Thinking Beyond Numbers

photo credit: SergioTudela

My wife and I love to travel. In my years as a financial planner I’ve never ran across someone that did NOT want to travel in retirement. My first point to that is, why wait? My second point is, learn to travel on a dime.

The beauty of traveling frugally is that you can easily make it more, or less extravagant, depending on your taste. But I’ve also never had anyone say “I would not stay at the Hilton on Michigan avenue in Chicago for $40 a night”. That’s because if you can sit in the rooftop jacuzzi and look at the skyline through their windowed ceiling for $250/night,  wouldn’t it look better with $210 more dollars getting wet in your swimsuit pockets? So here are my 5 tips for Traveling on a Dime.

1. Don’t own, Rent! Rent your next vacation home using a rental from owner site like www.vrbo.com or www.homeaway.com. We have stayed in Rome, Venice, Hilton Head Island, Fort Lauderdale, and are headed to Kauai, Hawaii for our 10th anniversary renting from sites like these. If you are going to stay for less than a few days, you might consider getting your place on #mce_temp_url# or www.hotwire.com. The challenge with Priceline is how much should you be bid? That leads me to tip #2.
2. Bid like a Champion! Use sites like www.betterbidding.com or www.biddingfortravel.com to figure out how much you should be bidding for a hotel. It can also work for renting cars. If you want to get really tricky, you can sometimes use Hotwire for figuring out what hotels you are bidding for on Priceline. But that takes a little experience.
3. Research your Flight! One of the best ways I’ve found that you can figure out how you can get a cheap flight is by getting set up weekly emails for your favorite destinations. My wife is from Spain, so I know weekly how much it costs to fly to Spain. Because I track these flights weekly, I can see how the prices ebb and flow with changes in gas prices, seasons, and demand. I use www.kayak.com to compare prices. After I find a carrier that is offering the best price, I might go to their site and see if it’s less expensive to buy direct. Sometimes visiting the actual airports websites makes you aware of discount airlines that they service that you’ve never heard of, like my $270 round trip flight from Detroit to LA on Frontier Airlines.
4. Plan! One of the most enjoyable things about travel is the anticipation. By planning a trip every 12 to 18 months, it gives you a time to save, research, and find the best deals.
5. FREE works too! If you like free, and you are on a real budget, check out sites like www.housesittersamerica.com and www.homeexchange.com. You may have heard of Home Exhange as it was the basis for the move The Holiday with Jack Black and Cameron Diaz. You actually swap places with someone. It might even be over seas, or across the country. I have a client that did this successfully and stayed in a high rise in Miami while someone stayed here in Michigan. We both thought, why would someone leave Miami for Michigan, but they did, and it worked out okay. Some places even allow use of cars with the home.

The sky is the limit when it comes to traveling. The point is that you shouldn’t wait to travel. My brother said that the one thing he wants to do before he dies is see that big hole in the ground out west. He’s talking about the Grand Canyon. We’ve seen it. It is spectacular. The only thing stopping him from seeing it, is himself. The only thing stopping you is….

Over the years you begin to see a pattern of mistakes that people make with their 401ks. Considering that upwards of 66% of current workers retirement income will come from their savings, I’m amazed that people don’t pay more attention. So here goes… the top 10 mistakes I see people make in 401ks or 403bs:

