Financial Resolutions for the New Year (2008-12-29)

Financial Resolutions for the New Year (2008-12-29)

by David John Marotta

Every year many of us make New Year's resolutions and then can't follow through because we claim we're too busy. The most common priority--if another hour can be found in the day--is to spend more time with family and friends. The second one on the list is to find time for physical fitness. But given two extra hours, far too many of us just work that much longer on our backlog of pressing responsibilities.

This year, however, is different. Financial planning concerns very likely threaten to consume your life and ruin all your other New Year's resolutions. The tsunami of 2008 left your finances beached in a tree, and a plan to get back on track in order to meet your goals is imperative. You can't afford to spend time with family and friends and make it to the gym unless you have someone on your team watching out for your finances. Few of us are disciplined enough to accomplish what we need to do without help.

If you are young, you may not have had that much saved relative to your annual spending anyway. But if you are older than 40, what you save each year is small compared with what you already have invested. So growing that money is critical. And for both young and old alike, for every seven years you delay saving and investing, you cut in half the lifestyle you might enjoy in retirement.

Here are some suggestions. First, ask the right questions and stay the course until you've found the answers. Goals that are shared are ten times more likely to be acted on. Don't wait until you have everything set up to seek out accountability.

Second, make those goals concrete and then document them. Set your savings goals as a specific annual percentage of your adjusted gross income (AGI). We recommend saving at least 10% of your AGI in tax-free retirement accounts and another 5% toward retirement in taxable investments. If you are behind on your savings (over age 40 with less than five times your AGI in investments), you may want to save more in order to catch up.

Third, craft the best strategy to implement your goals, including prioritizing the appropriate retirement vehicles. We recommend investing just enough to get the entire match that your company's 401(k) plan offers first and then funding your Roth IRA accounts next. After these two, make certain you have enough nonretirement savings. By prioritizing your investment vehicles, you are deliberately putting your money into accounts that combine the greatest number of asset allocation choices with the lowest possible fees. Many company 401(k) accounts have such high fees and poor choices that they frustrate investors.

Fourth, automate your plan. Automating putting money in an employer-defined contribution plan is easy. Automating a taxable savings plan is just as painless. Most brokers offer an automatic money link between your investment account and your checking account. They also offer a monthly automatic transfer between the two accounts.

Finally, monitor your plan and rebalance your portfolio regularly. I recommend doing this halfway through the year after your June 30 statement.

Your plan must be comprehensive. Investment management may be at the core, but it is not the most critical element. Managing your investments must be done in the context of sound financial planning that you and an advisor monitor and review regularly. Financial planning includes retirement projections, figuring out how much to save and setting reasonable spending rates in retirement.

But an even more important element than financial planning is a comprehensive wealth management plan, which should include reasonable and appropriate insurance and liability coverage.

Perhaps the most critical component of wealth management in the new year will be tax management. With the potential for tax rates to fluctuate even more than the stock market, the value of tax management has never been greater. In addition to positioning your family's wealth to take advantage of all the possibilities, from Roth conversion to municipal bonds, you also will need help to contend with the plethora of changes in estate planning laws over the next few years.

Investment management, financial planning, wealth management and estate planning underline the need for integrated life planning. You can learn to enjoy life more, and find time for family and exercise, if you delegate the financial, tax and legal issues to trustworthy advisors.

A skilled financial advisor can help you realize the benefit of saving and investing with a minimal amount of work. But be aware that salespeople cannot be objective in helping you determine what to purchase when they have a vested interest in selling you a product. To find a fee-only financial advisor, call the National Association of Personal Financial Advisors (NAPFA) at 1-888-FEE-ONLY (1-888-333-6659) for a list of members in your area or visit their website at www.napfa.org.





from http://www.emarotta.com/article.php?ID=317

A Christmas Sermon (2008-12-22)

A Christmas Sermon (2008-12-22)

by David John Marotta

Christians celebrate the birth of Jesus on Christmas Day. But for too many of us, it's the season that unravels the careful financial planning of the previous 11 months. So this year, instead of trading your financial goals for a mountain of gifts and debt, take a moment to contemplate how a spiritual perspective can help you put your wealth in perspective.

