t include what you could lose to federal or state income taxes! How is that possible? Think about how most Americans’ retirement savings grow. If you work 40 years to accumulate financial independence and put the money in 401(k) programs, IRA programs, and retirement funds, none of it is taxed as it grows because these are taxdeferred accounts. However, when you and your spouse die, it’s possible that the taxes—federal estate, federal income, and state income— on those tax-deferred accounts might very well exceed 75 percent! What happens if you die prematurely? Uncle Sam doesn’t care how old you are when you die. As a result, your heirs, whether you have designated them or not, will get only what’s left after the tax bills are paid! Is that the way it should be? Not in my book.
Plan for and Profit from Change Planning can cut those tax liabilities substantially and sometimes even eliminate them while still allowing you to control your money for the rest of your life. But not if you procrastinate, put off the decisions,
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and don’t identify the problem as an opportunity waiting to be solved. If you neglect your planning opportunities, your will may as well read: Being of sound mind, at the time of my death, I absolutely love the federal government, and I want Uncle Sam to be the biggest single beneficiary of my estate, no matter what size it might be. Happily, I will give between 37 percent and 49 percent (or whatever the highest estate tax rate is in the year of my death), and in some cases, if I’m feeling really generous, up to 86 percent of every single dollar I have accumulated in my lifetime. The government says that an estate, which includes homes, IRAs, business interests, and investments, must be valued at the time of death or six months later, whichever is more favorable to the estate. This information-gathering process is done via IRS Form 706, the federal estate tax return, which is nothing more than an in-depth data sheet. The only problem is that it’s going to be filled out when you’re dead and not there to defend yourself. Let’s assume you have an estate valued at about $5 million and you and your spouse die in 2003. Of your entire estate, $1 million is in taxdeferred retirement plans that have not been drawn down prior to your death and that of your spouse. If you are in the highest estate tax bracket, the federal estate tax is 49 percent, meaning that a $490,000 estate tax liability is due just on the IRA. Because you’ve never paid taxes on these retirement program monies, there also are federal and state income tax obligations. Before your heirs get anything, those $1 million retirement plans have shrunk to perhaps less than $250,000. That doesn’t happen if you create an exit plan in advance to reduce those tax obligations. A couple has a $10 million estate. They each have $1 million in their respective IRAs, plus they own two residences, stocks, municipal bonds, annuities, and commercial real estate. Without advance planning, when both die their heirs will get less than half of the $10 million thanks to a $4.43 million estate tax bill and the $620,000 in income taxes due on the IRAs. (See Figure 10.1.) On the other hand, by taking advantage of tax credits—each spouse is eligible as of 2003 to pass $1 million tax free to heirs—gifting pro-
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FIGURE 10.1 Scales of Procrastination
Heirs $4,500,000 49.5%
PROCRASTINATE AND DO NOTHING
Uncle Sam $5,500,000 50.5%
grams, unlimited charitable giving, life insurance, and various tax-advantaged trusts, the couple can slash that tax liability. All it takes is understanding the game and entrusting OPB. Do you need to have many millions of dollars in assets to make this kind of tax-reduction planning worthwhile? The answer is a resounding no. If I wanted to set up a $1 million foundation after my death, I would buy a $1 million life insurance policy at a cost of just over $27,300 (for a male, nonsmoker, at age 65) in annual premiums, then designate the charitable foundation as the beneficiary of the insurance policy proceeds upon my death. For a female the same age, the annual premium drops to about $22,000. What a simple way to leave a legacy to a charitable organization.
You’re Richer Than You Think Not in the $10 million estate category? What about the $1 million category? Before you say no way, think about the fact that for many of
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us in the future, the single biggest asset will not be the value of our home. It will be the value of our retirement fund. Still think the dollars and cents are out of your league? I had one client who worked for Publix supermarkets in Florida as a produce department manager for almost 40 years. His annual salary never exceeded $30,000, yet when he retired he had more than $1 million socked away. He did that by participating in his employer’s employee stock ownership plan (ESOP) through his 401(k), and just kept putting money away regularly a little at a time. If that now-retired produce manager took just $27,300 a year and created a $1 million life insurance trust with his kids designated as the beneficiaries, when he dies the money would go to them absolutely tax free. He’s guaranteeing his kids wealth without access to the actual dollars he’s accumulated. He’s taken care of his needs with the $1 million he has saved, and created wealth for the next generation through life insurance.
ESTATE PLANNING ISSUES AND TOOLS Whatever your assets or estate size, there are some key issues regarding planning. The way you handle each issue often depends on your intentions and your financial circumstances, as well as the value systems of you and your heirs and your heirs’ stages in life. • Asset distribution. This basically details who gets what when you die or become incapacitated. A will and various kinds of trusts can handle much of this. But also keep in mind that if certain family members stand to inherit certain investments or assets, special planning may be needed to ensure smooth asset transfer. Leaving everything to your spouse isn’t good enough. Doing this could waste your estate tax exemption. • Durable power of attorney. This states who will handle your finances and make investment decisions should you become incapacitated. • Tax consequences. These include federal and state income tax and capital gains or losses on investments, as well as federal and state estate taxes on what you leave your heirs. • Long-term care. Should you self-insure or purchase a long-term care policy? The cost of care is measured in both money and
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•
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human suffering. Are you willing to put family or loved ones through the financial and emotional strain of caring for you should you become incapacitated? I touched on this in Chapter 7. Family business succession. If you own a business, how will the transfer of control be accomplished when you die or should you become incapacitated? Retirement funding and withdrawal. How will you fund your retirement with the above issues in mind? What vehicles will you choose from among various IRAs, trusts, life insurance policies, and more? Once you have the money, what do you do with it? Funding for surviving spouse or loved one. Should you be the first to die, how will your surviving spouse, loved ones, and family members be cared for? This can be especially tricky with multiple marriages, extended families, and nonmarried couples. The right kind of life insurance policy or policies and trust vehicles can go a long way toward providing for these loved ones. Charitable giving. Do you want to ensure that certain charitable organizations receive funds or assets when you die? At the same time, through charitable giving you can reduce your estate tax liability, dispose of appreciated property without triggering capital gains or income tax consequences, or even provide additional lifetime income for yourself or others. Other bequests. This could include ensuring your grandchildren’s education will be paid for, perhaps through establishing a 529 college savings program.
Let’s take a closer look at how you can solve these issues.
Essential Documents First, you need to have a will. Even if you’re young and in perfectly good health, you never know when an unexpected tragedy might occur. I hope one doesn’t, but tomorrow you could get hit by a car and killed or left incapacitated. What will happen to you, your family or loved ones, and your assets? Unless you make the right moves and have the right documents today, your loved ones could be permanently scarred emotionally and financially for years to come. Contrary to what you may have read or heard, a trust is not a replacement for a will. And if
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property is held as community property, a will is needed when one spouse dies to transfer ownership of the portion of an asset held by the deceased. A will also is the document in which you typically designate one or more guardians for minor children. The court usually follows your stated wishes on this if it deems they’re in the best interests of the minor. If you die without a will (called dying intestate), you already have designated beneficiaries whether you wanted to or not because the assets will be distributed in accordance with the laws of intestacy of the state in which you resided. After all taxes and other liabilities are paid, the laws of intestacy generally disburse assets to the closest-in-relation family members. For example, your spouse and children would be first in line to inherit, followed by parents, siblings, nieces and nephews, and so on. A will operates only if you die. What happens if you become incapacitated, if you’re in an accident which results in a disability, or if senility or Alzheimer’s sets in? Who will handle your finances and make investment decisions for you? This is where a durable power of attorney comes in. It gives an individual designated by you as the agent or attorney-in-fact the authority to act for you if and when you become disabled and can no longer manage your financial, investment, or legal affairs. The durable power of attorney, for example, gives the designated person the authority to sign a contract, hire an attorney, or invest in a mutual fund. If you have a revocable living trust, you already have specified an individual (the successor trustee) to step in to manage your affairs. But that person is limited to making decisions only with regard to the assets within that living trust and situations could arise involving matters outside of the trust. When you choose a person to act as your attorney-in-fact, keep in mind that the document takes effect the moment it is signed and that person can act in your stead. Make sure you choose someone you really trust who will not utilize the power of attorney until necessary. Often an individual sets up a durable power of attorney and has his or her financial advisor keep the only copy of the document until it’s needed. (You can list the location of this document in the Asset Organizer found in Chapter 5.) Two other essential documents everyone needs are a health care surrogate designation and a living will. The health care surrogate document
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names a person to make health care decisions for you if you become incapacitated. The living will directs someone else to carry out your wishes with regard to removal of life support when you’re incapacitated, death is imminent, and there’s no chance of recovery. It’s more important now than ever to have these as part of a plan that can function if you are between life and death. Modern medical technology often enables machines to keep someone alive almost indefinitely. Do you want your loved ones to have to make the decision to pull the plug? If you have minor children, you also should set up a trust for them in the event of your premature death. The trust then would own the assets that eventually will be turned over to the minor children at the age designated by you through the trust documents. More on trusts later in this chapter.
Probate Probate is the legal process used to settle an individual’s affairs after he or she dies. It also is the mechanism that transfers an individual’s assets to the heirs after all outstanding debts—including taxes—have been paid. The probate process varies from state to state. In some states it’s simple, quick, and relatively inexpensive; in others, it’s complex and lengthy. In general, a will is probated in the state in which the individual resided, though if the deceased owned property in another state, that property must be probated in that other state. You could end up with multiple probates, multiple fees, and multiple years of waiting. An alternative to avoid probate is for your property to be owned in trust.
Home Sweet Home Next to your retirement account, your home is one of your largest assets. Wouldn’t it be nice to remove it from your estate for tax purposes? If you would like to give it to your child or continue living in it, there are a couple of ways to accomplish that. If all of your assets total less than the current $1 million estate tax exemption level, when you die, your home’s tax cost basis will be stepped up to the home’s fair market value at the time of death. Your
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heirs will escape capital gains taxes when they sell the home, and because your assets totaled less than $1 million, no federal estate taxes will be due. Do not give the house to your child before you die if you plan on living there, because even if you pay fair market value rent to your children, the IRS probably will include the full market value of the home in your taxable estate. However, if you are planning to live elsewhere, you can give portions or fractional interests in the property away today by using your annual gift tax exclusion and that of your spouse. As I’ve talked about, you can give away $11,000 ($22,000 for a couple) to as many individuals as you like in a tax year without owing any gift tax. If you have two children, for example, you and your spouse can gift $44,000 annually. As long as the value of your home and other assets total less than $1 million and you haven’t made any other substantial gifts that use part of your estate tax exemption, your estate would not owe any federal estate tax. While this removes any future appreciation of the home’s value from your estate, your children will have to pay capital gains taxes when they sell it, because their tax basis will be your previous tax basis for the property. You also can sell the home to your children and hold the mortgage. You and your spouse can then gift up to the $22,000 per couple to each child annually to help them with the mortgage payments. Just make sure to keep these gifts and the mortgage payments separate or the IRS could impose additional taxes. Also be sure the children pay fair market value for the house, and if you rent it back, you pay fair market value rent too.
TRUST OPTIONS Once the purview of the very wealthy, today trusts are an oftenused, excellent estate-planning tool that comes in almost every shape and size for almost everyone and every pocketbook. There are life insurance trusts, Crummey trusts, charitable remainder trusts, qualified terminable interest property or QTIP trusts, marital deduction and bypass trusts, generation-skipping trusts, dynasty trusts, Medicaid trusts, grantor retained annuity trusts (GRAT), qualified personal residence trusts (QPRT), and lots more.
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Simplified, a trust is an entity that holds property managed by one or more people for the benefit of another. It’s like a contract among three people: the grantor, sometimes referred to as the donor or settlor, who establishes the trust and puts money or property into it; the trustee who manages the assets in the trust; and the beneficiary, who receives benefits from the trust’s assets. Attorney Michael T. Palermo, CFP , describes a trust as a vessel or holding tank into which money and property can be poured. Transferring these items to the trustee with a revocable living trust does this. Usually a husband and wife serve as each other’s trustee initially. A formal transfer of property to the trustee is still required. Of course, for any trust to work, it must have some assets placed in it. The size of your estate has little to do with whether you could benefit from setting up a trust. Instead, it depends on your objectives. Trusts can reduce or defer estate taxes, make sure assets pass more quickly and inexpensively to your heirs, keep family financial affairs out of the public eye, protect financial interests of children from prior marriages, ensure how you or loved ones are cared for if incapacitated, and exercise considerable inf luence over how someone’s assets are used after they’re gone. Many people set up trusts because they want to pass more wealth to their survivors by saving federal estate tax while still retaining the maximum control over the money as permitted by law.
Distinguishing Different Types of Trusts Trusts that go into effect while you’re alive are called living trusts or inter vivos trusts. They can be irrevocable, in which case they are a gift and can carry restrictions and conditions, or they can be revocable, which means you can abolish them at any time, and the holdings are included in your estate for tax purposes. Trusts that go into effect after your death are called testamentary trusts. A living trust enables you to manage the assets in the trust yourself and live off the income the assets earn, name your heirs as successor beneficiaries when you die, and name a successor trustee to oversee the distribution of the trust’s assets when you die. The rising popularity of funded living trusts stems partly from the fact they help people avoid probate, which can be slow and costly. In some states, probate fees are a percentage of the estate, and that can add
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FIGURE 10.2 The Benefits of Different Types of Trusts
Trusts serve many purposes. Here’s a brief look at what a few common trusts can do. Funded Living Trust Becomes effective when its creator still is alive. Permits the person who establishes the trust to serve as trustee. Helps an estate avoid probate and keeps one’s affairs private. Provides protection if someone becomes disabled because a successor trustee immediately can step in to handle financial affairs.
• • • •
Credit-Shelter Trust • Lets each partner in a marriage claim an applicable credit and thereby exclude from estate taxes $1 million—rising to $3.5 million in 2009—worth of assets in each of their estates, and allows for that amount, including any growth, to pass to children or other heirs tax free. • Manages property for your beneficiaries if necessary. For example, a beneficiary may be too young or you may choose to delay receipt of the inheritance. Irrevocable Life Insurance Trust • Removes life insurance policies and proceeds from your estate, subsequently reducing estate taxes. • Offers a way to prevent the forced sale of a business, real estate, artwork, or other valuables to meet estate tax liabilities. • Manages policy and proceeds for trust beneficiaries as designated under terms of the trust. Marital Trust (Often called a QTIP Trust) • Provides a surviving spouse a means of managing assets (from the unlimited marital deduction) through the trust and the trustee. • The deceased spouse can direct how the assets will be managed through the terms of the trust.
up. A testamentary trust won’t keep your assets out of probate, but a living trust can. A living trust can dissolve at your death, at which time your successor trustee can immediately disburse the assets to your family. A trust doesn’t have to end when you die. If you are married, it can transform into a marital trust (for the surviving spouse) and a creditshelter trust for your other heirs, which will manage your assets and help lower the taxes on your estate. A credit-shelter trust often is called a family trust. Whatever name it goes by, it will enable you to inf luence when and how your heirs receive their inheritance and more. Figure 10.2 outlines the differences between these types of trusts.