1. They pick a bunch of funds when they get started, and never revisit, re-balance, or alter their holdings in any way from thence forward. Out of sight, out of mind.
2. They choose to invest in the top performing funds available at the time of their enrollment. Because this is usually done when they are initially hired, it doesn’t account for trends such as a dot.com bubble.
3. They fail to diversify across multiple asset classes. See number 2. I have seen a lot of investors that started investing in the 90s and never stopped investing in growth stocks. In more recent times, the same applies for international stocks.
4. They leave them with former employers, accentuating their mistakes in lack of management.
5. They ignore fees. Over time, fees can have a big impact on returns.
6. They manage too much. This is the opposite of number 1. Some people just choose the top performers from last year, and are constantly chasing returns. The problem here is that this investment philosophy usually buys high when things are hot, and sell low when things are not hot. It is not a disciplined long term investment philosophy.
7. They don’t save enough. If the majority of your income in retirement is going to come from your savings, most of you had better be putting at least 15% away.
8. They don’t take advantage of the match. If your company is going to match, it might not be a bad idea to at least save up to the match. If the plan is bad, you can put your other savings elsewhere.
9. They never sign up. Many people say they aren’t signed up because they know it’ll take away from their current paycheck, and they are living paycheck to paycheck right now. Try having to work when you are 80 because you need the money. Unfortunately, I’ve seen it.
10. They invest too much in the company stock. While this doesn’t occur too much after Enron, it can be fatal to your retirement goal, especially if you are anywhere near retirement. The same can be said for investing too much in one particular fund.

photo credit: ^riza^

One of my favorite parts of working with clients is that over the years I’ve heard some really neat stories as to how clients have imparted their financial wisdom on others. One of my favorite stories is this one about a Grandma and her grandkids:

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Mary Ann was neither rich nor poor. She lived a simple lifestyle with her basic living expenses being taken care of. Like many who’ve lived a full life, the one thing Mary Ann really wanted more than anything else was to spend time with her grand kids, Tommy and Becky.

Tommy and Becky enjoyed spending time with Grandma now, but Mary Ann feared that when they grew older, it would be more and more difficult to keep their attention. This was especially true because she didn’t follow in the latest and greatest trends.

Like most other kids, Tommy and Becky enjoyed playing video games, surfing the net, and watching TV. Mary Ann couldn’t accommodate any of these needs. She didn’t even have cable, let alone internet.

One day, while helping Tommy with a school project, Mary Ann had an idea. They were going to plan a trip. Wishing to show Tommy and Becky how to plan and save for a trip, Mary Ann told them that she would take them to any place in Michigan they wanted, when they turned 8 and 7 years old. Being that Tommy and Becky were only 6 and 5, they had a couple years to plan and save for their trip.

Grandma saved. Tommy saved. Becky saved. Each weekend at Grandma’s house, they would visit the library or pull out the encyclopedias, and research different places in Michigan. From Holland to Tahquamenon Falls, they sought the absolute best place to vacation. Both Tommy and Becky saved half their allowances in order to have spending money for their trip. Then it happened. They went to Sault Ste. Marie, the oldest European settlement in the US Midwest . They watched the boats travel the Soo Locks and went to Great Lakes Shipwreck Museum. They had a grand time.

After that, Mary Ann decided that she wanted to teach her grandkids another lesson: Dream Big!. This time, when they turned 12 and 11, she was going to take them anywhere they wanted to go in the whole United States. Imagine their excitement when they finally saw the Grand Canyon in all its majesty. At 17 and 16 Tommy and Becky visited Paris. They paid for much of their own trip, and before becoming adults, they could say they were world travelers.

All this was possible because someone wanted to teach them the lesson of delayed gratification. As you can imagine, it gave Mary Ann plenty of time with her grandkids. It also taught them that you don’t have to spend a lot of money to have fun because researching the different places to visit was almost as fun as going there. But learning to save over the course of several years taught them a skill they’ll carry throughout their lifetime.

The truth is that it doesn’t have to be your kids or grandkids. Many of us have nieces and nephews, and even friends that struggle with money. They simply don’t understand that in order for you to have success with money, you have to sacrifice today for tomorrow. And sometimes, that sacrifice is fun.

Share, or live this story with someone you care about. I know I will.

Daddy's Girl Will NOT Be Financially Illiterate!

Also alarming to this proud father of a 6 month old daughter is that according to Lusardi, women and girls are more ignorant than men and boys in every survey [they] have looked at.

So how can we make sure that their children or grandchildren are not ignorant about money?