In Christianity, my religious tradition, we are only stewards of our wealth. We are entrusted to use it wisely to meet the responsibilities we've been given. Thus our money belongs to God, and we must first ask ourselves, "What does God want us to do with his money?"

You may find a spiritual perspective on wealth either strange or presumptuous. But for all of us, money is an unconscious placeholder for what we value. The way each family uses money expresses their beliefs. Even when someone uses money hedonistically, it reveals their worldview. More commonly, our use of money negotiates a plethora of competing values such as education and recreation, security and travel, or children's needs and parents' needs.

Every spiritual tradition promotes certain actions and ideals as beautiful, virtuous and true and discourages others as ugly, sinful and false. Having a spiritual view of wealth management, whether based on the Judeo-Christian, Buddhist, Baha'i, or any other faith, helps us purposefully apply our values and use money to meet our goals.

The wisdom we gain from our spiritual traditions challenges us to consider our wealth from a new perspective. In the Christian tradition, the words directly attributed to Jesus, often marked in red in the Bible, have the highest authority. But whatever your religious faith, consider the words of Jesus as a prophet and spiritual leader. In the gospel of Matthew (23:23), Jesus says, "You give a tenth of your spices--mint, dill and cumin. But you have neglected the more important matters of the law--justice, mercy and faithfulness."

Giving a tenth of your income each year, or tithing, is a noble endeavor. Many people use this percentage as a benchmark of their generosity, but Jesus offers us a greater challenge and an important warning. He cites three values that are particularly germane when dealing with our perspectives toward wealth management: justice, mercy and faithfulness.

Justice, the first virtue, is acting fairly. The notion of justice seems to be instilled universally in the human mind and heart. We all recognize injustice, especially against ourselves! But the truth of justice is that all people, regardless of their wealth, have equal value in the eyes of God. Although most believe this to be true in the abstract, wealth can make people act otherwise.

We tend to treat those with power and wealth with more respect and deference than those without. And if we have acquired wealth, we may think ourselves better than others for having done so. But being more productive does not make us more valuable. True justice values every person. And its opposite is pride, believing ourselves better than others because we have wealth, status and power.

In the Christmas story, the wise men come bearing gifts for the baby Jesus. They bring him gold because he is a king. Some have cynically mocked the golden rule, misquoting, "He who has the gold makes the rules." The gift from the magi reminds us that Jesus has the gold, and with him as king, justice rules. Wealth need not make us prideful, and we can treat others with equity and humility.

Mercy, the second virtue that Jesus mentions, translates as kindness toward those in need. Mercy is also a universal virtue. Few would argue against being tenderhearted and compassionate. Although the goodness of mercy is universal, unfortunately the practice is not. Statistics show that the more money people possess, the smaller percentage they give to charity.

If mercy is the virtue, greed is the vice. Making progress toward our financial goals need not blind us to those struggling behind us. Part of our careful planning and budgeting should include cheerfully helping those charities and individuals in need. Jesus emphasizes that becoming generous and merciful is even more important than giving a fixed percentage of our income.

Frankincense, the second gift of the wise men, was used to offer prayers to God. It reminds us to have faith that a power greater than ourselves cares for us. Every person among us needs mercy.

The third virtue, faithfulness, involves a covenant relationship with God to trust ultimately in the spiritual, not the material. If we are not vigilant, the many things we buy with money can become the center of our lives. We can find ourselves literally worshipping material goods.

In his book "Mere Christianity," C.S. Lewis warns, "One of the dangers of having a lot of money is that you may be quite satisfied with the kinds of happiness money can give and so fail to realize your need for God. If everything seems to come simply by signing checks, you may forget that you are at every moment totally dependent on God."

The Old Testament law in Deuteronomy 8:11-18 makes this temptation even clearer: "Be careful that you do not forget the Lord your God. Otherwise, when you eat and are satisfied, when you build fine houses and settle down, and when your herds and flocks grow large and your silver and gold increase and all you have is multiplied, then your heart will become proud and you may say to yourself, 'My power and the strength of my hands have produced this wealth for me.' But remember the Lord your God, for it is he who gives you the ability to produce wealth, and so confirms his covenant."

The opposite of faithfulness is fear. We fear that God has forsaken us or is indifferent to our struggles. But fear can paralyze us. And if we do not take risks, we are unable to live and enjoy fully the life God has given us.

