Five Wealth Building Habits

“We are what we repeatedly do. Excellence, then, is not an act, but a habit.” – Aristotle

Accumulating wealth and developing financial independence does not happen overnight, but it’s not nearly as complicated as most people think. Good habits create results when consistently applied over time. Today, we are going to talk about how to get on track and create new habits.

Frankly, most of my clients are already doing these things. That’s why they have money to invest with me. So, I’m not really writing this for them. I meet a lot of people who have a similar level of income, who are intelligent and successful in their own field, but unfortunately, their habits are never going to lead them to become wealthy.   

This past week, I gave four presentations at different companies around Dallas about personal financial planning and estate planning. One of the most common questions was about saving money and creating wealth. I think there are a lot of myths about building wealth that are holding people back from success. We need to dispel those myths and replace old habits with a new habits that create wealth.

Myth 1: You don’t make enough money to become wealthy.

I’ve seen families who become millionaires with incomes under $100,000, and I’ve seen people go bankrupt who make over $300,000. Stop thinking that the problem is that you don’t have enough income. Until you have a savings plan, you are probably going to end up spending everything you earn. Without a savings plan, a raise will only stimulate additional spending.

To be a better saver, look at your biggest expenses. If you make smart choices about your home and car choices, everything else in your budget will fall into place nicely. If you have reached a bit too high for your budget, there is no magic way to save money when your fixed expenses consume all of your income. If you are in over your head with these costs, you need to find a way out. Don’t focus on how much you make, focus on how much you can save.

Habit 1: Wealth Builders are frugal about their two biggest expenses: their house (or rent) and their cars. They view these as expenses, not as investments or as “lifestyle” choices they deserve.
Read more: Rethink Your Car Expenses

Myth 2: You can’t save right now.
You’ve got student loans. You’ve got young children. You need to save for a down payment. You need to pay down your mortgage first. You’ve got a kid about to start college.

There’s always an excuse why people aren’t saving and investing today. But there’s never going to be a “green light” where you will feel that it is easy to invest.

Habit 2: Wealth Builders put their investing on autopilot.

First: establish an emergency fund with at least three months of living expenses. Pay off your credit cards so you do not carry a balance or pay any interest expenses. Then establish automatic monthly deposits into an account for each of your financial goals: 

  • a 401(k) or IRA for Retirement
  • a bank account for your next car purchase
  • a 529 Plan for your child’s college education

It doesn’t matter if you start small. If all you can afford today is $50 or $100 a month, just get started and don’t wait. When the money comes out automatically, you won’t miss it. As you are able, increase your monthly contributions. Your eventual goal is to save at least 15% of your income. Can you get there in a year or two? Calculate how much this is and get started. If you have to adjust later, that’s okay. Don’t wait another day, because that day could turn into years.

Read more: Don’t Budget, Focus on Saving

Myth 3: Things will take care of themselves.
You’re not worried. Time is on your side. You’ve got other things to deal with. It can wait.

Yikes. Get your head out of the sand. You can do this. Educate yourself about investing. 

While I encounter an attitude of denial sometimes with younger investors, it is not just Millennials who think this way. In fact, I think a lot of Millennials are proving to be much smarter than previous generations about materialism, credit card usage, and their life goals. 

What scares me more are older entrepreneurs who tell me that their business is their retirement plan and that their company is the best investment. Great, how many times have you built and sold a company for over a million dollars? Never done that? What is your exit strategy? 
It’s not a good idea to put all your eggs in one basket, and the successful entrepreneurs I know build a positive cash flow business which creates personal wealth in addition to their ownership value of the company.

Habit 3: Wealth builders educate themselves about their finances, are organized, and track their net worth. 

Read more: buy this book, it’s the best investment primer I have read.

The Cost of Waiting from 25 to 35

Myth 4: You have to become an expert in the stock market to be successful.
Day trading. Penny stocks. Cryptocurrency. Stock options. Commodity futures. Hedge funds.

You don’t need any of these things to become wealthy. You don’t have to read the Wall Street Journal everyday, watch CNBC for hours, or spend your weekends pouring over spreadsheets or stock reports. In fact, trying to beat the stock market is not only exceedingly difficult and unlikely to achieve, it often creates unnecessary risk in the process. The antidote is simple: 

Habit 4: Wealth Builders buy Index Funds. 

Buying the whole market gives you diversification, low cost, and tax efficiency. Evidence consistently shows the benefits of using an index approach. And you don’t have to be an expert, or become a stock trader, to use Index Funds.

