I recently read a post on one of my favorite blogs, Watch Your Wallet, and would like to respond. In the post, To Get Rich...Do Nothing?, Watch Your Wallet theorizes that most of us spend too much time thinking about what to do with the meager extra income we can allocate to investments and penny pinching, and far too little time thinking about how we can earn more money in our career and/or business. Watch Your Wallet says we would be better served, and therefore wealthier, to focus more on increasing our earning potential, and focus less on deciding what to do with our little pennies.
While I do agree we spend a great amount of time thinking about our pennies, I do not think it is too much time. It is impossible to be over-educated about any subject that you find interesting or beneficial. Is there a law of diminishing returns with knowledge of investment options? Yes, absolutely, but that seemingly unimportant fact you come across Friday morning on Yahoo Finance may link in a beneficial way to something you will learn in the future.
I'll use my favorite example: my friends and myself! This past week, I was in Maine with a group of friends, all young professionals, and all certainly successful in their chosen fields. It was a terrific trip: ocean front cottage, boats, beer, wine, and lobster. One member of our party was an advertising executive for a major U.S. newspaper. His father also happens to be a very senior executive of the very same publication. I would estimate that he earns probably twice or more of what I earn. He has regularly contributed to a 401k since graduating from college over ten years ago, has a financial planner who manages all of his investments, and received an inheritance a few years ago which he had the foresight not to spend on a new car or three.
He leaves all financial decisions in regards to investments to his financial planner, but I'm sure my friend has no idea of what he is paying the financial planner. He does not know the dollar limits on 401k investing, which leads me to believe that he has not increased his contribution amount for at least several years. He has also left his inheritance in the bank since he received it over five years ago (lucky for him it's in Euro's). Despite this negligence, he is quite successful and wealthier than the great majority of his peers, due primarily to his wages as an advertising executive.
Here's the rub: he has worked for more years than me (we are the same age, but I did an extra year of undergraduate, and two years of graduate school), has been given the great advantage of wealthy parents, is connected to a lucrative career, and has made good financial decisions, but I believe our net worth’s are very close. Mine may even be greater.
How is this possible? I have done all of the things you are supposed to do like avoiding debt, keeping my expenses low, regular savings, and pinching pennies like someone out of the great depression. I have also routinely invested in low cost mutual funds without the benefit of an advisor, even (especially) in down markets. For example, I purchased international mutual fund investments when they where returning losses every year. I made what was considered a risky real estate purchase when I was told real estate was dead, and I have done all this without paying an advisor what seems like a small percentage or fee each year.
The basic premise of what I did and continue to do is collect what I believe are valuable assets. This allows me to ride the waves that pass over us every few years. The first wave I caught was real estate, the second was the international equity markets, and currently it's the broader based U.S. markets, which are experiencing a very strong bull market. Do these waves influence my investing decisions? NO! Absolutely not. I cannot control them. I can only control what my dollars purchase: ASSETS!
Is it important to focus on earning more from your work or business? Absolutely. If I had been earning twice as much for these past years I would probably have four times as many assets. Can you achieve wealth on average earnings? Without a doubt, in modern day America, with a solid understanding of finance, YES! It is my belief that the boom of the mutual fund industry and personal finance has finally done what our forefathers claimed to have done, which is to democratize the ability to build wealth.
Sunday, July 22, 2007
Tuesday, July 10, 2007
Not Special Like the Rich
You're special!, or so you've been told for your entire life. You're so special that people always give you things and ask for nothing in return. No matter where you go - your parents house, your college, your employer, your wife, or your husband - they all give and give and give, and don't ask for a thing in return! Great!
This subject was broached recently by an article in the Wall Street Journal. Its discussion circled around good old Mr. Rogers, and his favorite saying, which of course, was, you guessed it, "you're special." The author further discussed research that indicates a growing level of selfishness and sense of entitlement in younger generations. He says that this increased sense of entitlement is in large part due to the child centered culture that has evolved over the past several decades. It's no longer important what mommy and daddy did today, but "how was school today?," and "what did you do/learn?"
It occurred to me that perhaps this new sense of entitlement, this sense of being special, has lead an entire generation to believe that they don't need to save for their futures. They think that someone else will take care of it for them, because, after all, don't they deserve that? Many young adults that I know have parents that are not wealthy, but have retired, live in nice homes, have nice cars, and take nice vacations and trips, and when the kids come, even though they're 32, the parents foot the bill for everything. When these "kids" get in trouble and can't pay their rent or insurance, guess who comes to the rescue? I think most of the parents actually prefer the relationship to continue this way, after all, they can remain an important part of their child's life, it is clear co-dependency.
But these parents are not doing their children any favors by solving every problem, and allowing them to sit back and wait for their inheritance. Most will not even get an inheritance that can sustain them after it has sustained mommy, daddy, and the dead beat son or daughter for so long. What most will receive is an amount that is not near enough to provide for an adequate retirement, and they won't be prepared to manage even that much.
Children need to start learning about money, whether they are 13 or 35, it is never too early and never to late, but now is the time to start. Mommy and Daddy, you are special, you have accomplished, earned, and saved and proved how special you are. Children, if you want to be special, you will need to prove it through your own accomplishments.