It starts at home. As parents and grand parents, we need to lead by example. We set the tone by making conscious decisions to delay gratification for future benefits and live within our means. Our kids and grand kids will see and should participate in making good financial decisions that will plant the seeds of financial growth in their young minds early on. The challenge is that according to Greene and Lusardi, many of these parents don’t know how to lead by example. As investors, we probably all know someone who has no idea of how to manage their finances. I would suggest to you, the same thing my dad did for me:  share with them something (about personal finances) that you’ve enjoyed.

In 2000, my dad and I listened to the audio book The Millionaire Next Door. This book peaked my curiosity about why some people have money, while others did not. From there I set a goal to be debt free (except my mortgage) and live below my means every year. So far, it’s worked.

As we head into Father’s Day weekend, share with someone a nugget of personal finance that you are excited about. If you are having trouble thinking of some, I’ve listed a few below:

• Wharton, Dartmouth and the Rand Corporation have established the new Financial Literacy Center, which will develop “educational materials and programs that help foster saving and retirement strategies over the life cycle.”
• The National Association of Personal Financial Advisors (NAPFA) has Consumer Webinar Series and a Your Money Bus which travels the country offering free advice.
• The Federal Reserve has Money Smart Week in April.
• The Financial Planning Association promotes Financial Planning week every October.
• Of course there’s also blogs like this one, Get Rich Slowly, Five Cent Nickel, and Free Money Finance and many more located in my blogroll.
• The Millionaire Next Door and many other books on finances can be found in my Libaray.
• There is FREE Financial Planning software available in the FREE Stuff section of this site that is a good reality check for someone who may never think about their finances

photo credit: kevinzhengli

What is more important, getting the most return, or not losing anything? For many, getting the highest possible return is the biggest goal. They obsess over return. But higher returns warrant more risk, and more risk can have a hidden villain not always discovered until it is too late. The villain - geometric return, or more correctly termed in statistician land - geometric mean.

According to Wikipedia, Geometric Mean is a type of mean or average,…similar to the arithmetic mean, which is what most people think of with the word “average”, except that… the geometric mean of a data set is less than or equal to the data set’s arithmetic mean, unless you are using the same data set.

Translation = Actual Returns May Differ from Average Returns.

I first ran into Geometric Mean or Return when talking to another advisor. We agreed that if a $100,000 portfolio went down 50% one year to $50,000, it would take a 100% return ($50,000) the next to get back to even. The total return over those two years would be 50%. (-50% + 100% = 50%) The average return over the two years would be 25%. (50% / 2 ) But clearly the investor has only gotten back to even. His actual gain is zip.

Let’s apply this to more realistic investment returns. Here are two 4 year average return scenarios.

Both return series  total 20%. Over 4 years they average 5% per year. But their actual return tells a different story. You can clearly see that the actual investment results differ because of the volatility of the portfolios. The bonds made $21,551, while stocks lost $12,250 ending with $87,750.

Actual return of the bonds were 21.55%, 1.55% more than the 20% total return. The extra 1.55% was due to compounding of return.  The actual return of the stocks were -12.25%, averaging negative 3.05% per year. The problem is that in the long run, bond returns do not keep up with inflation. We know we need stocks in our portfolio in order to keep up with inflation. Most of us also need higher than bond returns to achieve our goals. So how do we invest in stocks to keep pace with inflation while minimizing risk?

Asset Allocation

Asset allocation is a combination of stocks, bonds, and cash that can help take extreme peaks and valleys out of your returns.  Let’s look at returns without the peaks and valleys.

The average return is still 20%, or 5% per year. But less volatility produced a total return of 11.32% or 2.83% a year. How does this apply over longer periods? All Financial Matters.com did a really nice blog on the S&P 500 returns from 1986 to 2005. The average return was 13.17%. The geometric return was 11.94%.

How does this apply to planning for your retirement?

