Cash is King

You have probably heard the old adage that cash is king.  This is true whether you are running your own business, managing your household finances, or are an investor on the lookout for attractive investment opportunities.  If you are a business owner you need sufficient cash to meet payroll obligations, buy merchandise for resale, purchase raw materials for manufacturing, and meet your expenses.  If you manage your household finances you need cash to pay your bills, save or invest for your children’s education and your own retirement.  You need cash for discretionary expenses such as vacations and entertainment.   Finally, you need cash to take care of emergencies like home and auto repairs and unanticipated medical bills.

For many of us cash is what we have left after receiving a paycheck and paying our bills or worse yet we have no cash left.  Do any of the following apply to you?

·       You have credit card balances carrying high interest rates 

·       You are making the minimum monthly credit card payment rather than paying off the balance each month and avoiding exorbitant interest charges.  

·       You are robbing Peter to pay Paul. 

·       You do not have an emergency cash fund available to cover expenses if you are laid off or can’t work. 

You are probably not managing your cash flow if any of these describe you.

Here are 6 tips to help you better manage cash flow:

1.     Learn where your money is going by tracking your expenses for the last 12 months.  Use this data to create a budget for the next 12 months.  A 12-month period is useful since some expenses are not incurred monthly, but occur quarterly, semi-annually or annually.

2.     Consider refinancing your mortgage (interest rates remain low) and consolidating high interest credit card debt.  Managing your debt is an important element of cash flow.

3.     Build an emergency fund with three to six months of living expenses.  This is a rule of thumb and depends upon factors like job security, whether your family is a two income family, or has other resources available such as a line of credit.

4.     Pay yourself first even if you have to start with a small amount.  Make it a habit.

5.     Check your income tax withholdings.  Getting a big tax refund after you file your tax return is no way to save money.  Uncle Sam does not pay you interest so why make an interest-free loan to him?

6.     Seek help from a financial planner if necessary.  The planner can often find solutions to increase your cash flow that you would have never thought of, and develop strategies to give you financial peace of mind.  Be sure to check out my blog post, “Why a CPA Financial Planner” (2/14/13).

Gaining control over your cash flow is one of the most important steps in financial planning.

Detroit Bankruptcy, Pensions and Taxpayers

Bankruptcies are never a good thing.  Creditors, employees, investors, and sometimes the public can suffer losses.  There is often plenty of blame to go around with much finger pointing, and Detroit’s bankruptcy is no exception.  Will Detroit signal the beginning of more major U.S. cities to file for bankruptcy under Chapter 9 of the federal law that governs municipal bankruptcies?  No one can say for certain at this time.   However, there is a common thread that Detroit shares with many other state and local governments, and that is the problem of unfunded and underfunded employee pension obligations.

Unlike the private sector where many defined benefit pension plans have been terminated or frozen, this has not been the case in the public sector.  Many private sector employers have recognized that guaranteeing employees’ retirement benefits can be unsustainable, and have shifted to defined contribution retirement plans where the burden of providing retirement benefits falls primarily on the employee.  The employer’s responsibility is primarily for the administration of the plan without guaranteeing the amount of the benefit.  An example of a defined contribution retirement plan is a 401(k) plan.  An employee’s retirement benefit under a 401(k) plan is determined by whatever amount of money is in the account when he or she retires.  Not so a pension which may be payable over the employee’s remaining lifetime or in a lump sum upon retirement which is the actuarial equivalent.  A shift to defined contribution plans in the public sector has not occurred, at least in any significance.  There are several reasons for this, most notably collective bargaining agreements and the ability of state and local governments to levy taxes.

Already, unions representing Detroit municipal employees are going to court trying to convince the bankruptcy court that employee pensions must be honored since they are written promises made under contract.  Should they win this argument this will be at the loss of creditors, investors, and Detroit taxpayers.  Assets held in trust for Detroit’s general retirement system benefits were approximately $2.16 billion at June 30, 2012.  This belongs to the employees and not subject to restructuring.  It is only the unfunded portion of the pension (estimated to be $1 to $3 billion) that is subject to restructuring.  How this is done may determine how other state and local governments proceed to deal with their underfunded pension plans.