Most of the rich could not have become so if they believed that someone or something would make them rich, that all they had to do was relax, sit back, maintain status quo, and wait. To the contrary, the had to work to earn, save what was required, and make those savings earn.
I have an uncle who is a retired oil executive. He earns about $200,000 a year in investment income. He worked for the same company for 40 years. He has a small home in the city where he spent his working life, and an even smaller house at the beach. He has 4 adult children, the oldest in his 40's. None would qualify for a description of independent. But that's not the rub. The rub is that none are interested in becoming independent. They all have jobs, but none of them have jobs that can support the type of lifestyle that they want, so they all regularly receive money from him that they use to pay for their living expenses. I think this makes him feel rich and generous, powerful and useful.
But he is not teaching any of them what he understood so well, and what made him so successful. Which is, to amass wealth, you must live below your means, otherwise you will never save and will never take the basic first step to building your own fortune. How long do you think his children's inheritance will last when its manager is no longer with us?
This subject was broached recently by an article in the Wall Street Journal. Its discussion circled around good old Mr. Rogers, and his favorite saying, which of course, was, you guessed it, "you're special." The author further discussed research that indicates a growing level of selfishness and sense of entitlement in younger generations. He says that this increased sense of entitlement is in large part due to the child centered culture that has evolved over the past several decades. It's no longer important what mommy and daddy did today, but "how was school today?," and "what did you do/learn?"
It occurred to me that perhaps this new sense of entitlement, this sense of being special, has lead an entire generation to believe that they don't need to save for their futures. They think that someone else will take care of it for them, because, after all, don't they deserve that? Many young adults that I know have parents that are not wealthy, but have retired, live in nice homes, have nice cars, and take nice vacations and trips, and when the kids come, even though they're 32, the parents foot the bill for everything. When these "kids" get in trouble and can't pay their rent or insurance, guess who comes to the rescue? I think most of the parents actually prefer the relationship to continue this way, after all, they can remain an important part of their child's life, it is clear co-dependency.
But these parents are not doing their children any favors by solving every problem, and allowing them to sit back and wait for their inheritance. Most will not even get an inheritance that can sustain them after it has sustained mommy, daddy, and the dead beat son or daughter for so long. What most will receive is an amount that is not near enough to provide for an adequate retirement, and they won't be prepared to manage even that much.
Children need to start learning about money, whether they are 13 or 35, it is never too early and never to late, but now is the time to start. Mommy and Daddy, you are special, you have accomplished, earned, and saved and proved how special you are. Children, if you want to be special, you will need to prove it through your own accomplishments.
Most of the rich could not have become so if they believed that someone or something would make them rich, that all they had to do was relax, sit back, maintain status quo, and wait. To the contrary, the had to work to earn, save what was required, and make those savings earn.
I have an uncle who is a retired oil executive. He earns about $200,000 a year in investment income. He worked for the same company for 40 years. He has a small home in the city where he spent his working life, and an even smaller house at the beach. He has 4 adult children, the oldest in his 40's. None would qualify for a description of independent. But that's not the rub. The rub is that none are interested in becoming independent. They all have jobs, but none of them have jobs that can support the type of lifestyle that they want, so they all regularly receive money from him that they use to pay for their living expenses. I think this makes him feel rich and generous, powerful and useful.
But he is not teaching any of them what he understood so well, and what made him so successful. Which is, to amass wealth, you must live below your means, otherwise you will never save and will never take the basic first step to building your own fortune. How long do you think his children's inheritance will last when its manager is no longer with us?
Sunday, July 8, 2007
To be Young and Rich
An acquaintance of mine recently contacted me with a small problem he is having: a five year old daughter with an $80k inheritance. He's had the money in the bank for two years, and didn't know what to do with it. He asked if I had any suggestions. Here's what I sent him:
Richard,
If I were 5 or 6 and had 80k to invest, this is what I would advise my parents to do:
Split the money 4 - 7 ways and invest it in a portfolio of mutual funds. I would strongly suggest using index funds because their fees are by far the lowest, they are based on preexisting indexes (not a "smart" investor), and she can leave the funds invested as-is indefinitely and not concern herself with market trends. Lets face it, when you're 5 you don't want to worry about market trends or what your fund managers are doing. Remember, index funds have performed better over time than about 80% of funds that attempt to beat their performance, so they are a prime choice for long term investing in the stock market.
Also important to consider, 5 year olds have a lot of time for compounded returns to accrue, so don't be risk adverse. The market conservatively returns 9% over long periods of time, at that rate, with no other investments, she'd be worth 1.6 million at age 40, mid life crisis hello!
I like Fidelity. They have low cost index funds that are I believe high quality. Vangaurd and TRoweprice are two other low cost providers of index funds, but I just happen to prefer Fidelity.