By looking at a series of returns applied to your actual portfolio over time, you get a more clear picture or your likelihood of success. Unfortunately most online calculators that many do-it-yourself investors are using only use average returns. They don’t account for geometric “actual” returns. As advisors, we have access to the Monte Carlo Analysis. Monte Carlo analysis runs not 1, but 10,000 series of returns on your portfolio based on historical or projected returns. This gives you a more clear picture as to your likelihood of success given your investment allocation. It also allows your to see the impact of reduced volatility on a portfolio as you shift investments from stocks to bonds to find the right mix.

In conclusion, you may not have bragging rights for the biggest returns at the company social with a lower risk, less volatile portfolio, but your long term results may be better off because of it. Remember that there are no guarantees when investing in the stock market. Historical returns are not indicative of future returns.

Turning 50 might not be everyone’s idea of excitement, but when it comes to saving for retirement, 50 is when things start getting a lot more interesting.

That’s because people age 50 and over can make what are known as “catch-up” contributions to IRAs and most workplace-based retirement plans. These special contributions are in addition to regular contribution limits and allow individuals to maximize the amount of tax-advantaged retirement savings they can stash away.

The catch-up phenomenon has never been more important as American workers attempt to rebuild retirement savings devastated by recent market losses. Taxpayers 50 or older are permitted to make additional contributions beyond standard limits. For calendar year 2010, here are the standard contribution limits with their catch-up amount:

1.      Traditional and Roth IRAs have a standard contribution limit of $5,000 with an over-50 catch-up contribution of $1,000 for a total contribution limit of $6,000.

2.      SIMPLE IRAs have a standard contribution limit of $11,500 with an over-50 catch-up contribution of $2,500 for a total contribution limit of $14,000.

3.      401(k), 403(b), 457(b), Roth 401(k) and Roth 403(b) plans have a standard contribution limit of $16,500 with a catch-up contribution of $5,500 for a total contribution limit of $22,000.

So, where to find the money? Here are some suggestions to make it happen:

Earn more: Yes, a tall order in a tough economy. But if you can take on extra freelance work or a part-time job that you enjoy, you can work to extinguish debt and maximize your savings.

Cut out the extras: Either on paper or on the computer, write down every dollar you spend in the average week (and cut off credit card use during that week). At the end of that week, start marking out non-essential items just to see how much you could live without. Start with gourmet coffee and restaurant or carryout meals and work backward from there. And don’t forget those regular monthly expenditures that can really add up. Do you really need premium cable? Can you surrender your landline in favor of a cell phone that’s matched to the exact number of minutes you’ll need? Can you afford a higher deductible on your health, home or auto insurance to save on premiums?

Set a budget: Once you’ve established how your income covers the essential expenses you must plan for and a few inexpensive treats that should stay in, build a budget that includes specific amounts you can allocate toward debt. Going forward, keep a running total of your spending  and revisit how that budget is working on a monthly basis until you start to see some positive results, and then you can review the performance of that budget a little less frequently.

If you can do it safely, take over home and auto maintenance yourself: The do-it-yourself movement is in a new phase with the economic downturn. For any home or auto maintenance chores you may have during the year, learn as much as you can about those tasks and estimate the cost of materials and your time before doing them yourself.  Previous generations made do-it-yourself a necessity. See if that option is right for you and you might save considerable money doing it.  Also, for bigger jobs, pair up with friends and family and you can help each other save money.

Turn down the thermostat and park the car: Don’t underestimate the value of energy savings in your budget. Keep the temperature down at home and opt for public transit, biking and walking where you need to go. For a look at how much public transit can save you, go to the American Public Transit Association’s gas savings calculator . And if you’re going to walk or bike, that’s not only going to save your money, it’ll do wonders for your health.

Go debit: Debit cards wearing a bankcard logo are typically welcome at most stores where credit cards are accepted. This way, you pay cash without carrying cash. If you don’t have such a card, you can probably get one from your bank to replace your traditional ATM card, but remember to tell them to limit your buying power on the card to only what you have in your account. And use overdraft protection to avoid fees.

