All Things Financial Planning Blog

Leave a comment

5 Money Questions Graduates and Newlyweds Need To Have Answers To!

Tis the season for graduations and weddings. After attending a number of those events recently, I thought I would put together a checklist of the five questions that need to be answered by those who are newly married or graduating this spring and early summer. I’m making an assumption that most of those graduating or getting married are probably in their 20’s (although I know a large number of graduates and those getting married are older or may have a wedding or two behind them). With the economy being in the situation that is now, we all know how difficult it is to find a job, especially coming right out of school. That can be the same for newlyweds who now have a whole new set of expenses that they may have inherited from their new partner.

It would be easy to put down 100 things that they can worry about, but I wanted to focus in on the top five laundry list items to abide to help them for the rest of their life. These questions may not be of the magnitude of the 18th-century philosopher Marcel Proust (of which I have 33 of sitting on my desk right now), yet they are questions that will make your life better financially if you adhere to them.

  1. Do you understand what you’re getting into when it comes to your career and your earning power? How much money you make is certainly a driver of how financially successful you can be, but please don’t allow your pension to surpass your passion! Money is certainly important, but having a passion for what you want to do far exceeds just the dollars and cents. I think it is more important to do the things that you enjoy in life because it will give you constant motivation and improvement, which money alone rarely does. Living the life of George Bailey, from it’s a Wonderful Life, does not make for a happy or decent human being. Also if you start in a job that really doesn’t inspire passion but does pay well, it makes it harder to follow your passion later because you’ve gotten used to that financial lifestyle. The good news though is a lot of retirees are reigniting that passion that they may have not been able to pursue in their younger years and it’s making the retirement process much more gratifying as a result.
  2. Do you realize what is the single most important form of capital that most younger adults have? Human Capital is the largest form of capital that most possess. It’s all those potential years of earnings power that matters when you’re younger. That’s because most people don’t inherit sizable estates or wealth, they are dependent on their brains and their bodies to generate their lifetime income. Human capital is the most under looked and under mentioned asset in the financial world! With that being said you better go out and get some disability insurance right away, especially if you’re lucky enough to have a job. That’s because if something happens to you, you have zero protection to assure any quality-of-life other than government and family support. So when you run into the first person who prospects you for life insurance (and rest assured there will be someone) and you don’t have any dependents, tell them no, but you would like to buy some disability insurance! 
  3. Do you understand a budget? Cash is king in a meandering or down market, but its essential when you have to pay your rent, make a car payment, have healthcare and buy food. So just understand the premise that you need more money coming in, than going out! It’s the essence of financial management and unfortunately about 70% of America is either just making ends meet or taking on more debt, according to Jean Chatzky’s book, The Difference
  4. Do you know how to borrow money? I feel that the focus many times from Financial Planners is to get people to save money and not so much how to borrow better. Some of that may be how we are paid (compensated for commissions and fees on assets versus planning or refinancing debt). Don’t get me wrong as the asset side of the balance sheet building up is good, but it might go better if you’re paying less money on the liability side by lowering your interest payments for hundreds of thousands of dollars many have from home, school, car and credit card debt. As an example, if you’re paying over 20% for credit card debt, it doesn’t make a whole lot of sense to invest because you’re almost never going to get consistent 20% returns on your money to match the cost of your loans. 
  5. How much risk can you handle? This is where I have to interject that after 30 years of sitting down with clients and trying to determine their risk, I have yet to find anybody who knows how much risk they can handle. There’s also the question of what kind of risk. Is it risk of taking care of your family if something happens to you, is it the volatility that’s in the markets every day as we try and figure out how to invest, or the taking of risk and your job and profession so that you can make more money by taking on more responsibility or get more training (that’s that human capital thing again)? When it comes to investing I think that risk is essential. I feel most people want to maintain or increase their standard of living. That means if you’re going to have the same amount of spending power next year you need to get a rate of return better than inflation, after you pay your taxes. In order to do that you need to consider putting some of your money to work in stocks, real estate, commodity-based investments and even your business. History shows that over long periods of time, you rarely are able to do this by putting your money into guaranteed types of investments like money market funds and bank certificates of deposit. The younger you start doing this, the less risk you’ll take as time heals market corrections. This question also brings me back to what I call the rocking chair question, which is what you’re saying to your grandchildren as you’re sitting on your rocking chair somewhere many years in the future. Do you want to tell them that you took too much risk in life or too little? Unfortunately, only you can decide as risk is rarely comfortable for most people. When pursued diligently and prudently, it can be handled and can help you toward the financial life that you dream of.