Here are the funds I would choose (these are all Fidelity funds):
Spartan Total Market Index Fund (these are large cap stocks)
Fidelity Large Cap Value Fund (not an index fund)
Spartan Extended Market Index Fund (these are mid cap stocks)
Spartan International Index Fund
Fidelity Balanced Fund (hybrid stock/bond fund - not an index fund)
Fidelity Nasdaq Composite Index Fund
If you end up talking to a Financial Advisor, keep in mind that most work on commission, so use a jaundiced eye!
After he read my email he said,"but what if the whole market goes sour," to which I replied, "well, than you lose value, that is the risk, but she has a quite a long time to make up for any short term losses." But what I thought was: "The same thing that will happen if you don't take any action - you lose."
He asked what I would do and I told him, but what I won't do is tell him I think he is making a mistake by not following some similar course of action, and leaving a small fortune of future earnings on the table. Maybe not young and rich after all!
Richard,
If I were 5 or 6 and had 80k to invest, this is what I would advise my parents to do:
Split the money 4 - 7 ways and invest it in a portfolio of mutual funds. I would strongly suggest using index funds because their fees are by far the lowest, they are based on preexisting indexes (not a "smart" investor), and she can leave the funds invested as-is indefinitely and not concern herself with market trends. Lets face it, when you're 5 you don't want to worry about market trends or what your fund managers are doing. Remember, index funds have performed better over time than about 80% of funds that attempt to beat their performance, so they are a prime choice for long term investing in the stock market.
Also important to consider, 5 year olds have a lot of time for compounded returns to accrue, so don't be risk adverse. The market conservatively returns 9% over long periods of time, at that rate, with no other investments, she'd be worth 1.6 million at age 40, mid life crisis hello!
I like Fidelity. They have low cost index funds that are I believe high quality. Vangaurd and TRoweprice are two other low cost providers of index funds, but I just happen to prefer Fidelity.
Here are the funds I would choose (these are all Fidelity funds):
Spartan Total Market Index Fund (these are large cap stocks)
Fidelity Large Cap Value Fund (not an index fund)
Spartan Extended Market Index Fund (these are mid cap stocks)
Spartan International Index Fund
Fidelity Balanced Fund (hybrid stock/bond fund - not an index fund)
Fidelity Nasdaq Composite Index Fund
If you end up talking to a Financial Advisor, keep in mind that most work on commission, so use a jaundiced eye!
After he read my email he said,"but what if the whole market goes sour," to which I replied, "well, than you lose value, that is the risk, but she has a quite a long time to make up for any short term losses." But what I thought was: "The same thing that will happen if you don't take any action - you lose."
He asked what I would do and I told him, but what I won't do is tell him I think he is making a mistake by not following some similar course of action, and leaving a small fortune of future earnings on the table. Maybe not young and rich after all!
Annuity Puzzle
I don't like to invest in anything I don't understand. I think the greatest investor of our time, Warren Buffett, has expressed similar sentiments from time to time as well. So if a brilliant investor like Warren Buffett won't put his money where his brain can't get to, why should you or I?
What I'm talking about are annuities; variable, fixed, deferred, immediate, purple, and pink. There are so many different types of annuities all packaged differently from different insurance companies and sold under different names, it is very difficult to understand which would be most appropriate, if any, for your portfolio. This confusion leads investors (the purchases of these products) to ultimate confusion and into the arms of a perhaps untrustworthy "Investment Advisor" aka insurance salesman.
Many "Investment Advisors" will direct their clients (prey) into these products with promises of tax deferral heaven, compound returns, and the big S - safety. I'll do my best to rebut all of these benefits here, but please keep in mind that this is merely the tip of the annuity iceberg, and that each annuity contract (yes ladies and gentlemen, an annuity is a contract, and if you break its terms, guess what, you bought it, and it will cost you substantial fees) is very different and needs to analyzed on its own merits.
Tax deferral heaven. Annuities allow purchases to defer taxes on earnings and interest until the money is taken out of the annuity. These tax savings are therefore allowed to continue to compound over time, and increase overall earnings. But here's the rub, those deferred taxes, when paid, are paid out as income taxes, rather than the much lower capital gains rate your earnings would be subject to if, for example, you had simply invested at retail (sent the fund company a check directly) in an index based mutual fund. In addition, most experts agree that taxes will be higher in the future than they are today, so you will be paying at an even higher rate. As an aside, this belief that taxes will be higher in the future is what makes the Roth IRA such a powerful tool.
Compound returns. Yes its true that your annuity money will earn on its earnings over time, and you will experience compound returns, however, those compound earnings will in no way compare to the compound earnings you could have earned historically in the United State stock markets, and again if historical results are any guide (who else can guide us?), you will end up with considerably less money than if you had simply invested in that previously mentioned S&P 500 Index fund.
The big S - safety. For example, most deferred annuities will guarantee at least a very low rate of return, like 3%. They will also very often guarantee that your annuity contract will be worth at least the amount originally invested when you begin to take disbursements many years later. They will also charge you a tremendous amount for these insurances. There is often a 1-2% (of the total value of your annuity) charge for guaranteeing survivor benefits, a .1-.3% charge to guarantee a stated growth rate for death benefits, fees for waiver of withdrawal charges (a fee to waive a fee! What a terrific idea!), and a fee for something known as 'total protection.' If you feel confused, you're not alone. The important truth here is all of these fees work to reduce your earnings, and therefore the amount that is available to compound. Are you really safer with less money? Too little risk is very dangerous!