The final gift of the magi was myrrh, a bitter gum used in death and burial. In the Christian tradition, it reminds us that even at Jesus' birth, his death on our behalf is foreshadowed. As the apostle Paul writes in the letter to the Romans (8:32-34), "If God is for us, who is against us? He who did not spare His own Son, but delivered Him over for us all, how will He not also with Him freely give us all things? God is the one who justifies; Christ Jesus is He who died, yes, rather who was raised, who is at the right hand of God, He intercedes for us."

If God is for us, we can trust him, and take courage no matter how dark the future may appear. Look to integrate finances with your spiritual traditions to reflect the best of your values and live life holistically.

Seek to avoid pride, greed and fear is a common mantra in investment management. Jesus substitutes the positive virtues: justice, mercy and faithfulness. Don't think more highly of yourself if you have money. Be generous to those in need and trust that God cares for you. Remember these principles this Christmas season, and you will remember the one whose birth we celebrate.



from http://www.emarotta.com/article.php?ID=316

Financial Time Perspective (2008-12-15)

Financial Time Perspective

(2008-12-15) by David John Marotta

I was back at Stanford University recently and heard famed psychologist Philip Zimbardo lecture on his latest book, "The Time Paradox." His work suggests that understanding your own time perspective may help you unlock the secrets of financial freedom. In other words, how we think determines who we are and what we do.

Zimbardo's book focuses on how we perceive the effects of time on every aspect of our lives and our decision making. His Time Perspective Inventory scores individuals in six different time perspectives. Each perspective comes with strengths and weaknesses, and some are better at handling modern life and wealth management.

Within Zimbardo's categories are two past, two present, and two future perspectives. Both the past and future perspectives are abstractions. In a very real sense, we only experience the present. The past is an abstraction of gratitude and regrets. Similarly, the future is an abstraction of possible fears and longings.

Although present thinking may have been critical in simpler times of survival, it isn't necessarily the best perspective today when wealth itself is also the abstractions of shares in a company or zeros in a bank account.

People who live in the future are by far the most successful. Western civilization rose and prospered because of our future-oriented culture. Unlike present hedonists who live in their bodies, Zimbardo writes, "Futures live in their minds, envisioning other selves, scenarios, rewards, and successes."

He explains that you can test for future thinking as early as age four by giving children one marshmallow and telling them if they wait until you get back to eat the marshmallow, you will give them another one. Interestingly, children who have learned to delay gratification at age four score an average of 250 points higher on their Scholastic Aptitude Test (SAT) 14 years later. It isn't that time orientation is determined by age four. In fact, Zimbardo argues we are all born as present hedonists, seeking pleasure and sustenance while avoiding pain and bitter tastes. But by age four it is already apparent that some children live in an environment that encourages a future orientation.

Futures make money. They earn more. They get more education. They get better jobs. But most importantly, they save more and spend less. They discuss finances with their children and model future-oriented choices every day for the next generation.

Much of the advice in this column could be summarized as acting in a prudent future-oriented way in your investments.

Present hedonists use their money for fun and exciting experiences. They are the most likely to pile up credit card debt or experience home foreclosure. Their journey from rags to riches, if it happens, is often a round-trip ticket. They consider savings a token expense and a low priority. Impatience may cause them to chase returns.

To present fatalists, money just doesn't matter. They don't designate their money for present or for future enjoyment but simply spend it because it's there. Thus their spending and investments are random, and they are unlikely to reach their long-term goals.

Past-oriented people are rare in the United States. They generally do not take risks, and they invest conservatively. Past-positives focus on their achievement of earning and saving and do not want to risk losing money. Past-negatives remember only investment downturns and don't want to be burned again. Neither the past nor the present-time perspectives prove to be as successful as the future perspectives at managing their wealth.

We can view our present market turmoil through each of these time grids. Past-positives are thankful for longer term gains over the last few decades, whereas past-negatives only measure their losses from the recent high watermark. Present hedonists use market losses as an excuse to enjoy rather than invest; present fatalists don't believe what they do matters because global forces are completely out of their control. Only future goal-oriented investors recognize that the stock market has gone on sale, and today is an even better day to invest in a balanced portfolio.

