Seven Financial Resolutions for the New Year (2010-12-27)

Seven Financial Resolutions for the New Year

(2010-12-27) by David John Marotta

Financial resolutions usually don't even last until the end of January. Making a permanent change in our behavior requires both time and a steely resolve. We can only develop financial character one action at a time. Here are seven practices to take you from pauper to prince or princess if you add one each year.

Read through the list. If you already practice the resolution, move on to the next one. Adding one behavioral change is labor enough for the next 12 months. Keep it long enough for practice to become habit, and you are on your way to developing a millionaire mindset.

Share your resolution with everyone you meet. You are 10 times more likely to act on a goal that you have articulated to someone else. Don't wait until you have everything perfect to take ownership verbally.

First, and most critical, resolve to be and stay debt free. You may have a fixed-rate fixed-year traditional mortgage on your house but nothing else. No equity line of credit on your house. No car payments. Certainly no credit card debt. You have to learn to live within your income, which sometimes means going without. Millionaires are frugal. Learn to enjoy it.

Second, automate saving enough to get the entire match that your company's 401(k) plan offers. Usually this translates to saving 5% of your salary while the company contributes a 4% match, the fastest way to get an 80% return on your money. Most Americans forgo this match, believing they need to spend 100% of their salary. But you can learn to think like a millionaire and live well on 95% of what you make.

Next, fully fund your Roth IRA ($5,000 in 2011). If you can't manage the entire amount in January, put in $416 monthly.

Automating deposits in an employer-defined contribution plan is easy. Fortunately, automating saving in a Roth IRA or a taxable savings plan is equally painless. Most brokers offer an automatic money link between your checking account and an investment account. Set your savings on autopilot.

Fourth, save an additional 5% of your salary in a taxable account. Again, set up an automated transfer. You need taxable savings for a host of financial planning opportunities as well as for a plethora of life's challenges.

By now you are saving 15% to 20% of your salary and living off the remainder. Learning to live deferring many of your wants until later is a crucial habit that millionaires have cultivated. Money makes money. And the money you need to make money is called "capital," defined in textbooks as "deferred consumption." Money spent is gone forever. Money saved and invested works for you, adding income every year.

Fifth, save an additional 10% for charitable giving. Many millionaires might suggest being generous should be number one on your list. But until you have your own financial security on track, it is difficult to help others don their own oxygen masks.

No matter where you think charity belongs in your priorities, a sensitivity to the truly needy will change your perspective about distinguishing needs and wants. Many millionaires live simply in order that others may simply live.

Save this additional 10% in your taxable account. By now you are saving 15% in a taxable account. For your charitable giving, gift the investments from the account that has appreciated the most.

No matter which worthy organizations you support, you can donate up to 20% more if you give appreciated stock instead of cash. If you sell $1,000 worth of appreciated stock, you will have to pay the capital gains tax of 20%. If most of the stock's value is appreciation, the tax owed approaches $200, leaving only $800 for charitable giving. But if you give the stock directly to the charitable organization, you can take the full $1,000 tax deduction, and the organization will not have to pay any taxes when it sells the stock.

Up until now you may have been giving cash to charities. Now that you are developing some taxable savings, run your giving through your taxable investments. For every $1,000 of appreciated investments donated, use the $1,000 in cash you would have gifted to buy additional investments. Think of this as planting the saplings you will harvest later for future gifting.

After several years, your $1,000 worth of cash should have grown to $2,000 worth of investments. Gifting a $1,000 worth of appreciated investments leaves the original $1,000 to keep increasing in value and fund future giving. This is one reason why frugal supersavers can be much more generous than those whose rich lifestyles preclude saving and investing.

Sixth, save an additional 10% in your taxable account for unknown unknowns. If your response is to ask, "Like what?" remember that you can't plan for everything. But you can save cash for the unexpected.

Families inevitably encounter cash flow problems because of unanticipated expenses. If you are living paycheck to paycheck, your budget cannot handle large unplanned outlays such as the car breaking down, the roof leaking or emergency medical bills.

When a financial crisis strikes, you will be glad to have an emergency fund. Afterward, see if you could have predicted the expense, and adjust your plan accordingly. Budget each month for the inevitable expense of buying your next car. Budget for replacing your roof. The more you can foresee these expenses, the more this category can fund discretional big purchases instead of financial emergencies.