Annuities are insurance products. Your money is usually invested in the same types of instruments that you could invest in yourself, again like that S&P 500 Index fund, only there are at least two more sets of hands in the money pot: the insurance salesman aka "Investment Advisor" (who is often an independent broker who works on commission), and the insurance company. They both need to get paid for their services, and they both get paid from your money. With so many hands in the pot, someone will be left short, and it won't be the mutual fund managers who get a fixed percentage of the monies they manage, it won't be the salesman who gets a fixed commission for selling you the annuity, and it won't be the insurance company who gets paid by insuring your money against all future catastrophe, it will be you!
Annuities are appropriate for some portfolios at some times, but they are a highly commissioned financial product, and are largely oversold for this reason. Please remember that a financial advisor has a great deal of interest and incentive in persuading you to purchase one of these products. If you are considering an annuity of any kind, make sure you understand all of the fine print, even if your financial advisor does not.
What I'm talking about are annuities; variable, fixed, deferred, immediate, purple, and pink. There are so many different types of annuities all packaged differently from different insurance companies and sold under different names, it is very difficult to understand which would be most appropriate, if any, for your portfolio. This confusion leads investors (the purchases of these products) to ultimate confusion and into the arms of a perhaps untrustworthy "Investment Advisor" aka insurance salesman.
Many "Investment Advisors" will direct their clients (prey) into these products with promises of tax deferral heaven, compound returns, and the big S - safety. I'll do my best to rebut all of these benefits here, but please keep in mind that this is merely the tip of the annuity iceberg, and that each annuity contract (yes ladies and gentlemen, an annuity is a contract, and if you break its terms, guess what, you bought it, and it will cost you substantial fees) is very different and needs to analyzed on its own merits.
Tax deferral heaven. Annuities allow purchases to defer taxes on earnings and interest until the money is taken out of the annuity. These tax savings are therefore allowed to continue to compound over time, and increase overall earnings. But here's the rub, those deferred taxes, when paid, are paid out as income taxes, rather than the much lower capital gains rate your earnings would be subject to if, for example, you had simply invested at retail (sent the fund company a check directly) in an index based mutual fund. In addition, most experts agree that taxes will be higher in the future than they are today, so you will be paying at an even higher rate. As an aside, this belief that taxes will be higher in the future is what makes the Roth IRA such a powerful tool.
Compound returns. Yes its true that your annuity money will earn on its earnings over time, and you will experience compound returns, however, those compound earnings will in no way compare to the compound earnings you could have earned historically in the United State stock markets, and again if historical results are any guide (who else can guide us?), you will end up with considerably less money than if you had simply invested in that previously mentioned S&P 500 Index fund.
The big S - safety. For example, most deferred annuities will guarantee at least a very low rate of return, like 3%. They will also very often guarantee that your annuity contract will be worth at least the amount originally invested when you begin to take disbursements many years later. They will also charge you a tremendous amount for these insurances. There is often a 1-2% (of the total value of your annuity) charge for guaranteeing survivor benefits, a .1-.3% charge to guarantee a stated growth rate for death benefits, fees for waiver of withdrawal charges (a fee to waive a fee! What a terrific idea!), and a fee for something known as 'total protection.' If you feel confused, you're not alone. The important truth here is all of these fees work to reduce your earnings, and therefore the amount that is available to compound. Are you really safer with less money? Too little risk is very dangerous!
Annuities are insurance products. Your money is usually invested in the same types of instruments that you could invest in yourself, again like that S&P 500 Index fund, only there are at least two more sets of hands in the money pot: the insurance salesman aka "Investment Advisor" (who is often an independent broker who works on commission), and the insurance company. They both need to get paid for their services, and they both get paid from your money. With so many hands in the pot, someone will be left short, and it won't be the mutual fund managers who get a fixed percentage of the monies they manage, it won't be the salesman who gets a fixed commission for selling you the annuity, and it won't be the insurance company who gets paid by insuring your money against all future catastrophe, it will be you!
Annuities are appropriate for some portfolios at some times, but they are a highly commissioned financial product, and are largely oversold for this reason. Please remember that a financial advisor has a great deal of interest and incentive in persuading you to purchase one of these products. If you are considering an annuity of any kind, make sure you understand all of the fine print, even if your financial advisor does not.
Friday, July 6, 2007
Watch Those Fees
I'm a CPA and worked for several years at Ernst and Young, a big 4 accounting firm. When I was working there, I spent many days and weeks working on prospectuses, which are the shareholder reports that are the ultimate end result of an audit. Even though I was helping to produce these important documents, it wasn't until I had several years of experience with them that I finally began to get comfortable with understanding how to read and interpret them.
This is a disturbing fact of our financial systems: very few investors will ever have the opportunities I did to get up close and personal with audited financial statements. If that is the case, then how can they be expected to make informed decisions about how and where to invest their hard-earned money? The answer is: They can't! Which is exactly how many investment firms, insurance companies, and big banks would like it to remain. After all, an uninformed investor is usually a happy investor.