Here’s a poem that I thought appropriate as we make those determinations of risk:

William Arthur Ward on “Risk”  

To laugh is to risk appearing a fool
To weep is to risk appearing sentimental
To reach out for another is to risk involvement
To expose your feelings is to risk exposing your true self
To place your ideas and your dreams before a crowd is to risk embarrassment
To love is to risk not being loved in return
To live is to risk dying
To hope is to risk despair
To try is to risk failure
But risks must be taken because the greatest hazard in life is to risk nothing at all
The person who risks nothing does nothing, has nothing, and is nothing, and may avoid suffering and sorrow, but they cannot learn, feel, change, grow, love, or live
Chained by their certitudes, they are slaves
They have forfeited their freedom
Only a person who risks is free

Dave Caruso is a Registered Representative with and securities offered through LPL Financial, member FINRA/SIPC.

Dave Caruso, CFP®
Certified Financial Planner™
Coastal Capital Group
Danvers, MA

1 Comment

If I Had 10 Million Dollars

You probably remember the Barenaked Ladies song – “If I Had a Million Dollars” (I must confess – I remembered the song, but not whose it was). A recent New York Times article called it to mind: a husband and father received $10 million after tax from the sale of his family’s business and then proceeded to spend it all.

The song provides a long list of (often eccentric) ideas for what to do with a million dollars (e.g., a tree fort), and the article provides ideas for what to do with ten (million dollars): horses, a yellow Aston Martin, a house in England, a camp on a lake in the Adirondacks, a home in Vermont…

Even though $1 million is a lot of money, and $10 million is a whole lot of money, neither amount is inexhaustible. Unfortunately, while it’s easy to think of things to buy with a lot of money, it’s hard to believe that there still are limits. (“The fortune evaporated in little more than a decade.”)

You may be thinking, so what? I’ll certainly never have $10 million. I’ll never even have $1 million.

You may be wealthier than you think.

Suppose that you earn $30,000 per year. If you work for 40 years (25 to 65), your earnings will add up to $1.2 million. If you earn $50,000 per year, the total will be $2 million, if $100,000 – $4 million.

So, each of us has, or will have, access to significant wealth. What can we learn from the sad story in the New York Times article that will help us manage it? I extracted these lessons from the article (I’m sure you can find more):

  • Keep track of your important values. Fancy cars and big houses can be very attractive, but they won’t put your children through college, and they may be long gone by the time you are ready to retire.
  • Keep your day job. Your earning power is probably your most important asset. Steady annual earnings add up! If you want to quit your job to write a novel, it’s wise to have a backup plan. You may have a hard time finding remunerative work if the novel doesn’t sell.
  • Manage your spending. Your cash flow may support living large now, but the price could be reduced circumstances later. Your lifetime resources must support your lifetime expenses. A financial plan (a lifetime budget), even if it’s just an outline, can help you be sure that your luxuries are affordable.
  • Don’t risk more than you can afford to lose. When you make an investment, take care to understand how much you could lose (the potential gain will be front and center). Despite the confident assertions of many brokers and financial advisers, the future performance of the stock market is unknown. It can go down as well as up, as recent experience demonstrates. And, believe it or not, you can live a very comfortable life without ever owning a single stock.