At this point you are saving more than 35% of your salary and living on less than 65%. This is the benchmark for a millionaire mindset. As you save and invest, the appreciation on your investments can provide income that replaces your salary, bringing you closer to financial freedom. When you can replace all of your income, you are free to retire or tackle challenges that do not make you any money.

Every 25% of your salary you save replaces over 1% of your regular income in retirement. Money makes money, which then gives you the gift of financial freedom.

The seventh and final challenge is to expand this financial engine beyond 35% toward 50%. Living off half your income requires a frugal lifestyle in comparison to your income. Impossible, you say? Unless you are among the truly needy, there are families out there living comfortably on less than half of what you earn.

And if you are among the genuinely wealthy, the only obstacle standing in your way is being accustomed to an affluent lifestyle. Learn to value financial freedom over opulence. Developing an engine of wealth production takes foresight and self-restraint in addition to time and patience. But the reward is financial peace and contentment.

from http://www.emarotta.com/article.php?ID=432

The Poorhouses of "A Christmas Carol"

(2010-12-20) by David John Marotta

There are few better stories for talking about economics than Charles Dickens's "A Christmas Carol." Perhaps the most telling discussion in the story comes early in the first chapter when "two portly gentlemen" call on Scrooge to ask him for a donation to charity.

Dickens describes them as portly to show their affluence and success, not their weight. They were probably large and heavy in a dignified and stately way. Given that few people in those days had enough to eat, today we would probably describe them as well fed or robust. Dickens describes them as pleasant to behold.

These two portly gentlemen have made a list of establishments to visit and solicit for donations. They approach their charity work like they do their businesses, with organized efficiency. They have papers and books. They come as a team. They present their credentials. They are polite. They remove their hats.

Subsequent reinterpretations of the story often try to make capitalism Scrooge's problem and government-run social programs the answer, but that was not the case in Dickens's day or in his story. The two portly gentlemen are capitalists and entrepreneurs. Their initiative extends to good works within their community.

They are passionate about their charitable work. They assume the best about Scrooge and his former partner. Their liberality is to make slight provisions for the poor and destitute who suffer during the Winter Season. They know their efforts will not end poverty for all time. They are simply trying to spread some "Christian cheer of mind and body."

The two gentlemen focus on providing some meat, drink and means of warmth. The poor have nothing but a meager allocation of bread and gruel. They would like a little more bread. Some meat would be a great kindness. Drink and warmth are a great extravagance.

Scrooge will have none of this personal philanthropy. He argues that public entitlements are the solution. "Are there no prisons?" he asks. "And the Union workhouses? Are they still in operation? The Treadmill and the Poor Law are in full vigour, then?" After hearing these are still active, he complains, "I help to support the establishments I have mentioned: they cost enough: and those who are badly off must go there."

Dickens was very critical of the New Poor Laws passed in England in 1834 by Lord Melbourne's government. They altered the locally administered structure run by local parishes into a centralized system of workhouses. These changes cost more money and provided less relief.

The New Poor Laws were influenced by the ideas of three writers of the day. The first was Thomas Robert Malthus, who advocated limiting population growth so it wouldn't increase faster than food production. Families were split up in the workhouses into three separate barracks to discourage conception.

The second writer was David Ricardo, who argued that wages naturally tend toward a subsistence level. This view, called the "Iron Law of Wages," influenced Karl Marx's dim view of the prospects of workers benefiting from capitalism.

And the third was the philosopher Jeremy Bentham, whose idea was utilitarianism, or the idea that the moral or ethical thing to do was whatever brought the greatest happiness to the greatest number of people. Similarly, laws ought to be structured to discourage what hurts society and encourage what helps society. That these principles be put into place with draconian authoritarianism is irrelevant to his view of ethics.

That each of these thinkers was wrong was unfortunate. That the government instituted their ideas was catastrophic. One of the two portly gentlemen reminds Scrooge, "Many can't go there; and many would rather die." Scrooge's reply is Malthusian and utilitarian: "If they would rather die, they had better do it, and decrease the surplus population."

Make no mistake. Scrooge is the advocate of the sufficiency of the state to involve itself in society's welfare. Ill-conceived government programs are able to inflict misery better than any private charity. They have the force of law. How effectively the government actually does the job, Scrooge argues, is none of his business. He pays his taxes, minds his business and no additional concern is required.