The sad part of this is that many investors do not want to learn more about investing. Their eyes get glossy when the subject turns to asset allocations, and they reply "I have a financial planner to make those decisions." Well, what they don't know is that he is probably just an insurance salesman, and may know less about investing than them! The bright side of this is that financial adviser gives the uneducated investor someone to blame when things go sour.
I'll give you an example. A close friend of mine, Sara, got a job as a school teacher right out of college. Soon after she started working, Sara met with a representative from NEA Valuebuilder, one of the companies that had a retirement plan for employees of Sara's school. NEA offered a 403b plan that was packaged as a variable annuity. Sara didn't know what a 403b was or who variable annuity was, but the representative was a close friend of Sara's parents, and everyone knew that Sara was making a wise choice to start saving for retirement when she was still so young.
Sara didn't asked the rep too many questions, if any at all. She wouldn't have known what to ask anyway - she had majored in fine arts, not finance - and would leave those decisions to the experts. Sara worked as a school teacher for seven years, dutifully contributing the same amount each pay check, for a total contribution over all seven years of $20,000.
We were friends for this entire period, but she never once asked me for any advice or information, so I never offered any, even though I had private concerns about how she had invested her life savings. Two years after leaving her teaching job to work full time as an artist, she could no longer contribute to the fund, and asked me to help her make a decision about what to do with the money in her 403b.
After calling NEA Valuebuilder and requesting a prospectus, I confirmed my fears. Only, it was worse than I could have imagined. Allow me to explain. In every prospectus of every mutual fund that sells shares in the United States, there is a table detailing the approximate cost of investing $10,000 in the fund over a ten year period. I turned immediately to this page when I got the prospectus, and the approximate cost was $5,600. (NEA Value Builder Prospectus) I was shocked. In all of my experience I had never seen fees this high. I immediately showed the fee table to Sara and explained what it was. I then showed her the fee tables of the index funds I suggested she consider. They each had approximate 10 year cost of under $300. (Spartan Index Funds)
The reasons for the extremely high fees are because it is an annuity, which is an insurance product. Sara's retirement savings were insured for many things at a great cost. This type of variable annuity is an antiquated investment vehicle that really no longer has a place in the great majority of portfolios, and absolutely not in the portfolio of a very young school teacher just starting out on the road to financial freedom. She didn't need this type of insurance; she needed appropriate risk and the opportunity for compounded returns.
The very sad part is that all of this information was available to Sara when she set up the plan. It could be said that the "Financial Advisor" who set up Sara's plan should have explained this information to her, but he was really just an insurance salesman, so he may not have even understood the plan, much less the prospectus.
Sara decided to cut her losses and roll her money into an IRA with low cost mutual funds. Even though her NEA Valuebuilder plan was a 403b and therefore she was allowed to roll the money into an IRA, she still had to pay NEA Valuebuilder over $1,000 to cancel her annuity contract. Over time the great advantage of the lower fees will boast her returns and more than make up for the loss. When she finally did do the rollover, the total in her account was just over $29,000. After nine years, she had only earned $9,000 in her annuity, despite never taking any disbursements. The high fees had destroyed her ability to benefit from compounded returns. That is the high cost of ignorance.
This is a disturbing fact of our financial systems: very few investors will ever have the opportunities I did to get up close and personal with audited financial statements. If that is the case, then how can they be expected to make informed decisions about how and where to invest their hard-earned money? The answer is: They can't! Which is exactly how many investment firms, insurance companies, and big banks would like it to remain. After all, an uninformed investor is usually a happy investor.
The sad part of this is that many investors do not want to learn more about investing. Their eyes get glossy when the subject turns to asset allocations, and they reply "I have a financial planner to make those decisions." Well, what they don't know is that he is probably just an insurance salesman, and may know less about investing than them! The bright side of this is that financial adviser gives the uneducated investor someone to blame when things go sour.
I'll give you an example. A close friend of mine, Sara, got a job as a school teacher right out of college. Soon after she started working, Sara met with a representative from NEA Valuebuilder, one of the companies that had a retirement plan for employees of Sara's school. NEA offered a 403b plan that was packaged as a variable annuity. Sara didn't know what a 403b was or who variable annuity was, but the representative was a close friend of Sara's parents, and everyone knew that Sara was making a wise choice to start saving for retirement when she was still so young.
Sara didn't asked the rep too many questions, if any at all. She wouldn't have known what to ask anyway - she had majored in fine arts, not finance - and would leave those decisions to the experts. Sara worked as a school teacher for seven years, dutifully contributing the same amount each pay check, for a total contribution over all seven years of $20,000.
We were friends for this entire period, but she never once asked me for any advice or information, so I never offered any, even though I had private concerns about how she had invested her life savings. Two years after leaving her teaching job to work full time as an artist, she could no longer contribute to the fund, and asked me to help her make a decision about what to do with the money in her 403b.
