Leveraging Your Financial Intelligence Read online

  KEY ELEMENTS OF THE SMART MONEY PHILOSOPHY

  The Smart Money Philosophy offers a clear and simple framework for making financially smart decisions. The Smart Money Philosophy includes a step-by-step process for financial planning that you can use on your own or with the support of a financial advisor. Although applying the Smart Money Philosophy can involve the use of complex financial instruments, it does not require them. It will help you figure out basic strategies such as diversifying your investments and how to use financial products such as insurance. It guides you about what to do—or not do—when you need money. You can make your plan as complicated as your circumstances warrant, but the beauty of the Smart Money Philosophy is that you don't need to get involved in sophisticated investments or complicated wheeling-and-dealing to achieve and enjoy financial independence. The Smart Money Philosophy will help you put in place a powerful financial plan that includes three key elements: saving money, diversifying your assets, and managing uncertainty risks. That said, our experience has been that you can get the best results from using the Smart Money Philosophy if you enlist the support of a values-based financial advisor. We recommend you hire the right type of financial advisor to help you apply the Smart Money Philosophy. Such an advisor is not interested in directing you to investment products that maximize his or her profits. The right advisor for you is one who seeks to deeply understand and support your values and goals. The right advisor for you goes even beyond that. He or she encourages you on a continuous basis to keep engaged in key activities for financial, physical, and emotional goals you've prioritized. Though Donna Krone, whom you met in Chapter 3, left her 18-year practice as an AEFA financial advisor to pursue her passion to be a life coach, she and her husband greatly value the support their financial advisor provides, no more so than when Donna's husband recently began to contemplate retirement. As Donna said:

  We just had our financial planner come out to the house to help us plan for my husband's upcoming retirement. He asked a lot of questions about our values and goals, and really listened. I was so impressed with him. Usually when financial advisors ask questions about values and goals, it's to help them translate that information into the financial analysis. With our advisor, it was clear that he was asking about our plans, values, and goals because he was genuinely interested and wanted us to achieve our dreams.

  Dennis and Diane Dykema, now happily retired, began their married life together in Iowa with very limited resources. Dennis became a college professor at Buena Vista College.6 Diane was a real estate agent for four years, and after that worked at Buena Vista College as an administrator. In the early years of their marriage, Dennis and Diane could never have imagined enjoying the financial security they treasure today. They credit their financial advisor with helping them develop a financial plan that incorporated Smart Money Philosophy principles. One of the best outcomes of their work with their advisor was ultimately to be able to buy a second home on fabled Sanibel Island off the Gulf coast of Florida. Their Sanibel Island home offers them and their family members extended periods of time when they can engage in outdoor fitness activities that contribute to their health and well-being. Following their financial plan over many years has also given Dennis and Diane the flexibility to provide financial help to children and grandchildren when needed.

  Recognize That You Must Save Money

  If you want to be certain you'll have enough money, you must save. You must save money to have money. There is no escaping that fundamental rule of the Smart Money Philosophy. You can never know with certainty that you won't need money. Therefore, there are no shortcuts to saving. If there is one lesson learned from the Great Recession that exploded in 2008–2009, it is this: You cannot rely on credit cards or home equity as sources of cash to make desired purchases. Before the housing bubble began to burst in 2006, many people mistakenly thought that they didn't have to save. Real estate values kept rising, and banks were often aggressive about offering home equity lines of credit (HELOCs) that made it easy for people to turn their home equity into cash. Then home property values deflated. Seven million Americans lost their homes to foreclosure during the Great Recession, and fewer than one-third of them are likely to ever buy a home again. As of the end of 2016, five million Americans—more than 10 percent of homeowners—still owed more on their homes than they are worth. Half of those held mortgages at least 20 percent more than their homes are worth.7 A generation ago, people knew they had to save money and that they needed to keep on saving money, no matter their age. For example, Doug's dad grew up during the Great Depression. When he died in 2009 at age 84, he was still saving money. No matter what, find a way to spend less than you earn, so you can put money aside for future needs.

  In addition to cultivating the habit of saving money yourself, make a point of encouraging children to save, even at a very young age. Erin and Doug Livermore have taught their five- and eight-year-old daughters to save at least half of the money received from doting grandparents and the cash they get from doing extra chores around the house. When five-year-old Addison broke the screen on her iPad, she had a smart place to go to pay for the repair—her piggy bank. As you can see, the Livermores are also teaching their kids the principle of responsibility. Making sure that teenagers learn how to manage and save money is one of the best gifts you can give them. Young adults can also benefit from their parents' encouragement to save. When Pat McKenna was in his mid-twenties and working as a healthcare administrator in a pediatric medical center, his mother encouraged him to open up an IRA. When Pat checked his IRA account balance only a few years later, he was surprised at how much its value had increased.