Read more: Manager Risk: Avoidable and Unnecessary

Myth 5: Your best bet is to do it yourself.

We can all agree that no one cares more about your money than yourself. Unfortunately, there are reasons to distrust the financial services industry and to question whether they are putting their own interests ahead of yours. And it costs money to get professional advice. Those are the three main reasons why people want to manage their finances on their own.

Over the past 15 years, working at three different firms, I’ve had the pleasure to serve some incredibly successful people. There was a retired surgeon who served as a chairman of a major University. The president of an S&P 500 company. The co-founder of an oil and gas company who sold his company for $300 million. A Harvard educated software engineer. An engineering PhD who speaks five languages. 

These people are way smarter and more successful than I am. They could do it themselves if they wanted. But they all decided to hire a financial advisor, develop that relationship, and out-source their financial planning. Why?

  • You cannot be an expert in all fields. Successful people want to have team members who have specialized training, knowledge, and experience, including accountants, lawyers, and financial planners.
  • Time. They have more valuable uses of their time, not just for work, but also to spend with their family, hobbies, or other interests.
  • You don’t know what you don’t know. A qualified professional might help you avoid costly mistakes as well as to identify any behavioral biases or blindspots you might not be thinking about. Laws and regulations change all the time.
  • Accountability. An advisor will help you set goals, coach you to make good decisions, and proactively keep you on track even when you are busy thinking about other things.
  • Family: knowing they have planned for their family if something should happen to them and that the professional management of their financial affairs would continue.

If the most successful people you know have a financial advisor, maybe it’s time you stop trying to do it on your own.   

Habit 5: Wealth Builders value and seek professional help.

New habits take time to establish. In an age of instant gratification, recognizing that today’s steps might take years to pay off takes particular maturity. It won’t happen overnight, but I can assure you, you don’t have to be a rocket scientist to build wealth – just keep good habits. Apply your habits consistently, with patience and perseverance, and you won’t be surprised when someday you open an account statement and see a seven-figure number.  

Or you could keep doing what you are doing, and you will stay right where you are. Everyone believes that they are rational and logical, but in reality, we all naturally resist change even if that change is in our own best interest. We have to look in the mirror and be honest with ourselves if our actions are truly in line with our goals. That can be painful to acknowledge, but the reward of radical honesty could be the realization that you need to create new, better habits.

Unless you receive an inheritance or win the lottery, wealth is not an event, but a habit. Thankfully, even small changes in your habits can pay big rewards over time.

How to Succeed at Financial Resolutions

DeathtoStock_NotStock2

I know that New Year’s Resolutions are often lampooned as pointless and misguided, but I, for one, love the idea that people can change and take steps to improve their life. To me, a resolution is the wonderful intersection of optimism to motivate you and realism to recognize that it takes hard work to accomplish worthwhile goals.

Fidelity Investments has undertaken a New Year Financial Resolutions Study for seven years and found that individuals who started 2015 with a financial resolution feel more optimistic, are more debt-free, and feel more financially secure than individuals who did not make a resolution. The key to succeeding with a resolution, in my experience, is having the ability to translate a desire into a clear objective, determining how to accomplish that goal, and then having the discipline to stick to your plan.

In other words, a New Year’s Resolution is just a small scale financial plan. Here are three categories of financial resolutions and how to best achieve those objectives:

1) That one thing you’ve been putting off. A lot of times, people have something they know they should be doing, but haven’t started. Maybe they don’t know where to begin, are overwhelmed by the number of decisions they will have to make, or maybe there just never is enough time.

Here are some classic examples of financial needs that many organized, otherwise responsible people have not “gotten around to”:

  • Starting a college fund for children or grandchildren.
  • Securing a term life insurance policy to protect your spouse or loved ones.
  • Establishing your will and estate planning documents.

If these are on your “keeps me up at night” list, give me a call and we will accomplish these in no time. You haven’t done this before, but we do this all the time. Start now and you could have these New Year’s Resolutions wrapped up before the end of January!

2) Save more. Many families worry they are not saving as much as they should. For some, it may be setting up an emergency fund; for others it may be saving for retirement, college, or other long-term goals.

Whatever your investment need, you are more likely to be successful when you put your saving on auto-pilot with electronic monthly contributions. When you pay yourself first every month, most people find they don’t even miss the money. Spending often takes up whatever amount we don’t save; if we recognize this, then we can also understand that it is usually very easy to adjust our discretionary expenses when our saving is automatic.