After calling NEA Valuebuilder and requesting a prospectus, I confirmed my fears. Only, it was worse than I could have imagined. Allow me to explain. In every prospectus of every mutual fund that sells shares in the United States, there is a table detailing the approximate cost of investing $10,000 in the fund over a ten year period. I turned immediately to this page when I got the prospectus, and the approximate cost was $5,600. (NEA Value Builder Prospectus) I was shocked. In all of my experience I had never seen fees this high. I immediately showed the fee table to Sara and explained what it was. I then showed her the fee tables of the index funds I suggested she consider. They each had approximate 10 year cost of under $300. (Spartan Index Funds)
The reasons for the extremely high fees are because it is an annuity, which is an insurance product. Sara's retirement savings were insured for many things at a great cost. This type of variable annuity is an antiquated investment vehicle that really no longer has a place in the great majority of portfolios, and absolutely not in the portfolio of a very young school teacher just starting out on the road to financial freedom. She didn't need this type of insurance; she needed appropriate risk and the opportunity for compounded returns.
The very sad part is that all of this information was available to Sara when she set up the plan. It could be said that the "Financial Advisor" who set up Sara's plan should have explained this information to her, but he was really just an insurance salesman, so he may not have even understood the plan, much less the prospectus.
Sara decided to cut her losses and roll her money into an IRA with low cost mutual funds. Even though her NEA Valuebuilder plan was a 403b and therefore she was allowed to roll the money into an IRA, she still had to pay NEA Valuebuilder over $1,000 to cancel her annuity contract. Over time the great advantage of the lower fees will boast her returns and more than make up for the loss. When she finally did do the rollover, the total in her account was just over $29,000. After nine years, she had only earned $9,000 in her annuity, despite never taking any disbursements. The high fees had destroyed her ability to benefit from compounded returns. That is the high cost of ignorance.
Thursday, July 5, 2007
Buy Assets Like the Rich
An asset is anything you own that puts money in your pocket, while a liability is anything that takes money out of your pocket. The rich buy assets, while the rest of us only buy liabilities. The most dangerous of these are liabilities that we think are assets.
I was struck the other day when a friend of mine purchased a brand new Audi sports car, complete with all leather interior and two sunroofs. She owns a dog walking service and probably earns about $80,000 a year, and, like most others of our generation, sees little to no value in saving for the future. She plans to quit working in a few years, have a baby, and raise a family. However, she's doing the opposite of preparing for that.
She put $500 down on a car that cost her future earnings of about $26,000. She got a very low dealer interest rate that puts her monthly payment at $440. She has a terrible driving record and her insurance is sky high, considering she lives in a city and needs to have full coverage because the dealership has a lien on the title of the car, about $400 a month. The first week she had the car a "client" (I think it was a Doberman) chewed off her drivers side mirror. The next week she left both the sunroofs open overnight during what turned into a very rainy evening. Finally, within her first month of possession, a truck backed into her at a stop light, damaging the entire passenger side of the car.
While her car is being repaired she is still making payments. She is out money for the cost of deductibles, and the rain has likely done extensive damage to the electrical systems. The real irony in this situation is that her husband described the car to me as an asset. Does that sound like an asset you would buy (invest in)? When does that asset start putting cash in your pocket?
I understand that most of us need a car or truck to take us to and from our jobs and errands, and that we cannot always find a reliable vehicle that we can pay cash for. It is important to plan appropriately for these major purchases and to have the savings available when the time arrives. It is also important to purchase an appropriate vehicle. For example, if you have a very long commute, or have to drive a lot for your work, then consider your comfort level and gas mileage. If you need to wear a suit to work each day, you probably need air conditioning, and if your job involves taking dogs in your vehicle many times a day, you probably don't want a sports car; a small van may be much more adequate. My friend's new Audi is both inappropriate for its use and too expensive for her. But her fundamental problem is not the Audi - that is merely the most recent manifestation of her problem. Her true issue is with her thinking. She needs to understand that a car is not an asset, and further, what an asset is and what a liability is. A car is, at best, an expense when you have no lien/debt attached to it. My cars are an expense (no debt, but there is still insurance, maintenance, and repair). But, at worst, they are an expense and also a liability.
Several years ago my grandfather died. He fought in WWII, came home from the Pacific, and worked in the shipyards as a welder. He also raised 9 children, only 4 of which were his own. After he retired from the shipyards, he bought a very small house near the ocean and worked as a security guard. He worked until he was too sick to work, and died after only truly being retired for about a month. He left half of his life savings to his wife, and the other half to be divided among his four biological children.
My aunt used her inheritance to purchase new cars for her and her husband, take a trip to Greece, and make several improvements to her house. Now the money is gone and she is still working as a bank teller with little savings, just like she has for over 30 years. The only difference is she now has two new cars to maintain. She thinks she will get the money "invested" on home improvements out of the house when she sells. My mother, on the other hand, used all of her inheritance to purchase a conservative allocation of low cost mutual funds and certificates of deposits, and has the dividends distributed to her each quarter. The value of her investments has grown in the past few years, and so has the size of her dividends. My mother now owns my grandfather's beach house, and uses the dividends to pay the costs of maintaining it. As a result, she can enjoy the house all summer long. Who purchased an asset and who purchased liabilities and expenses?