Buy used for yourself: If you need clothing, a car or a new watch to replace the old one that’s past fixing, it might be worthwhile to buy second-hand at shops or on the Internet. Plenty of people have unloaded items in relatively good shape to bring in cash during the recent downturn. Get in the habit of saving money on everything.

April 2010 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Rich Feight, CFP, a local member of FPA.

According to Mirriam-Websters.com, frugal means characterized by, or reflecting economy in the use of resources. Frugal comes from the Latin word frux, which interestingly enough can mean both fruits AND success, as in the fruits of my success. In fact, an old Latin phrase ad bonam frugem se recipere, means to improve oneself.  That sounds successful to me.

Creative Commons License photo credit: GViciano

So why the etymology lesson? Because I want to point out the connection between success (frux) and the economic resourcefulness of frugality. Most of us have just lost sight of the beauty of simple living. In fact, there is another Latin word from frux called frugalis, meaning virtuous. This is a philosophy the Puritans subscribed to, living a very simple life which would allow their focus to be more on spirituality, rather than materiality. Get the connection? So why aren’t more of us frugal? Quite simply it is because we’ve been taught to be consumers.

Prior to the 1950s, people understood the idea of frugality. In my short 13 years as a financial advisor I have run across a few frugal types. They may have a net worth of $2.7 million or more, but they look like you and me. The difference is they never bought into the idea of the consumption of “stuff”. (See Annie’s www.thestoryofstuff.com.) When the spending of the government brought the US out of the economic slump left over from the great depression, economists and government officials decided that spending was going to keep this country strong, even if it was at the expense of Americans’ savings. We were going to be a country of consumers.  The rub? The cost of retirement was getting too high. Companies and government got sick of footing the retirement bill for retirees who, with improving health care, were living too long. So what did they do? They shifted the retirement burden to us with 401k and other defined contribution plans. But they never taught us how to save. They’d only taught us how to spend. And the booming stock market of the 80’s and 90’s only hindered our need to save because of their stellar returns, capitulating in 1999 with the technology bubble.

So what do we need to do? We need to learn to save. For further reading on how much we should be saving, read my post How Much Should We Be Saving. In order to get your budget on track, avoid the major pitfalls of spending like constantly driving new cars and refinancing your home every few years. For further reading on car habits and mortgage habits, see Black Hole Car Habits and Mortgage Habits of Millionaires. We need to knuckle down on our spending habits. We can do this using sites like mint.com, wesabi.com, and geezeo.com to track your spending for free.

The good news is that there is some sign that Americans’ are learning to save as the personal savings rate is approaching almost respectable levels (see Bureau of Economic Analysis Personal Savings Rate). But we are far from the 15% to 20% needed to fund most retirements. In order to get there, we’ll need to change our habits from consumption to simple living with good old fashion frugality.

Creative Commons License photo credit: {Guerrilla Futures | Jason Tester}

A Roth IRA allows you to save tax deferred money like a regular IRA, and withdraw money tax free. The catch is that instead of paying taxes when you are retired and withdrawing money, you pay tax before you make your contribution.

Besides tax free withdrawals, one of the best features of a Roth IRA is that there is NO required minimum distribution (RMD) at age 70 ½. This works great for extending the life of your nest egg, which is crucial in down years like 2008, when many IRA owners age 70 ½ would rather let their portfolios recover. Lower IRA values after the 2008 recession is partially why Congress passed a law allowing retirees to skip their required minimum distribution last year.

Because of the benefits, Congress limits those who can have a Roth IRA. If your Modified Adjusted Gross Income (MAGI) is above $120,000 (single) or $176,000 (married), under most circumstances, you cannot benefit from a Roth. If your MAGI is below these figures you can make up to a $5,000 contribution to a Roth in 2010 ($6,000 if you are over age 50).

When does a Roth make sense?

1.    You don’t want to be forced to take required minimum distributions at 70 ½.
2.    You will be in a higher tax bracket during retirement
3.    You think tax rates will increase

There are other times a Roth IRA makes sense, but these are a few of the main reasons. Some other questions you may have are:

· If I make 401k contributions, can I still make Roth contributions? Yes. You can make Roth IRA AND 401k contributions as long as your MAGI is below the limits discussed above.