While the 401(k) is the classic example of automatic investing, we can just as easily use the same approach for an IRA, taxable joint account, 529 college savings plan, or any other type of investment vehicle. Saving more doesn’t happen by accident. You can’t wait until next December to do something if you expect to be a good saver in 2016.

3) Reduce Debt. If you are looking to reduce your spending to get out of debt, you can follow the same advice of making automatic monthly payments. Focus on paying down your highest interest rates loans first.

If you’re not sure where your money goes every month, your first step is to get better organized. Technology can be a big help; consider an app like Mint or Quicken to track your spending. Increasing your self-awareness is an essential step towards changing behavior.

A financial planner can help you with all of your financial questions and goals. Besides bringing expertise, training, and real world experience, a planner can also offer two of the most important elements of success: a concrete plan and accountability to stay on course.

If you are thinking about including financial goals in your New Year’s Resolutions, don’t go it alone, give me a call! I’m here to help.

Behavioral Tricks to Improve Your Finances

picjumbo.com_HNCK7388

I was saddened to hear of Yogi Berra’s passing last week. One of the great quotes attributed to him is “In theory, there is no difference between theory and practice. In practice, there is.” I’ve always thought this quote applied well to personal finance, where the academic expected behavior could differ significantly from the choices people make in real life.

The fact is that we all use our feelings, intuition, and past experience to make our decisions as much, or more, than we rely on logic, research, or an open-minded examination of evidence and data. Many academics take the view that any behavioral deviation from the theoretically optimal decision will lead to poor outcomes. And while that is definitely the case in many situations, my observation as a practitioner is that even the most successful individuals are not immune from this “irrational” behavior.

My point is that when theory and practice do deviate, there can still be good outcomes, in fact, sometimes even improved outcomes. Here are six ways you can use behavioral concepts to improve your financial situation. In theory, these won’t help. In practice, they will.

  1. The 15-year mortgage. In theory, you can make more in stocks than the interest cost of a mortgage, so you should get an interest-only loan and never pay it off. Home values generally appreciate over the long-term, and there is no additional benefit to having equity in your home. Although this is theoretically correct, I suggest that home buyers get a 15-year mortgage instead of a 30-year or interest only note. The reason that the 15-year mortgage benefits buyers is that it will force you to buy a lower priced home to be able to afford the higher monthly payment. If you start your house hunt with a 15-year mortgage in mind, it might mean looking for a $300,000 home instead of a $350,000 home. The lower cost home will have lower property taxes, insurance, utilities, and other costs. More of your monthly payment will go towards principal with the shorter loan, so you will build equity faster, which is very valuable if you should need to move after five or ten years. Having a higher monthly mortgage payment will also force you to save more. By that I mean that if you had a payment that was $500 less, you probably would not save an additional $500 a month; you’d probably save only a small part of this, maybe $100 or $200 a month, and increase your spending by $300 or $400.
  2. Set up your 401(k) contributions as a percentage. People are shockingly lazy with their 401(k) accounts. Many never change funds, and even more never change their contribution level. If you set up a $100 contribution per pay period, chances are good that five years later you are still contributing $100. If, on the other hand, you established a 10% contribution, your dollars contributed would have increased with your raises, promotions, and bonuses. If you can, increase your percentage contribution every year until you make the maximum allowable contribution, $18,000 for 2015.
  3. Make it automatic. We are creatures of habit and momentum and will seldom change established our course. If you give someone $100,000 to invest, they will agonize over the fund choices and try to time their purchases. If the market goes down, they’ll bail out and blame the fund or the manager or something else. It’s better to set your investing on auto-pilot, invest every month into your 401(k), IRA, 529 college savings plan, or other investment vehicle. And then do what is natural for most of us: nothing. Keep investing when the market goes down. Stick with a basic, diversified allocation. That’s why people who have a created a $100,000 account by investing $1000 a month are more likely to stay on course than the investor who puts in a lump sum. Already have your investing on cruise control? Take the next step and make your rebalancing automatic, too!
  4. Pay cash for cars. In theory, there’s nothing wrong with financing or leasing cars. However, if you get in the habit of paying cash for cars it will change your behavior for the better. It is incredibly painful to write a $35,000 check for a vehicle. If you pay cash for cars, it will force you to keep your current car for longer while you save for the next one. It will make you consider a used car or a lower cost vehicle. And it will be a strong incentive to keep your next vehicle for a very long time. Cars are often our second largest expense after housing. Most cars lose 50% of their value in five years, so would you prefer to lose half of $75,000 or half of $30,000? People don’t think this way when all they know is their monthly payment. When you pay cash for a car, you start to think like an owner and not a renter.
  5. Do less research. One of the mental biases facing investors is overconfidence; the more research we do, the more we believe we can predict the outcome of our investing choices. This can lead to people being overweight in their company stock, getting in and out of the market, or making large sector bets. These choices often lead to increased risk taking and quite often to long-term under performance. We’re also likely to suffer from “confirmation bias”, where we cherry pick the data or articles which corroborate our existing point of view and ignore any contradictory evidence. Overconfidence and confirmation bias don’t just affect individual investors, they are significant challenges for professional fund managers. Since the majority of professional managers cannot beat the index, I don’t hold much optimism that an individual can do better. So, cancel your subscription to the Wall Street Journal, turn off CNBC, and buy an index fund.
  6. Use “mental accounting” to your advantage. Money is fungible, meaning $1 is $1 regardless of where it is located. However, people like to divide their money into buckets for retirement, saving, spending, emergency funds, college, vacation, or whatever. In theory, this is meaningless, you’d be equally well off with just one account invested appropriately for your risk tolerance. Even though Academics would like to banish mental accounting, people are enamored with their buckets. While you should look at all your holdings as being slices of one pie, you can use mental accounting to your advantage. You are less likely to touch money when it is in a dedicated account. For example, if you put money in a savings account for emergencies, you may later be tempted to spend that money on a vacation or other splurge. If you instead put that money into a Roth IRA, you’d be much less likely to touch it. But if you did have an emergency, you could access the principal from your Roth, tax-free. The other benefit of buckets is that it may force you to do more saving when you have specific dollar goals for retirement, college, or other purposes. Then if you need to plan for a vacation, you know you will have to do additional saving and cannot touch the buckets allocated for other goals.