Charles Dickens opposed the New Poor Laws as cruel and unchristian. He wrote "Oliver Twist" in 1837 and "A Christmas Carol" five years later partly as a response to this legislation. And in 1850 he wrote the journalistic account "A Walk in the Workhouse," in which he decried the conditions he found.

Dickens's biographer Jane Smiley described his competing philosophy this way: "It is not enough to seize power or to change wherein society power lies. With power must come an inner sense of connection to others that, in Dickens's life and work comes from the model of Jesus Christ as benevolent Savior. The truth of 'A Christmas Carol' that Dickens understood perfectly and bodied forth successfully is that life is transformed by an inner shift that is then acted upon, not by a change in circumstances."

We see that transformation in Scrooge when the nameless and faceless poor over which he has little power and means to save are replaced by his own clerk's crippled son Tiny Tim. Whereas the nameless masses might be undeserving and able bodied, Tiny Tim is both a child and disabled.

"Oh no, kind Spirit! Say he will be spared," Scrooge laments, only to hear the Ghost respond, "If he be like to die, he had better do it and decrease the surplus population." Scrooge lowers his head in shame at hearing his own words and is overcome with penitence and grief.

Mercy embodies the idea that God puts the responsibility of alleviating some of the suffering in the world on you. God doesn't charge you with all of it. And God doesn't expect you to solve the problem completely. But He does expect you to be open to being the person He chooses to use to help. This openness does not solve the problem of trying to determine where God wants you to put your resources to work. Starting a viable business and hiring people can be an act of the highest charity. So can giving to charitable causes. The principle is summarized in apostle Paul's letter to the Philippians 2:3: "Do nothing from selfishness or empty conceit, but with humility of mind regard one another as more important than yourselves."

Dickens believed in the power of a changed heart. In "The Life of Our Lord" he wrote, "people who have been wicked . . . and who are truly sorry for it, however late in their lives, and pray God to forgive them will be forgiven and will go to Heaven too."

The moment of Scrooge's redemption occurs when struggling with the final Spirit, he holds "up his hands in one last prayer to have his fate reversed." At this prayer the Phantom shrinks and dwindles down into a bedpost.

We see Scrooge's changed heart on Christmas Day. He sends the prize turkey to the Cratchit family. He raises Bob Cratchit's salary. But perhaps most convincingly for men of business is his generous giving to the two portly gentlemen including a great many back payments.

A changed heart freed from past sins is a powerful force of authentic spirituality in life. If you believe all of your time, talent and wealth belong to God, you won't make any distinction between the charitable work you do for God and the rest of your life. And you won't have any fear about doing what a benevolent God sets in your path to do.

from http://www.emarotta.com/article.php?ID=430

The Two Portly Gentlemen Are Entrepreneurial Philanthropists

(2010-12-13) by David John Marotta

As I do every December, I have been enjoying rereading "A Christmas Carol" by Charles Dickens. This year I've been thinking about Scrooge's interaction with the two portly gentlemen who stop by to collect for the poor. These entrepreneurs represent one of my favorite financial personalities.

In his book "Why Smart People Do Stupid Things with Money," Bert Whitehead describes different financial personalities. He depicts an "entrepreneur" as someone who tends toward greed rather than fear but is balanced between a propensity to save or spend.

Whitehead maps financial personality on two different scales. The first measures people's tendency toward greed or fear. As entrepreneurs, the two portly gentlemen are motivated by greed (high risk acceptance). Ebenezer Scrooge shares this same inclination. The two men see opportunities and the risk excites them. Even soliciting funds for the poor is an integral part of their entrepreneurial spirit.

When the two portly gentlemen stop by Scrooge's office soliciting charitable donations, they discover his partner Marley has been dead for seven years. One comments, "We have no doubt that Marley's liberality is well represented by his surviving partner." The narrative continues, "It certainly was; for they had been two kindred spirits."

Liberality toward others cannot come from someone motivated by fear. Distrust drives out emotions like kindness and compassion. Later in the story, Scrooge confirms this condition in Marley as he looks through his ghostly form and remembers ironically that it was said of Marley he had no bowels. Marley had no empathy for others because he was overly anxious for himself.

When fearful misers like Marley move from savings to spending, they move first to a bon vivant and then to a shopaholic personality. Their fear motivates them to spend more but only on themselves.

Scrooge, in contrast, is more of a risk taker. Thus as he shifts toward spending some of the wealth he has accumulated, he moves squarely into the entrepreneurial financial personality shared by the two portly gentlemen.

