10 Axioms of Personal Finance

An axiom is defined as “A self-evident or universally recognized truth.” The following 10 axioms of personal finance provide a foundation by which individuals, no matter where they are within their own financial life cycle, can measure the soundness and direction of their personal financial planning and lifestyle. 

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1)   Knowledge is Power:  You do not have to understand every detail but it is important to have a familiarity with the key elements of your financial plan and investment strategy. Never forget that it is your money, resources and lifestyle. Because of that no financial advisor worth her or his salt should ever begrudge you the time in answering questions.

2)   Protect Yourself Against Major Catastrophes:  Everything in life involves risk and it is impossible to protect yourself from all dangers. However, there are things you can do to help protect your health, income, assets and family well-being.  Refrain from dangerous activities and spend precious premium dollars on the right type and amount of insurance.

3) Stuff Happens (or: the Importance of Liquidity):  Despite our best forecasting, the unexpected is always right around the corner.  According to whichever old wives tale you wish to subscribe, “Bad things happen in threes,” and “When it rains it pours,” so make sure you can access ready resources for an emergency whether it is in near cash reserves, or a line of credit. 

4)  Do Not Underestimate Future Requirements:  When it comes to saving for later versus spending today, it is always simple to rationalize that ‘I will not need as much to support my lifestyle when I retire.’ Increasingly retirees are finding that they have substantially understated the resources that they will require during their retirement years.  The reasons for this include higher healthcare costs, taxes, living expenses, travel, long-term care and additional support required by children.



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5) The Importance of Time: Time is the single most important factor in the success of any investment plan. Time is the greatest cure all for periods of high volatility and low investment performance.

6) The Risk / Return Paradigm:  Risk and return have an inverse relationship. If we expect a higher return, we need to be prepared to expect a higher risk posture. If we want a lower risk posture, we need to expect a lower investment return. Investors who have tried to flaunt this rule have paid a high price (for example, clients of Bernie Madoff). Remember, if it sounds too good to be true, it is!

7) All Risk is Not Equal:  All investments carry risk but not all risk is the same. Market or systematic risk cannot be totally avoided by all investors. Unsystematic risk, which is exclusive to a specific holding, can be avoided by limiting your holding in a single investment and diversifying your assets. 

8)   Diversification Reduces Risk:  By investing in a broad spectrum of loosely- or non-correlated asset classes, (cash, bonds, equities, real assets, commodities) investors can often reduce their overall risk posture. 

9)  Taxes Affect Decisions:  Unlike most institutional investors where pre-tax rates of return are the priority, the after-tax return is critical to the success of an individual investor’s financial plan. Investing strategies that utilize high-turnover trading strategies often generate higher rates of return initially, but when taxes are due the after-tax return is much lower.  Asset location in either taxable or tax-deferred accounts can make a huge after-tax difference over time.

10) Have a Plan, but Be Flexible:  More often than not, the greatest impediment to a successful financial plan is…us! We get busy, we get emotional, we get scared of not being in the pack, we panic, our emotions change our worldview. All of these things can cause us to go off plan and make hasty and ill judged decisions.  Sometimes it will be necessary to stray from the plan, but it should be in a thoughtful way as opposed to a knee-jerk way.  Financial Plans are not static documents but they are a useful tool in reminding us what our goals and priorities are. 

Written By: Tom Gates, CFP®

Social Security Updates: 2012

In April the trustees of the Social Security and Medicare trust funds issued key updates about the solvency of the programs.  Some of the more crucial points follow:


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·        The Social Security Disability Insurance trust fund will exhaust its reserves in 2016, two years earlier than projected one year ago.

·        The Social Security trust fund that goes mainly to retirees will be exhausted in 2036, two years earlier than projected last year.

·        If the funds are combined, they would be exhausted in 2033, three years earlier than projected last year.

·        In 2011, 44.8 million received benefits from Social Security’s trust fund for retirees, compared with 43.8 million in 2010.

·        In 2011, 48.7 million people were covered by Medicare, up from 47.5 million in 2010. That means the program is covering on net an additional 100,000 Americans every month.

·        The trustees said the worsening picture for the Social Security trust funds was due to “updated economic data and assumptions.”

·        The ratio of workers paying taxes per Social Security beneficiary continued to fall. It will hit 2.8 workers per beneficiary in 2012, down from 3.4 in 2000.

This problem has been years in the making.  In 1965 the ratio of workers to Social Security beneficiaries was about 4 to 1. By 2035 it is projected to be a ratio of 2 workers for every beneficiary. 