The achievement of wealth usually requires methodical asset accumulation. It is easier to accumulate assets when you aren't spending your time accumulating liabilities and sacrificing future earnings. When you sacrifice future earnings, you sacrifice unforeseen opportunity, and when you sacrifice unforeseen opportunity, you sacrifice your ability to accumulate assets in the future, all for two sunroofs and leather interior!
I was struck the other day when a friend of mine purchased a brand new Audi sports car, complete with all leather interior and two sunroofs. She owns a dog walking service and probably earns about $80,000 a year, and, like most others of our generation, sees little to no value in saving for the future. She plans to quit working in a few years, have a baby, and raise a family. However, she's doing the opposite of preparing for that.
She put $500 down on a car that cost her future earnings of about $26,000. She got a very low dealer interest rate that puts her monthly payment at $440. She has a terrible driving record and her insurance is sky high, considering she lives in a city and needs to have full coverage because the dealership has a lien on the title of the car, about $400 a month. The first week she had the car a "client" (I think it was a Doberman) chewed off her drivers side mirror. The next week she left both the sunroofs open overnight during what turned into a very rainy evening. Finally, within her first month of possession, a truck backed into her at a stop light, damaging the entire passenger side of the car.
While her car is being repaired she is still making payments. She is out money for the cost of deductibles, and the rain has likely done extensive damage to the electrical systems. The real irony in this situation is that her husband described the car to me as an asset. Does that sound like an asset you would buy (invest in)? When does that asset start putting cash in your pocket?
I understand that most of us need a car or truck to take us to and from our jobs and errands, and that we cannot always find a reliable vehicle that we can pay cash for. It is important to plan appropriately for these major purchases and to have the savings available when the time arrives. It is also important to purchase an appropriate vehicle. For example, if you have a very long commute, or have to drive a lot for your work, then consider your comfort level and gas mileage. If you need to wear a suit to work each day, you probably need air conditioning, and if your job involves taking dogs in your vehicle many times a day, you probably don't want a sports car; a small van may be much more adequate. My friend's new Audi is both inappropriate for its use and too expensive for her. But her fundamental problem is not the Audi - that is merely the most recent manifestation of her problem. Her true issue is with her thinking. She needs to understand that a car is not an asset, and further, what an asset is and what a liability is. A car is, at best, an expense when you have no lien/debt attached to it. My cars are an expense (no debt, but there is still insurance, maintenance, and repair). But, at worst, they are an expense and also a liability.
Several years ago my grandfather died. He fought in WWII, came home from the Pacific, and worked in the shipyards as a welder. He also raised 9 children, only 4 of which were his own. After he retired from the shipyards, he bought a very small house near the ocean and worked as a security guard. He worked until he was too sick to work, and died after only truly being retired for about a month. He left half of his life savings to his wife, and the other half to be divided among his four biological children.
My aunt used her inheritance to purchase new cars for her and her husband, take a trip to Greece, and make several improvements to her house. Now the money is gone and she is still working as a bank teller with little savings, just like she has for over 30 years. The only difference is she now has two new cars to maintain. She thinks she will get the money "invested" on home improvements out of the house when she sells. My mother, on the other hand, used all of her inheritance to purchase a conservative allocation of low cost mutual funds and certificates of deposits, and has the dividends distributed to her each quarter. The value of her investments has grown in the past few years, and so has the size of her dividends. My mother now owns my grandfather's beach house, and uses the dividends to pay the costs of maintaining it. As a result, she can enjoy the house all summer long. Who purchased an asset and who purchased liabilities and expenses?
The achievement of wealth usually requires methodical asset accumulation. It is easier to accumulate assets when you aren't spending your time accumulating liabilities and sacrificing future earnings. When you sacrifice future earnings, you sacrifice unforeseen opportunity, and when you sacrifice unforeseen opportunity, you sacrifice your ability to accumulate assets in the future, all for two sunroofs and leather interior!
Tuesday, July 3, 2007
Don't Live Like the Rich Part 2
I've been reading lately about increasing income to get richer and about cutting expenses to do the same. I want to point out the obvious, which is that you will actually have to do both. The tricky part is that you can't increase your spending once your income increases; you need to use that extra money to increase your savings, investments, or debt repayments. Once you decrease your fixed expenses to an appropriate level, you become virtually financially indestructible. I'll use myself as an example.
I was working as a tax consultant when I decided I wanted to attend graduate school. I didn't have any hopes of a scholarship, so I explored other payment options. I also never incur debt unless it is attached to real estate and at well-negotiated rates, so a student loan was out of the question, and since I can't incur debt I have to pay for everything in cash, including large purchases like an automobile. As a result, my fixed annual expenses are extremely low. So when I wanted to go to graduate school it wasn't a concern if I could afford it or not, my only concern was the opportunity cost of not working because I'd be in school for two years.