Zimbardo also points out that "smarter people have higher annual incomes but are no wealthier than average people are." Given that every 10 IQ points correlates to $4,250 a year more in annual income, smart people should be richer. Alas, they are not. Smart people make more, but they also spend more, sometimes a lot more. Zimbardo concludes with this simple moral: "To become wealthy you cannot spend more money than you make, and you must invest wisely." Sage advice.

Some researchers suggest that the present orientation of the poor is pathological. But Zimbardo is more optimistic. He believes we can learn to be sufficiently motivated and to change our attitudes and the behaviors associated with them.

Zimbardo offers the following five simple steps toward achieving financial freedom and using time to work for you: (1) The present is the best time to start investing. (2) Time in the market is more important than timing the market. (3) Know when your time will be up; those with a long time ahead of them can afford more risky investments. (4) You can't time the markets. (5) A hedonistic time perspective is an expensive habit few can afford.

I asked Professor Zimbardo what he thought was the ideal time perspective for Americans today. He replied, "It is vital to develop an optimal blend of several time zones, so that you are able to flexibly shift mentally from one to the other depending on the situation. When there is work to get done, call up your future focus--but not excessively so (that can lead to sacrificing family, friends, fun and sleep). When you complete a task, take a time-out to reward yourself, indulge the present hedonist in you (get a massage, manicure, hot tub, see a movie, read a good book, meet a friend at a coffeehouse) but only moderately so. And always make time to engage with your positive past, your family, your own identity over time, with your legacy and cultural foundation. The past gives you roots; the present hedonism supplies the energy to take chances, to improvise, to take risks; the future gives you wings to soar to new destinations, to imagine new visions. You can have it all if you work at creating this balanced time perspective."

Perhaps a future study could find the correlation between your Zimbardo Time Perspective Inventory Score, your credit score and the size of your investment portfolio. To see how you score, visit www.thetimeparadox.com; take the test and score it.

from http://www.emarotta.com/article.php?ID=315

Owners of Second Homes: Beware of New Tax Laws (2008-12-08)

Owners of Second Homes: Beware of New Tax Laws

(2008-12-08) by David John Marotta

If you own two homes, sell the one you are living in and move into your second home as soon as possible. Tax changes taking effect on January 1 will make owning a second home much less attractive in 2009. As a result, the already depressed market for vacation homes will deflate even more.

Previously, any capital gains on your primary residence were excluded up to $250,000 for singles and $500,000 for couples. A primary residence was defined as any home you had lived in for two of the previous five years. The "prior rule" gave seniors moving to a new residence three years to make the move permanent. During that time they could still sell their original residence and take advantage of the exclusion.

It also allowed seniors who had a vacation home to move there and sell their primary residence. After two years their vacation home qualified as their primary residence. Young grandparents approaching retirement could buy a retirement home as a vacation destination while they were still working. After retirement they had time to sell their original home and in two years gain a full exclusion for their new residence.

With the new rule, primary residence is not something you can qualify for. Rather it is just a percentage of the time you live there.

The new law eliminates the capital gains exclusion, prorated on the amount of time a home was not your primary residence. After January 1, every day you aren't living in a home starts adding to the percentage of capital gains tax you will ultimately be obliged to pay.

Also, capital gains are no longer waived on a primary residence unless it has always been your primary residence. Starting in 2009, the percentage of time a home is not your primary residence will be the same number used to calculate the amount of capital gains that won't be waived. For example, if you own a house for ten years and have only lived in it for five, you will have to pay taxes on half of the capital gains when you sell it.

These are the same capital gains that President-elect Obama promised during his campaign to raise from 15% to 28% on the most productive citizens. Some states (e.g., California) tax capital gains at ordinary income tax rates, adding an additional 9.3%. So people who make significant contributions to society could easily be facing taxes of 37.3% on gains that are mostly inflation.

This isn't just a problem for the wealthy. You can be pushed into the top 1% of income tax payments simply by selling a house in California. Middle-class couples routinely get hit with unexpected taxes selling a home with capital gains well over the $500,000 exclusion. Because it is not a onetime exclusion, couples who have stayed in the same house for 40 years get socked with the tax, whereas couples who move every decade have multiple chances to realize smaller gains that are under the limits. People who move frequently shouldn't be rewarded with a tax break.