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More on the Revocable Living Trust This estate planning tool can benefit every couple or individual. You can fund a trust with an investment portfolio, bank account, or even your home. Like a will, a revocable living trust expresses your wishes for what will happen after you die. But unlike a will, which doesn’t go into effect until after you die, the trust functions while you are alive and if you’re incapacitated or die. In addition, a revocable living trust is not subject to probate. All the income and gains generated by assets in the trust are reported on your individual income tax return. The trust is not required to file a separate tax return. A living trust also has a built-in plan for a successor trustee who can act on your behalf in the event you become incapacitated. This eliminates the need for a guardian to be appointed by the state in which you live. With the addition of a pour over will, assets not in the trust automatically transfer into the trust when you die.
Crummey Trust This trust takes its name from the court decision in the case of Crummey versus the IRS. It’s a way to take advantage of current gifting laws ($11,000 per individual per beneficiary per year) and give the beneficiary future rights to the assets. Annual gifts to the trust slowly reduce your taxable estate while at the same time passing along wealth to the next generation. When the gifts also pay for insurance on the estate owner’s life, the ultimate benefit to the beneficiaries can be far greater than the actual dollar amount given. Strict rules govern this and any trust, so tread carefully and be sure your advisors are competent estate-planning experts. An irrevocable life insurance trust almost always has Crummey powers. The trust is the owner and beneficiary of the life insurance policy, and therefore the money is not subject to estate tax when the insured dies. The Crummey powers relate to the gifts you make to the trust to fund it and receive the annual gift tax exclusion while you are alive. Assets of the trust may be passed to anyone you choose by designating them as trust beneficiaries. A word to the wise with these trusts: The IRS doesn’t like the fact that life insurance enjoys some unique tax ad-
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vantages. To save yourself the possibility of headaches, consider naming the trust The (your name here) Family Irrevocable Trust instead of The (your name here) Family Irrevocable Life Insurance Trust.
Charitable Remainder Trust If you make a charitable contribution to a qualified organization while you’re alive, it’s deductible from your income tax. If you leave money or assets to a charity in your will, they’re deductible from the gross value of your estate. A charitable remainder trust accomplishes both of these objectives, plus provides you or someone you designate with income for life. The Penn Mutual Family of Companies points out that a charitable remainder trust: • Secures an immediate income tax deduction based on the fair market value of the remainder interest that when you die passes to the charity (with certain limitations). • Removes a taxable asset from your estate. • Eliminates the potential capital gains tax on the sale of your appreciated asset. Assets placed in a charitable remainder trust are not subject to these taxes when sold. • Generates income for you or anyone else specified for a certain time frame. • Enables you to diversify an investment portfolio without triggering capital gains. Keep in mind that this is a very complex topic with many variations, so look to OPB for competent professional guidance.
Qualified Terminable Interest Property (QTIP) Trust This can be a good arrangement if you’re getting married a second time and both you and your new spouse already have substantial estates. A QTIP trust provides lifetime income for the surviving current spouse while leaving the remainder of the trust property to the children of a previous marriage. Although the surviving spouse has an income interest in the QTIP trust, he or she cannot decide to whom the property
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shall pass at his or her own death. Distributions from a QTIP trust are not permitted to anyone but the surviving spouse during his or her lifetime.
Total Return Trust Planning for the future of your loved ones after you’re gone can be a tricky process. For instance, let’s say you set up a standard credit-shelter trust to leave assets to your heirs. This popular trust option leaves a lifetime income to your spouse, with the remainder of the assets going to your children or your grandchildren after your spouse passes on. But there’s a catch that could leave your heirs vulnerable. What if your heirs disagree on how the trust should be managed or invested? One party may want the assets right now while others want to let the trust grow. A total return trust will protect assets for the current generation while still assuring assets for generations to come. The primary beneficiary still can draw income, but it doesn’t have to come from dividends and interest. Appreciated assets can be sold as well. As long as the payouts remain within a predetermined range, perhaps 3 to 5 percent of the total trust’s value, the portfolio should continue to grow, providing more assets for all. The surviving spouse has access to the income right away while the principal is left intact to grow for the remaining heirs. Everybody is a winner.
Family Limited Partnership While the family limited partnership is not a trust, this estate-planning tool is growing in popularity, probably because in recent years the IRS has been placing more restrictions on how to give your money away. By creating a family limited partnership, your heirs get the benefits, your estate gets tax advantages, your assets are protected from creditors’ claims, and you maintain overall control of the trust’s assets while you’re alive. Contributions to a family limited partnership can be business assets, cash, personal assets, real estate, and investment assets. Over time parents who own a business can continue gifting company assets to their kids, thus reducing the value of their estate. The beauty of this arrangement is that parents can reduce their tax obliga-
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tions while still giving away substantial assets to their kids. Because the gift is in the form of units in the family limited partnership, the value is reduced for gift-tax purposes. Because the parents are lowering their net worth, the estate will be subjected to less estate tax when they die. If the kids are in a lower tax bracket than their parents, the kids will pay fewer taxes even though they have received the assets. That spells tax benefits for everyone in the family. But you have to plan carefully. If not set up perfectly by a tax attorney, the IRS can decide to disallow it.
More Trusts The grantor retained annuity trust (GRAT) is an irrevocable trust that reduces the value of your estate, entitles you to an annual payout for a certain length of time, and, at the end of that time, provides assets for the ultimate benefit of your children. This type of gifting is considered a future-interest gift and does not qualify for the annual gift tax exclusion. The gift tax may be applicable on the value of the remainder interest if that value exceeds the grantor’s applicable credit amount. The GRAT will reduce the estate tax liability based on having removed assets from the grantor’s estate. Often this type of trust can be a good way for an owner of a growing business to pass the business to his or her heirs and still retain the income. Another irrevocable trust similar to a GRAT is the qualified personal residence trust (QPRT), which can be a good way to remove your home’s value from your estate. Like a GRAT, some gift tax liability (or use of the gift tax exemption) may be assumed at the outset, but instead of getting an income from the trust, the grantor may live in the house for a certain length of time. If the grantor outlives the specified time, the home then will no longer be part of the grantor’s estate. The grantor must pay fair market rent to live in the home. Also, when the children sell the home, the tax basis of the property is the original purchase price (plus cost of improvements). That can result in a hefty capital gains tax bill if the value of the home has appreciated substantially since it was purchased.
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Putting It All Together What’s right for you and your circumstances? That’s up to you. Here’s how my wife, Rosemarie, and I designed our estate to avoid many tax pitfalls. We started with a solid foundation. Remember, I couldn’t build my oceanfront home on the sand; the builders had to dig down to solid ground. For estate planning purposes, that solid ground is based on two revocable living trusts: the James A. Barry, Jr., Trust and the Rosemarie C. Barry Trust. Why not settle for simple wills? There are three reasons. First, we want to spell out clearly the person or people to handle our affairs if we become disabled. You cannot do that under a will, which is a document that operates only after you die. I can get creative with the trust and spell out what constitutes my disability. In my case, the successor trustee, the person to handle my affairs if I can’t, is Rosemarie, and vice versa. If both of us are disabled at the same time, the trusts also name who is next in line to handle our affairs. We also designate special trustees, specifying who handles what aspect of the affairs, and the beneficiaries of our trusts. Second, if the trusts are properly funded, our estates can avoid probate. Wills, on the other hand, must be probated. The third reason for the trust is privacy. A will is public record. A trust is not. Beyond the revocable living trusts, we also have pour over wills. These act as catch-alls so that when either of us die, everything left out of the trusts pours over into them. Of course, we also have living wills, health care surrogate designations, and durable powers of attorney. The pour over wills handle anything out of our trusts, whether we forgot to put it in or it can’t be put into the trust. For example, a retirement fund can’t be put into a revocable living trust, otherwise the deferred tax obligations would be payable in the year of the transfer. Next, we have substantial money in tax-deferred retirement programs that I would like to retain control of until I die because I don’t know how much we’ll need later in our senior years. With the unlimited marital deduction, each of us is the designated beneficiary of the other’s IRAs. But whenever the second person in our marriage dies, the money goes to the Jim and Rosemarie Barry Charitable Foundation to avoid the massive taxes due on the IRAs. Our children are directors of
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the foundation and have the right to receive salaries and compensation for their responsibilities of managing that foundation. (You even can set up a foundation so that the board of directors meets once a year in Aspen while skiing or in the Bahamas while sailing!) There are no federal estate taxes and no federal and state income tax obligations because the money goes directly to a charitable foundation created prior to our deaths. You can pump money into the foundation while you’re alive. Any contributions are tax deductible and can reduce the size of your estate. The bulk of that foundation’s funding occurs, however, after we both die, because the foundation is the beneficiary of the remaining IRA monies. There’s more. I really don’t need the IRA funds—hypothetically, let’s say the value is $1 million—but I have an exit plan anyway. I take a 10 percent per year withdrawal from the IRA because I’m over age 59¹⁄₂, and pay the income taxes on it. I then take what’s left of each withdrawal after taxes and transfer it into the James A. Barry, Jr., Trust and the Rosemarie C. Barry Trust. But I don’t just put the cash there outright because then it remains part of our estates and therefore is subject to federal estate tax upon death. Instead, we gift the money to our children who in turn “reject” it, and then it goes into the family trust. We can do that tax free through the use of Crummey letters that I talked about earlier. Rosemarie and I have the right to give $22,000 annually ($11,000 from each of us) to whomever gift-tax free (with our three kids, that’s $66,000). The kids have 30 days to reject the gift in writing (technically, that’s time to take the money as an unrestricted gift), after which time it goes into the trust. Our kids are the trustees of the family trust. They don’t own what’s in the trust (although they are beneficiaries), but as trustees they have the designated right to buy life insurance on their parents’ lives. The trust then buys last-survivor life insurance on my life and on Rosemarie’s life. (Each $66,000 pays the annual premium for almost $5 million in life insurance.) The end result: When Rosemarie and I both die, the kids get substantial life insurance proceeds as the beneficiaries of the family trust. There is no estate tax and no income tax on the proceeds from the lastsurvivor life insurance purchased by the family trust. The charitable foundation gets what’s left in my retirement accounts—also estate-tax free and income-tax free—because of its status as a charitable organization. (Incidentally, the law requires that to maintain its tax-advantaged
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status, the foundation must make minimum distributions every year.) Also, while I’m living I can donate cash to the foundation (which also has the authority to buy life insurance), take a tax deduction for the charitable donation, and further reduce the size of our estate. You have to understand the game and become aware of the opportunities in order to make them work for you. Knowledge is power, and together with OPB, you too can do it.
THE BOTTOM LINE • You are the captain of your financial destiny. Steer the right course. • If you don’t plan while you’re living for what will happen to your estate after you die, as much as 75 to 80 percent or more of the money you worked so hard for could go to taxes. • Use the maximum allowed estate tax exemption or lose it. • No matter your age, you should have a will, durable power of attorney, health care surrogate designation, and living will. • Once the purview of only the very wealthy, trusts today have become an excellent estate-planning tool that comes in almost every shape and size for almost everyone and every pocketbook. • Once you know the game, planning today for tomorrow pays off for you and for future generations.
C h a p t e r
11 HIRING THE RIGHT ADVISORS
D
o not hire me to do a root canal on you. It would be a disaster. That doesn’t mean I’m dumb. It means that I haven’t been trained as a dentist. When it comes to investing a little bit or a lot, the great majority of people would be better off turning to someone who has expertise in that area to guide them. You have to hire the right financial captains to guide you through your financial journey in life. I’m even getting away from calling these advisors estate-planning, financial-planning, or tax-planning experts. It’s life planning, and that means understanding 401(k)s, IRAs, a client’s personal relationships with family members, and his or her value systems, interests, background, education, and approach toward money. Why can’t you do it yourself? We saw what happened to people during the period between 2000 and 2002 who left their jobs to become online day traders with margin accounts. Where are they today? If they are lucky, they are working again. The majority of them are broke because they ventured off into an area where they lacked expertise and tried to compete against professionals in the investing field.
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THE BIG GAMBLE A number of years ago, my wife and I were in Las Vegas for a convention. I had been paid what I thought at the time was the astronomical sum of $10,000 to be the keynote speaker. The group paid me on the spot, and I proceeded to lose it all at the blackjack tables. I violated my cardinal rule: Don’t go up against professionals if you’re not one. That croupier or blackjack dealer was a professional who knew his business. While I won at times, given enough time at his table, there was no question the money would shift because he’s the pro, not me. After my loss, Rosemarie consoled me by saying, “But Jim, we’re having fun.” It was not fun to lose $10,000. I hated it. I haven’t gambled since! In the investment arena, a mutual fund is nothing more than a portfolio of stocks, bonds, and cash positions managed by professional money managers. If you decide to buy and sell stocks on your own, you’re creating a mini-mutual fund with you as the money manager. The question is, are you really a money manager? If you go this route, you had better be because you are competing against some of the most astute people and organizations in the world that manage substantial dollars with professional staffs. Those managers aren’t perfect. As I’ve said before in this book, no one has a crystal ball that can predict the future short term. But managing your own investments is equivalent to me playing blackjack against that croupier in Las Vegas. I was the neophyte and he was the professional. Why then should you be managing your own monies?
The Broker Misconception If you deal with an investment broker from any size firm and his or her income is made primarily on a transactional basis—buying and selling investments—that relationship is not the same as if he or she charged you a fee to be an ongoing money manager. If your broker works on commission, who is your big picture person? Every day in the real world, I see prospective clients with pieces of their financial life scattered everywhere. They have accounts spread across several brokerages, different life insurance policies with different companies, out-of-date wills, and unenforceable trust agreements. If I
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were to contact one of these clients’ brokers and mention the person’s name, the response would be, “That’s my client.” But that’s not really true. What does the broker know of that person’s life? The broker handled some transactions, but probably doesn’t know that the client has accounts at four other brokerages, has gone through a divorce, has a son with a drug problem, and a stepdaughter from a previous marriage. The broker hasn’t looked at the details and knows that person on a transactional basis only. That isn’t problem solving with the client’s personal long-term plan and goals in mind. I could list some great investments you should buy, but if I don’t know your life-planning details, how do I know the investments will work for you?
Remember the T-Square: Your Strengths and Weaknesses Not very long ago, I had an operation to unclog blocked arteries in my heart. It was a humbling experience to lie on the table while looking at a big TV monitor, watching the doctors work on my arteries, and not feeling a thing. But I really watched closely, so let me do that same procedure on you this weekend, OK? You better have sense enough to say “no” because if I tried it you would be dead. I stay out of the areas of my weaknesses. You should too. The I-don’t-need-anyone-to-help-me approach doesn’t cut it either. With the increasing availability of financial information on the Web and beyond, many people ignore all this talk about using professional money managers. They feel they can do just fine managing their own financial affairs. If they’re successful, good for them. But are they prepared to do what it really takes? There’s more to the equation than money. Do these people have the time to research every potential investment, compare every mutual fund available, and keep daily tabs on the market? Probably not, but a financial advisor does. Look around the room. It’s full of things built by other people who are specialists at their trade. Even if you built the chair you’re sitting on, I’ll bet you turned to someone for advice somewhere along the line. You relied on other experts for help in lots of areas. The same should hold true in money management. Look for advisors strong in areas of your weaknesses and hire professionals. Their job is to try to get the best dayin and day-out return based on the investment objective.