Use behavior to your advantage by making sure your choices are helping you get closer to achieving your goals. Investing can be simple; it’s people who choose to make it complicated. Stick to the basics and stay focused on saving and diversification. I’m not sure we can ever completely remove behavioral biases from our decision making process, but the more we are aware of those biases, the easier it is to step back and recognize what exactly is driving our choices.

Deferral Rates Trump Fund Performance, Rebalancing as Key to Retirement Plan Success

DeathtoStock_Objects4

A study by the Putnam Institute, “Defined Contribution Plans: Missing the forest for the trees?” contends that while a number of variables, such as fund selection, asset allocation, portfolio rebalancing, and deferral rates all contribute to a defined contribution plan’s effectiveness — or lack thereof — it is deferral rates that should be placed near the top of the hierarchy when considering ways to boost retirement saving success.1

As part of its analysis, the research team created a hypothetical scenario in which an individual’s contribution rate increased from 3% of income to 4%, 6%, and 8%. After 29 years, the final balance jumped from $138,000, to $181,000, $272,000, and $334,000, respectively.

Even with a just a 1% increase — to a 4% deferral rate — the participant’s final accumulation would have been 30% greater than it would have been using a fund selection strategy defined as the “Crystal Ball” strategy, in which the plan sponsor uses a predefined formula to predict which funds may potentially perform well for the next three-year period. Further, the 1% boost in income deferral would have had a wealth accumulation effect nearly 100% larger than a growth asset allocation strategy, and 2,000% greater than rebalancing. Of course these results are hypothetical and past performance does not guarantee future results.

One key takeaway of the study was for plan sponsors to find ways to communicate the benefits of higher deferral rates to employees, and to help them find ways to do so.

Retirement Savings Tips

The Employee Benefit Research Institute reported in 2014 that 44% of American workers have tried to figure out how much money they will need to accumulate for retirement, and one-third admit they are not doing a good job in their financial planning for retirement.2 Are you? If so, these strategies may help you to better identify and pursue your retirement savings goals:

Double-check your assumptions. When do you plan to retire? How much money will you need each year? Where and when do you plan to get your retirement income? Are your investment expectations in line with the performance potential of the investments you own?

Use a proper “calculator.” The best way to calculate your goal is by using one of the many interactive worksheets now available free of charge online and in print. Each type features questions about your financial situation as well as blank spaces for you to provide answers. But remember, your ultimate goal is to save as much money as possible for retirement regardless of what any calculator might suggest.