The Pension Benefit Guaranty Corporation (PBGC), a government agency insuring pension plans in the private sector and funded with premiums from employers who sponsor pension plans, provide retirement benefits to those whose companies have gone out of business.  However, the PBGC provides benefits up to a fixed amount and does not guarantee full benefits to retirees.  The PBGC does not cover public sector plans and therefore, taxpayers may become the insurers of last resort.

It is time that public sector employers with underfunded plans think seriously about moving to defined contribution plans and terminating or freezing their defined benefit pension plans.    

The Benefits of a Post-Filing Review of Your Income Tax Return

The tax return contains a wealth of information that can be used to maximize tax savings, make better investment decisions, develop strategies to cope with the wave of recent tax changes, and assist in wealth transfer to the next generation. 

The benefits of a post-filing review include:

·       Identifying strategies for minimizing taxes relevant to the particular circumstances of the taxpayer,

·       Analyzing the effects that additional taxes have on investment and compensation strategies such as the new Medicare tax on excess earned income and the new 3.8 percent tax on net investment income beginning this year,

·       Explaining the criteria that must be considered in determining when a taxpayer should begin taking Social Security benefits,

·       Pointing out alternatives to paying estimated taxes that may help to avoid penalties,

·       Identifying the considerations for establishing a Roth IRA, converting a traditional IRA to a Roth or a 401(k) to a Roth 401(k), and

·       Spotting errors or omissions which can result in additional tax savings due to missed deductions or credits.

Look at the total tax paid on last year’s tax return.  If you think it is more than you should be paying or have concerns about next year’s taxes have a qualified tax professional review your return.  Unfortunately, many professional tax preparers are happy to make it through tax season, and planning, if any, is delayed until they meet with clients prior to or during next year’s filing season. Taxpayers who prepare their own returns (at their own risk) are usually focused on filing their return, and are unlikely to meet with a professional who could perform a post-filing review of their tax return for planning purposes. 

As part of my financial check-up (see www.wmtfinancialservices.com) I ask clients for their tax returns for the prior two years.  A post-filing review of tax returns can result in savings and planning opportunities that are often well worth the reviewer’s fee.

The Case for Mutual Funds (and low-cost ETFs)

Do you own individual stocks?  Maybe you should, but maybe not.  It may depend on what type an investor you are.  You need to own stocks if you are a day trader since without stocks you are unlikely to have much if anything to trade.  This posting is not directed to day traders, but to investors who are interested in achieving longer term financial goals such as paying for children’s college, saving for retirement or buying a first home.  People in this category should not be day trading, but investing for the longer term.  I don’t consider day traders investors, but more like gamblers.

Long-term investors are folks likely to invest for at least five years or longer, consistent with the amount of time required for achieving their financial goals.  These people should not generally own individual stocks for the following reasons:

1.     They can never know as much about individual companies as do insiders (officers, directors, employees and consultants).

2.     Sound investing means being diversified and unless you own 20 to 25 different stocks you will not be well diversified.  Even then you run the risk of not being sufficiently diversified since companies change their business model, products and services from time to time.

3.     Owning individual stocks requires continuous research and tracking performance to know when to sell, or buy more.  This requires a substantial amount of time that most people will not devote unless they are professional investment advisors.

4.     Low cost no load mutual funds make diversification easier, can provide access to professional investment managers who do the research for you, track their holdings and often have access to companies’ management.

5.     Low cost index funds and ETFs (exchange traded funds) facilitate diversification at very low cost by replicating various market indices and segments.