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One of my clients is a prominent heart surgeon. When he first came to me, he had more than 100 individual stocks and bonds along with other securities in his portfolio. He managed all the monies and made the daily decisions himself. During his first visit we were sitting in my office and, after looking over his portfolio, I looked up and told him point blank there was no way I would ever let him operate on me. It would be my luck that on the day of my surgery the Dow would drop 1,000 points. Where would his mind be? On his medical skills or on his portfolio that had just plummeted in value? Are you the surgeon or the money manager? I don’t do root canals or open-heart surgery part time, nor do I expect you to be a money manager part time. That doesn’t mean, however, that you should not be aware of what’s going on or that you should not participate in financial decisions. Surround yourself with very talented OPB and then work with those people to build your wealth. Yes, there are investors who rely on advice from professionals and end up broke. But there are bad doctors, bad dentists, bad lawyers, bad mechanics, and bad cooks too. Your job is to do your homework when it comes to selecting your advisors. Meet the person, interview him or her, ask questions, check out references, and research credentials.
WHAT TO LOOK FOR IN AN ADVISOR In today’s world, there’s a hell of a lot of competition for your dollars. Don’t forget that. Remember that, despite all the fancy computer models, split-second data access, and investment planning hoopla, this is still a people business. Getting advice on how to manage aspects of your financial life is a very personal thing. If you can’t talk honestly and openly to someone and have them truly listen and understand the details, don’t hire that person as an advisor. If you don’t like an advisor, fire that person. You’re the captain of your financial ship. Whether you’re in the market for a tax, estate planning, investment, financial, insurance, or other advisor, some of the things to look for include: • The right credentials, including educational and professional designations
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• Good listening skills so they can understand your personal objectives, concerns, risk tolerance, outlook toward family, and more • Specialization in the specific area of expertise you need • Board certification from a professional organization or state that attests to his or her knowledge and skills in a particular specialty • Willingness to commit to a long-term relationship
Advice Options Does everyone need every kind of advisor? Do you need a tax specialist, a CPA, an estate-planning lawyer, a real estate lawyer, a financial planner, a professional money manager, a life insurance specialist, and a property and casualty agent? Deciding on the advisors you need is like a trip to the buffet for dinner. You probably don’t need everything on your plate at the same time. With wealth planning, the experts you need depend on that T-square that defines your strengths and weaknesses, personal needs, circumstances, point in life, and goals and expectations. If you’re young, single, and just starting out with few assets, you probably can start building your foundation to wealth with the help of only a big-picture person, the quarterback of your financial game plan. I would suggest someone with the CFP designation from the Certified Financial Planner Board of Standards in Denver. The comprehensiveness of the CFP training program indicates that person’s commitment to the business. That’s important because you want someone with tremendous empathy who really will listen to you and stay with you long term. If you’re nearing retirement and have an extended family, diverse assets, and hefty tax-deferred investments, you may need to call on various types of advisors and most likely develop ongoing relationships. After you determine what kind of advisors you need, talk to friends, business associates professionals, and others you know. Ask if they know of or would recommend an advisor with a particular specialty. Even if they don’t personally know one, ask if they have any ideas, contacts, or suggestions. Then put together a list of several names as a starting point.
Your Next Assignment You don’t go to a knee surgeon for a heart problem. The expert you choose to solve your heart problems must have the right training for the
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job. The easiest way to discover that is to look at his or her credentials. Does the person have the right academic and practical degrees, training, and experience? Beware, however. Lots of initials after someone’s name doesn’t always ref lect competence and training. It’s the same when it comes to any of your advisors. I have attorneys who don’t understand the first thing about how to put together a living trust, but I wouldn’t get involved in a real estate deal without them. Why? Because they specialize in real estate transactions. In general, you don’t want to hire a certified public accountant (CPA) specializing in estate tax planning to be your quarterback, the one who is your big-picture planner. But you do want that tax attorney to structure your trust agreements and durable power of attorney. You choose the expert whose specialty fits each part of the wealth-building mosaic you design. With estate planning, for example, your advisor needs to be familiar with the ever-changing nuances of tax laws that affect your future. You don’t want someone who does a little of this, a little of that, with wills and estates on the side. Understand what a particular professional designation really means. Does it ref lect solid training, regulatory oversight, or only payment of a fee? Lots of investment advisors tout expertise as a registered investment advisor with the SEC (using the initials RIA after their name), but did you know that all it takes to get that designation is paying a nominal fee and filling out some forms? (More on what other designations mean later in this chapter.) Look for experts who have advanced training and do the little extras, too. If I needed someone to help me with estate planning, I would look for an attorney who is board certified by my state in estate planning, perhaps active in my state’s bar association in the estate planning field, writes articles on the topic, and also gives lectures. The American Institute of Certified Public Accountants offers a PFS designation to qualified CPAs, and I also might consider hiring a generalist with a CFP designation who has links to other experts to help with my objectives. Tax specialist and estate-planning attorney David Pratt, JD, LL.M., CPA, will tell you that a specialist with the right credentials is especially important if you’re young and just beginning your wealth-building journey. You want to start by building a solid foundation. You may think that you can’t afford this kind of advice. But no matter what your age or financial circumstances, someone out there in the money-management business, property and casualty business, estate-
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planning business, tax-planning business, or investment business is willing to spend the time to help you build. How much will their services cost you? I can’t tell you that, but I can tell you that every time you go into a store to buy a shirt, a steak, or bottle of shampoo, somebody is making a profit. That’s the system. The financial-planning business is no different. Your advisor is entitled to a reasonable amount of money for the services he or she renders. You have to determine whether the amount is fair. You also have to shop around. I can give you some guidelines, but the decision again is up to you. Take the time to do your homework. It will pay off.
BEYOND THE CREDENTIALS No matter what kind of advisor you’re looking for, once you come up with several candidates from which to choose, are satisfied their academic and professional qualifications meet your needs, and review their supportive references, look at their people skills. You might call it their bedside manner. Sit down with each candidate. Does the person listen to you or hustle you through the meeting? Does he or she seem to understand your ideas, concerns, family issues, values, personal and financial goals, and attitudes toward money and risk? Your situation is unique, and you need an advisor who will accommodate you according to your needs. Find out the advisor’s procedure for working with clients. Is it something you can live with? How does the person deal with your questions? I don’t know about you, but if it’s my life, I want to see all the blueprints. I want the advisors to understand my risk tolerance. If I lose sleep over a situation and can’t understand it, I want that advisor to counsel me and help find a solution. Are you comfortable and confident talking with the person? This will be a person you have to trust and work closely with over the long term. If you decide to hire someone, give him or her a reasonable time to prove their value. If you find that things are not working out to your satisfaction, then fire that advisor. With a financial planner specifically, I also would look for the most intuitive person who really empathizes and understands the big picture. He or she will not be well-versed in all areas of concern, but should have the sources—OPB—to help with the specialized parts of the big picture.
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Does one candidate stand out as a possible fit for you and your family? Again, is he or she listening carefully? Does that person surround himself or herself with other experts to shore up the weak areas?
Digesting the Alphabet Soup There are dozens, perhaps hundreds of different educational, professional, and specialized designations in the various financial fields. It can be a confusing and sometimes misleading kettle of alphabet soup. It’s important that you understand what many of the designations mean so you can choose advisors with the right credentials. Some, like certified public accountant (CPA) or juris doctorate (J.D., a law degree), ref lect extensive education, testing, and ongoing review and oversight. Others, like the Certified Financial Planner certification, signify additional and ongoing training and oversight. Still others simply mean membership in a professional organization. Once again, knowledge can help you wade through it all. Here’s a quick look at some of those designations. One is not necessarily better than the other. It means only that the particular individual has had to meet a different set of criteria or has undergone a different method of training or testing or belongs to a different group to gain the designation. That’s where you have to do your homework. Talk to professional organizations (I’ve listed a few more in the appendix of this book) about qualifications and training. Surf the Web. Go to the library. You need to know the differences before you hire your advisors. A few of the designations you may encounter include: • AICPA. Member of American Institute of Certified Public Accountants, 1211 Avenue of the Americas, New York, NY 100368775; 888-777-7077; <www.aicpa.org>. This designates that a CPA is governed by a code of ethics and subject to regular quality reviews. Check your member state board of accountancy to determine if complaints have been filed against a member. • ATA. Accredited tax advisor designated by the Accreditation Council for Accountancy and Taxation, affiliated with National Society of Accountants, 1010 N. Fairfax Street, Alexandria, VA 22314; 888-289-7763; <www.nsacct.org>, or <www.acatcredentials .org> . This requires exam/coursework, continuing education, and adherence to a code of ethics.
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• CCIM. Certified commercial investment member from the Commercial Investment Real Estate Institute, 430 N. Michigan Avenue, 8th Floor, Chicago, IL 60611; 312-321-4460; <www.ccim .com>. This requires coursework, experience, and examination. CFA. Chartered financial analyst from the Association for Invest• ment Management and Research (AIMR), 560 Ray C. Hunt Drive, Charlottesville, VA 22903; 800-247-8132; <www.aimr.com>. This requires a college degree, work experience, and adherence to a code of ethics. • CFP. Certified Financial Planner from the Certified Financial Planner Board of Standards, 1700 Broadway, Suite, 2100, Denver, CO 80290; 888-CFP-MARK (888-237-6275 ); <www.CFP.com> . This requires coursework, examination, adherence to a code of ethics, and continuing education. • ChFC. Chartered Financial Consultant from the American College, 270 S. Bryn Mawr Avenue, Bryn Mawr, PA 19010; 888-2637265; < www.amercoll.edu> . This requires courses in personal finance and business, industry experience, adherence to a code of ethics, and continuing education. • CPA. Certified public accountant is a licensure granted by state boards of accountancy; National Association of State Boards of Accountancy, 150 Fourth Avenue North, Suite 700, Nashville, TN 37219-2417; 615-880-4200; <www.nasba.org>. Most states require education, examination, experience; and continuing education. Some also have ethics requirements. • CLU. Chartered life underwriter from the American College, 270 S. Bryn Mawr Avenue, Bryn Mawr, PA 19010; 888-263-7265; <www.amercoll.edu>. This site is the top credential for life insurance agents requiring coursework, experience, adherence to a code of ethics, and continuing education. • CPCU. Chartered property and casualty underwriter from the American Institute for CPCU/Insurance Institute of America, 720 Providence Road, PO Box 3016, Malvern, PA 19355-0716; 800-644-2101; <www.aicpcu.org>. This organization also offers a number of other risk management and property/casualty-related professional designations and certifications. The CPCU designation requires coursework, examination, adherence to a code of ethics, and continuing education.
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• EA. Enrolled agent from the National Association of Enrolled Agents, 200 Orchard Ridge Drive, Suite 302, Gaithersburg, MD 20878; 800-424-4339; <www.naea.org>. Requires an individual to be a former IRS auditor or complete a two-day exam. This is followed by continuing education. • J.D. Juris doctorate is a basic law school degree based on three years of coursework. • J.M. Juris master is a post-J.D. law degree for practicing lawyers. • LL.M. Master of laws is a post-J.D. law degree for practicing lawyers. • MSFS. Master of science in financial services is a post-graduate college degree in financial services. • PFS. Personal financial specialist, from American Institute of Certified Public Accountants, 121 Avenue of the Americas, New York, NY 10036-8775; 888-777-7077; <www.aicpa.org>. This individual must be a CPA, and the designation requires continuing education on financial planning, experience, examination, and peer review. • RHU. Registered health underwriter from American College in conjunction with the National Association of Health Underwriters, 270 S. Bryn Mawr Avenue, Bryn Mawr, PA 19010; 888-2637265; <www.amercoll.edu>. RIA. Registered investment advisor with the Securities and Ex• change Commission, 450 Fifth Street, N.W., Washington, DC 20549; 202-942-7040; <www.sec.gov>. This designation simply requires an individual to pay a fee and fill out a form.
THE BOTTOM LINE • Success often depends on utilizing OPB. Capitalize on the brains of experts. Rely on professional money management. • Remember the T-square. Your advisors should be strongest in the areas in which you’re weakest. • Do your research when looking for the right advisor. He or she will have more than just expertise in a field. Look for references, credentials, listening skills, and empathy. • A string of initials after a name does not always make for a topnotch expert. Do your homework so the alphabet soup does not mislead you.
C h a p t e r
12 PUTTING IT ALL TOGETHER
H
opefully I’ve opened your eyes to the possibilities and shown you that it doesn’t take a great deal of money to build wealth in this great country of ours. Are you ready now to take control of your financial life? Are you ready to put together the pieces of the puzzle of your financial future? (See Figure 12.1.) Have you thrown out the excuses for why you can’t, replaced that outdated software package in your brain, tuned out the noise, started to think long term, and decided to f ly like an eagle? Remember, it starts with a positive attitude. There’s no sense in blaming the economy, your neighbor, national politics, your background, or your boss for not achieving financial success. I grew up in a six-family tenement house. My family didn’t have two nickels to rub together. I was supposed to accept my lot in life and go on. But I had the desire and the drive to succeed, to break out of the herd, to think independently, and to get ahead. I recognized the importance of knowledge and the power it brings if only we make the effort. The wealthy don’t have an edge; they have knowledge and they’re not afraid to use it. I saw my childhood friend Cliffy Austin’s dad, a successful entrepreneur who enjoyed his life and his successes, and I saw my dad, who like many people, made excuses for not getting ahead. I chose the entrepre203
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FIGURE 12.1. The Puzzle of Your Financial Future
EQUITY INCOME FUNDS
DIVIDEND INCOME
LIVING WILL EQUITY VS. DEBT
T ASSE TION A C O L AL
ROTH IRA
FUND MANAGEMENT
INVESTMENT PLANNING REAL ESTATE
INCOME TAXES
VARIABLE VS. FIXED ANNUITIES
IO TFOL N POR IZATIO IM OPT
RETIREMENT PLANNING
CAPITAL GAINS TAX
ESTATE PLANNING
neurial path, to f ly like the eagle. It has been a journey full of challenges. At times, I thought I wouldn’t make it. Other times it seemed as if I was going backward. But that fire in my belly sustained me, kept me going, and helped me make it. I have built wealth for myself, my family, and generations to come. I face every day with a smile. My attitude is and always has been that I can and will succeed despite what the herd says. You can too, no matter where you begin. Just start!
