Raising Money Savvy Kids - Postpone Spending (2007-02-19)

Raising Money Savvy Kids - Postpone Spending

(2007-02-19) by David John Marotta

One of the critical concerns of generational wealth management is raising young people to be financially savvy. Many have written to say that they read and discuss this column at the dinner table with their children. If you want to raise kids who can create and manage wealth, there are a handful of critical rules that are foundational.

Here's the main one: Postpone spending.

In economics, "deferred consumption" is the very definition of wealth and capital. So defer your consumption. Everything you don't spend today is wealth. Only what you don't spend today is available for investing. And since money makes money, what you don't spend today can provide a lifetime of income to spend in the coming days.

Wealth is what you save, not what you spend.

Being a millionaire isn't that difficult. On average, U.S. stock investments earn 10% each year. If your investments earn 10% a year, and you contribute $100 per month, you will have a million dollars in a little over forty-five years. So, if you start saving when you are twenty, you can retire a millionaire at sixty-five.

A hundred dollars a month isn't that much. Lots of things cost about $100 a month. Live without that nice cell phone plan and retire with an extra million dollars. Go without high speed internet and you'll have another million to add to it. Reduce your eating out budget by $100 and you'll have a million more dollars. Avoid the average family's credit card interest and you'll have a million extra bucks by the time you retire.

Most of the younger generation is under the false impression that wealth is based on the luck of a big salary. Nothing could be further from the truth. According the book The Millionaire Next Door by Thomas J. Stanley, the affluent tend to answer 'yes' to these three questions: 1.) Were your parents very frugal? 2.) Are you frugal? 3.) Is your spouse more frugal than you are?

So how did they build their wealth? According to The Millonaire Next Door they did it slowly, living well below their means and investing about 20% of their household income each year. And because money makes money, over time, they grew gradually richer and richer.

Imagine you purchase a pair of shoes for $50 every year. The person that makes do with the old ones and only buys shoes every other year will be able to save and invest the difference. After seven years, their savings will be earning enough interest to pay for a new pair of shoes every other year. After eleven years, the interest from the investment will pay for the cost of buying new shoes every year, forever. Being frugal early in life produces great wealth later in life.

Because of the affluence of American culture, it is difficult to learn to distinguish between needs and wants. Very few purchases are needs. Other than food, shelter and clothing, everything else is optional. In the United States, we show our extravagance even in these three essentials.

Practically speaking, you can learn to postpone spending one purchase at a time. When our children were very young, we required them to wait one week before spending money on a toy. Often, after waiting a week, they wanted a different toy instead. Then, they had to wait another week for that purchase. Simply learning to delay and avoid impulse buying can cut your spending in half.

Reuse, recycle, or do without. Turn down all those extra features and services and start on your way to real wealth. Postpone spending, and save and invest instead.

If you'd like to further your family's financial education, consider attending the NAPFA Consumer Education Foundation's monthly meetings. This Saturday, February 24th Lynn Diveley is speaking on "Protecting your Loved Ones with Estate Planning." Next month, on March 24th, I will be speaking on "Raising Money-Savvy Kids" and reviewing additional wealth management principles. All presentations are held at the Charlottesville Northside Library Meeting Room from 12:00pm to 1:30pm. For more information visit http://www.napfa.org/consumer/NCEFCharlottesville.asp.

from http://www.emarotta.com/article.php?ID=218

Donor Advised Funds (2007-02-12)

Donor Advised Funds

(2007-02-12) by David John Marotta

Donor Advised Funds offer the charitably inclined new flexibility for managing gifts to charity. By funding an account, donors receive an immediate tax deduction for their contribution and gain the flexibility to direct payouts to charity on their own timetable.

However, donor advised accounts are not for everyone. Before funding an account of your own, consider the cost. Using a donor advised fund to manage your charitable donations may actually diminish the tax benefits of giving.

The growing popularity of donor advised accounts is due, in part, to the hassle-free gifting solutions they offer givers. The Chronicle of Philanthropy reported donor advised funds topped out at $15.5 billion in assets and over $3 billion in grants to charities in 2005, both figures up nearly 20% from the previous year.