I often hear, “Bill, I agree with your reasons, but are you telling me I should never own at least one stock”?  Not necessarily, but let me give you an example and some caveats.  We all are familiar with Apple and the Steve Jobs story.  During the last 12 months Apple stock reached a high of around $700 a share.  More recently Apple was trading at around $400.  That is a decline of more than 40 percent.  Many people were buying Apple on the way up or near the top, and now own a stock worth 40 percent less.  Worse yet, if they have to sell or have already sold Apple stock they will incur or already incurred a substantial loss.  I happen to believe that Apple is a terrific company, but no one likes seeing their investment decline by 40 percent.  My guess is that Apple was overvalued at $700 and probably undervalued at $400.  Investors who own Apple shares through mutual funds or ETFs are less susceptible to huge swings like this since other holdings in the fund tend to offset.

 Some caveats if you must invest in individual stocks are:

·       Maintain a separate pool of money that is not earmarked for any specific goal (think slush fund) for this purpose.

·       Do the research and monitor these holdings at least quarterly.

·       Do not try to time the market

·       Do not buy any stock you plan on holding less than one year since that is the holding period for taxing capital gains at the lower capital gains tax rate.

·       If someone tells you about a “hot” stock, wait until it cools off prior to buying it.

Feel free to add your comments to this posting.

Dow Reaches New All-Time High…So What

The Dow recently hit a new high, but what does this mean to the average investor.  An investor is likely to see many new highs along with occasional market declines often referred to as corrections over many years.  However, the general trend of the market over the long-term has been higher.  The intelligent investor will not experience euphoria when the Dow achieves a record high, but will continue to maintain a diversified portfolio and invest in accordance with his or her financial goals.  Nor will the investor panic and move out of equities when the market incurs a 10 or 20 percent decline. 

Does this mean that investors should ignore current economic conditions?  Not at all, but it does not mean taking drastic measures like moving in and out of equities as a reaction to market highs and lows, a recipe for buying high and selling low.

We must face facts that tell us our government cannot sustain the current fiscal course that it is on. Our deficit is approaching $17 trillion of which $6 trillion has been added in the last four years. Entitlement programs (Medicare, Medicaid and Social Security) need revision and placed on a sustainable basis for the future.  The Affordable Care Act is now estimated to cost three times as much as when it was enacted by Congress.  Our economy is barely growing and unemployment remains close to 8 percent.  The Federal Reserve is keeping interest rates at artificial lows and is buying $85 billion of U.S. debt per month, effectively printing money.  This has in part led to the new highs in the stock market.  As a long-time student of economics I know that this cannot continue.  Look at what has been happening to some of the European countries, like Greece, Spain, Italy and now Cypress.  These countries with huge social welfare programs have long been spending more than they could afford and are now paying a steep price.

Where do we go from here?  We must continue to save and invest to reach our financial goals and hope that our government changes fiscal course before it is too late.  As a long-term investor and a student of economics I can share with you what I have learned from history which I use as a guide in helping me make decisions regarding money management and investing. 

I stress defensive portfolios not only for tough economic times, but for all the time since we cannot predict with accuracy when tough times will occur.  Defensive portfolios are low cost, diversified portfolios designed to protect against market declines, recessions, high inflation and bad news.  They tend to be risk adjusted but not risk free.  Diversification and low cost are key components of defensive portfolios.  You will find low cost index funds and Exchange Traded Funds (ETFs) in a defensive portfolio.  A defensive portfolio will not produce the high returns we see in a booming stock market, but will help mitigate the sharp losses often experienced in a declining market.

You can begin making your portfolio more defensive by looking at your investment expenses as a percentage of your portfolio.  Average investment expense should be in the range of one-half to one and a quarter percent.  Investment expenses include mutual fund and ETF expenses and fees charged by an advisor if applicable.  Frequent trading of securities can result in excessive commissions.  As a long-term investor you should not be engaging in frequent trading.  Remember, the lower your investment expenses the greater your investment return.

Finally, invest regularly if you can to benefit from dollar cost averaging.  By investing a fixed sum monthly or quarterly in your employer’s 401(k), IRA or other retirement plan you will be accumulating more shares when prices are lower.  Disciplined regular investing will have a greater impact on your long-term wealth accumulation than investment returns.