WEALTH-BUILDING BASICS I hope you have decided to soar with me, learn what it takes, and then invest for success. Before you head off to seek your financial fortune though, step back and be sure you have the basics in place to take care of yourself, your family, and loved ones. • Do you have a will? Without one, careful planning can go down the drain (or the cash to Uncle Sam). To do it right, you should involve an attorney and a financial advisor.
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• You may want to consider a living trust. It enables your assets to bypass probate and go directly to your heirs. There are other ramifications, however, so utilize an expert to draw up the documents. • Have you established a durable power of attorney? This is a formal document that allows adult children, your spouse, or anyone else you designate to step in and take care of your financial affairs in case you become physically or mentally incapacitated by serious injury or illness. • Don’t overlook a health care surrogate, which is a third party to make health care decisions for you if you can’t. Also consider a living will that directs someone else to carry out your wishes regarding removal of life support when you’re incapacitated, death is imminent, and there’s no chance of recovery. • It may seem a bit morbid, but you need to be sure your funeral and burial plans are taken care of long before you pass away. Why burden your family with difficult decisions during their grief? A little bit of planning on your part certainly will be appreciated later in life.
MORE SECRETS TO SUCCESS Don’t expect any stunningly new and different ideas on how to succeed in the 21st century. The American Dream is alive and well, and people have been doing the same thing with slight variations for years. Some of these “secrets” may sound pretty elementary, but often people are not willing to make the effort. This entire book, after all, is about opening your eyes to what it takes to get ahead. Just remember, everyone who succeeds has to start somewhere.
You Need a Goal Why do you really want to build wealth? Is it for your retirement, to start a business, or to pay for your children or your grandchildren’s college education? Answer that question first. Then, with a clear goal, you can determine how much money you need to meet that goal. Remember
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always to write down your goals. They should be specific, measurable, and have a time frame. You may find that when you look closely, what you truly want is to become financially independent and have enough money to make the choices you want to make in life, instead of achieving tremendous wealth.
Spend Less Than You Earn Sounds pretty simple. But spending less than you earn means living below your means and not spending every penny you earn. How many credit cards do you have in your wallet? I’ll bet lots more than you need. How often do you use them on wasting assets—things you don’t need and really could do without? Instead, why not put that money into appreciating assets like stocks or your retirement account. Spending wisely and trying to get the most out of your dollars are fairly simple rules to building personal wealth, but they also are essential rules. Make sure you minimize your consumer debt. One way to do that is to cut up your credit cards. If that’s too drastic, keep them but pay off the entire balances each month because those balances represent highpriced money that offers no tax breaks. The exception is a home equity line of credit because the interest is tax deductible. If you go that route, keep in mind that your home is on the line. Following are some other tips to get your credit card habits under control: • Use low-interest cards. Shop around by checking out Web sites like CardWeb.com and Bankrate.com. • Don’t overlook negotiating lower rates from your current card issuers. It’s a competitive world out there for those of you with a good credit rating. • Don’t load up your card buying wasting assets. How badly do you need that big-screen TV? Can you instead take the money, buy an increasing asset, hold it for a time, and then liquidate a portion to buy the wasting asset with the profits? • Don’t charge more than you can afford to pay off. If you owe $2,000 on a card that carries an 18 percent interest rate and pay
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only the minimum 2 percent per month, it will take you more than 30 years to pay off the card! • Pay credit card bills in full as soon as they arrive. That’s the only way to go.
Invest Early and Often Start investing as early in your life as possible and put aside as much money as you can afford. That doesn’t mean you can’t do it if you get a late start. You will just have to work harder at it and invest more to end up with more. Take advantage of tax-deferred investments and invest on a regular basis. Building wealth is a long-term process—the marathon not the sprint. Buy and hold equity investments like stock mutual funds because over time the return will be greater than if you switch in and out of those same funds every couple of years. Patience is key!
Protect Your Wealth You don’t want to lose your earning capacity or hard-earned wealth to an unexpected financial catastrophe. An automobile wreck, a loved one in a nursing home, the death of a spouse, a lawsuit at work, or even a fire in your home can destroy your life savings. Do you have disability insurance, health care insurance, long-term care insurance, life insurance, and liability insurance along with your basic home and auto coverage? All kinds of estate-planning tools shelter and protect you, your spouse, your family, your loved ones, and your wealth while you’re alive as well as after you die. Tax laws governing these estate-management techniques constantly change, so make sure your estate-planning specialist is an expert and familiar with the nuances.
THE TIME LINE Learning to manage money and build wealth may take an attitude adjustment for you, but you can start the next generation on the right
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path by teaching them solid financial habits now. The lesson will pay off for the rest of their lives. When your kids are small, show them how to budget their allowance and open their first savings account. Help them understand the importance of investing money. Get them started with an investment account. Once a child starts working and making money, teach him or her to begin investing. Putting money aside in an IRA should become a lifelong habit. The next important step is to help your kids establish their credit and to learn to be careful using a credit card. Don’t just hand your teen the card and expect him or her to handle it responsibly without some coaching. As children grow up, they need to take charge of their financial lives. Here are a few more tips for the early earning years. • Put a minimum of 5 percent to 10 percent or more of your income away for retirement in a tax-deferred plan such as an IRA. • As young as possible, start saving for a down payment on a home. • Plan your finances before you get married. • Make sure you and your dependents are well taken care of. Get life insurance, medical insurance, and disability insurance if it’s not provided through your employer. By the time you reach your 30s, you’re probably feeling financially overcome, even if you are making more money. This is when you might feel you should cut down on your IRA contributions in order to afford putting your children through college. Big mistake. Remember there are many ways to pay for college, but only you will be responsible for your retirement. At age 40, you have to consider your aging parents. Can they take care of themselves financially? Are they properly insured? It’s wise to buy long-term care insurance for your folks if their situation warrants it. Also, make absolutely sure that their estate is in order. From 50 on is the time to increase your retirement contributions. Consider putting 15 to 20 percent or more of your income aside. Get serious about how you see yourself in retirement. Keep in mind the type of lifestyle you and your spouse want to maintain in later years. After retirement there still is plenty of living to be done.
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When you are 60 years of age, you want to take full advantage of your Social Security and Medicare benefits. Make sure your health insurance doesn’t lapse until you are eligible for Medicare. If you are retired, you may choose to work part time. If you haven’t already, buy longterm health care insurance if it’s appropriate for your situation. Once you turn 70, it’s finally time to slow down and enjoy. You’ve earned it. Talk to your children about your estate so they won’t face any unpleasant surprises once you are gone from this good earth. Figure 12.2 outlines the steps you should take at each stage of your life to ensure a healthy financial future.
RULES OF THE ROAD On the road to building wealth, it’s important to follow the rules of the road that I’ve discussed throughout this book. There aren’t many, but if you heed them the chances of reaching your long-range destination are much greater.
Rule 1: Keep Your Emotions Out of Investing When the value of your investments is falling, don’t even think about selling unless a major change occurs in the world. Instead, think about buying more. The more the markets fall, the more you should buy. There is a very logical reason for all this. If there’s a precipitous drop in the market, ask yourself two questions: 1. What is the most direct cause of the falling market? Most likely, it’s frightened investors selling their stocks, mutual funds, and other investments. 2. What’s the most direct cause for the drop in your investment? Most likely, it’s frightened people selling their investments. When a mutual fund suddenly loses ground, it doesn’t mean the intrinsic value of that fund suddenly drops. It means there are more sellers than buyers and that’s usually due to many millions of alarmed people doing the same thing—dumping their investments.
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FIGURE. 12.2 Planning for the Stages of Your Financial Life
Ages 0-20 • Learn sound financial habits. • Understand how to budget an allowance. • Open a first savings and/or investing account. • If you’re earning money, open an individual retirement account. Ages 21-30 • Establish good credit that includes learning how to use credit cards wisely. • Whittle down college debts as quickly as possible. • Earmark at least 5 percent to 10 percent of your income for retirement. • Earmark certain money for a down payment on a home. • Buy life, health, and disability insurance. • Draft a will. Ages 31-40 • Despite the growing family pinch, don’t cut down on retirement plan contributions. • Update your will and durable power of attorney. • Periodically review your life insurance policy to make sure it’s adequate. Ages 41-50 • Keep socking away retirement money. • Assess whether your aging parents can financially take care of themselves if the need arises. • Consider buying long-term care insurance for your parents if their situation warrants it. • Discuss with your parents their financial needs and concerns. • Be sure your parents’ estate planning is in place. Ages 51-60 • If your expenses start to ease as the kids move out, really beef up your retirement contributions to 15 percent or more of your income every year. • Start getting serious about your vision of retirement. • Buy long-term care insurance if you haven’t already. • Don’t get too conservative in your investing even if you plan to retire soon. • Get serious about an estate plan. Ages 61-70 • Study your Social Security and Medicare options to take full advantage of them. • Be sure you don’t have gaps in medical coverage if you retire before you’re eligible for Medicare. • Consider working part time in retirement. • Review retirement plan payout options and start withdrawals from these plans. • Absolutely have an estate plan. • Investments may grow more conservative, but not too conservative. With good health, you’ll have many years left and need a good nest egg to stay ahead of inflation. Ages 70 and beyond • Slow down and enjoy. • Talk to your kids about your estate.
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I’m reminded of a quote from former President Richard M. Nixon, “People react to fear, not love.” They don’t teach that in Sunday school, but it’s true.
Rule 2: Don’t Follow the Herd When one herd animal gets frightened, the rest start running and that creates a stampede. It’s the same with the markets. When the herd runs, the wisest investors not only stay, they buy quality investments. As I said in Chapter 8, wise investors never see any lions threatening the herd because there are no lions in long-term investing. No one knows what the future will bring, but we can tell from the past that over time markets go up.
Rule 3: Tune Out the Noise There’s no need to check your investments every day. If I did that I’d have a blood pressure problem, and I don’t. A long-term investment is likely to be a good investment. For every person selling his or her shares, there is a buyer. Don’t worry. Be happy. Think long term. Think diversification. Think patience. Think professional money management. Those words are not just for good times; they are for all times.
THE BOTTOM LINE I hope this book has inspired you to start your own journey to building wealth and that now, with me as your partner, you will explore the possibilities, take charge of your financial life, and learn more about what I have discussed. If you think inside the box, you’ll stay in the box. If you think proactively, you will soar like that eagle, achieve your goals, and complete the puzzle of your financial future. (See Figure 12.3.) You can’t hit a home run from the dugout. You have to get to the plate. I have told you about many options that are out there for you to explore—401(k)s, IRAs, long-term care, life insurance, family trusts, Crummey letters, revocable living trusts, charitable foundations, annu-
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FIGURE 12.3 Completing the Puzzle
EQUITY INCOME FUNDS
DIVIDEND INCOME
ROTH IRA
FUND MANAGEMENT PORTFOLIO OPTIMIZATION
LIVING WILL EQUITY VS. DEBT
INVESTMENT PLANNING
REAL ESTATE
RETIREMENT PLANNING
ASSET ALLOCATION
VARIABLE VS. FIXED ANNUITIES
ESTATE PLANNING
INCOME TAXES
CAPITAL GAINS TAX
ities, mutual funds, diversification, asset allocation, and more. Now it’s up to you to use your brain and OPB to make it happen. I also hope I have given you the inspiration to elevate your thinking despite all the negative events that occur at times in our lives. We are traveling a path together. We are going to face detours on that path. Some of the detours are premature death, disability, and procrastination. Some are things over which you have no control. We’re not going to worry about those. We are going to take charge of our lives long term. It’s not an even playing field, but look what you can accomplish. Look what others have accomplished. The ingredients are right in America for you to do it. I don’t see boats full of people f leeing America. I see boats coming in. Maybe they know something that often we take for granted. That’s freedom of choice, freedom of speech, freedom to seek a better life. What a great country we live in! Sometimes when I ref lect back on my own wealth-building journey, I am amazed at my perseverance. There was a fire in the belly to succeed. Despite the overwhelming odds at times, I never doubted I would achieve success. By success, I don’t mean just financial wealth. Money alone doesn’t make you truly happy. What matters is family and loved ones with whom to share it.
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The motivation doesn’t stop there, either. As I grow older, I want to be self-sufficient. I don’t want to end up in a fetal position in a sterile nursing home somewhere. I want to be in my home on the ocean, and I have made that option possible. Don’t make excuses that you can’t do it. What about Dr. Stephen William Hawking, Lucasian professor of mathematics at Cambridge University in England? One of the world’s leading theoretical physicists, he holds the same post at Cambridge once held by Sir Isaac Newton! A victim of Lou Gehrig’s disease, he’s confined to a wheelchair and can speak only with the aid of a voice synthesizer. There’s a guy with strikes against him. But did that stop him? He was supposed to be dead in the 1960s and look what he’s accomplished since. What a story of a guy taking charge of his life! He has more working against him than the average human being in America or anywhere. He doesn’t cry about it. He doesn’t see what’s wrong. He’s positive. He’s proactive. He takes charge. I look at Sir John Templeton’s wisdom from decades ago, the cornerstone of which is using common sense. That common sense isn’t common today. If I took the dates away, it’s as if he made those statements today. Yes, history has a way of repeating itself. It’s not different this time. The opportunities are there despite all the negatives if you believe. You and I are equals. We both put our pants on the same way—one leg at a time. You have the same basic problems in life that I have. Maybe sometimes my problems are bigger or vice versa. We each have an opportunity. Take it and soar. Start by asking yourself two questions that I asked earlier in this book: 1. Do you think America will survive? 2. Do you think the world will survive? If you say no to both, tear up this book and throw it away. My answer to both is yes, absolutely. Change, however, is inevitable, so don’t fight it. Grab it. Embrace it. Be proactive. Take charge. Don’t be a member of the herd. Be the eagle. Believe in yourself and together we will travel the journey to success.