“Until now a politically gridlocked Washington seems to have been unable to see that Social Security, like the ‘unsinkable’ Titanic of 100 years ago, is heading for an iceberg.” [1] 

Our legislators in Washington DC seem to be paralyzed when it comes to this issue.  And there’s a conflict of interest there, because their jobs are up for re-election every 2, 4 or 6 years.  Legislators risk votes and re-election if they recommend cutting Social Security. 

So what does this mean for you?  For now, it depends on your age.  The consensus seems to be that it would be unfair to make significant cuts to current retirees because they have planned around the current rules and don’t have time to rebuild their nest eggs.  However, if nothing is done and the trust fund is exhausted in 2033, all benefits would then be cut by approximately 25%...for anyone collecting at that time.  

At JoycePayne Partners, as part of our Financial Planning for clients, we show estimated Social Security benefits as a component of our clients’ retirement income projections.  Depending on a client’s age we often recommend projecting a reduced amount of Social Security.  We do this in order to provide a conservative and more realistic retirement income plan.  Based on the latest news we should continue to reduce estimated Social Security Income in our projections by 25% beginning in 2033.

Medicare is also in trouble.  The Medicare fund that pays for hospital benefits is on target to be exhausted by 2024.  Obviously something has to be done.  Proposals include changing the program to give more support to low-income seniors and less to wealthier Americans and raising the eligibility age from 65 by one month per year beginning in 2022.



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Retirees must also be prepared to spend more of their income on health expenses.  Recent data from Fidelity Investments reports that you and your spouse may spend $240,000 during retirement on health expenses.  That does not include assisted-living or nursing-home costs.  The estimate assumes that a couple retires when both spouses are 65 years old and that they qualify for Medicare but have no retiree-health coverage through an employer.  It uses a life expectancy of 17 additional years for men (age 82) and 20 years for women (age 85). 

A 65-year-old couple retiring this year with $75,000 of household income, including $29,970 in Social Security, should expect that 35% of that Social Security amount, about $10,000 (per year), could be needed to pay health-care costs.  By 2027, their portion of Social Security covering health costs may reach 61% of a $41,000 Social Security benefit, or about $25,000 per year. 

What all this means is that Americans may be working longer and will need to be saving more to be able to fund a secure retirement.  How you can act now: if you are currently contributing to a 401(k) or another employer-sponsored retirement plan, consider increasing your contribution.  You can also set up regular monthly contributions to an IRA, or make a one-time transfer (at any time).  Contact your Financial Adviser if you have any questions.

Written By: Marilee A. Falco, CFP®, ChFC®

[1] http://humanresourceslegislation.wordpress.com/2012/05/09/social-security-broke-in-2033/

Information for this article was collected from the following sources:

Stress Rises on Social Security

The Retiree Health Cost Price Spiral

Fidelity® Estimates Couples Retiring In 2012....

Freeing Baby Boomers From Social Security Cuts Blows Up Math

Trustees Warn About Social Security Fiscal Picture

Why Fee-Only?

 

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 When selecting a Financial Advisor, there are many factors you should take into account.  These factors include the advisor’s educational background, professional designations, experience and references.  One of the most important considerations when choosing an advisor is how the advisor is compensated for his or her services.


Advisors and their firms can be compensated in myriad ways.  The following is a brief description of some of the most common advisory compensation schemes:

• Fee-Only:  Clients are charged an hourly rate, flat fee, or asset management fee for comprehensive financial services.  Fee-Only Advisors never collect commissions or referral fees paid by other product or service providers.
• Commission Only:  The advisor charges a commission on transactions and/or securities, insurance, and other products that a client purchases through the Advisor’s firm.
• Fee and Commissions:  Also known as “fee-based,” the advisor charges a fee (as defined above for Fee-Only) on some products and services, and also collects a commission on other transactions and products. 

Fee-Only Advisory relationships can provide significant benefits to the client compared to the other common compensation models.  One of the benefits of Fee-Only advice is that it often results in lower out-of-pocket expenses for the client.  Fee-Only Advisors use only no-load and low-load products as well as a host of discounted services.  In contrast, advisors who are not Fee-Only often utilize products that have significant upfront sales loads (sometimes to the tune of 5% or more) as well as annual and deferred sales charges.


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Another issue with commission-based advisors is that many of the charges a client pays are fairly well hidden.  It's not unusual for a client to be paying much more in sales and related charges than they realize they are paying because much of the overall cost is hidden in fine print.