Paying for College in Tough Economic Times

You are a parent with kids and would like them to attend college.  Have you thought about how you will pay for it?  No need to panic as there are a number of options available to you.  We are currently seeing more transparency from colleges and universities concerning their finances, and increased government pressure on them to better control costs should help facilitate the process.

A couple of ground rules for your consideration:

1.     Be involved in the selection process with your child.  Getting “more bang for your buck” is becoming an important criterion in the selection process.  Colleges and universities are coming under more pressure to disclose cost/benefit relationships for their schools.  Outcomes in terms of starting salaries for recent graduates as well as other metrics to make comparisons across schools easier for parents are becoming more widespread.

2.     File for financial aid even if you think your family may not be eligible.  You may be leaving money on the table by not filing.  It is not unusual for families with six-figure income to receive some form of financial aid for a variety of reasons (e.g., multiple kids in school at the same time, dependent parents, and special needs children, etc.).  Private schools tend to be more generous with their aid packages making them somewhat competitive with public schools.  Also, file each year the student is in school. 

3.     Your child’s major or chosen field of study should have some relationship to an occupation where they can earn sufficient income after graduation, and no longer be dependent upon you.

4.     Have your son or daughter buy into sharing in the cost of their education.  They can do this by working part-time while in school, or through student loans or a combination of both.  This rule may be the most important, and parents should be receptive to it and be able to explain the benefits to their children.  Care should be taken to insure that they will not amass more debt than they can reasonably expect to handle after graduation.  Having skin in the game is not a guarantee, but it can go a long way in achieving successful college outcomes.

Two excellent web sites for helping to finance college are www.finaid.org., and www.savingforcollege.com.  These sites provide detailed information for applying for financial aid, scholarship availability and Sec. 529 plan information for tax-free college saving.

I am often asked by parents, if they should borrow from their 401(k) to help pay for college.  This is not a good idea for several reasons.  There are many options available for borrowing for college, but borrowing to pay for retirement is not an option,  Also, a 401(k) loan can turn into a taxable distribution if your employment is terminated, and subject to a 10 percent tax penalty if you are under age 59 ½.  I once worked at the same company where a father of three borrowed from his 401(k) to help pay for the kids’ college education.  The last I heard the kids all made it through college and were doing fine, but dad was still working.  He expects to continue working indefinitely, or until all three children begin supporting him if he lives long enough.    

Why a CPA Financial Planner

CPAs who provide personal financial planning services are able to combine their financial savvy and professional integrity in developing the creative planning strategies you need for financial peace of mind.

A good CPA financial planner will review your entire financial life, including your current investments, insurance policies and employment benefits.  The planner can help you budget, manage debt, plan for both death and taxes and find the right insurance, as well as help you with your investments.  This individual may manage money for you, or makes recommendations for you to carry out.

The CPA financial planner will be acting as a fiduciary by putting your interests first, disclosing any conflicts of interests that may affect his or her decisions, and how the planner will be compensated, typically by fee based on time spent on the engagement.

Know that all financial advisors are not financial planners as this term is often widely used by stock brokers, insurance salespersons and others.  Not all CPAs are financial planners, most are not.  Only CPAs who have specialized training and planning experience can call themselves CPA financial planners.  The American Institute of CPAs grants the designation of Personal Financial Specialist (PFS) to those CPAs demonstrating their knowledge and expertise in personal financial planning, who earn this designation by having specific experience, education and fulfill an examination requirement.

Most importantly, a good financial planner will not be trying to sell you a financial product where he or she will be earning a commission.   It is possible that a planning engagement may disclose the need for a specific product (e.g., additional life insurance), but should never be the focus of the engagement.

I provide financial planning services for individuals and business owners.  My services are outlined in a written engagement letter, along with my responsibilities as well as the client’s, and my fee.  There is no charge for an initial consultation.