One of the biggest benefits donor advised funds offer is the chance to step away from so called "checkbook philanthropy." Instead of the hassle of writing checks and keeping up with gift receipts, a donor advised fund manages the gifting process from beginning to end. From checking the authenticity of each charity to check-writing and accounting, donor advised funds simplify the gifting process. And, for donors who prefer to make anonymous donations, donor advised funds also offer much-valued privacy.

Here's how they work: Donor advised funds are themselves public charities, and are typically run by community foundations, independent organizations or corporate sponsors. Among the 88 or so donor advised funds, Fidelity, Vanguard and Schwab rank as the biggest corporate sponsors, having each established a charitable arm to manage the new accounts. With more than $3 billion in assets in 2005, the Fidelity Charitable Gift Fund ranks as America's sixth largest charity.

To open an account, donors are required to make an initial contribution, usually of $10,000 (but as little as $5,000 at Fidelity Charitable Gift Fund). Accounts can be funded with cash or securities. Some donor advised funds accept real estate, pass through securities and closely held stock.

Donors who itemize can take a deduction for contributions to a donor advised fund come tax time. Best of all, donors can then make "grant recommendations" (gifts) to their favorite charities on their own timetable. Some programs allow donors to delay grant making almost indefinitely.

In the mean time, donor advised accounts can be invested for growth, allowing the donor to make larger payouts to charities in the future. Donor advised fund sponsors like the American Endowment Foundation even allow donors the freedom to tailor their portfolio using stocks, bonds, and the universe of mutual fund options. Most, however, offer donors a menu of investment "pools," or fund options, based on the donor's risk tolerance.

Making gifts to a favorite charity can be as easy as calling the sponsoring organization or completing a grant recommendation form online. Minimum gift amounts typically range from $100 to $300 per gift. So, donor advised funds aren't a solution for those who like to give in smaller denominations.

But convenience comes with its own price tag. Account holders are hit with layers of fees including administration fees, investment management fees, and annual fees. This is, of course, on top of the fees associated with the underlying funds in their investment pools.

Corporate sponsored funds such as Fidelity, Vanguard, and Schwab have all slashed fees in the hope of capturing more of America's philanthropic dollars. Nevertheless, fees at Fidelity and Schwab hover around 2% annually for accounts less than $500,000.

Fees aside, donor advised funds have other drawbacks. Donors surrender ownership of their contribution and act only as an "advisor" to his or her separate account. Sponsoring organizations like Schwab's Charitable Fund are quick to add that grant recommendations by the account advisor are almost always accepted, providing that the receiving organization is a qualified charity. Legally, though, the assets become the property of the donor advised fund.

If donors have no immediate plans to make payouts to charity, a donor advised fund may not be the best option. For those who enjoy the tax benefits of gifting highly appreciated stock, donor advised funds may shortchange givers from a making the most of their charitable gift deductions.

Here's why: Let's say Jane Doe transferred stock worth $10,000 to a donor advised fund. After five years, the stock was valued at $13,000. By gifting through a donor advised fund, Jane Doe received a $10,000 charitable deduction up-front. However, had she kept the stock in a regular investment account and later transferred it directly to her favorite charity, she could have taken a bigger deduction of $13,000.

Although these accounts may not be ideal for managing charitable gifts, they may offer an attractive alternative to setting up a private family foundation.

Donor advised funds allow donors to deduct contributions up to 50% of their adjusted gross income, instead of the 30% allowed for donations to private family foundations. Furthermore, donor advised funds do not impose a 5% spending requirement on investment income like the one required of family foundations. Donor advised funds also allow for multiple "advisors" to the fund, meaning a group of family members can participate in the grant-making process. And, donor advised funds also free trustees from the burden of preparing tax documents on an annual basis.