Whitehead's second scale measures an individual's tendency to save or spend. Here the two portly gentlemen are balanced between thrift and spendthrift, whereas Scrooge is a practiced saver. A risk taker who is also profligate would be considered a gambler personality. These two gentlemen are balanced between these two extremes.

Many of our clients are small business owners. They are fascinating and passionate people to work with. They are willing to take the risks required to cultivate a business, and they devote their time and effort into doing what it takes to make it succeed. Their family and friendships grow out of running their business. They employ their children.

Interestingly, their sense of mission about their companies extends to combining corporate and charitable intent. According to a 2010 Ernst and Young study, Entrepreneurs and Philanthropy, nine of ten entrepreneurs extend their personal giving practices to the corporations they run. The motivations they cited as most important were to give back to their local communities and to incorporate their personal philosophy into their corporate culture. In addition to starting their own businesses, 43% have started their own charities.

Most entrepreneurs surveyed have a quiet or passive giving style. Although their involvement may be known, they prefer not to be overtly recognized. Most have made charitable giving an essential part of their personal financial planning. They are as intentional about the causes they champion as they are about their companies.

You might think entrepreneurs possess the perfect financial personality, but they do have their weaknesses. First, they have a tendency to overwork. Perhaps this is how the two portly gentlemen acquired their girth by sitting behind their desks too long. Nesters spend less money and more time at home; travelers spend more money enjoying diverse experiences. In this regard the philanthropy of entrepreneurs is a healthy diversification of their business interests to "making mankind their business."

The second weakness is a tendency to run out of liquid assets. Entrepreneurs often sink all of their treasure as well as their time in their work. They are also much more tolerant of risk and wild swings of fortune. When times in their businesses get tough, they need to have liquid assets to survive a negative cash flow. Having a diversified base of liquid investments and lines of credit established during the good years can mean the difference between survival and bankruptcy.

Most entrepreneurs have complex finances but don't have the time to handle all the moving parts. But with great complexity comes great opportunity. Fiduciary advisors are invaluable to an entrepreneurial family. They can free them from some of the details and allow them to focus on their core business. They can also be proactive in suggesting aspects of comprehensive wealth management where small changes can have an enormous impact.

Delegating and accepting advice is the other impediment to entrepreneurs working with a financial advisor. They are accustomed to being the smartest people in the room, and a traditional commission-based agent or broker has little of value to offer. They need an expert, a savvy and reliable advisor to whom they can delegate key aspects of their financial well-being. They need a fiduciary who sits on their side of the table and has a legal obligation to act in their best interests.

The National Association of Personal Financial Advisors is the best organization I know to find such an advisor in your area. Visit www.napfa.org to find a fiduciary advisor worth trusting.

from http://www.emarotta.com/article.php?ID=429

You Deserve a Fiduciary Standard of Care

(2010-12-06) by David John Marotta

Most investors are not aware of a critical division of professionals in the world of financial services. This distinction lies between fee-only fiduciaries who are free to act in your best interests and commission-based agents and brokers who are required to act in the best interest of the companies that employ them. Even when people have some inkling about the differences, several important misconceptions continue about both the nature of the problem and an adequate solution.

Fiduciaries are bound by a code of ethics. They take oaths and their conduct is based on applying ethical principles. The Certified Financial Planner (CFP) Board of Standards has a published code of ethics that includes seven principles including integrity and fairness. It states, "Integrity demands honesty and candor which must not be subordinated to personal gain and advantage." And "Fairness is treating others in the same fashion that you would want to be treated."

The National Association of Personal Financial Advisors (NAPFA) offers a similar guideline in their fiduciary oath. Advisors promise to "exercise his/her best efforts to act in good faith and in the best interests of the client." These ethical guidelines imply standards of conduct far above what may be legal. They demand what is right. They require the highest obligation of care, good faith, trust and candor.

In contrast, the nonfiduciary world is based on rules rather than on principles and ethics. If an agent has followed the correct procedures, has the paperwork in order and has client signatures on the correct disclaimer forms, no rules have been broken. The behavior can be called unethical, but it is not illegal. Thus additional rules do not necessarily translate into exemplary conduct.

This is one reason why investment advisors objected to a proposal to give the Financial Industry Regulatory Authority (FINRA) oversight of fiduciary advisors. FINRA governs nonfiduciaries such as agents and brokers by means of rule-based conduct. Such an approach is diametrically opposed to being a fiduciary.

