Getting Your Financial House in Order

People often say to me, “Bill, I know you are a financial advisor, but what is it exactly that you do?”  The short answer is that I help people get their financial house in order.  The next question usually is “How do you do that?”  I do that by helping them plan for financial emergencies, manage risk, identify and prioritize their financial goals including educating their children and saving for a comfortable retirement.   Having their financial house in order also means managing their debt, lowering their taxes and possibly preparing a budget.  It also means doing some estate planning so that their family is not financially devastated by their premature death.

But what about investments, don’t you handle those also?  Sure, but investments need to be appropriate for individuals and well managed to help them achieve their financial goals and keep their financial house in order.  The key word in achieving financial order is planning.  Here are some examples of financial concerns that I have helped people with.

Planning for financial emergencies generally requires accumulating an emergency fund so that cash will be available when that furnace or roof needs replacement.  The fund must be liquid since the need is immediate.  Planning requires estimating the size of the emergency fund.  Perhaps $5,000 or $10,000 will be enough to cover the cost of a new roof and/or a furnace, but may not be enough for other types of emergencies.  What if the wage earner is laid off from his or her job?  The emergency fund will need to cover monthly living expenses not covered by unemployment insurance for some period of time (say 3 to 6 months or possibly longer).

Managing risk includes planning for the breadwinner’s premature death or disability.  This can be accomplished by reviewing life and disability insurance coverage, and if necessary recommending and assisting in securing additional coverage.

Identifying and prioritizing financial goals are important parts of the planning process.  Often there are conflicting goals (e.g., saving for their children’s college education and saving for their own retirement).  Paying for college can sometimes be accomplished in part through the use of a tax-advantaged Sec. 529 Plan, named after a section in the Internal Revenue Code, and financial aid packages offered through government programs and the colleges or universities.  Student and parent loans are additional options.  Parents need to be educated about their options and reminded that they can borrow for their children’s education but not for their retirement.

Saving for retirement can be accomplished in part through tax-deferred retirement plans offered by employers, tax-deferred retirement plans available to the self-employed, individual retirement accounts (IRAs) and deferred annuities.  These plans work best through continuous savings (e.g., payroll deductions, checking account drafts, etc.) over long periods of time.  I have set up qualified retirement plans for small businesses and individuals tailored to their budgets.

Managing debt is often a critical factor in getting one’s financial house in order.  Refinancing a mortgage or home equity line of credit can reduce borrowing costs and often be a source of additional cash.  Reducing or eliminating credit card debt can result in substantial savings that can be directed to achieving other financial goals.

I sometimes find that people are paying too much in taxes.  Most of us work hard for our money and should not be sending more of it to the IRS than what is legally required.  By reviewing recent tax returns it is often possible to find opportunities for savings.  Sometimes the review will result in filing an amended return (or returns) and claiming a refund for taxes paid in prior years.

Finally, having a will and reviewing it periodically is an important part of having your financial house in order.  A living will along with a durable power of attorney should be part of your documents.  Be sure to name a guardian for minor children.  It is also a good idea to review your beneficiary designations on life insurance policies, annuity contracts, and retirement plans to insure that they are current.  Having an ex-spouse or a deceased relative listed as a beneficiary can cause major problems.

Remember, it is never too late to get your financial house in order and now is a great time to start.

Do You Need a Second Opinion?

It has become customary to obtain a second opinion when an individual is diagnosed with a serious medical condition or advised to have invasive surgery.  A second opinion from a reputable contractor can also be useful if you are contemplating a major home improvement project.  There is another example where a second opinion can be helpful, and that is in the financial services area.  Suppose you work with a financial advisor who you have been using for several years to help manage your investments and/or provide financial planning services, but you are not sure if you are receiving the quality of service you have been paying for.  Worse yet, you may not be sure how much your advisor is costing you.  For these and other reasons enumerated below it may be beneficial to request a second opinion from an independent financial professional.

A second opinion can help you determine if you are receiving sufficient value from your advisor for what you are paying by:

·       determining if all fees are being properly disclosed to you as some fees may be hidden (e.g., commissions on certain financial products, investment expenses deducted from your accounts, referral fees, etc.)