Determining whether a donor advised fund is a good "fit" with your financial goals, ask your financial advisor. To find a fee-only financial advisor in your area, visit www.napfa.org.

from http://www.emarotta.com/article.php?ID=217

IPS: Build Your Financial Dream Home with a Good Blueprint (2007-02-05)

IPS: Build Your Financial Dream Home with a Good Blueprint

(2007-02-05) by David John Marotta

Would you be willing to give a contractor a blank check and no time limit to build your dream home? Beware of doing the same thing with your finances. Without a financial plan, your investments are controlling your dreams, not the other way around. You need a blueprint for your financial dreams to come true.

The blueprint in sound financial planning is called an Investment Policy Statement (IPS). A good one can put a stop to irrational investment decisions. Like a blueprint, an IPS not only provides a map of the project ahead, but it also provides a tool by which you can measure your success - or the success of your investment advisor. As your investment advisor implements your investment policy, you can determine if the construction accurately matches the blueprint.

Failure to Plan is Expensive

An IPS should tie all of your investment decisions to your goals and dreams. Although investment advisors are not required to create an Investment Policy Statement for their clients, drafting an IPS is certainly considered a best practice. Without one, you could easily find yourself with investments which do not help you reach your financial objectives.

The stories are many, like the one when one of our clients came to us because an advisor had invested his 85-year-old father's money in 25-year bonds and a basket of high-tech stocks. The investments turned his father's dream into a nightmare because of the advisor's lack of a good blueprint.

The Core Attributes of an IPS

Your IPS should be both fixed and flexible: tough enough to anchor investment decisions during market fluctuations, yet elastic enough to allow you to take advantage of the dynamic nature of the market. A good Investment Policy Statement should do four things: tell your story, list your financial objectives, define your investment strategy, and establish an implementation plan. And, it should be clear enough for a third party to implement.

The IPS tells your story

Your IPS should begin by telling your story. It should include information such as your age, marital status, children, grandchildren, job status, and interests. It should also include a snapshot of your financial picture. For example, it should state your cash inflows and outflows and outline your current assets and liabilities.

The IPS lists your financial objectives

Next, your IPS should identify both your big-picture wants and your detailed needs. Do you have aspirations of opening a small-business? Will you be paying for your children’s college educations? Do you plan on retiring? If so, at what age? And, what lifestyle do you hope to enjoy in retirement? Do you have any special philanthropic goals? The IPS should capture your dreams and express them in terms of realizable objectives.

The IPS defines your investment strategy

Now, with an understanding of your financial position and a clear picture of what you want to accomplish financially, you can begin to define your investment strategy.

Each investment carries with it a certain level of risk, or volatility. In the investing world, bigger risks are rewarded with higher potential returns. How much risk are you willing to accept in order to meet your objectives? What is your time-horizon? What are your liquidity needs? What should be your mix between stocks and bonds? How should this change over time?

After establishing the parameters of time horizon and risk assumption, you are now ready to set your asset allocation. When it comes to predicting your investment returns, nothing influences returns more than your portfolio's asset allocation mix. We invest our clients in six asset classes: US stocks, US bonds, foreign stocks, foreign bonds, hard assets, and cash.

The asset allocation portion of your IPS should outline investment vehicles and rebalancing procedures for your portfolio. For example, do you own investments which you do not wish to sell? Also, are there any investments vehicles or asset classes you do not wish to hold in your portfolio?

With your asset allocations now in place your IPS should define the rebalancing protocols to keep your portfolio in-line with your original allocations. For instance, will your account be rebalanced based on a particular timetable? And by what margin will the asset allocations be allowed to fluctuate before they are rebalanced?

The IPS determines how your account is monitored

Lastly, your IPS should outline the management procedure for your portfolio. Control procedures should list your investment advisor's responsibilities, the criteria by which your advisor selects and monitors your investment vehicles, and the process for measuring and reporting performance.

Many investors don't know the annual return on their investments, nor do they know how their returns compare to other benchmarks. A good IPS should include reporting requirements such as annual time-weighted returns on your investment. Without reporting protocols and benchmarking procedures, who can say if your advisor is making the grade or falling below average?

A well drafted, periodically updated Investment Policy Statement is critical to insure that your financial future will be safe and secure - that your financial dream home will actually be built.

from http://www.emarotta.com/article.php?ID=216