  Put Your Investments in a Variety of Financial Instruments

  Develop the discipline of placing your money in varied places, such as cash or cash equivalents i.e., a bank savings account, money market account, and CDs (certificates of deposit). Also diversify by putting some of your money in equity investments, such as stocks or real estate; fixed-income investments (government or corporate bonds); or insurance, such as life insurance, disability insurance, or long-term care insurance. When you establish your investment routines, make sure that the places to which you allocate investments are diversified. Having money in different places ensures that whenever you need money, and for whatever reason, you will have a smart place to get it. That also implies that you should put money away in instruments that have minimal or no risk, such as money market funds. You can also systematically buy government bonds, which are guaranteed by the government that issues them. Even in difficult economic times, it is unlikely that the U.S. government is going to go out of business.

  To invest for retirement, you can also regularly put money into a tax-deferred retirement plan such as a company-sponsored 401(k), an IRA (individual retirement account), or tax-deferred annuity. To prepare for the “certainty” of your children's college expenses, you can also set up special college savings plans (so-called “529 Plans”) that include mutual funds. In addition, you can buy stocks, bonds, or mutual funds outside of any special plan for retirement or college savings.

  When making decisions about how to save and invest your money, avoid the temptation to put all your money in any financial instrument that is currently performing at a high level, for example, a top-performing mutual fund or a real estate investment in a hot market. As we're writing this in June 2017, many people are investing in the latest phenomenon—the digital currency Bitcoin, up more than 200 percent over a period of six months. One bitcoin investment vehicle, the Bitcoin Investment Trust, recently soared 1,600 percent in a single month. Many experts warn that Bitcoin is in a bubble and headed for a correction. Like Newton's apple, “What goes up, must come down.” A high-performing fund this month can crash and burn next month. So, don't put all your eggs in one basket. This advice sounds like a no-brainer, but it bears repeating, since so many people are seduced by the prospect of making a lot of money in a short time.

  Use Insurance to Transfer S
ome of the Risks of Uncertainty to Someone Else

  Many of us make the mistake of “insuring the golden egg but not the income or life of the goose that laid the golden egg.” In most states, you can't drive a car without car insurance. The simple idea everyone understands is that if you have a car accident, the costs of repairing vehicles and treating injuries can be enormous. The government therefore requires that we have a way to pay for those potential costs. But automobile insurance doesn't adequately insure the income or life of the person who drives or is a passenger in the insured car. It's ironic that we don't apply the simple logic of car insurance to other likely life events. Life crises can be massively expensive. That is why insurance is so important. When we buy insurance, we transfer some of the financial risks of uncertainty to others, that is, insurance companies.

  You don't know when you'll get sick or injured and need healthcare, but if you have health insurance, you can greatly reduce uncertainty about how much you would have to pay to get treatment for a major health problem.

  You don't know when you'll die, but you can transfer the financial risk of dying early to a life insurance company, thus providing funds to support your loved ones after your death.

  You don't know if an illness or injury will happen, but you can transfer the risk of being unable to work to an insurance company that offers disability insurance.

  You don't know if a disability will make it impossible to care for yourself, but it's highly likely, since 70 percent of people 65 or older will need some kind of care before death.8 You can transfer the financial risk of needing care (for example, in an assisted living or nursing home) by using long-term care insurance.

  Doug shares this example of what happens when you don't use the Smart Money Philosophy:

  When my mom died, she didn't have life insurance. She was the only working spouse because my dad had previously retired, and her death produced both death expenses and resulted in lost income to the family. When my dad moved into an assisted living facility, he didn't have long-term care insurance, and had to pay for it out of pocket using his investments. Even if you enjoyed excellent returns on your lifetime investments, the costs of long-term care can wipe out your legacy. I was a CFP by the time my parents were getting older, and regret that I didn't help my parents recognize the importance of insurance.

  Doug shares this example about how he used the Smart Money philosophy:

  My son went to college at a time when the stock market had been on an upswing. Because my wife Beth Ann and I had invested in the stock market for years, we had a smart place to go for tuition money. We sold stocks whose value had gone up since we had bought them. When our oldest daughter started college in 2003, our stock investments had been pummeled. Had we sold stocks to pay for her tuition, we would have taken losses. But since we also had access to cash, we had a smart alternative: We paid her tuition in cash. When our younger daughter started college in 2006, stocks were up, so we sold profitable stocks to pay for her first two years of college. By my daughter's junior year, the stock market was dropping precipitously, so we paid her last two years of tuition by drawing on cash savings.

  MAKING YOUR OWN SMART MONEY PLAN

  You already know that you're responsible for your financial well-being and that the best way to prepare for the certainty of uncertainty is to save and invest money. But how do you figure out how much you need to save? Ultimately the answer to that question is up to you. But we recommend that you aim for saving enough to be financially independent. Financial independence is sometimes thought of as freedom from the need to work. However, a more realistic definition is that financial independence is freedom from being financially dependent on anyone else. For some, financial independence can mean that you have enough income from your savings and other assets that you do not have to work, and that that income will come to you for as long as you need it. Another way to understand financial independence is to determine how much you need to “have enough” to align your day-to-day behavior with your values and goals.