· How can I get a Roth IRA if my MAGI is too high? In 2010 Congress is giving us a gift. They are allowing anyone with an IRA, regardless of income, to convert to a Roth IRAs. The catch is that you have to pay ordinary income tax on the converted money. Fortunately, the provisions in the law allows you to spread the tax due over your 2011 and 2012 tax bill. For some this may allow you to stay in the same tax bracket, assuming tax brackets aren’t raised.

Example: Jean has $100,000 in her IRA. She is in the 25% tax bracket, but expects to be in the 28% bracket when she retires in 10 years. She is planning on being retired for 30 years. My analysis shows that if she converts now, she’ll owe $25,000 in taxes, but will increase her total value of after tax distributions by $83,622.

This is an overly simplistic example, but it illustrates the point that Roth IRAs can save you money on tax in the long run depending on your situation. You may even be able to convert 401ks or 403bs with past employers to Roth IRAs as long as they are rolled into a traditional IRA and converted to a Roth before the end of the year. Also remember that this analysis is based on variables that may change over time. There is no guarantee you will benefit.

In summary, Roth IRAs are retirement accounts where you pay no income tax on withdrawals. This year, investors who were previously unable to get access to Roth IRAs, have the ability to convert their current IRA to a Roth regardless of income.

Money Shirt Creative Commons License photo credit: Rob Lee

This time of year can mean an influx of stuff and an outflow of dough. One way to counter this is to go through your closet and get rid of all your unwanted clothes. Every year I have a few shirts, sweaters, coats, and other things that I just don’t need anymore. Between my wife and I, this year we had six bags of clothes to donate.

How can you Give, Save, and Simplify your life? Follow these simple steps:

1. Clean Your Closet - Go through your clothes and get rid of the obvious things that you no longer wear. Then go over the things you are keeping for sentimental reasons and ask yourself, would someone else benefit more from this than me?

2. Catalog your items. I use an Excel spread sheet I created a couple years ago. This sheet catalogs your clothes and household items, and assigns them an estimated value based on tax valuations at bankrate.com. You can download your own FREE copy of this excel sheet here.

3. Take a Picture - I usually stack the items together and take a picture for reference. This is followed by good notes at the bottom of the excel sheet. 

4. Give - Give the items to your preferred charity. While I choose Volunteers of America because of how they indirectly helped a friend of mine, my neighbor finds it more convenient to donate to Good Will. You may prefer The Salvation Army. The important part is to find the charity that fits you, and start this new habit.

5. Take Documents to Your Accountant - Give the donations receipt, excel worksheet, and pictures to your accountant for your tax records. For non-cash donations greater than $500, you may need to fill out form 8283 along with your Schedule A. You can download that form from the IRS website at http://www.irs.gov/pub/irs-pdf/f8283.pdf.

It should be noted that in order to get the deduction, you need to itemize your taxes. But even if you don’t’ itemize and get the deductions, it still feels good to Give, and Simplify.

For more on donating items, visit the IRS website Publication 526.

Due to market conditions over the past 18 months, the IRS announced that required minimum distributions (RMD) for 2009 are waived for IRAs and other retirement plans, including Traditional IRAs, SEP, SIMPLE, Inherited IRAs, 401(k), and 403(b)(7).

As a result of the IRS waiver and its late announcement in 2008, the IRS recently issued new guidance for additional relief.  If you are an IRA owner, plan participant, and eligible beneficiary that has already taken a 2009 required minimum distributions, you now have the option to roll 2009 distributions back into the same account or into another tax-deferred retirement account.  You have until November 30, 2009, (already passed) or 60 days from the date the funds were received, whichever is later.  Only one RMD distribution roll-back is allowed.  2008 RMDs were not waived and may not be rolled back, under this new guidance.