Perhaps the most important benefit from working with a Fee-Only Advisor is objectivity.  When an advisor charges a commission for products or services, a conflict of interest is introduced into the relationship.  That conflict may impact the quality of advice that the client receives.  In contrast, the Fee-Only Advisor is able to choose from a host of products and services and choose the ones that are best for the client, without regard to personal gain that may come from making a certain recommendation.  The Fee-Only Advisor is not beholden to insurance companies, particular investments or other financial companies.

The following are some examples of conflicts of interest introduced by the commission model of advisor compensation:

*  A commissioned advisor might be incentivized to advise a client to make investments so that the advisor may collect a commission, when in actuality holding cash may be a more suitable recommendation at the time. 
*  A commissioned advisor may be tempted to unnecessarily buy and sell securities (known as “churning”) to generate commissions.
*  A commissioned advisor might be motivated to recommend that a client convert non-cash assets such as real estate and collectibles to cash that can be reinvested so that the advisor can collect commissions.
*  A commissioned advisor may be tempted to make recommendations that pay higher commissions when a less expensive and/or more suitable alternative is available.

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In conclusion, clients should strongly consider a firm's method of collecting compensation for its products and services when choosing a Financial Advisor.  Fee-Only compensation schemes often result in lower out-of-pocket costs for clients, as well as more objective advice.  Here at JoycePayne Partners we are proud of our Fee-Only structure, and we are happy to be able to focus fully on what is best for each and every client. 

Written By: Lisa M. DeStein, MBA, CFP®

Purchasing Power and Your Future

It may come as a surprise to many investors, but the largest risk to their lifestyle in the long-term is the hidden and destructive impact of inflation through the loss of purchasing power.  Investors tend to spend a lot of time focusing on the swings in investment market values caused by volatility, and because of this they may seek a ‘safe’ investment such as Bonds and CDs.  The truth of the matter is that a portfolio made up of Bonds and CDs alone will not earn enough interest to keep up (let alone beat) inflation.

A dollar today will not equal a dollar in ten years, and your money needs to be put to work in order to keep up.

Source: The Art of Asset Allocation, Second Addition, David Darst. McGraw Hill. Published by Morgan Stanley, 2008

If you are retiring at age 65 today and inflation is running at 2% per year, after 20 years your ‘today’ dollar buys just 67 cents of value. At a 3% inflation rate  per year (closer to the historical average), purchasing power drops to just 54 cents of today’s dollar. Another way to look at this is that it will take 1.85 times of today’s investment market value, on a pre-tax basis, merely to maintain purchasing power in 20 years.

Purchasing Power in Action

Information for this chart gathered from: http://www.thepeoplehistory.com/

Luckily, there are a number of easy ways to mitigate inflation risk.

Maintain flexibility in your cash outflows by limiting long-term obligations as well as floating rate debt. Make sure that your investment portfolios are diversified with asset classes such as equities and commodities (they tend to do well over the long run; keeping up with inflation through higher revenues, increased profits and larger dividends payments). Ensure that your fixed income portfolios, bonds, notes, and CDs alike, carry maturities along the interest yield curve.

The key to this issue is: Balance.  We deal with market volatility nearly every day.  Inflation is a more hidden and longer-term risk, but it cannot be ignored.

Written By: Tom Gates, CFP®

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Saving for College

When the topic of College Savings comes up, most parents have the same questions.  Should I start saving?  When should I start?  What type of account should I open?  What if my child decides not to go to college?

If you are in an income bracket in which you know you will have to pay at least part of your child’s college expenses out of pocket, not taking into account any possible scholarships, it is never too early to start saving.   An account can be opened for your child as soon as the child has a social security number.  You can invest as little as $25 per month in some accounts.  The sooner you start saving, the less money you will need to contribute either periodically or in a single payment in order to have enough money accumulated to cover your child’s college expenses.  The most common savings tool for college is the 529 Plan.

What is a 529 Plan?  A 529 Plan is an education savings plan operated by a state or financial institution.  It is intended to help parents set aside money for future college costs.  The plan is named after the Internal Revenue Code which created these types of accounts in 1996.  529 Plan contributions are eligible for deductions to Federal Income Tax.  State Income Tax deduction eligibility is dependent upon the state.  There are two types of 529 plans:  a Savings Plan and a Prepaid Plan.  The Independent 529 Plan (a Prepaid Plan) is the only institution-sponsored plan thus far.

