Achieving Personal Wealth Goals

Achieving Personal Wealth Goals

Live enough ‘below your means’ so that you can save and invest. Most of us will need it for emergencies, children, college expenses, retirement, etc.. Starting young increases your potential to build huge nest eggs for retirement early. Also, life is a lot less stressful when you can pay all your bills and still have money left over. Take advantage of government and business 401K/IRA savings plans and company matches to savings that may be available to you. If possible, favor Roth IRAs over Traditional IRAs. A Traditional IRA saves you some tax money the year you invest, but costs you taxes when you withdraw from it. Those Traditional IRA withdrawal taxes, particularly if your investment has grown significantly over 20 to 40 years or more can be enormous. And you must start withdrawing, like it or not, at age 70 ½. With a Roth IRA, you save no taxes the year you invest, which may cost you a few hundred dollars, but have no withdrawal taxes when you retire which can save you tens of thousands of dollars. And there are no forced withdrawals. Plus your heirs who may inherit what's left of your Roth IRA also pay no withdrawal taxes, but do for a traditional IRA.

Most of us are not expert enough to buy and sell individual company stocks profitably. That requires daily monitoring of stock price and volume movements, plus knowing how to use them to determine when to buy and sell. Very complex and easy to get wrong. Splitting investments between several mutual funds and/or key indexes reduces risk. Learn about and invest in a market basket over time of value and growth mutual funds. Also funds that focus on either small, medium, or large size companies plus emerging markets, and index funds like the S&P 500 that performs better than 70% of all mutual funds (the ETF “SPY” is a cheap way to buy that index), plus all of the above. Nothing eliminates risk. Still want more diversity – try the ETFs – MDY (S&P 400 Mid-Caps) and SLY (S&P 600 small caps), and also QQQ (Nasdaq 100 – top 100 Nasdaq stocks; more of a technology play). For additional diversity and balance, there are also “growth” and “value” versions of the S&P 500 indices - just put a “G” for growth, or a “V” for value at the end of them (SPYG, SPYV, SLYG, SLYV, MDYG, and MDYV).

I always recommend using the research tools and fund screeners many brokerage firms and other websites give you to view how an asset you are considering buying has historically performed. Look at year to date, one year, 3 year, 5 year, 10 year, and since inception average annual growth rates. If they performed well in all those timeframes compared to the general stock market, then they were managed well in good times and bad. Yields a higher probability (but no gaurantee) of success in the future.

Stocks over the long run have outperformed other financial investments. Keeping your costs down increases your potential to save money. Think about this – the long term average growth of the stock market over decades has been around 11%. That implies a doubling every six and half years (“72” rule – divide the anticipated growth or interest rate into 72 to determine how many years it takes to double).

In some of those periods stocks did better than double, while in others it did worse or even lost money. Also and very importantly, there is no guarantee that those results will be repeated in the future. Life is a game of calculated risk and the best we can do is evaluate the risk and play the best odds available to us. A $1,000 investment that averages that rate of growth is worth $16,000 in 32 years, $64,000 in less than 40 years, and $512,000 in 65 years! Think about a twenty something investing just $1,000 every year and lucky enough to earn that rate of return. Then 40 years from now, when that person retires, he she receives the equivalent of a $64,000 check every year retired. So many companies now do not offer pensions, but do offer company matching of your savings. Always take advantage of that gift. The amount of savings you need to contribute to assure your financial independence could be cut in half! Or you could invest the same amount of money to reach a higher level of savings at any age (think early retirement options that you may give yourself - nice to have even if you choose not to use it).

Invest $3,000 one time in a newborn child or grandchild and keep it there for 65 years and that child may have two million dollars at retirement if the 11% rate holds. $750,000 if the rate is only 8%. Wow – why wouldn’t you do that if you can afford it (and many of you absolutely can)?

There are a whole host of incremental choices on large purchases for houses, cars, vacations, colleges, furniture, etc. that can produce good satisfaction while possibly not being all that you originally wanted. Make prudent choices on quantity and price of less expensive purchases that can still build to significant dollars such as clothes, shoes, restaurant meals, entertainment, phone service, etc.. As time goes by, if your income grows, you can still follow the same policy of living below your means, while incrementally increasing your purchase choices due to that higher income. Don’t forget however, to also increase your savings at the same time. When you’re retired you may want to be able to afford more than just watching T.V. all day long and eating at home with little or no money available for entertainment or vacations.