·       advising you whether your investments are appropriate for your risk tolerance, age and financial situation

·       asking you specific questions (e.g., accessibility of your advisor, is he or she meeting your investment objectives, and frequency of reviews)

·       pointing out areas that should be discussed with your advisor

·       providing you with specific recommendations that you may wish to share with your advisor

The fee for a second opinion should be based on the time expended on the engagement at the financial professional’s hourly rate.  The independent advisor will need to know the specific services your advisor is providing, and will ask you for financial information and records such as tax returns for the last two years, brokerage statements and other relevant financial data (e.g., retirement plan and annuity statements).  This will enable the independent advisor to better understand your financial situation and provide an estimate of the fee to you.

The second opinion should tell you if your advisor is doing a good job for you and is being reasonably compensated for his or her services.  It is often the case that you will decide to stay with your advisor, but you will be armed with recommendations and suggestions that will enable him or her to do a better job for you.  If the second opinion shows that the advisor is not giving you sufficient value it may be time to change advisors.

Don't Let the Economy Steal Your Retirement (Part II)

Part I of this posting focused on the plight of small business owners in their 60s and 70s adversely affected by the economy, and unable to retire.  They feel forced to hang on for a recovery that is taking too long because they are unable to sell their business for what they believe it is worth.  Funding their retirement was predicated on realizing sufficient funds from the sale of the business.  Now they feel they either have to delay retirement or keep working indefinitely.

Here are some suggestions that may help you if you are one of these individuals or know someone in this situation:

·       Consider a phased retirement

·       Accept that you may not sell your business for the price that you think it is worth.

·       Structure the sale to make it more attractive to the buyer.

·       Be flexible and offer creative financing by leveraging the business profits to help make the sale and get closer to your target price.

Let’s say you are 61 years old and your goal was to retire at 62.  You have a catering business that you believe was worth $1 million three years ago, but now may be worth only $750,000.  You had planned to sell it for $1.1 million because that is what you believed you needed for a comfortable retirement.  You received an unsolicited offer from an informed prospective buyer earlier this year for $500,000.  You laughed and told her she must be joking.  But by structuring the sale and leveraging the business profits you may be able to realize close to your goal of $1.1 million.  Perhaps the buyer’s offer assumed that you would no longer be involved in the business, and some loss of customers would occur due to your absence.   

Consider this scenario:  Instead of brushing her offer aside you tell her that her offer is well below what you would take, but there are some options for making such a deal.  First, and most importantly you are willing to stay on for a temporary period.  This would assist her in the transition and help to minimize the loss of any customers.  You would make her a counter offer asking her to pay you the sum of $250,000 for 25% of the business.  You would receive a salary of $100,000 for the next three years with an agreement requiring you to work 30 hours per week instead of the 60 or so that you have been working.  At the end of three years assuming that certain revenue and profit goals had been achieved, she would pay you $300,000 and you would receive a consulting contract with a non-compete clause for three more years paying you $50,000 per year.  At that point you would transfer the remainder of the company to her.  In summary your deal would be as follows:

       

        Payment for 25% of the company at contract signing…………... .……..$  250,000

        Salary for three years at $100,000 per year................................................300,000

        Second payment at the end of three years……….......................................300,000

        Three-year consulting/non-compete contract at $50,000 per year………..150,000

                                                Total                                                               $1,000,000

 

The buyer’s cash outlay would be $550,000 or 10% more than her offer with only $250,000 payable up front and three years to pay the balance.  The remaining $450,000 would be paid from the business earnings over a period of six years.  An additional benefit from this arrangement would be a phased retirement by the business owner which can often be helpful to new retirees.

Should the revenue and profit goals not be met the deal can be modified or possibly continued for two more years depending upon the wishes of the parties.  This is one example of structured deal-making that would allow the business owner to retire at 65 and receive an additional $50,000 per year until age 68, allowing more time to accumulate the necessary funds for his retirement. 

Other variations of this example may also work and often can be uncovered through continuing negotiations.  Installment buy-outs can often save the seller taxes depending upon the specifics of the sale.  Taxes should always be taken into account as it is the after-tax proceeds from the sale that will help pay for the seller’s retirement.  Always have your tax advisor review the proposed transaction.

*      *       *      

Business owners should aim to save for retirement outside of the business since they can never be sure of what the business will fetch when they are ready to retire.  One of the best ways to do this is through the use of a tax advantaged retirement plan for the business owner and his employees.  In many cases retirement plans can be designed to benefit owners and key employees without violating IRS non-discrimination rules.