Here's another factor to consider: Home appreciation is mostly inflation. Taxing government-created inflation as so-called gains isn't fair. Even according to the official inflation numbers reported by the government, the equivalent of a million-dollar home today was a $179,154 home in 1970. Calling the $820,846 inflation a capital "gain" is ludicrous.

Class envy is equally mindless. Capital gains on real estate affect your finances even if you don't own a second home. The housing market isn't segmented into primary and secondary residences. What depresses the values on second houses depresses the value of all homes.

The second-house class is the very group that could have helped shore up today's slumping housing market. Speculators who would have bought real estate at the current depressed prices will find this option far less attractive in 2009. Instead the new law will encourage them to sell their current residence (taking the full deduction) and move into their second home. Then their second home will become their sole and primary residence, and they won't have to deal with future nonexempt capital gains taxes. Ask your financial advisor about the potential costs of continuing to own two homes. If you delay, you may be holding an unused vacation home until you die just to avoid this new tax burden. And as a result, your heirs will inherit the house with a step-up in cost basis.

Because of the law, thousands of additional homes will be added to the market, softening the demand for housing even further. It is as though a shortage of people are buying real estate and we've passed a one-per-customer tax incentive law. There is no reason to discourage what no one is willing to buy. The new legislation will probably push home values to new lows during 2009.

Why the law was changed is unclear. The old law was difficult to abuse. Those who were rapidly turning over real estate could not take advantage of the law. If someone tried to flip 25 homes, it would take 50 years. The new law doesn't make any sense, but if it did make sense, it probably would not be Congress.

The new law won't bring in much additional revenue either. But it will complicate record keeping and tax returns for anyone selling a home they have not lived in continuously. As a result of these disincentives, buying or selling vacation homes will become less desirable.

This legislation graphically illustrates the deadweight costs of taxation. Rarely is the concept so clear. The law will remove much of the value of vacation homes from the economy without collecting much additional tax revenue. All pain, no gain. It teaches us a sad lesson about the destructive power of taxation.

Vacation homes represent an expense that can easily be let go in challenging economic times. Many families own a vacation home during the season of children or young grandchildren. After that, the travails of maintenance and repairs outweigh their pleasure in the home. Management companies remove much of the headache but make the economics even more problematic.

In times of rising home values, the investment in a home at least kept up with inflation, but with the new laws the government will tax you on that inflation. As a result of these changes, consider simply renting a vacation home and letting someone else pay the capital gains tax.

from http://www.emarotta.com/article.php?ID=314

When Will the Markets Stop Dropping? (2008-12-01)

When Will the Markets Stop Dropping?

(2008-12-01) by David John Marotta

For the many investors glued to the news, the markets appear to be dropping uncontrollably and unstoppably. It doesn't appear rational, and they worry it could go to zero. From high to low, losses have halved account values. Waiting appears foolish, and selling seems cowardly. When will the markets stop dropping?

U.S. credit market debt is at an all-time high. It has grown from 250% of gross domestic product (GDP) a decade ago to more than 350% this year. Even 250% a decade ago set highs we hadn't seen since the Great Depression. The problem has not been the federal deficit, which has actually shrunk from 46% to only 37% of GDP. The primary problem has been borrowing, both by our financial institutions and by households. These two components (domestic financial debt and household debt) have both risen dramatically.

Domestic financial debt rose from 64% of GDP to 114% over the past decade. Financial institutions leveraged because it meant they were making more money. Borrowing money and putting that money to work translated to bigger profits in a rising economy.

Household debt was the second biggest increase. It rose from 66% of GDP to 100%. Savings rates dropped and spending rates soared.

If Adam put $100 in the bank, the bank only kept $10 and loaned the other $90 to Cain. Then Cain bought a plow from his brother Seth, who put $90 back in the bank. The bank kept $9 and promptly loaned the other $81 to Cain's son Enoch. Enoch paid his cousin Enosh, who put the money back in the bank. Feeling rich again, the bank loaned $73 to Irad, who paid Kenan for a pair of sandals. Kenan put the money back in the bank, which loaned $66 of it to Lamech.

The debt was fruitful and multiplied.