Glossary
aggressive growth fund A mutual fund with an investment objective of substantial capital gains and little income. One aggressive growth fund describes itself as a “speculative mutual fund seeking capital appreciation.” American depository receipt (ADR) A negotiable security evidencing ownership of blocks of a foreign security held on deposit in a foreign branch of an American bank. ADRs are listed on the NYSE, AMEX, or Nasdaq. annual renewable term (ART) A form of pure protection life insurance that guarantees renewable coverage each year without evidence of insurability (physical examination). annuity: A retirement vehicle that provides for the payment of a specific sum of money at uniform intervals of time. Usually purchased from an insurance company, it provides the annuitant with a guaranteed income either immediately or at retirement. Annuities usually pay until death (or for a specific period of time) and provide protection against the possibility of outliving your financial resources. annuity trust One of the vehicles for receiving income from a charitable gift. Provides the donor with an annual income that represents a fixed percentage of at least 5 percent of the initial value of the gift. appreciation participation mortgage (APM) A mortgage through which the lender participates in the appreciation of the property by exchanging a reduction in the mortgage interest rate for a percentage of equity in the property. The mortgagee shares in the appreciation at the time of loan payoff or sale. asked The price requested by the selling party for any particular stock. (When bid and asked prices are quoted, the asked price is the lowest anyone has offered to accept for the stock at that time, while the bid 215
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is the highest anyone has offered to pay for it.) See also bid and spread. assets Everything owned by or due to a person or corporate entity. assumed benefit plan See target benefit plan. automatic reinvestment An optional feature of most mutual funds providing for the reinvestment of all income distributions through the automatic purchase of additional shares. balance sheet A financial report that includes assets, liabilities, net worth (or deficit), and other related information. Usually standardized in columnar form; subtracting liabilities from assets produces a “net worth” figure. balanced fund Mutual fund that maintains a balance between stocks and bonds in the investment portfolio; the rationale: stocks for growth, bonds for safety. beneficiary The person who receives or is identified to receive something. Mainly used to identify the person(s) to receive insurance proceeds at the death of the insured. bid The price offered by a prospective buyer for a stock. In mutual funds, the bid price is usually the liquidating or net asset value of its shares. See asked and spread. bond Basically, an IOU or promissory note of a corporation, municipality, or federal government, usually issued in denominations of $1,000. A bond represents debt and the holder of the bond (the investor) is a creditor of the entity, not a shareholder. Hundreds of different types of bonds have been issued. If you invest in bonds, usually you receive your interest twice a year, and at maturity your original principal is returned. bond fund A mutual fund that invests mainly in bonds, hoping to achieve maximum income and safety of principal. book value The net worth of a company or the value of its depreciated assets. Also referred to as capital or shareholder’s equity. Book value may differ from the liquidating value because assets are estimated by depreciated rather than market value. calculated risk A venture that includes uncertainties, alternatives to which have been carefully studied to select the highest probability of success.
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call option An option to buy a predetermined amount of stock at a specified price within a specific time frame. call price The price at which a company will repurchase a callable security. capital Generally, the money or property used in a business. The term also is used to apply to cash in reserve, savings, or other property of value. In financial reports, it is the total of all assets less the total of all liabilities. capital gain Profit gained from the sale of real estate, securities, or another capital asset. cash value insurance Insurance policies with built-in “savings account” features, e.g., whole and ordinary life. certificate of deposit (CD) Interest-bearing FDIC-insured debt instrument offered by banks and savings and loans. Money removed before maturity is subject to a penalty. Certified Financial Planner A certification granted by the Certified Financial Planner Board of Standards (Denver) to individuals who successfully complete rigorous coursework and pass an examination; also includes adherence to a code of ethics, and continuing education. CFP See Certified Financial Planner. charitable remainder trust A trust that donates the principal to a charity at termination of the trust period. See also annuity trust. Chartered Life Underwriter (CLU) A designation granted by the American College (Bryn Mawr, Pennsylvania) to individuals who successfully complete rigorous coursework and have practical experience; it requires following a code of ethics and completing continuing education. College for Financial Planning An organization that offers professional training curricula leading to the CFP certification granted by the Certified Financial Planner Board of Standards, Inc. combined purchase privilege The right to accomplish any of several transactions involving simultaneous purchases of puts, calls, and futures contracts. Used for purposes of hedging in speculative trading. comfort zone That area of comfort you feel regarding the safety of your investments or above which you feel investments are too speculative.
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Glossary
commercial paper Short-term, usually unsecured obligation issued by a bank or corporation to finance its credit needs; issued by companies with high credit ratings, therefore carries relatively low risk. commodities Staple products basic to many industries and usually traded in bulk form. Examples include corn, copper, pork, and lumber. Frequently when investors “buy commodities,” they are in effect signing a contract to buy or sell a quantity of the product at some future date, called a commodity future contract. common stocks Certificates representing undivided interest in the assets of a corporation with no set rate of return. Ownership of common stock provides for corporate voting rights and a share in the future profit (or loss) of the corporation. compound interest Interest paid on both the principal and previously accrued interest. convertible term insurance An option offered with some term insurance policies that allows the insured to convert the term policy to a whole life policy at some future date. corporate income statement A company’s statement of profit and loss (showing revenue, costs, taxes, and profit). One of the three major reports included in corporate financial statements. creative financing Unique and innovative ways of financing a major investment purchase by reducing cash outlay and increasing leverage. Usually in the realm of real estate, it would include arrangements like second mortgages, wrap-around mortgages, and appreciation participation mortgages. custodian Any person or organization holding the assets of another. Also used to refer to an adult who agrees to take responsibility for a minor who purchases securities, or to a bank that serves as a depository for the assets of a mutual fund. decreasing term A type of pure protection life insurance (term) in which the premiums remain the same and face value of coverage decreases over the life of the policy. deferred compensation plan (nonqualified ) A retirement strategy that defers some present employment compensation until a future date (either when you retire or leave employment). Advantages include
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tax-deferred investment income and substantive lack of government red tape. defined-benefit plan A special form of retirement plan that pays a retired employee a specific amount based on salary history and years of service. depreciate Lose value due to wear, tear, or obsolescence, usually charged against income as a business expense. discretionary funds Money left after expenses for essentials. Usually refers to money spent on leisure, travel, and savings. diversification The spreading of investments among numerous vehicles and over a distribution of risk levels. Rationale: The adverse effect of weakness or loss in one area will be spread among the entire portfolio. Also known as “spreading the risks.” dividends Payments by a corporation to its shareholders proportionate to corporate earnings. Dow Jones Industrial Average (DJIA) A composite index of 30 large industrial stock prices. Employee Retirement Income Security Act (ERISA) 1974 pension reform. endowment life insurance In effect, a forced savings account with a life insurance company, with a death benefit as a secondary feature. Usually purchased to ensure a future payback to meet an anticipated obligation, such as children’s education. equity The net worth of a corporation (or proportional ownership by a shareholder). In real estate or other installment purchased assets, the paid-up portion of the property’s value. estate All of a person’s property, especially that left by a deceased person. estate planning A system of planning that ensures your estate will be passed to your chosen heirs with limited red tape and the most favorable tax treatment. estate tax A tax assessed on the transfer of property from a deceased person to his or her heirs. executor A person named in a will by a decedent to carry out the provisions of the will.
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Glossary
family of funds A system of mutual funds, managed by the same company, that provides the option of switching investments from one type of fund to another, either for free or for a small administrative fee. family trust A type of trust that provides income to a spouse which, upon the spouse’s death, is automatically disbursed to children. first in, first out (FIFO) One of several bookkeeping techniques used to assign value to inventory. The method assumes that older inventory is used before newer, thereby keeping books consonant with current prices by valuing inventory only on recently purchased goods. fixed interest An interest rate that does not vary and is guaranteed (can be good or bad!) for the duration of the investment term. floor interest The lowest interest rate allowed. Usually used in single premium deferred annuities where a f loor interest rate (most often one percentage point below the guarantee) is established to allow the investor to bail out if interest rates dip appreciably. foundation investments In the investment pyramid, those vehicles with guaranteed returns that are usually lower than higher-risk investments, but provide safety of principal. Includes savings accounts, checking accounts, savings bonds, cash value insurance, etc. four Cs The four categories used to determine the value of investment-grade diamonds all beginning with the letter C: clarity, carat weight, color, and cut. 403 (b ) plan A retirement plan for people employed by a tax-exempt organization or public school. Whether you are employed part or full time, the employer may make a limited contribution (usually through withheld salary or forfeited raise, if so requested) to a selected group of investment vehicles. The same tax-deferral benefits of other retirement plans apply. gemology The science or study of natural and artificial gemstones. general partner The individual (or individuals) who has unlimited liability in a partnership. Usually distinguished from a limited partner in tax-shelter investments, the general partner secures the proper income-producing properties and has the responsibility of managing them on a profitable basis. General partners usually share about 15 percent of the costs and profits.
Glossary
221
generation skipping trust A trust that allocates income from the donor’s assets to one generation following the donor (say, your children) but preserves the principal for the generation beyond that (your grandchildren). Usually includes an exclusion from estate taxes when your grandchildren receive the principal. gift tax A tax levied on the transfer of property as a gift when the donor gifts more than the lifetime exemption. This tax does not apply to gifts between spouses, unless the spouse is not a U.S. citizen. gold bullion Bars of gold that can be purchased on world markets with little markup. Problems include minimum purchases, delivery, storage, and lack of liquidity. graduated payment mortgage A creative financing technique in which the earlier mortgage payments are lower than they would be with ordinary mortgage financing. Payments gradually increase at a predetermined rate. Successful for first-time, young, homebuyers, who usually sell the home before the payments become unbearable. growth fund A mutual fund with an investment objective of capital growth and capital gains. Usually, a common stock fund seeking long-term capital growth and future income rather than current income. growth investments The center portion of the investment pyramid, between the foundation and speculative investments. Middle-of-theroad risk investments. Usually include mutual funds, managed equities, and stocks, among others. growth stock Stock of a company that is growing earnings or revenue and usually pays little or no dividends to shareholders. See income stock. hard assets Investments that are tangible as opposed to paper or intangibles. These include metals, gems, art, stamps, collectibles, etc. health care surrogate A third party designated to make health care decisions for you if you can’t. income fund A mutual fund with an investment objective of current income rather than capital growth. Many bond funds are considered income funds. income stock A stock with a history of paying consistently high dividends. See growth stock.
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Glossary
individual retirement account (IRA) A tax-deferred retirement plan established by an individual taxpayer. inflation A condition of increasing prices usually caused by an undue expansion in paper money and credit. International Association for Financial Planning A professional organization that merged with the Institute of Certified Financial Planners to form the Financial Planning Association. investment pyramid A method for identifying the mix of investments in individual portfolios. irrevocable trust A trust that cannot be altered or canceled. joint and two-thirds survivor annuity An annuity under which joint annuitants receive payments during a joint lifetime. After the demise of one of the annuitants, the other receives two-thirds of the annuity payments in effect during the joint lifetime. Keogh plan A tax-deferred qualified retirement plan available to self-employed individuals. krugerrand A gold coin minted in South Africa. land contract A form of creative financing used in real estate wherein the seller retains legal title to the property until the buyer makes an agreed-upon number of payments to the seller. Usually, the buyer has all the benefits of tax deductions and the seller pays the existing mortgage. The technique is usually used when there is a legally enforceable “due on sale” clause in the mortgage. lease option A creative real estate financing technique wherein the buyer, for a consideration (compensation), leases a home with the option to buy later when interest rates may be lower. In most cases the monthly payments and the consideration are applied to the purchase price. letter of intent privilege In front-end load mutual fund purchases, a discount is allowed for large investors who intend to purchase amounts that qualify for the discount. When the large amounts are not purchased immediately, the fund requests a letter of intent to do so and allows the discounted load to be charged. level term A form of pure protection insurance (term) in which the face value and the premiums remain level for the life of the policy.
Glossary
223
leverage The use of someone else’s money in an attempt to increase your rate of return on investment. liabilities The negative side of a balance sheet including monies owed, debt, and pecuniary obligations. life annuity An annuity that carries no death benefit. Usually, when the annuitant dies, all benefits end, even if there is a surviving spouse. limit order An advance order, given to a stockbroker, indicating a maximum price at which you will buy a stock and a minimum price at which you will sell. limited partner In a limited partnership, the investor whose liabilities are limited only to the extent of the investment capital contributed. See general partner. limited payment life A type of whole life (cash value) insurance that insures you for life but requires premiums to be paid for a limited number of years. Sometimes named for the periods (20-year paidup or paid-up at 65), the premiums are higher than if paid for the entire term of the policy. liquidity The quality of assets that can easily and quickly be converted to cash without a significant loss. For example, stocks are considered to be more liquid than real estate. living trust A trust into which you transfer your assets for the eventual benefit of your heirs, made while you are still living. Usually, you can comanage, with a trustee, all of your property and receive all the income. This type of trust is fully taxed in your estate. Also known as an inter vivos trust. living will A document that directs someone else to carry out your wishes regarding removal of life support when you’re incapacitated, death is imminent, and there’s no chance of recovery. load/no-load Mutual fund front-end sales charges and administrative fees are called loads. Funds that do not impose front-end fees are called no-load funds. long-term care insurance Provides coverage of healthcare expenses should the insured become incapacitated in accordance with the policy; premiums may be fully or partially deductible as a medical expense on your tax return.
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Glossary
margin Using money borrowed from a broker/dealer to purchase securities; also referred to as buying on margin. Margin also refers to the amount of equity required for an investment in securities purchased on credit. marital deduction Deduction that allows unlimited transfers of assets to a spouse without incurring estate or gift taxes. market order An order to your broker to buy or sell stock at the best currently available price. Medigap Insurance that supplements Medicare coverage. money-purchase pension plan A defined-contribution pension plan in which the employer must contribute a certain percentage of each employee’s salary each year, regardless of the company’s profit. mutual fund A company that uses the proceeds from the public sale of its shares to invest in various securities for the benefit of its shareholders. The number of shares is unlimited and the company will repurchase shares at any time. The fund’s net asset value (NAV) is calculated at the end of each trading day. mysterious disappearance A provision of property and casualty homeowner’s insurance that provides compensation for items that “disappear” from your home. Many business people who entertain at their homes have this type of insurance protection. National Association of Insurance Commissioners Organization of insurance regulators from the 50 states, the District of Columbia, and the four U.S. territories; provides a forum for the development of uniform policy when uniformity is appropriate. National Association of Securities Dealers (NASD) Under federal law, virtually every securities firm doing business with the U.S. public is a member of this private, not-for-profit organization. NASD registers member firms, writes rules to govern their behavior, examines them for compliance, and disciplines those that fail to comply. Also monitors all trading on the Nasdaq stock market and other selected markets worldwide. nonforfeiture values Options that become available to the cash-value insurance policyowner as value itself, borrowing options, and the purchase of paid-up whole life from cash reserves.
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225
numismatics The study of collecting or investing in coins. Usually refers to rare-coin collections. offering memorandum A term, used mainly in the case of tax-shelter programs, that explains the company, its objectives, and the investment. A private-placement prospectus. OPB Other people’s brains; utilizing the expertise of specialists in various areas. OPM Other people’s money. See also leverage. option The right to buy or sell a certain number of shares of stock or other optionable securities at a specific price within a specific time frame. ordinary life insurance Cash-value life insurance with a “savings” provision. paid-up life insurance See limited payment life. permanent life insurance Cash-value life insurance. pledged account mortgage A variation of the graduated payment mortgage, this creative technique uses a portion of the buyer’s down payment to fund a pledged savings account. Money is drawn from the account to supplement monthly payments during the early years of the loan. Net effect: lower initial payments. Disadvantage: Down payments must usually be large. pooled income fund A trust maintained by a charitable organization that pools the assets contributed by a number of people. Each of those people, while living, shares the investment income proportionally. At the death of each of the designated income beneficiaries, the contributed assets pass to the charity. preferred stock A security on which a fixed dividend is required to be paid before the common shareholder is entitled to a dividend. premium waiver feature An optional feature of some insurance policies that waives the continued payment of premiums if you are disabled and unable to pay. price-earnings ratio (PE) A ratio that indicates the value of a company’s stock (rather than its strength). Achieved by dividing the stock price by its earnings per share.