Contribute more. At the very least, try to contribute enough to receive the full amount of any employer’s matching contribution. It’s also a good idea to increase contributions annually, such as after a pay raise.

Retirement will likely be one of the biggest expenses in your life, so it’s important to maintain an accurate cost estimate and financial plan. Make it a priority to calculate your savings goal at least once a year.

Today’s blog content is provided courtesy of the Financial Planning Association.

Source/Disclaimer:

1Putnam Institute, Defined Contribution Plans: Missing the forest for the trees?, May 2014.

2Ruth Helman, Nevin Adams, Craig Copeland, and Jack VanDerhei. “The 2014 Retirement Confidence Survey: Confidence Rebounds–for Those With Retirement Plans,” EBRI Issue Brief, no. 397, March 2014.

Because of the possibility of human or mechanical error by Wealth Management Systems Inc. or its sources, neither Wealth Management Systems Inc. nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall Wealth Management Systems Inc. be liable for any indirect, special or consequential damages in connection with subscriber’s or others’ use of the content.

© 2015 Wealth Management Systems Inc. All rights reserved.

Who’s Going to Pay for Your Retirement, Freelancer?

unsplash_52b6b4db7397c_1

A regular employee has a steady paycheck which makes planning and budgeting easy.  For a freelancer, your income may fluctuate greatly from month to month and be very difficult to predict from year to year.  You may not know what work you will be doing six months from now and that’s likely to be a more immediate concern than retirement which could be 20 or 30 years away. 

It’s often impractical for a freelancer to save up a large lump sum investment each year.  What does work for freelancers is to “pay yourself first” by setting up a monthly automatic investment program into an Individual Retirement Account (IRA).  This forces you to budget for retirement savings just as you would do for any other bill, such as your car payment or rent. It is easier to plan for smaller monthly contributions and this creates the same regular investment plan as an employee who is participating in a 401(k).

The maximum annual contribution for an IRA in 2014 is $5,500, which works out to $458 per month.  If you aren’t able to contribute the maximum, that’s okay, there are mutual funds that will let you invest with as little as $100 a month.  The most important thing is to get started and not put it off for another year.  You can always increase your contributions in the future as you are able.  If you are over the age of 50, you can contribute an additional $1,000 a year into an IRA, a total of $6,500 a year, or $541 per month. 

If you can use a tax deduction, open a Traditional IRA.  If you don’t need the tax deduction, and meet the income limitations, select a Roth IRA.  Additionally, there is another reason the Roth IRA is very popular with freelancers.  Many freelancers worry about hitting a slow patch in their business and needing to tap into their savings.  A nice benefit of the Roth IRA – which may help you sleep well at night – is that you can access your principal without tax or penalty at any time.  So if you do have an emergency in the future, you would be able to withdraw funds from your Roth IRA.  (Principal is the amount you contributed; if you withdraw your earnings (the gains), the earnings portion would be subject to income tax and a 10% penalty if you are under age 59 1/2.)  

If you are able to contribute more than $5,500 (or $6,500 if over age 50), the SEP-IRA is your best choice.  You could contribute as much as $52,000 into a SEP this year, if your net income is over $260,000.  The contribution for a SEP is roughly 20% of your net profit each year, so it works great for freelancers who want to save as much as possible.  Why not just recommend a SEP for all freelancers?  The challenge with a SEP is that it is impossible to know the exact dollar amount you can contribute until you actually prepare your tax return each year.  That’s why most SEP contributions are not made until March or April of the following year.  For freelancers who are getting started with saving for retirement, your best bet is to first maximize your contributions to a Traditional or Roth IRA through automatic monthly deposits.  Then if you want to make an additional investment, you can also fund a SEP at tax time.  A lot of investors assume that you cannot do a SEP if you do a Roth or Traditional IRA, but that is not the case, you can do both. 

Being a freelancer can be very rewarding and fulfilling, but it does carry some additional financial responsibilities.  You don’t have an employer to pay half of your social security taxes or to provide any retirement or insurance benefits.  Unlike traditional employees, however, many freelancers don’t go from working full-time one day to completely retired the next day.  What I often see is that many freelancers choose to keep working but reduce their schedule and select only the projects which really interest them.  In this manner, they are never fully retired, but still stay active and have multiple sources of income.  Regardless of your plans or intentions for retirement, my job is to help you become financially independent, so you work because you want to and not because you have to.