Eventually I worked out an arrangement with the school. We took the total cost of the program, divided it by 24, and I made those payments for the next two years with no interest. Many schools will make similar payment arrangements if you inquire.
Because of my planning and low fixed expenses, I was able to earn enough working three days a week at a local coffee shop to pay for all of my living expenses and tuition cost, even though I was only earning about 1/4 of what I had been earning as a tax consultant. I also had an emergency fund that could have sustained me for a year, so I never worried about what I would do if my fly by night barista job expired from circumstances beyond my control.
Once I was out of graduate school and back into the full time work force, my fixed expenses remained the same. This is a very powerful paragon, and one that you must achieve in order to obtain wealth through working.
I was working as a tax consultant when I decided I wanted to attend graduate school. I didn't have any hopes of a scholarship, so I explored other payment options. I also never incur debt unless it is attached to real estate and at well-negotiated rates, so a student loan was out of the question, and since I can't incur debt I have to pay for everything in cash, including large purchases like an automobile. As a result, my fixed annual expenses are extremely low. So when I wanted to go to graduate school it wasn't a concern if I could afford it or not, my only concern was the opportunity cost of not working because I'd be in school for two years.
Eventually I worked out an arrangement with the school. We took the total cost of the program, divided it by 24, and I made those payments for the next two years with no interest. Many schools will make similar payment arrangements if you inquire.
Because of my planning and low fixed expenses, I was able to earn enough working three days a week at a local coffee shop to pay for all of my living expenses and tuition cost, even though I was only earning about 1/4 of what I had been earning as a tax consultant. I also had an emergency fund that could have sustained me for a year, so I never worried about what I would do if my fly by night barista job expired from circumstances beyond my control.
Once I was out of graduate school and back into the full time work force, my fixed expenses remained the same. This is a very powerful paragon, and one that you must achieve in order to obtain wealth through working.
Monday, July 2, 2007
Don't Live Like the Rich
All of the recent excitement about the iPhone got me thinking about purchasing stock in Apple, something I wish I had done back in 2002 when a good friend of mine suggested I do so. Instead I bought shares of Boeing, and well, that's worked out just fine.
The excitement about the iPhone did not get my friends thinking about which stocks that they had bought, wished they'd bought, or might buy because it will benefit from the iPhone, no, instead, they talked about whether they would buy the iPhone itself. How strange!
To my great surprise, the consensus arrived at over dinner on my deck was a resounding no; no one would buy the iPhone. Why? It cost to much, this from a group whose wardrobe that very night I'm sure included at least one pair of $300 jeans, a few $100 t-shirts, and of course the latest fashion in flip flops. This also came from a group were each member has a new car that has been financed for 5 years, dines out several times a week, and seems to know no limit to what canine accessory their lucky pooches need next. I predict they will all have iPhones within the span of 6 months.
However, I was pleasantly surprised that there were no immediate iPhone takers. IPhones will make most of us a little less rich, but it will make some of us (Apple shareholders) a little more rich. I prefer to be a member of the little more rich crowd whenever I can, but most of my friends are members of the little less rich crowd all of the time.
The modern economy is a wonderful machine that allows its' users to be a member of one of these two classes. In the United States you can even choose which crowd to belong to. Even though you can choose, most of us are and will always be members of the little less rich crowd, but a few of us will choose to be members of the other class.
How do you choose to be a member of the little more rich class? Simply, by always living below your means. Living below your means, as long as you have enough to survive, will allow you to save money regularly, and will allow that money to last longer should you ever need to tap into it. Living below your means and saving money will allow you to purchase stock in the next Apple or Boeing, and then earn even more money when that company releases the next iPhone or super jet.
The excitement about the iPhone did not get my friends thinking about which stocks that they had bought, wished they'd bought, or might buy because it will benefit from the iPhone, no, instead, they talked about whether they would buy the iPhone itself. How strange!
To my great surprise, the consensus arrived at over dinner on my deck was a resounding no; no one would buy the iPhone. Why? It cost to much, this from a group whose wardrobe that very night I'm sure included at least one pair of $300 jeans, a few $100 t-shirts, and of course the latest fashion in flip flops. This also came from a group were each member has a new car that has been financed for 5 years, dines out several times a week, and seems to know no limit to what canine accessory their lucky pooches need next. I predict they will all have iPhones within the span of 6 months.
However, I was pleasantly surprised that there were no immediate iPhone takers. IPhones will make most of us a little less rich, but it will make some of us (Apple shareholders) a little more rich. I prefer to be a member of the little more rich crowd whenever I can, but most of my friends are members of the little less rich crowd all of the time.
The modern economy is a wonderful machine that allows its' users to be a member of one of these two classes. In the United States you can even choose which crowd to belong to. Even though you can choose, most of us are and will always be members of the little less rich crowd, but a few of us will choose to be members of the other class.
How do you choose to be a member of the little more rich class? Simply, by always living below your means. Living below your means, as long as you have enough to survive, will allow you to save money regularly, and will allow that money to last longer should you ever need to tap into it. Living below your means and saving money will allow you to purchase stock in the next Apple or Boeing, and then earn even more money when that company releases the next iPhone or super jet.
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