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Glossary
probate The judicial process used to establish the validity of a will and carry out its terms. Also used to refer to the judicial proceedings needed to settle an estate. profit and loss statement (P&L) See corporate income statement. profit-sharing plan A retirement plan (or simply a plan for the sharing of profits) through which employees share in the profit of the corporation for which they work. Contributions are required only when there is a profit. Compare to money purchase pension plan. pro forma Latin, meaning “according to form.” In financial planning, usually used to refer to an analysis done by a professional regarding the prediction of tax or other financial obligations. property and casualty insurance Insurance coverage to provide for the replacement of or compensation for property lost, stolen, damaged, or destroyed. prospectus A legal document that describes the securities or mutual fund shares to be issued and the conditions under which they are to be offered as well as the prospects for company performance. put option An option to sell a specified number of shares of a particular stock at a specified price within a set period of time. qualified annuity An annuity that meets IRS requirements for inclusion in group pension plans, Keogh retirement plans, and IRAs. real estate investment trust (REIT) An equity trust that can hold income properties of all types and offers shares that are publicly traded. Note: This is a modification of a limited partnership that does not require net worth or income minimums for the investor. red book Actually called A Guide Book of United States Coins, it sets down standards for estimating coin condition and retail value by comparing with others of the same type and year. registered investment advisor ( RIA ) A person who provides advice to the public concerning the purchase or sale of securities is required, by the Securities and Exchange Commission and the Investment Advisers Act, to be registered with the SEC as an RIA; requires payment of a fee and completion of forms. reverse mortgage A method of providing income (usually used by people on fixed incomes who own outright a substantial portion if not
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all of their private residence) through the borrowing of money against equity in their home. right of accumulation A mutual fund load discount provided by some investment companies that allows you to accumulate the amount of shares needed to obtain the discount. rollover A method of avoiding the substantial tax bite of a lump-sum retirement plan payment, allowing you to roll it over into an IRA or similar vehicle to continue its deferred tax status. rollover mortgage A mortgage for which the unpaid balance is refinanced every few years at then-current rates. rule of 72 A simple financial formula for calculating the number of years it takes an investment to double at any rate of return. Divide the rate of return into 72. second mortgage A mortgage on real estate that already has been pledged as collateral for an earlier mortgage. Securities and Exchange Commission (SEC) Established by Congress to assist in the protection of investors, it is a government agency that administers the various laws governing the sale and trading of securities. selling short Selling stock not owned; a risky technique of borrowing stock from the broker in anticipation of a drop in stock value that will bring rewards. Instead of looking for market winners, the short seller looks for and bets on losers. simplified employee pension (SEP) An individual retirement arrangement to which your employer or you as a self-employed individual can contribute a certain percentage of your compensation annually. Contributions are not mandatory. single premium deferred annuity (SPDA) An annuity funded with a lumpsum payment (single premium) and purchased before the anticipated date of retirement (deferred). specialty fund A mutual fund that limits investments to a specific industry. Some examples are technology funds, transportation funds, and precious metals funds. speculate To invest with a high amount of risk with the objective of substantial gain. Usually used when referring to investors who seek increase of capital rather than dividend income.
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Glossary
speculative investments Vehicles at the apex of the investment pyramid. Risk-laden investments that could provide substantial gain or loss. Examples include art, rare coins, commodities, oil and gas, etc. split funding A method of channeling some pension assets into the purchase of term and whole life insurance policies. Because life insurance may be issued as part of a retirement plan without physical examinations, employees in poor health stand to benefit. spread The difference between the bid and asked prices for securities. stock certificate A certificate, issued in shares that verifies stock ownership and entitles the owner to dividends and participation in company profit. stock purchase plan A corporate plan that allows employees or outside investors to buy the stock of that corporation without a broker (avoiding a commission). Most plans also include automatic dividend reinvestment, allowing additional purchase of shares directly from the company. stop order An advance order to a broker to buy or sell securities when a specific price has been reached. straight life annuity An annuity that carries a guarantee of payments to the annuitant for life. All payments stop at the death of the annuitant. syndication In real estate, when two or more individuals pool funds to purchase and manage one or more income-producing properties. A limited partnership is a form of syndication. tangibles Assets that have physical form, such as land, buildings, machinery, and cash. target-benefit plan A form of retirement plan that combines the advantages of a defined-benefit plan (guarantees benefit levels) and a money-purchase plan (requiring the employer to contribute a certain amount without regard to corporate profit). tax avoidance Legal methods of avoiding tax payments through various methods including deferral and shelter. tax deductible Expenses that can reduce the amount of taxable income. Examples include medical expenses, charitable contributions, and mortgage interest.
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tax deferral A method of tax avoidance that defers the payment of taxes on income until a future time. Rationale: Future tax brackets will be lower and the payment of the tax will be made with inf lated dollars. tax incentive Corporate or venture vehicles that include major tax deferring or sheltering characteristics. term insurance As opposed to cash value insurance, death protection that is pure and does not include “savings” programs as a part of the policy. Usually issued for a certain period of time, hence “term.” time sharing A creative financing technique in the field of real estate that allows the use of property on a time-shared basis while building equity for all the owners. Two types: right-to-use (membership right) and interval ownership (purchase of a particular week or weeks each year). Treasury bills (T-bills) U.S. government debt security with no stated interest rate. A short-term investment with a maximum maturity of one year, and sold at a discount from par with competitive bidding. trust A legal arrangement within which a person contracts for the management and control of certain assets for benefit of self or others. trustee One who holds the legal title to property for the benefit of another. 12b-1 fee A fee that some mutual funds charge that pays for marketing and promotion expenses. unit investment trust An SEC-registered investment company that buys a fixed portfolio of securities, then sells investors shares of the trust. Unlike a mutual fund, a UIT is unmanaged. At the end of a set period, the trust dissolves, and proceeds are paid to shareholders. unit refund life annuity A type of annuity that pays on a periodic basis during your lifetime and provides your beneficiary with a lump-sum payment based on the dollar amount of your remaining annuity units. variable annuity An insurance contract that allows the owner/annuitant to choose from among several mutual fund selections within the annuity’s investment portfolio. vested benefits Those benefits of a retirement, pension, or profit sharing plan that belong to the employee outright. Vesting normally takes place gradually until, after a specified period, the employee
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is totally vested and is entitled to 100 percent of the retirement account. whole life insurance See ordinary life insurance. will A document wherein an individual provides for the distribution of property or wealth after death. wrap-around mortgage A creative real estate financing technique that is akin to the second mortgage but includes both the original and the second mortgage in a single package, “wrapping” a new mortgage around the other two. yield Return on an investment, usually expressed as a percentage.
References
TRADE ASSOCIATIONS Following are just a few of the dozens of professional trade organizations in personal-finance and wealth-management businesses. Many groups have free locator options to help consumers find a professional tailored to their needs, complaint and dispute resolution services, and plenty of free information for the public either online or off. American Arbitration Association. 335 Madison Avenue, 10th Floor, New York, NY 10017; 800-778-7879; <www.adr.org>. Source of arbitrators to settle disputes with financial advisors. Association for Advanced Life Underwriting. 2901 Telestar Court, PO Box 12012, Falls Church, VA 22042; 888-275-0092; <www.aalu.org>. Association of advanced life insurance planners. Experienced professionals with business qualifications. American Bar Association. 750 N. Lake Shore Drive, Chicago, IL 60611; 312-988-5000; 800-285-2221; <www.abanet.org>. Trade association for U.S. lawyers. American Institute of Certified Public Accountants. 1211 Avenue of the Americas, New York, NY 10036-8775; 888-777-7077; <www.aicpa .org>. Professional organization for accountants; licenses personal financial specialists (PFS), who are accountants concentrating on financial planning. For a list of PFS members nationally, call 888-999-9256. American Savings Education Council. 2121 K Street, N.W., Suite 600, Washington, DC 20049; 202-775-6360; <www.asec.org>. National nonprofit organization with information on all aspects of personal finance and wealth development.
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Association for Investment Management and Research. 560 Ray C. Hunt Drive, Charlottesville, VA 22903-0668; 800-247-8132; <www.aimr .org>; CFA designation. Certified Financial Planner Board of Standards. 1700 Broadway, Suite 2100, Denver, CO 80290; 888-237-6275; <www.cfp-board.org>. Grants CFP certification. Chartered Property Casualty Under writers. 720 Providence Road, Malvern, PA 19355; 800-932-2728; <www.cpcusociety.org>. Professional association for agents and other insurance specialists. College for Financial Planning. 6161 South Syracuse Way, Greenwood Village, CO 80111; 800-237-9990; <www.fp.edu>. Financial planning coursework and continuing education. Consumer Federation of America. 1424 16th Street, N.W., Suite 604, Washington, DC 20036; 202-387-6121; <www.consumerfed.org>. Nonprofit association of proconsumer groups offering free information on variety of consumer products and issues. Consumer Information Center. Dept. WWW, Pueblo, CO 81009; 888-878-3256; <www.pueblo.gsa.gov>. Federal Citizen Information Center with lots of information on many aspects of investing, saving, planning, and more. Employee Benefit Research Institute. 2121 K Street, N.W., Suite 600, Washington, DC 20037; 202-659-0670; <www.ebri.com>. Nonprofit, nonpartisan organization that offers information and education on economic security and employee benefits. Financial Planning Association. 3801 E. Florida Avenue, Suite 708, Denver, CO 80210; 303-759-4900; 800-322-4237; < www.fpanet.org> . Membership organization for the financial planning community. Futures Industry Association. 2001 Pennsylvania Avenue N.W., Suite 600, Washington, DC 20006; 202-466-5460; < www.futuresindustry .org>. Educates consumers on futures and options. Insurance Information Institute. 110 William Street 4th Floor, New York, NY 10038; 800-942-4242; <www.iii.org>. Nonprofit communications organization supported by association of property/casualty insurance business. International Association for Financial Planning. Merged with Institute of Certified Financial Planners to form the Financial Planning Association.
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Investment Counsel Association of America. 1050 17th Street, Suite 725, Washington, DC 20036; 202-293-4222; <www.icaa.org> . Professional association of independent investment counsel firms that manage the assets of individuals, pension plans, trusts, and nonprofit institutions. Investment Management Consultants Association. 9101 E. Kenyon Avenue, Suite 3000, Denver, CO 80237-8015; 303-770-3377; <www.imca .org>. Professional association for consultants who find and monitor the performance of money managers on behalf of individual and institutional investors. Life and Health Insurance Foundation for Education. 2175 K Street, Suite 250, N.W., Washington, DC 20037; 888-543-3777; <www.life-line .org>. Nonprofit foundation with information on life, health, and disability insurance. National Association of Charitable Estate Counselors. 6201 Leesburg Pike, Suite 405, Falls Church, VA 22044; 800-9-TOGIVE (800-986-4483); <www.nhf.org/nacec>. Nonprofit and part of National Heritage Foundation, which is a facilitator of charitable, educational, scientific, and religious activities. National Association of Enrolled Agents. 200 Orchard Ridge Drive, Suite 302, Gaithersburg, MD 20878; 301-212-9608; 800-424-4339; <www .naea.org>. Professional association of enrolled agents, many former IRS employees who offer tax advice and preparation services. National Association of Insurance and Financial Advisors. 2901 Telestar Court, Falls Church, VA 22042; 877-TO-NAIFA (877-866-2432); <www.naifa.org>. Trade association of health and life insurance agents and brokers. National Association of Investors Corp. PO Box 220, Royal Oak, MI 48068; 877-275-6242; <www.better-investing.org>. Nonprofit membership organization of investment clubs and individual investors that emphasizes strategic long-term investing. National Association of Life Underwriters. Now National Association of Insurance and Financial Advisors. See above. National Association of Personal Financial Advisors. 3250 N. Arlington Heights Road, Suite 109, Arlington Heights, IL 60004; 800-3662732; <www. napfa.org>. Professional association of fee-only financial advisors.
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References
National Association of Real Estate Investment Trusts. 1875 Eye Street N.W., Washington, DC 20006; 800-3NAREIT (800-362-7348); <www.na reit.org>. National trade association for real estate companies; members include REITS and other businesses that own, operate, and finance income-producing real estate, and companies that advise, study, and service them. National Association of Variable Annuities. 11710 Plaza America Drive, Suite 100, Reston, VA 20190; 703-707-8830; <www.navanet.org>. Nonprofit trade association for the annuities industry. National Consumers League. 1701 K Street, N.W., 12th Floor, Washington, DC 20006; 202-835-3323; <www.natlconsumersleague.org>. Private, nonprofit advocacy group representing consumers on marketplace and workplace issues. National Endowment for Financial Education. 5299 DTC Boulevard, Suite 1300, Greenwood Village, CO 80111; 303-741-6333; <www.nefe .org>. Nonprofit foundation that promotes information and education on personal finance for Americans. National Foundation for Consumer Credit. 801 Roeder Road, Suite 900, Silver Spring, MD 20910; 800-388-2227; <www.nfcc.org>. Source of credit information, counseling, and advice. National Futures Association. 200 W. Madison Street, Suite 1600, Chicago, IL 60606; 800-621-3570; <www.nfa.futures.org>. Industry association of firms that trade in futures. National Society of Accountants. 1010 N. Fairfax Street, Alexandria, VA 22314; 800-966-6679; <www.nsacct.org>. Accredits accounting and taxation specialists; also oversees the examinations and standards for Accredited Tax Preparers and Accredited Tax Advisors. National Institute for Consumer Education. G12 Boone Hall, Eastern Michigan University, Ypsilanti, MI 48197; 734-487-2292; <www.nice .emich.edu>. Professional development, training, and research institute and resource clearinghouse in personal finance and economic and consumer education. New York Stock Exchange Inc. 11 Wall Street, New York, NY 10005; 212-656-3000; <www.nyse.com>. Nation’s oldest stock exchange. Society of Financial Ser vice Professionals (formerly the American Society of CLU & ChFC). 270 S. Bryn Mawr Avenue, Bryn Mawr, PA 19010-2195; 610-526-2500; <www.financialpro.org>. Industry association of credentialed insurance and financial advisors.
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World Gold Council. 444 Madison Avenue, New York, NY 10022 (regional office); 212-317-3800; <www.gold.org>. Organization formed and funded by leading gold mining companies to promote and inform people about gold.