  Because you don't know with certainty how long you will need to have income, your plan for saving and accumulating assets ideally will be designed to keep generating adequate income indefinitely. We recognize that not everyone will be able to accomplish this goal. But even the act of setting financial goals, and taking steps to achieve them, will dramatically increase your financial security.

  HOW MUCH DO YOU NEED?

  How much you really need depends on how much income you think you need to support your desired lifestyle. What if someone said, “I will pay you enough money each month so you don't have to work ever again if you don't want to.” How much would that be? For some people, the answer would be more than they make now. For others, it would be the same income they're making from their jobs. Still others would happily take, say, 60 percent of what they earn now if they could quit working—or change their behavior so they can financially support their values and key activities for their goals. Until five years ago, Brenda Blake was a successful, high-powered corporate executive with American Express. Today she is a vibrant yoga practitioner and founder of Livin' Fully, which offers programs that help women accelerate their personal and professional development. As Brenda explains on her website:

  I had made a promise to myself a bunch of years back that I had to do or start something that gave me the flexibility to watch my boys play sports, to give myself at least an hour a day for my Yoga practice, the autonomy to be totally self-directed, and the opportunity to impact something that mattered.9

  So, when Brenda was 40 years old, she decided that she wanted to be able to leave corporate life and have the choice not to work by the time she was 50. Brenda and her husband put together a savings and investment plan that would allow her to do that. Brenda is now “livin' fully” in alignment with her values, and making a difference to the many women whose lives she touches through her organization's unique and powerful workshops and personal coaching. Another benefit of Brenda's current lifestyle is that she now has the freedom to spend four to five months a year in Tamarindo, on Costa Rica's Nicoya Peninsula, one of the five famous “Blue Zones” on Earth where people are healthiest and live the longest.

  How much is enough for you? Do you want or need to replace all the income you are currently making in your job? Do you think you would be happy with less? Do you want more income than you currently make in salary to achieve your goals?

  Saša Mirković immigrated to the United States in 1997 with only a suitcase and $1,400, which he had saved for an engagement ring for his then-fiancée Laura. When Saša told Laura about the money for the ring, Laura said, “I don't want to spend that much on a ring because that's like what it would cost to buy a sofa.” Saša recalls that at that moment, he looked up to the sky and said to himself, “Thank you, God. We're going to be millionaires someday, because we agree about money.” Saša and Laura found a less expensive ring and spent the rest of the money on two air-conditioning units that would get them through a hot and sticky Baltimore summer on the top-floor apartment of a converted townhouse on historic Charles Street. As a young married couple, Laura and Saša followed the Smart Money philosophy, and today they are financially very well off. Part of their secret is that they understand the concept of sufficiency—Saša describes Laura and himself as “delayed gratification people.” They don't have any desire to keep up with the Joneses. They own a modest home in a good neighborhood. The money they don't spend on a McMansion goes to providing meaningful experiences and a healthy lifestyle for themselves and their three children. As Saša says, “To me, money is not a goal. Money and wealth are tools. The total dollar amount you have is irrelevant. It's what you use that money for.”

  SMART MONEY PLANNING GUIDELINES

  Financial Aspirations. Smart money planning works backward. That is, it's helpful to decide how much money you need or want on an annual basis to accomplish your financial and personal goals, as Brenda Blake and her husband and Laura and Saša Mirkovi�
� did.

  Your next step is to begin a systematic savings and investment program based on the following planning framework:

  Life includes two main events: your physical life and your death. Your physical life ends when you die, but your financial life goes on beyond your death. That's because most of us leave behind some expenses, and often loved ones who need our financial support, or to whom we want to leave a financial legacy.

  Health involves being healthy or not healthy. Your health status may or may not affect your ability to work. Your health may affect your ability to generate desired levels of income.

  The economy may be either strong or weak. The strength of the economy can have varied effects on your financial status, depending on the particulars of economic conditions and your life, health, employment, and personal financial assets.

  The Smart Money framework begins by systematically planning for worst-case scenarios related to life, health, and the economy before moving to more desirable life scenarios.

  Smart Money Planning Scenarios

  Death. Most people agree that untimely death is the worst-case scenario, both financially and personally. So, plan for death first. Determine, for instance, how much income or money your loved ones would need if you died suddenly. Then compare that with the income currently being generated by your existing capital and assets. If there is a gap, then buy enough life insurance to cover that gap. That ensures your family will have a smart place to get money in the event of your death.

  Life. The financial needs you have during your physical life will vary depending on your health, your ability to work to gain income, and the varying nature of the economy. The major planning scenarios appear below: Not Healthy. A large percentage of people will experience the need for some significant medical treatment at some point in their lives. One trip to the emergency room with a child's broken bone can severely strain finances. That's why health insurance is so important. It's also very expensive, because so many people make claims against their health insurance. There are additional not-healthy scenarios that you need to plan for. Not Healthy and Not Able to Work: How much income would you need if you suddenly became unable to work? Compare that with the income you could generate from your existing capital and assets. If that is not sufficient to meet your needs, and even if it is, you should purchase long-term disability insurance.