NAPFA strongly advocates a fiduciary standard. As part of the oath that NAPFA advisors sign, they pledge they will "not receive a fee or other compensation from another party based on the referral of a client or the client's business."

NAPFA also promoted the idea of a "fee-only" advisor. Their ad campaigns were largely successful at raising public awareness about the difference between advisors who are fee only and those whose compensation is based on commissions. But as if purposefully to confuse consumers, many agents and brokers introduced and started using the category "fee based," which means charging a fee as well as continuing to collect commissions.

The distinction should be easy to understand. You would object strongly if you had to ask your doctor to act in your best interests. You would never think physicians would hesitate to sign the Hippocratic Oath. Neither would you consult a pharmaceutical salesperson instead of your doctor. But the rules-based world of most financial services is like relying on a printout of a drug's potential side effects instead of on a medical degree and the responsibility to treat patients ethically.

Fee-only fiduciaries act as agents for investors. They have permission to manage your investments and make decisions in your best interests. They are held to the highest standard of fiduciary care.

In contrast, an agent or broker is an employee. They work for the mutual fund company or the life insurance company or the brokerage firm and are empowered to act only on behalf of the company they represent. So they are not allowed to make decisions without your consent. They can suggest services and products for you to purchase, but they must have your explicit permission to complete the sale. They are held to a lower standard called "suitability." They are permitted to sell you any product that is generally suitable for your class of investors.

According to FINRA, suitability means the agent or broker only must have "reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer." The more superficial the agent or broker's knowledge of the client, the better this works. The only items mentioned in FINRA's rules are the customer's financial status, tax status and investment objectives.

I've never seen a case of unsuitability or know what an unsuitable investment would look like. Selling 30-year bonds to a 90-year-old might be unsuitable. But age is not part of the information an agent or broker is supposed to elicit from a client.

The claim in any dispute will be that the salesperson explained everything and the client chose to purchase the product. All the disclosures are stated in the sales document you sign, so you have no excuse. You should have read the document. It's your mistake.

Salespeople are trained to get acquainted with their clients to make sales. They ask questions that begin, "Would you be willing to buy if . . ." and "Which of these choices would you prefer . . ." They are supposed to stop asking questions after the customer has agreed. Their lack of familiarity with a client's needs often results in substandard care.

The differences between these two worlds are seen most clearly in the decision-making process. Fiduciaries can't simply put your money into good investments. First they must understand as much as they can about you and your goals. They are required to have an undivided loyalty to help you meet those goals. Taking the time to understand your goals is simply part of their ethos.

Next, they have to strategize how to best meet those goals. They must be analytical and purposeful. They need to clearly articulate an investment strategy, which should include writing a customized investment policy statement for each client before investing. It means practicing comprehensive wealth management. It means striving to be proactive in areas of wealth management for which there will never be products and commissions.

One of the many questions we pose to potential clients is if they have made any investment mistakes in the past. A sad but common response is that they believed a friend, family member or fellow parishioner had their best interests at heart. One way of explaining the difference between a fiduciary and an agent or broker is that you do not have a legal right to trust that an agent or broker is acting in your best interests. They have no such legal responsibility. It really is your mistake.

Here are three questions you should ask any prospective financial advisor: Do you have a legal obligation to act in my best interests? Do you receive any compensation other than the fee I pay you? Do you offer comprehensive wealth management?

Don't accept anything less than a fiduciary standard of care. Your family's finances and welfare may depend on the real differences between what is in your best interests and what is just potentially suitable. You deserve better than satisfactory compliance to the rules. You deserve a firm that offers proactive comprehensive wealth management.

Don Trone, founder and executive director of the Foundation for Fiduciary Studies, describes the difference this way: "A fiduciary relationship requires a consultative, rather than sales, approach to working with the client. The question moves from, 'Is this a good investment?' to 'Is this a good investment for me (the client)?' Such a relationship, by necessity, has to be based on a much deeper understanding of the goals and objectives of the client."

Heed this important distinction between advisers who earn their living from the commissions of products and services they sell and those whose only payment comes from the client. One owes loyalty solely to serving the client. The other's interests are divided at best. NAPFA has promoted this distinction with their slogan "Truly Comprehensive, Strictly Fee-Only" and the "Fee Only" logo. Visit www.napfa.org to find an advisor in your area.

from http://www.emarotta.com/article.php?ID=428