REGULATORS AND MORE Administration on Aging (U.S. Department of Health and Human Services). Administration on Aging, Washington, DC 20201; 202-6190724; <www.aoa.gov>. Government agency that is excellent source of resources on senior issues. A.M. Best. Ambest Road, Oldwick NJ 08858; 908-439-2200; <www .ambest.com>. Source of insurance company ratings and information. American Association of Retired Persons. 601 E. Street, N.W., Washington, DC 20004; 800-424-3410; <www.aarp.com>. Organization with wealth of knowledge on all kinds of information including financial, life, estate, and health care planning, insurance, and more. Commodity Futures Trading Commission (CFTC ). Three Lafayette Centre, 1155 21st Street, N.W., Washington, DC 20581; 202-418-5000; <www.cftc.gov>. Independent agency of the federal government that regulates U.S. commodity futures and options markets. Council of Better Business Bureaus (BBB ). 4200 Wilson Boulevard, Suite 800, Arlington, VA 22203-1838; 703-276-0100; <www.bbb.org>, <www.bbbonline.org>. Organization with which you can check out a broker or business, or find out about fraud issues. Federal National Mortgage Association. 3900 Wisconsin Avenue N.W., Washington, DC 20016; 202-752-7000; <www.fanniemae.org>. Creates secondary market in mortgage-backed securities. Federal Reserve Board. 20th Street and Constitution Avenue, N.W., Washington, DC 20551; 202-452-3946; <www.federalreserve.gov>. Federal agency that oversees banking and savings and loans. Federal Trade Commission (FTC). CRC-240, Washington, DC 20580; 202-382-4357; 877-FTC-HELP (800-382-4357); <www.ftc.gov>. Monitors consumer fraud and complaint issues. Fitch Ratings (merged with Duff & Phelps Credit Rating Co. in 2000). 1 State Street Plaza, 3rd Floor, New York, NY 10004; 800-8934824 (ratings desk); <www.fitchratings.com>. A global rating agency.
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References
Frank Russell Co. 909 A Street, Tacoma, WA 98402; 253-572-9500; <www.russell.com>. A global investment services firm that produces a number of equity indexes, including the widely watched Russell 2000. Internet Fraud Complaint Center. < www1.ifccfbi.gov/index.asp> . Partnership between the Federal Bureau of Investigation (FBI) and the National White Collar Crime Center (NW3C) to provide easy mechanism to alert authorities of fraud over the Internet. Investor Protection Trust ( IPT ) . < www.investorprotection.org> . Independent source of noncommercial investor education materials. Medicare. Centers for Medicare & Medicaid Services, 7500 Security Boulevard, Baltimore, MD 21244-1850; 877-267-2323; <www.medi care.gov>. Federal agency within the U.S. Department of Health and Human Services that runs Medicare and Medicaid national health care programs. Moody’s Investors Services. 99 Church Street, New York, NY 10007; 212-553-0300; <www.moodys.com>. Bond and insurance rating agency. National Association of Securities Dealers ( NASD ) . 1735 K Street N.W., Washington, DC 2006-1506; 202-728-8000; <www.nasd.org>. By federal law registers, governs, and regulates virtually every securities firm doing business with the U.S. public. National Association of State Treasurers College Savings Plans Network. 2760 Research Park Drive, Lexington, KY 40511; 877-277-6496; <www.collegesavings.org>. Information clearinghouse on college savings (529) programs. National Family Caregivers Association. 10400 Connecticut Avenue, #500, Kensington, MD 20895-3944; 800-896-3650; < www.nfcacares .org>. Nonprofit association with information on long-term care and related issues. National Futures Association (NFA ). 200 W. Madison Street, Chicago, IL 60606; 800-621-3570; <www.nfa.futures.org>. Self-regulatory agency of the futures industry. North American Securities Administrators Association (NASAA). 10 G Street, N.E., Suite 710, Washington, DC 20002; 202-737-0900; 888-8462722; <www.nasaa.org>. Represents state securities enforcement agencies and handles investor protection. Office of Thrift Supervision. 1700 G Street N.W., Washington, DC 20552; 202-906-6000; <www.ots.treas.gov>. Federal agency that regulates savings and loan industry.
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237
Public Securities Association. 40 Broad Street, 12th Floor, New York, NY 10004; 212-809-7000; <www.psa.com>. Industry group for brokerages, dealers, and banks that trade government, mortgage-backed, and municipal securities. Securities and Exchange Commission (SEC). 450 Fifth Street, N.W., Washington, DC 20549; Office of Investor Education and Assistance, 202-942-7040; <www.sec.gov>. Government agency that regulates securities industry; sponsors EDGAR, the electronic data gathering, analysis, and retrieval system that provides access to forms filed with the SEC; <www.sec.gov/edgar.shtml. Securities Industr y Association (SIA). 120 Broadway, 35th Floor, New York, NY 10271-0080; 212-608-1500; <www.sia.com>. Established in 1972 through the merger of the Association of Stock Exchange Firms (1913) and the Investment Banker’s Association (1912). Securities Investor Protection Corp. 805 15th Street, N.W., Suite 800, Washington, DC 20005-2215; 202-371-8300; <www.sipc.org>. Nonprofit organization created by Congress to protect customers cash and securities if a brokerage runs into difficulties. Social Security Administration. 6401 Security Boulevard, Baltimore, MD 21235-0001; 800-772-1213; <www.socialsecurity.gov>. Government organization charged with administering the nation’s social insurance/ Social Security program. Standard & Poors. 25 Broadway, New York, NY; 212-208-1527; <www2.standardandpoors.com>. Provides independent analysis on investment products; includes ratings service. Weiss Research, Inc. 4176 Burns Road, Palm Beach Gardens, FL 33410; 800-289-9222; < www.weissratings.com> . Rates the safety of banks, savings and loans, insurance companies, and brokerage firms.
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HOW TO FIND MORE INFORMATION AND ADVISORS In addition to contacting various trade organizations, regulators, and more, the following offer valuable information and assistance.
College and Education Funding BabyMint Inc. 404-591-3600; <www.babymint.com>. The College Board. 212-713-8000; <www.collegeboard.com>. Upromise.com. <www.upromise.com>. Xap Corp. 310-842-9800; <www.xap.com>.
Credit Cards and Interest Rates BankRate.com. <www.bankrate.com>. Free lowdown on the lowest interest rates, credit cards, and more. CardWeb. <www.cardweb.com>. Another solid source of credit card rates and information.
Estate Planning LegalZoom. <www.legalzoom.com>. Online legal service center. Michael T. Palermo, J.D., CFP. <www.mtpalermo.com>. Good information on estate planning, wills, and trusts. SaveWealth.com. <www.savewealth.com>. Information on retirement and estate planning and more.
Financial Planners and advisors Financial Planning Association. 800-647-6340; < www.fpanet.org> . Online advisor referral network. National Association of Personal Financial Advisors. 800-366-2732; www.napfa.org < >. Online advisor search network.
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Investing Information HowStuffWorks. <www.howstuffworks.com>. Simple explanations of investment terms, techniques and more. Investor words.com. <www.investorwords.com>. Good place to get short explanations of investment terms. Jump$tart Coalition. <www.jumpstartcoalition.com>. A nonprofit organization for personal financial literacy. National Endowment for Financial Education. <www.nefe.org>. Free, personal finance basics and then some.
Lawyers Martindale-Hubbell Law Directory. Martindale-Hubbell, 121 Chanlon Road, New Providence, NJ 07974; 908-464-6800, 800-526-4902; <www.martindale.com>, <www.lawyers.com>. American Bar Association. 750 N. Lake Shore Drive, Chicago, IL 60611; 312-988-5000; <www.abanet.org/legalservices>.
Life Insurance National Insurance Consumer Helpline (NICH). 800-942-4242. Consumer Affairs Division. Each state has an insurance department or commission; check your local phone directory.
MUTUAL FUNDS Here is a tiny sampling of the hundreds of mutual fund families on the market today. I don’t endorse one group over another, and the following list is by no means all encompassing. AIM Family of Funds. PO Box 4739, Houston, TX 77210; 800-9594246; <www.aimfunds.com>. Alger Funds. 30 Montgomery Street, Jersey City, NJ 07302; 800992-3863; <www.algerfund.com>.
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References
Alliance Funds. 1345 Avenue of the Americas, New York, NY 10105; 800-227-4618; <www.alliancecapital.com>. American Century Investments. 4500 Main Street, Kansas City, MO 64111; 800-345-2021; <www.americancentury.com> American Funds. PO Box 25065, Santa Ana, CA 92799; 800-4210180; <www.americanfunds.com>. Dreyfus. 144 Glenn Curtiss Boulevard, Uniondale, NY 11556-0144; 800-782-6620; <www.dreyfus.com>. Eaton Vance Funds. The Eaton Vance Building, 255 State Street, Boston, MA 02109; 800-225-6265; <www.eatonvance.com>. Fidelity Group. 82 Devonshire Street, Boston, MA 02109; 800-5446666; <www.fidelity.com>. Franklin Templeton Investments. One Franklin Parkway, Building 970, 1st Floor, San Mateo, CA 94403; 800-632-2301; <www.franklin-templeton.com>. Gabelli Funds. Gabelli Asset Management Inc., One Corporate Center, Rye, NY 10580-1422; 800 872-5365; <www.gabelli.com>. INVESCO Family of Funds. PO Box 173706, Denver, CO 802173706; 800 675-1705; <www.invescofunds.com>. Janus Funds. 100 Fillmore Street, Suite 300, Denver, CO 802064923; 800-525-8983 (ww3.janus.com>. MFS Family of Funds. PO Box 2281, Boston, MA 02107-9906; 800225-2606; <www.mfs.com>. Oppenheimer Funds. PO Box 5270, Denver, CO 80217-5270; 888470-0862; <www.oppenheimerfunds.com>. PIMCO Funds. PIMCO Funds Distributors LLC, 2187 Atlantic Street, Stamford, CT 06902; 800-927-4648; <www.pimcofunds.com>. Putnam Funds. One Post Office Square, Boston, MA 02109; 800225-1581; <www.putnaminvestments.com>. Scudder Funds. PO Box 219151, Kansas City, MO 64121-9151; 800621-1048; <www.scudder.com>. Strong Funds. Strong Investment, 208 LaSalle Street, Suite 2075, Chicago, IL 60604; 800-368-3863; <www.estrong.com>. T. Rowe Price Funds. 100 E. Pratt Street, Baltimore, MD 21202; 800-225-5132; <www.troweprice.com>. Van Kampen Funds. One Parkview Plaza, Oakbrook Terrace, IL 60181; 800-421-5666; <www.vankampen.com>. Vanguard Group. PO Box 2600, Valley Forge, PA 19482; 800-6627447; <www.vanguard.com>.
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INSURANCE CARRIERS Nearly 6,000 insurance companies in the United States offer a variety of policies for life, annuity, disability, and long-term care insurance. Here is a sampling of a few major carriers. Allstate Life Insurance Co. 2775 Sanders Road, Northbrook, IL 60062; 847-402-5000; <www.allstate.com>. AIG/American General. 2929 Allen Parkway, Houston, TX 77019; 800-346-7692; <www.agc.com>. Ameritus Life Insurance Corp. 5900 O Street, Lincoln, NE 685102234; 800-745-6665; <www.ameritas.com>. Continental Assurance Co. (CNA ). CNA Plaza, Chicago, IL 60685; 800-437-8854; <www.cnalife.com>. Equitable Variable Life Insurance Co. PO Box 1047, Charlotte, NC 28201-1047; 212-554-1234; <www.equitable.com>. GE Financial Assurance Co. 6604 West Broad Street, Richmond, VA 23230; 800-844-6543; <www.gefinancialassurance.com>. Guardian Life Insurance Co. of America. 7 Hanover Square, New York, NY 10004; 212-598-8000; <www.glic.com>. Hartford Life Insurance Co. Hartford Plaza, Hartford CN 06115; 860-547-5000; <www.thehartford.com>. Jackson National Life Insurance Co. One Corporate Way, IMG Service Center, Lansing, MI 48909; 800-644-4565; <www.jnl.com>. John Hancock Mutual Life. 200 Clarendon Street, Boston, MA 02117; 800-695-7389; <www.jhancock.com>. Lincoln National Life Insurance Co. 350 Church Street, Hartford, CN 06103; 877-275-5462; <www.lincolnlife.com>. Manufacturers Life Insurance Co. PO Box 40, Buffalo, NY 14240; 800-387-2747; <www.manulife.com>. Metropolitan Life Insurance Co. One Madison Avenue, New York, NY 10010; 800-638-5433; <www.metlife.com>. Minnesota Life Insurance Co. 400 Robert Street North, Street Paul, MN 55101; 800-606-5433; <www.minnesotamutual.com>. MONY Life Insurance Co. of America. 1740 Broadway, New York, NY 10019; 800-487-6669; <www.mony.com>. Mutual of Omaha Insurance Co. Mutual of Omaha Plaza, Omaha, NE 68175; 402-342-7600; <www.mutualofomaha.com>.
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Nationwide Life Insurance Co. One Nationwide Plaza, Columbus, OH 43218; 800-882-2822; <www.nationwide.com>. New England Financial. 501 Boylston Street, Boston, MA 02116; 800-388-4000; <www.tne.com>. NY Life Insurance Co. 51 Madison Avenue, New York, NY 10010; 800-710-7945; <www.newyorklife.com>. Pacific Life Insurance Co. 700 Newport Center Drive, Newport Beach, CA, 92660; 800-800-7646; <www.pacificlife.com>. Penn Mutual Life Insurance Co. 600 Drescher Road, Philadelphia, PA 19172; 800-523-0650; <www.pennmutual.com>. Phoenix Home Life Mutual. PO Box 22012, Albany, NY 12201; 800628-1936; <www.phoenixhomelife.com>. Nationwide Provident. 1000 Chesterbrook Boulevard, Berwyn, PA 19312; 610-889-1717; <www.nationwideprovident.com>. Prudential Insurance Co. of America. PO Box 59172, Minneapolis, MN 55459; 800-843-7625 ext. 5555; <www.prudential.com>. State Farm Life Insurance Co. One State Farm Plaza, Bloomington, IL, 61710; 877-734-2265; <www.statefarm.com>. Transamerica Life Insurance & Annuity. 1150 South Olive Street, Los Angeles, CA 90015; 800-852-4678; <www.transamerica.com>. Travelers Insurance Co. One Tower Square, Hartford, CN 06183; 860-277-0111; <www.travelers.com>. Zurich Life Insurance Co. 1600 McConnor Parkway, Schaumburg, IL 60196; 800-321-9313; <www.zurichkemper.com>.