The 529 Savings Plan works much like a retirement plan.  You have a list of options that may include age-based or investment strategy-based portfolios managed by the state or individual mutual funds.  These investments are market sensitive and will go up and down based on the performance of your particular investment choice.  The investments grow tax-free, and any distribution taken for qualified higher education expenses are tax-free.  Savings Plans may be used at any institution that is eligible for Federal Student Financial Aid, so you can pick from any state’s plan that does not have residential requirements if it is not your or the beneficiary’s resident state.

The 529 Prepaid Plan allows you to prepay all or part of future college tuition and fees and qualified college expenses. What the prepaid plan actually pays depends on the state’s plan. Most of these plans have residency requirements and not all states offer a prepaid plan.  The prepaid plan allows you to “lock in” at the current tuition plus an additional premium to help keep the plan fiscally sound.  All the state-provided plans cover only in-state public college tuition and fees.  The Independent 529 Plan is covered by a consortium of private colleges and currently includes 274 private colleges.

If your child decides not to attend college, decides to attend college out of state or receives a scholarship, you still have options for the plan.  Some of your plan options may include transferring the plan to another beneficiary, using the money toward skills training programs or overseas education programs that are eligible for Federal Student Financial Aid, or withdrawal from the plan altogether.  If your child decides not to attend college or a skills training program, the plan may be transferred to fund the education of another beneficiary who is related to the original beneficiary (i.e. brother or sister, cousin, mother or father, son or daughter).  Keep in mind that for most plans the child has up to ten years from the expected date of high school graduation to use the funds with the ability to extend for up to 30 years with written request to some plans.  If your child receives a scholarship, you may withdraw an amount equal to the amount of the scholarship from the plan to use for other than qualified college expenses without penalty.  If your child decides to attend college out of state and you have purchased a prepaid plan, you can still use the prepaid plan to pay for college expenses.  The amount you will receive for each unit or year of the in-state prepaid plan to pay for the out of state college will be the amount you put in plus a reasonable interest rate or plan performance or the average in-state tuition depending on the prepaid plan you purchased.  Some state prepaid plans will even pay the full tuition no matter what state you attend college.  If you are still not interested in keeping the plan, you may cash out of the plan.  You will be responsible for taxes on any interest on contributions made as well as a recapture of any tax deductions you’ve taken on the contributions.  So even if your child does not make traditional use of the 529 Plan account you have opened for his/her benefit, you still have many options for the plan.

Savings for a child’s college education is a very important decision to make.  The 529 Plan is only one of the options and is the one briefly described above.  To find out more about the 529 Plan and other options for saving for college, a good place to start is the savingforcollege.com website.  Celebrating 529 College Savings Day, May 29, 2012, the website is currently offering the free download of its Family Guide to College Savings, written by Joseph Hurley, their “529 Guru.”  You should also discuss with your financial advisor your savings options and how much you could/should save.

Written By: Van Nguyen


Child Reading photo credit: Stuart Miles   Line of Students photo credit: photostock

Investment Policy Statements

The Investment Policy Statement, or IPS, is possibly the most important tool in the Investor/Advisor relationship.  The IPS is a highly customized personal strategic document for the planning and implementation of an investment program.  It serves as a communication and governance medium between investor and advisor for making financial decisions as the investment environment and personal circumstances change.  Most importantly the IPS serves as a buffer; its consistent longer-term outlook balances the overload of information we take in about short-term economic volatility.  In other words, the IPS assists us in mitigating panic and prevents us from making knee-jerk decisions.

By definition, an investor’s IPS must be quite specific to that investor’s particular needs and wants.  In order to prepare an accurate IPS, the advisor gathers information from questionnaires, account and income statements, and interviews with the investor.  For example, each new investor is given an ‘Investment Preferences Questionnaire’ that asks questions about the investor’s investment style and risk tolerance, as well as financial goals and current and future needs.  Some of the questions we ask are real-life kind of ‘What would you do…?’ scenarios about investing.  These are particularly important because people (whether they are new to investing or not) often perceive their risk tolerance as higher or lower than it actually is, and the questionnaire brings this discrepancy to light and allows the investor and advisor to agree on an appropriate long-term strategy.

The IPS typically includes a rundown of an investor’s investment objectives, strategic philosophy and both the advisor and the investor’s responsibilities.  It also summarizes how the portfolio will be diversified (in a big-picture way), and what the goals are for each asset category.  The IPS is signed by both the advisor and the investor and is typically reviewed at least annually.

Written By: Tom Gates, CFP®

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