While you may never have $10 million (or even $1 million) all in one place, you still have very substantial wealth. A bit of planning, a dose of self-discipline and cautious investing will help you make the most of it.

rickMillerRick Miller, CFP®
Sensible Financial Planning & Management
Cambridge, MA

1 Comment

Do You Know What Your Biggest Asset Is? (With Implications for Saving)

Economists refer to your earning power as “human capital.”

Your human capital is “human” because it is part of you. Unlike your other assets (your home, your car, your financial assets such as your bank account or retirement savings), you cannot sell it to someone else and only you can use it. Your employer can pay you to use your human capital on their behalf, but they can’t buy your human capital (that would be slavery).

Your human capital is “capital” because it is an asset. You can use it to generate income. If you use it more intensively, you can generate more income. And, you can increase the amount of your human capital by investing in it – more education can make it possible for you to earn more.

Well, so what? What’s the benefit of thinking about your earning power as human capital? Well, for one thing, human capital is the largest asset for most people under, say, 50. Even for people in their 60s, it is still very important.

In addition, human capital as a concept offers a powerful change in perspective. Perhaps most importantly, it helps you think more clearly about what you can afford in your life.

Consider a 31-year-old couple trying to decide how much they should save. Traditionally, they’d pick a retirement asset goal, and then save toward that goal. That’s hard! Who knows how much they’ll need to have when they retire? Many web-based calculators claim to be able to tell you, but they don’t agree.

Let’s make this concrete. The couple earns $100,000 per year, pays $25,000 per year in taxes, has accumulated $100,000 in savings, expects to pay $50,000 per year for four years for their child’s college education, will receive $20k per year in Social Security once they retire at age 71, and expect to live to age 100.

We can look at a balance sheet, but it doesn’t tell us very much about how much our couple should save:

Assets ($000) Liabilities and Net Worth ($000)
Savings: 100 Net Worth: 100

Now let’s bring in human capital.

Since they expect to work for 40 years, their Human Capital is worth $4,000,000 (if the interest rate is zero). We can calculate their other assets and liabilities in the same way, and we get:

Assets ($000) Liabilities and Net Worth ($000)
Human Capital: 4,000 Taxes: 1,000
Savings: 100 College: 200
Social Security: 600 Net Worth: 3,500
Total: 4,700 Total 4,700

So, this is a very wealthy family, with a net worth of $3.5 million. Now, what do they want to do with that wealth? Suppose they decide that, having paid for their child’s college education, they don’t need to leave a bequest. Then they can spend that net worth over the rest of their lives, which is 70 more years, or $50,000 per year (we’ll call that annual spending “consumption”). Now the balance sheet looks like this:

Assets ($000) Liabilities and Net Worth ($000)
Human Capital: 4,000 Taxes: 1,000
Savings: 100 College: 200
Social Security: 600 Consumption: 3,500
Total: 4,700 Total 4,700

And, we’ve solved the saving problem! They should save their earnings less their taxes and consumption, or $100,000 – $25 ,000 – $50,000  = $25,000 per year. They’ll work 40 more years, and save $1M. They’ll use $200k for college, leaving $900k (don’t forget the $100k they’ve already saved!). Then, they can use $30,000 per year plus their $20,000 per year of Social Security to support their $50,000 per year of consumption spending for 30 years of retirement.

If you like pictures, here’s a graph of the balance sheet. It highlights the point that you can’t spend more than you earn, and because your human capital is what you earn, you can’t spend more than your human capital!

This has major implications for how you should think about your financial situation. For one thing, it highlights the need for life insurance and disability insurance. You can really see clearly that if something happens to your ability to earn, your entire financial plan is at risk.

Financial planning is all about deciding how you want to spend your wealth (when, and on what), and how to protect the wealth you have. Knowing about your human capital is essential if you want to make good financial decisions.

rickMillerRick Miller, CFP®
Sensible Financial Planning & Management
Cambridge, MA