Don't Let the Economy Steal Your Retirement (Part I)

The Wall Street Journal recently published an article entitled “The Economy Stole My Retirement”.  The article was based on an August survey of 799 small business owners conducted by the Journal and Vistage International, an executive-mentoring organization.  Nearly half of the business owners expect to retire after age 65, with 38% saying that their planned retirement date is later than they had predicted five years ago.  In addition, 56% said most of their retirement nest egg is tied to their business.

The recession has hurt many small businesses by negatively impacting their earnings.  Reduced earnings lower the value of the business and can reduce or eliminate contributions to retirement plans.   Many small business owners planned to sell their business to help fund their retirement.  Now they are discovering that their businesses are worth less than they were three years ago and there are fewer buyers.  In the first half of this year 3,332 small businesses exchanged ownership, down 40% from the first half of 2008.  The article cited specific examples of small business owners who are now in their 60s and 70s and find themselves in “business purgatory”, unable to retire and forced to hang on for a recovery that is taking too long.  Others have made the mistake of looking at their business as the principal component of their retirement nest egg.  These folks failed to heed one of the basic principles of investing, which is to diversify your investments.   Making the assumption the proceeds from the sale of your business will be sufficient to fund your retirement can be a risky strategy since the business may not be worth what you think it will bring (especially now), and your business may be worth less when you are no longer involved.

Before you conclude that delaying retirement or not retiring at all may be the only options available, you may be surprised to learn that there may be better alternatives.  First, understand that you are not likely to sell it for what you think it is worth in today’s market.  Second, by structuring the sale of your business in a manner that makes it more attractive to the prospective buyer you may be able to facilitate your retirement and even get closer to your price. 

Part II of this posting will offer several suggestions and an example of a structured sale for those business owners that are interested in selling their business, but cannot wait for the economy to recover.

Did You Invest in Facebook?

Perhaps you did or maybe you elected to take a wait and see approach.  It doesn’t matter as there are lessons to be learned regardless of which group you are in.  You probably lost money if you are in the first group and have sold your shares.  There is a possibility that you may recover all or part of your loss if you can prove that your trades were not executed in accordance with your wishes.   Investigations are likely to go on for some time until we learn how the opening day fiasco will be resolved.  If you are in the second group and remained on the sidelines, you can wait it out and purchase shares on the open market whenever you choose or never purchase shares in Facebook. 

Shares of Facebook were hovering around the $28.00 mark, $10.00 below the offering price when I posted this blog.  Some of you are probably kicking yourself and moaning, “If I only knew, I would have waited”.

What about the lessons referred to above, lessons that may make us smarter investors?  First, it should be recognized that there was a huge amount of anticipation and emotion regarding this IPO.  Most of this stems from the fact that there are in the neighborhood of 900 million Facebook users.  That is a humongous number of users for one social networking platform.  Secondly, we know that Facebook’s primary source of revenue is from advertisers.  I don’t know the number of advertisers on Facebook, but it is safe to say that it is nowhere near 900 million.  In the interest of full disclosure I do not have a Facebook page much to the displeasure of my son and daughter-in-law who have been applying much pressure to get me on the social network.  As part of my fact checking I called my son to ask him several questions about Facebook.  He has been on Facebook for some time and on one occasion took great pride in showing me his farm.  My first question to him was did he have to pay any money for his Facebook page.  His reply was negative and he quickly responded with “If I had to pay do you think I would be on it?”  My next question was whether any of his Facebook activities require him to pay money to Facebook.  He assured me that nothing he does on Facebook requires the payment of money, use of a credit card, etc. 

The 900 million mostly non-paying users do not translate directly into a Facebook revenue stream.  I recognize they can be a great target for advertisers, but we heard shortly before the IPO that General Motors was pulling their $10 million worth of advertising from Facebook due to difficulty measuring the effectiveness of their advertising.  If a sophisticated advertiser like GM could not determine the number of cars sold from advertising on Facebook how will other advertisers measure their advertising effectiveness on this platform?