Index
A Accreditation Council for Accountancy and Taxation, 200 Accredited tax advisor, 200 Advisor(s), 146, 193–202 see also specific advisor credentials of, 196–98, 200–202 misconceptions concerning brokers, 194–95 options, 197 people skills of, 199–200 Aging parents, 208 AICPA, 200 AIM Constellation Fund, 49–50 Alcoa, 167, 168 Alternative minimum tax, 60 Alzheimer’s disease, 133 American College, 201, 202 American Express, 167, 168 American Funds, 6, 23, 50, 68, 129, 149, 150 American Institute for CPCU/ Insurance Institute of America, 201 American Institute of Certified Public Accountants, 198, 200, 202 AMT, 60 Annual reports, 21 Annuities, 126, 155–57, 160 AOL Time Warner, 165 Asset(s) asset organizer form, 93, 94–110 distribution, in estate planning, 179 increasing assets, 13–14 wasting assets, 11–12, 13–14
Asset allocation funds, 169 Association for Investment Management and Research, 201 AT&T, 165, 167, 168 ATA, 20 Attitude, 2, 7, 12, 75, 203
B Bankrate.com, 206 Bargains, 48 Barry Financial, 9, 86–87, 123 Asset Organizer form, 93, 94–110 fact-finding questionnaire, 18, 23, 25–45 international investments, 150 Barry, James Michael, 8–9, 161 Barry, Rosemarie, 113–14, 148 Bed Bath & Beyond, 165 Beneficiary, of trust, 184 Best of America annuities, 156 Beta, 172 Bigwriteoff.com, 61 Boeing, 167, 168 Bond(s), 82–84, 159–60 bond funds, 169 inf lation and, 116 risk and, 116
C Capital gains, 57, 126 Capital losses, 57 Capitation, 139 CardWeb.com, 206 Carnegie, Andrew, 112 243
244
Index
Cash f low, 81–93 determining, 20 down markets and, 84, 86–89 family relationships and, 89–93 investing for, 88–89, 90 liquidity and, 84–86 total return strategies, 81–84 Cash reserves, 85–86 Caterpillar, 167, 168 CCIM (certified commercial investment member), 201 CDs (certificates of deposit), 11–12, 82–84, 88, 160 Certified Financial Planner Board of Standards, 201 Certified public accountant (CPA), 198, 201 CFA (Chartered Financial Analyst), 201 CFP (Certified Financial Planner), 197, 201 Change, as opportunity, 48–64 Charitable giving, 61–62, 180 Charitable remainder trust, 187 Chartered financial analyst (CFA), 201 Chartered Financial Consultant (ChFC), 201 Chartered life underwriter (CLU), 201 Chartered property and casualty underwriter, 201 ChFC (Chartered Financial Consultant), 201 Children financial education of, 207–8 guardianship of minor, 181 trusts and, 182 Circuit City Stores, 165 Cisco Systems, 165 Citigroup, 167, 168 Closed-end funds, 155 CLU (chartered life underwriter), 201 Coca-Cola, 167, 168 Cokely, Ethel, 113 College funding, 69–72 comparing education savings options, 73–74
projected costs, 69, 70 tax considerations, 56–57, 70–72 Commercial Investment Real Estate Institute, 201 Commitment, to financial planning, 3–14 Consumer debt, minimizing, 206 Costco Wholesale, 165 Coverdell Education Savings Account, 56, 73–74 CPA (certified public accountant), 201 CPCU (chartered property and casualty underwriter), 201 Credit card(s) interest, 13, 206 long-term planning and, 121–22, 206–7 Credit-shelter trust, 185 Crummey Letter, 132 Crummey Trust, 186–87
D Debt and taxes, 60 Debt investments, defined, 152 Defined-contribution plans, 127–28 Dental expenses, 62–63 Disability insurance, 137, 207 Discretionary money, 121 Disney, 167, 168 Diversification, 23, 51, 144–45, 171 Dividends, 57 Dollar cost averaging, 68, 125, 129, 150 Dow Jones Industrial Average, 118, 167–68 Down markets, 118 DuPont, 167, 168 Durable power of attorney, 179, 181, 205
E Eastman Kodak, 167, 168 Economic Growth and Tax Relief Reconciliation Act, 53 ED, 202 EDGAR, 77
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Index
Education funding. See College funding Emotions, investing and, 145, 209 Enron, 127, 144 Equity investments see also Stock(s) and bond/CD performance compared, 83 defined, 152 Estate planning, 54–56, 175–92, 207 advisors, 198 essential documents, 180–82 home ownership and, 182–83 life insurance and, 132 probate, 182 procrastination and, 178 retirement withdrawals and, 130–31 taxes and, 176–78 trust options, 183–89 Expense ratios (mutual funds), 21 Exxon Mobil, 167, 168
F Fact-finding questionnaire, 18, 23–24, 25–45 Failure, 76, 77 Family business succession, 180 Family limited partnership, 188–89 Family relationships, 89–93 essential contingency plan, 90–92 money discussions, 92–93 Family trust, 185 Federal Express, 76 Fidelity Investments, 151–52 Fidelity Magellan, 144–45 Financial plan, 66–67 Financial planner(s), 17–18, 146. See also Advisor(s) Financial planning control and, 19–20 education and, 77 success tips, 72, 75–77, 205–7 timeline, 208–9, 210 529 plans, 70–72, 73–74 Fixed annuities, 155–57 Flexible spending account, 140
Ford Motor, 165 401(k) plans, 58, 126, 127 403(b) plans, 58, 126 457 deferred compensation plans, 58 Franklin Resources, 123 Franklin Templeton Growth Fund, 3–4 Franklin Templeton Investments, 123 Funded living trust, 184–85 Funeral planning, 205
G Gates, Bill, 112 GE Financial Assurance Company, 135 General Electric, 144, 165, 167, 168 General Electric Financial Assurance, 126 General Motors, 165, 167, 168 Generation–skipping transfer tax, 55 Gifting, 54, 55, 132, 186 Global Crossing, 127 Global investing, 149–50 Goals, 19–20, 67–72, 77, 205–6 college education, 69–72 long-term, 122–23 retirement, 67–69 written, 75–76 Grantor retained annuity trust (GRAT), 189 Grantor, of trust, 184 Guardianship, of minor children, 176, 181
H Hartford Financial Services Group, 165 Hartford, The, 126 Hawking, Stephen William, 213 Health care surrogate, 181–82, 205 Health insurance, 137–40, 209 Health maintenance organization. See HMOs Hedge funds, 154 Herd mentality, 7–8, 76, 145, 162–63, 211 Hewlett-Packard, 167, 168 HMOs, 138–39
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Index
Home Depot, 165, 167, 168 Home equity, 148 line of credit, 206 loans, 61 Home ownership, 117 estate planning and, 182–83 Honeywell International, 167, 168
I IBM, 165, 167, 168 ICA Fund, 23 Income taxes, 54, 177 capital gains/losses and, 57 on savings, 12–13 Index mutual funds, 147, 169 Individual retirement accounts. See IRAs Inf lation, 6, 10–11, 13, 89, 160 annuities and, 156 bonds and, 116 fixed-income investments and, 159 long-term care insurance and, 136 Information source, considering, 21 Insurance disability, 137 health, 137–40, 209 life, 90–92, 131–32 long-term care, 134–36 Intel, 167, 168 Inter vivos trusts, 184 Interest credit cards and, 13 tax deductible, 60–61 International investing, 150 International Paper, 167, 168 Intestacy laws, 181 Investing strategies/options, 143–60 see also Long-term investing advisors and, 146, 151–52 discipline over emotion, 145, 209 dollar cost averaging, 150 global opportunities, 149–50 holistic approach to, 143–45 investment vehicles, 152–60. See also specific type of investment
large caps/small caps, 147 mortgage equity use, 148 noise tune out, 146, 211 portfolio options, 88–89 real estate considerations, 148–49 tax efficiency and, 147 Investment Company Institute, 154 Investment Company of America, 50–51, 124, 144–45, 151, 168, 169 Investment pyramid, 114–17 IRAs, 126, 127–28 education. See Coverdell education savings accounts growth of money invested in, 3–4 maximum allowable, 61 SEP, 127 Stretch IRA, 131 taxes and, 57–58 Irrevocable life insurance trust, 132, 185, 186–87 Irrevocable trust, 189
J J.D. (Juris doctorate), 202 J.M. (Juris master), 202 J.P. Morgan Chase, 167, 168 Jobs, Steve, 112 Jobs and Growth Tax Relief Reconciliation Act of 2003, 53 Johnson & Johnson, 167, 168 Johnson, Edward C. III, 152
K–L Keogh, 127 Leveraging, 154 Life insurance, 90–92, 160 term vs. permanent, 157–58 types of, 131–32 viatical settlements and, 159 Limited liability companies, 154 Limited partnerships, 154 Lincoln National, 156–57 Liquidity, 84–86 Living trusts, 184, 205 Living will, 181–82
247
Index
Loans home equity, 61 student, 56 Long-term care, 134–36, 141, 179–80, 207, 209 Long-term planning, 121–41 see also Estate planning credit cards and, 121–22 disability insurance, 137 health insurance, 137–40 historical market performance and, 129 long-term care, 133–36, 141, 179–80, 207, 209 retirement and, 127–32 taxes and, 126
M McDonald’s, 165, 167, 168 McGuiness, Jim, 113 Managed accounts, 154 Marital trust, 185 Market downturns, 49–51 Market timing, 51, 153, 164, 166 Massachusetts Investors Growth, 124 Massachusetts Investors Trust, 153 Matching-funds retirement benefits, 126 Media reports, 146, 160 Medical expenses, 62–63 Medical savings account, 140 Medicare, 134, 209 Merck, 167, 168 Microsoft, 165, 167, 168 Money, 9–13, 65–66. See also Cash f low; Cash reserves Money market accounts, 85 Money Purchase Pension Plan, 127 Morgan, J.P., 112 MSFS (Master of science in financial services), 202 Mutual fund(s), 153–54, 169–71 asset allocation funds, 169 bond funds, 169 fees, 153–54 global funds, 149 index funds, 147, 169
large, mid, and small cap funds, 171 objectives of, 21 prospectus, 170–71
N Nasdaq performance, 4–5 National Association of Enrolled Agents, 202 National Association of Health Underwriters, 202 National Association of Securities Dealers, 21, 77 National Association of State Boards of Accountancy, 201 National Family Caregivers Association, 133–34 Nationwide Life Insurance Co., 156 Nationwide Mutual Insurance, 126 New Perspective Fund, 149 Nixon, Richard M., 211 “No decision” dilemma, 15–16
O Oppenheimer funds, 149 Orange County, California, 116
P Palermo, Michael T., 184 Pay yourself first system, 125–29, 141 PE ratio, 172 Penn Mutual Family of Companies, 132, 187 Pension plans see also Retirement plans/ planning company offered, 127–28 taxation and, 57–59 PFS (Personal financial specialist), 202 Philip Morris Companies, 165, 167, 168 Planning for the unexpected, 49 long-term. See Long-term planning Point of service (POS) plan, 139
248
Index
Portfolio management, 151 Positive attitude/thinking, 75, 203 Pour over will, 186, 190 PPOs (Preferred provider organizations), 139 Pratt, David, 176, 198 Price-earnings ratio, 172 Principal, growth of, 143 Probate, 182, 184–85. See also Estate planning Procter & Gamble, 167, 168 Profit-sharing, 126, 127 Property taxes, 62 Prospectus (mutual fund), 21, 170–71 Putnam Funds, 111
Q QTIP trust, 185, 187–88 Qualified retirement programs, 126, 127–28 Qualified personal residence trust (QPRT), 189 Qualified terminable interest property (QTIP) trust, 185, 187–88 Qualified tuition programs, 56 Questionnaire, fact-finding, 18, 23–24, 25–45
R Registered health underwriter, 202 Registered investment advisor, 202 Retirement plans/planning, 86–87, 127–28 comparison of, 59 determining retirement needs, 128–29 funding and withdrawal, 60–61, 130–31, 180 goals, 67–69 life insurance and, 131–32 taxes and, 53 timeline, 208–9, 210 Revocable living trust, 181, 184, 186 RHU, 202 RIA, 202 Risk, 111–20 investment pyramid, 114–17 tolerance, 119
Rockefeller, John D., 112 Rollover pension plans, 58 Roth IRA, 58, 87, 127, 130 Rule of 72, 10–11, 68, 128
S S&P 500 Composite Index, 4–5 fund, 169 historical return, 68, 129 Salvation Army, 61 Saving Incentive Match Plan for Employee (SIMPLE), 127 Savings accounts, 11–12 SBC Communications, 167, 168 Sears Roebuck, 165 Section 529 plans, 56 Sector fund, 153 Securities and Exchange Commission, 21, 77, 156, 202 Self-employed persons health insurance and, 138, 140 retirement plans for, 127 SIMPLE, 127 Simplified Employee Pensions (SEPs), 58, 127 Smith, Frederick W., 76 Social Security, 67, 209 Standard indemnity plan, 139 Starbucks, 165 State taxes, 62 Stock(s), 152–53, 161–73 bear market opportunities, 164 beta and PE ratio, 172 Dow Jones Industrial Average, 167–68 herd mentality and, 162 market timing and, 164, 166 mutual funds, 169–72 performance f luctuations of, 165 skill in choosing, 166 Stock market crash of 1987, 49–50 Stock options, 111 Strengths, identifying, 18–19 Stretch IRA, 131 Student loan interest deduction, 56
249
Index
T Tax credits, 177 Tax Relief Act of 2001, 53, 55 Tax Relief Act of 2003, 53 Taxes see also specific type of tax alternative minimum, 60 annuities and, 126 benefits from changes in, 51, 53 capital gains, 126 college-funding and, 70–72 deductions for education expenses, 57 dividends and, 57 estate planning and, 179 estate taxes, 176 income taxes, 12–13, 177 long-term planning and, 126 property, 62 retirement plans and, 57–59 state, 62 tax rate reduction schedule, 54 tax relief, 53–60 tax-saving tips, 60–63 Technology investments, 51 Templeton, Sir John, 123, 125, 144, 161, 163, 213 Testamentary trusts, 184 3M, 167, 168 Time, investments and, 49–51, 52, 123–25 Total return, 81–84 Total return trust, 188 Transamerica, 126 Trust(s) estate planning and, 183–89 irrevocable life insurance, 132 minor children and, 182
Trustee, 184 T-square approach, 18–19 Turner, Ted, 112
U U.S. Centers for Medicare and Medicaid Services, 137–38 Unified credit, 54, 55 Uniform Gift to Minors Act, 71, 72, 73–74 Unit investment trusts, 155 United Technologies, 167, 168 Upromise.com, 71
V Value system, 6–7, 8 Vanguard Group, 21, 147 Variable annuities, 155–57 Variable universal life insurance, 157 Vesting, 127–28 Viatical settlements, 159 Volunteer work, 62
W Wal-Mart Stores, 165, 167, 168 Walgreens, 165 Walt Disney, 165 Wasting assets, 11–12, 13–14 Watermark, 156 Weaknesses, identifying, 17–19 Wealth-building basics, 204–5 Wealth-building principles, 113–14 Will(s), 176, 179, 180–81, 204 pour over will, 186, 190
About
the
Author
Jim Barry hosts the following weekly television shows; check your local listings for the channels in your area. • Jim Barry’s Financial Success, public broadcasting stations • Talk About Money, Fox On his Web site <www.talkmoney.com> you can find: • Special reports available free of charge on a variety of personal finance, investing, tax, and estate planning issues. • Information about the importance of financial planning. • The dates and locations of free seminars by James A. Barry Jr., CFP. • Free life insurance quotes. You can contact James A. Barry Jr. to address your organization at his corporate headquarters: Barry Financial Inc. The Barry Plaza 40 SE 5th Street, Suite 600 Boca Raton, FL 33432 Phone: 561-368-9120; 800- 366-9120 Web site: <www.talkmoney.com>. E-mail: Midge Novoth (
[email protected])
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