At this point the bank had $27 in cash reserves and $244 in outstanding loans. This situation was the United States a decade ago. Nobody wanted dollars while profit could still be made by keeping the money moving.

Lamech bought a couple of wedding rings from Jared, who put the money back in the bank. The bank loaned Jubal $59, who bought wood from Noah to make a lyre.

At this point the bank had $41 in reserves and $369 in outstanding loans. There appears to be $410 of wealth, and if there had been a stock market back then it would have been at an all-time high.

The number of dollars flying around is so high that people would rather have stuff than dollars. The line of Seth was preparing for a rainy day, but the line of Cain, so long as the velocity of money continues and no one tries to lower their debt or deleverage everything, will appear normal, perhaps even better than normal.

And then the rainy day came, and the bank asked everyone to pay them back.

A day of reckoning always comes when people use debt to leverage their investments. Only those who have assets will survive the deluge intact, and even the savers will not avoid getting wet. It is as if being debt free is your boarding pass for entering the ark. A little rain, and suddenly no one wants fancy jewelry and musical instruments. The only thing people want is cash to pay off their bank debt. Their very survival depends on it.

Highly leveraged financial institutions are going out of business, and the marginally leveraged ones are scrambling to pay down some of their debt in advance of the rising water. They are selling whatever they can to raise money. Individuals who enjoyed using their mortgages as ATM machines are now in danger of losing their homes. People used to be willing to pay $140 for a barrel of oil. Now they would prefer $60 cash instead.

To use a different analogy, it is as though your next-door neighbor got into credit card debt and is now trying to pay it off. On his front lawn he is having a yard sale. His couch is going for $10, his good china for $20 and his plasma TV for $25. And you think to yourself, "That's the exact same couch I just paid $200 for, and my neighbor is selling it for $10!" In fact, you are amazed that the entire contents of your house have dropped in value.

Diversification among household contents did not help because the financial institutions that are deleveraging also owned a nice diversified portfolio. Nothing is fundamentally wrong with couches, china and plasma TVs. The problem is that when a nation is deleveraging, everyone wants cash to pay off their debts. When you look down the block, it seems like every other house is having a yard sale.

Selling your assets in this market is a foolish move.

If you don't need to sell your couch, getting $10 for it is even more risky than holding on to it. If you sell your couch for $10 (fearing the going price for couches might drop to $9), at what price would you buy another couch again? If couch prices drop to $8, would you buy then? If couch prices rise to $12, would you buy then? Study after study suggests that by getting out, you risk having to buy the investment again later at a higher price.

The contrarian move is to look for an antique dining room table for $30. Buy it, store it in your basement for a few years and then sell it for a nice profit. Your neighbor desperately wants the $5. If you sell your couch for $5, you are investing in cash. You are betting that one of your neighbors is going to want $5 tomorrow even more than he wants $5 today. You are getting $5 today and offer that $5, hoping to get something even more valuable than a couch for it.

In other words, you are generating cash with the expectation that if the markets drop further you will put the money back into the markets and get some good china for it.

Many seasoned investors are fearful, which drives them to get the $5 one way or another and never buy household goods again. That is not a wise long-term plan. It is easy to get out of the markets, but it is difficult knowing when to get back in. Investor psychology tells us people won't get back in if the markets drop lower. They simply stay out until the markets show signs of recovering. And "recovering" means waiting to get back in until the markets have risen considerably higher than the point at which they got out.

Second-guessing the markets is especially difficult because they are a leading rather than a lagging indicator. They change direction long before the underlying fundamentals of the economy. Studies suggest that the markets start to go up 9 months to a year before the economy begins to recover. That means the markets may be bottoming out now in the expectation that the economy will recover in the third or fourth quarter of next year. As financier Warren Buffett recently wrote, "What is likely is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up."

With market volatility and deleveraging pushing the markets to irrational lows, the corresponding recovery could be an equally volatile snap-up in some sectors. Missing the upside could be costly.

As an investor, you should always have five to seven years of spending in relatively stable investments. The remainder of your portfolio should be able to weather the duration of even this tsunami. If you don't need to sell your couch to deleverage, sit on it. And if you are especially contrarian and courageous, buy your neighbor's antique dining room table.

from http://www.emarotta.com/article.php?ID=313