In my more than 40 years of business experience I learned that successful companies require a sound business model.  In my opinion much of the euphoria over Facebook was not based so much on its business model or its future earnings prospects, but was attributable to the 900 million Facebook users.  I also have experience in valuing businesses and have given expert witness testimony on this subject.  Shortly before the Facebook IPO I was listening to analysts on CNBC attempting to justify Facebook's pre-IPO value of nearly $100 billion.  One analyst stated that by valuing Facebook’s 900 million users at $100 each results in a value of $90 billion.  The problem is that Facebook does not earn $100 per user.  Facebook’s total revenue per user is currently about $4.50.  To place this in context CNBC stated that Netflix earns on average $150 a year per subscriber for their video rental business.  Using this metric to value Netflix would give it a value of $3.5 billion based on 23.3 million subscribers.  At Netflix’s recent stock quotation of $63.42, its value is approximately $3.5 billion compared to a value of $63 billion for Facebook at $28 per share.  Finally, Netflix is currently trading at a price of 21.5 times earnings while Facebook is trading at 69 times earnings.  This is a very high multiple and Facebook will have to demonstrate that it can justify such a value.

No one knows what the future holds for Facebook.  The company has a strong balance sheet and is flush with cash and could get into new businesses (e.g., smart phones), make acquisitions and make changes to their business model.  Getting in at $38, $42 or $28 a share could prove to be a great deal or a real turkey….only time will tell.

How to Reduce Interest Costs and Pay Off Your Mortgage Faster

Here is a money saving idea that is worth considering.   Do you have a fixed interest 30-year term mortgage as many people do?  Perhaps the low interest rate environment enticed you to refinance, but you were declined because of credit issues, high closing costs or the numbers just did not seem to make it worthwhile.  There may be another alternative for you that will save you interest and pay off your mortgage sooner.  By increasing your monthly mortgage payment by a modest amount you may be able to save a significant amount of interest and pay off your mortgage years sooner.  Here is an example.

Let’s say you purchased your home ten years ago and borrowed $100,000 using a fixed rate 30-year mortgage at 6.5 percent interest.  Your monthly payments are $632, and your current balance on the mortgage is $84,776.  You have been making payments for ten years and you have twenty years remaining on the mortgage.  You will pay an additional $66,920 in interest costs if you continue to make the same monthly payments over the remaining life of the mortgage.  By increasing your monthly payment by approximately $100 at the beginning of the eleventh year, you will pay off your mortgage five years earlier and save $18,768 in interest.

I refer to this strategy as downsizing your mortgage.  In the above example we downsized the mortgage from 30 years to 25 years.  You can choose the term that works best for you.  The shorter the term the more interest you will save, however, the monthly payment will be higher.  On a fixed term mortgage you are generally locked into the interest rate over the entire term, but in most cases you can accelerate the term.  In the above example the borrower will pay total interest of $127,544 over the 30-year term if he continues to pay the same monthly payment over the entire 30 years for a total payment of $227,544 on a $100,000 mortgage!

Be sure to check your mortgage document for any prepayment penalties as this would have to be factored into the calculation.  Increasing the monthly payment is considered a partial prepayment by most lenders.  The good news is that this technique does not involve closing costs, appraisals or new documents that would be required for a refinancing.  You may be able to increase your monthly payment online as some lending institutions offer this capability on their web sites.  If not, check with your lender prior to implementing this technique.  You must be current with your payments before initiating this. 

There is a mortgage calculator on Bankrate.com that is helpful for crunching the numbers.  Bottom line is that even if you do not qualify for a lower interest rate you may be able to significantly reduce your interest costs on your home mortgage.

Unsure How to Profit from the Low Interest Rate Environment?

Interest rates remain at unbelievably low levels and the Fed has stated that they may remain so until late in 2014.  Retirees and others who like to invest in bank CDs and other low risk investments hate this low interest rate environment, and rightly so since they are earning less than the rate of inflation on these investments.  But there are ways that you can profit from today’s low interest rates.

You may have already refinanced your mortgage and may be thinking about doing so again.  If you have not refinanced, now may be a great time to do so as rates on a fixed rate 30-year mortgage can still be had for around 4 percent and even lower on a 15-year term.  But there are some caveats.  Closing costs can be high, ranging from $2,000 - $3,500 and you will need good credit.  You need to do some number crunching, and if you are not comfortable doing this get some help.  One strategy that I like is refinancing from a 30-year to a 15-year term.  This can work well if you have built up some equity (have made eight to ten years of payments).  You can get a slightly lower rate on a 15-year term and often the monthly payments will be only slightly more than your current payments.  The benefit is the savings in interest costs from reducing the term to 15 years and the lower interest rate.  Also, be sure to calculate the time required to recover your closing costs.