The goal is to save enough to become self-sustaining (to be able to live the rest of your life off the interest or growth and eventually principle of your savings alone or in conjunction with pensions and/or Social Security). For instance, if you need $50,000 gross per year to live and you (and/or your spouse if relevant to your situation) receive or will receive at retirement $30,000 from social security plus pensions, then you have to generate $20,000 a year from other sources. At 4% interest, you need $500,000 saved not to touch the $500,000. Really you need much less, because you won’t live forever and you therefore can touch the principal. If you think you only will live 20 years after retirement, $400,000 is enough without any interest (the interest will cover taxes and some years if you live more than 20 years.

Also, you live on net pay, not gross pay. When you are retired, there are no social security tax deductions, possibly no life insurance and no disability deductions needed anymore, no charity and other deductions now taken from your paycheck. There is only federal taxes at a lower rate from when you worked and if less than age 65, medical insurance that increases substantially until you reach 65, then it goes down below what you paid while working. Therefore, your dollar amount to be self sufficient is even less. If you own a house not yet paid off but will be paid off by the time you are retired, your living expenses go down and you need even less income. Take an IRS tax booklet and your expected retirement income from all sources and calculate your annual net pay after taxes. Compare it to your net pay today. You might be pleasantly surprised.

If you invest part of your savings in stock/mutual funds while you are still drawing funds from it and it grows at better than 4% per year, you need even less. A financial adviser can help you do the math. The dollar total to raise may still seem daunting, but it is doable if you save each year and invest wisely. Shoot for 10% or more savings per year as your goal. Never less than 5%. Pay yourself this savings first from your paycheck, and then determine what choices (housing, cars, clothes, etc.) need to be made to support a reasonable daily standard of living for you and your family. Even if you don’t make your ultimate goals (and most of you with effort can probably far exceed them), you are still way better off than you would have been if you didn’t save.

Note that I never mentioned buying bonds as so many stock advisers do. Bond prices gyrate just as much as stocks and their long term growth averages are half that of stocks. Also stay away from commodities which can gyrate up, and especially down, faster and worse than stocks.

There is another kind of investment that I recommend avoiding because it amounts to investments in a single company that again can go to zero. They are sold by “Certified Financial Advisers” who are not associated with a brokerage firm. These are investments into “illiquid” (meaning you can't sell them), income producing assets. Most of these are a diverse array of different funds that are for fixed periods of 2-8 years that pay monthly dividends in the 6-8% range which you can keep or reinvest in the same fund automatically), then are sold or liquidated with principal and interest returned to investors, or sometimes they are converted into a new stock that gets listed on the regular stock market exchanges. Most funds give themselves a 1-2 year option to delay liquidation in case the market is bad. If the market is extremely good, they can self liquidate early to achieve higher returns. There are also “legacy” (i.e. lifetime) illiquid investments for energy drilling investments (stick with land drilling to minimize risks). For the first year, you will be made a “general partner” meaning that you can be sued and lose everything you own, not just that asset. After one year, you are changed to a limited partner and cannot be sued. Returns historically are were in the 8-12% range (now much less due to Fracking increasing energy supplies), plus there are huge tax benefits. 80 to 100% of your investment can be subtracted from your income (because you are a 'General Partner' the first year) unless you buy these from an IRA. You get depreciation tax benefits for several years after that. It is also a way to avoid taxes when converting a Traditional IRA into a Roth IRA. A normal stock broker can't sell these. You need to use financial advisers associated with national firms such as Madison Avenue Securities. A good financial broker does 'due diligence' research before recommending a fund to you to purchase. IRAs can be used to purchase these funds but don't do energy drilling with IRA funds since you lose the tax benefit since your IRA is already tax deferred. Again, I wanted you to be aware of them so you are financially educated, but don't buy them. Too many fail completely or deliver losses.

Finally, the elimination of debt is a solid way to work toward financial independence. By lowering your bills, less income is needed to maintain a standard of living. Normally, a home mortgage is the largest debt we owe. Some of us attempt to pay off the mortgage early. A popular method is to overpay your monthly mortgage payments since all the excess reduces principal. Especially in the early years of a mortgage, a very small percentage of your payment actually reduces principal. Most of the payment goes to interest expense. There is a better way. When you overpay your mortgage, you are in effect giving your mortgage lender an interest free loan with the excess money. Instead, put that excess money in a dedicated savings account. The interest you earn will help you pay off the mortgage principal even sooner. Also, if injury or loss of job results in a loss of income, you have something to fall back on. When that investment is large enough to pay off the entire mortgage balance, then consider, depending on your circumstances at that time, paying off the mortgage.