Another way of benefiting from the lower interest rate environment is reducing or eliminating other indebtedness, specifically high interest credit card debt.  Credit card interest rates range from approximately 12 to 24 percent.  In my opinion no one should be paying this level of interest today, but many are.  Are you having deductions made from your pay checks for your 401(k) plan, credit union or other savings plan?  Consider stopping these deductions at least temporarily and using the money to pay down credit card debt.  One exception, to this suggestion is to continue 401(k) contributions if there are matching employer funds.  This is “free” money, but once you have received the maximum stop contributing and use the funds to pay down credit card indebtedness.

Take a look at any outstanding loans you may have with variable interest rates.  Most home equity credit lines have variable interest rates that are tied to published rates such as prime, Libor or the bank’s lending rate to its’ best customers.  Rates on bank home equity credit lines are likely to be quite low now (mine is currently 2.5 percent).   Look at your home equity credit line indebtedness with the goal of reducing it while rates are low.  It will be more difficult to pay down principal when interest rates begin climbing.  I am not sure that these low rates will last until 2014 given our country’s current level of debt and the Congress’ difficulty in cutting spending.

An Educated Investor

Some of you may remember the tag line used by Si Syms, founder of Syms’ chain of retail clothing stores:  “An educated consumer is our best customer.”

Syms sold brand name clothing for men and women at discounted prices and used the tag line in his radio and television advertising.  Si Syms was correct about his best customers since they had to know the brands well enough to know how good his prices were.   Syms filed for bankruptcy and is no longer in business, a likely victim of the retailing onslaught by Walmart, Kohls and Target.  Syms was quite successful before the big guys came along and much of their success was due to their advertising about the educated consumer.

How does this relate to the world of investments and finance?  I have often said that an educated client is a good client.  An educated client is one who is financially literate and knows the difference between stocks, bonds, mutual funds and ETFs.  He or she is not an expert or professional; if they were they would not need my services.  The facts are many people are not as financially literate as they should be.  This is not necessarily their fault as most people have had no formal training in personal finance or investments.

We can categorize investors into two groups.  The first manage their investments on their own, and the second are those who work with a professional.  We will find educated investors in both groups, and conversely, non-educated investors in both groups.  You may wonder how a non-educated investor can manage investments on their own.  Keep in mind that when I refer to a non-educated investor I do not mean an uneducated person, but rather someone who may not be as financially literate as they should or may not know much about investments.   Many employee participants in their employers’ 401(k) plans are responsible for making investment decisions regarding their 401(k) accounts but are uncomfortable doing this.  They often make bad decisions resulting from lack of investment knowledge.

As a financial advisor I have a responsibility to make sure my clients understand the recommendations that I make to them regarding their financial plan.  I am responsible for educating them about recommendations I make either about a strategy, financial product or solution to their financial problem.  I cannot charge them for all of my time spent educating them since this could make my fee prohibitive.  This relates to my earlier statement that we sometimes find non-educated individuals who work with advisors.  I am not speaking about them when they first seek the advice of a professional, but even after they have been working with a financial advisor after a number of years.  This results from advisors who do not adequately educate their clients because they are unable to charge for their time, or do not believe it is part of their job.
 
As a tax practitioner I have witnessed too many instances of individuals purchasing insurance products or making investments that were not appropriate for them based upon the advice of so-called financial advisors.  It is imperative that financial professionals educate their clients to fully understand their recommendations and/or solutions so that the client will not be underserved.

Is your advisor educating you?

New Year's Financial Resolutions

So, you have resolved to lose weight or quit smoking in 2012.  Good for you.  Have you thought about making some financial New Year’s resolutions?  If not, here are some suggestions to help you get started:

1.     Spend less and save more.

2.     Increase your contributions to your 401(k), IRA or other retirement plan in 2012 (this will help you with number 1).  Here is a hint to help you…..contribute the two percent savings in the Social Security Tax for 2012 to your plan (you won’t miss it).

3.     Reduce or eliminate credit card debt.

4.     Write down your financial goals and refer to them often.

5.     Review your investments and re-balance if necessary.

Be sure to see how well you did next year at this time.  Give yourself a pat on the back if you succeeded in accomplishing all of them.  Don’t be too discouraged if you succeeded with more than half of them.  Start a new list for 2013 and include the ones you did not achieve from 2012.  If you failed at all of them seek professional help.  Enroll in a weight loss and/or smoking cessation clinic and meet with a financial advisor for a consultation.

One last thing, if you do not have a will, get one made.  You should not be caught dead without one.