February 28, 2010
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“Perhaps the most valuable result of all education is the ability to make yourself do the thing you have to do, when it ought to be done, whether you like it or not; it is the first lesson that ought to be learned; and however early a man’s training begins, it is probably the last lesson that he learns thoroughly.” — Thomas H. Huxley, English biologist (1825 – 1895)
Often the biggest challenges most people face in reaching their objectives, financial or otherwise, are not external, but internal. For reasons we can’t entirely comprehend, great plans and good intentions are undone by our poor behavior.
We may blame it on a lack of willpower, a character flaw, or even a psychological condition; regardless the explanation, we find we are our own worst enemy. And even the best among us feel the frustration. Paul the Apostle once wrote:
“For what I am doing, I do not understand; for I am not practicing what I would like to do, but I am doing the very thing I hate.”
At one time or another, we’ve all been there. So if some of the biggest obstacles are internal and psychological, what can be done to fix them?
Hey, this isn’t a Dr. Phil column. There are a bunch of ways to resolve your issues, and a bunch of people to help you. But when it comes to achieving your financial objectives, there is one simple, practical thing anyone can do to improve their chances for success:
“GET IT IN WRITING.”
Seriously. Whether you use a pencil or a word processor, getting things out of your head and onto paper increases your chances of achieving your objectives. As Will Farrell would say in Anchorman, “It’s science.”
First, the physical act of preparing a paper document requires a greater level of engagement. Thoughts and words are vapors that can easily dissipate when new distractions emerge. But getting things in writing usually focuses thought and encourages clarity. And the physical act of writing (or, to a lesser degree, typing) engenders another level of reinforcement – your thoughts take on a visual aspect, and even acquire some “muscle memory.”
Second, getting it in writing leaves a trail, including one that is visible to others. Getting it in writing provides you with a definitive reference point, for the past and the future. You’re saying “on this day, here’s where I was, and there’s where I wanted to be.” And when you put it in writing before a spouse, partner, or advisor, that document becomes a common point of reference. It can be used by others to understand you, help you, remind you, and challenge you.
When it comes to my finances, what should I get in writing?
1. Write (or type) your present financial condition. Most people believe they have a general sense of their financial status. They can tell you if they’re current with their bills, if they’re saving money, and roughly how much they earn in a year. But move beyond the generalities, and you’ll find most people don’t have a good grip on what’s really going on – it’s all sort of fuzzy.
Consequently, it’s difficult to make new financial decisions with any degree of confidence. Are you sure you can afford a new car payment? What about re-financing? If you start a new life insurance program, will you be able to make the premium payments? When you’re not sure, you either make guesses or put off deciding, and neither of those options have a high success rate.
Imagine what could happen if you committed to preparing an accurate cash-flow statement every month. First, just attempting it would improve your financial organization. Checks would be written from the correct account, receipts would be kept – if nothing else, you would begin to have a paper trail.
For some, making an accurate monthly cash-flow statement might be a challenging task. It might take a lot of effort to set up the process and sort through your piles. If you find a cash flow statement requires too much work, start by picking one or two financial categories that need the most attention, like tracking your debt reduction progress, or monitoring the monthly accumulations in your savings and investments. Just collect some accurate information, and write it down.
2. Write (or type) your financial objectives. In general, everybody wants more money. But how much do you want, and for what purpose?
Everyone knows the job of sales and marketing departments is to convince consumers to buy their products. And most people understand that sales and marketing experts use a range of psychological ploys, both blunt and subtle, to compel people to buy. If you’re not clear on what you really want, you are much more susceptible to being sold something else.
Writing down what you want to accomplish makes it easier to resist the daily bombardment of sales pitches. You’ve embedded your own financial values, which allows you to see which items align with your objectives and which ones don’t. Clearly articulated objectives help you recognize that a flat-screen TV priced 50% off is a great deal – but only if you really want a flat-screen TV.
3. Write (or type) your plan of action. The default option for contemporary American culture is often the tyranny of the urgent; what’s immediately in front of us demands our attention. We deal with one momentary crisis after another, then either collapse in exhaustion or seek some recreational escape. And then we do it all over again the next day.
At some point we may notice the track we thought we were on is really a treadmill, but those moments of recognition are fleeting; there are new items hitting our in-box, and each one seems to be stamped “urgent.” Even if you decide to get off one treadmill – by changing careers, relocating, etc. – you may find yourself on another treadmill, running just as hard, yet still staying in the same place. Taking the time to write down a course of action in order to achieve your financial objectives gets you off the treadmill, first to reflect on, and then to redirect, your activities.
Does getting it in writing really work?
Intuitively, most people know getting it in writing would help them make progress. Of course, there are caveats. Making a direct cause-and-effect connection between writing it down and success is difficult because so many other factors are involved. You may have some financial issues that aren’t going to be resolved by simply writing them down (like back taxes to the IRS), but the very act of deciding to get your financial life in writing means you’re giving it a higher priority and a higher likelihood of success.
Thomas Stanley and William Danko are the co-authors of the Millionaire Next Door. Released in 1996, the book was a comprehensive study of the character traits and actions of American millionaires, particularly those the authors classified as PAWs – prodigious accumulators of wealth. Stanley and Danko found that the most successful millionaires spent a significantly higher percentage of their time reviewing their financial condition and planning their next financial action. Both activities required them to obtain accurate information, and develop clear plans of action – in some fashion, you could say they were “getting it in writing”.
You can find a lot of information about financial recording and goal-setting. Those details may help you, but the basic issue is this: When it comes to your finances, do you have it in writing? If you don’t, you have a simple question to answer: Are you going to get it in writing?
• HOW MUCH OF YOUR FINANCIAL LIFE IS IN WRITING?
• DO YOU HAVE A MONTHLY CASH FLOW STATEMENT?
• DO YOU HAVE A WRITTEN LIST OF FINANCIAL OBJECTIVES?
• DO THE FINANCIAL PROFESSIONALS YOU WORK WITH HAVE COPIES OF YOUR WRITTEN INFORMATION?
• OR… WOULD YOU LIKE TO HAVE A FINANCIAL PROFESSIONAL HELP YOU TO GET IT IN WRITING?
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February 16, 2010
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IDEAS THAT ENDURE
Ideas matter. The value of every statistic, every calculation, is determined by the ideas and philosophies to which the numbers are applied.
In the past several years, several trade publications have republished a short commentary on the essential elements of life insurance. Originally titled “Just a Life Insurance Policy,” this is a brief yet powerful statement of the timeless ideals that make life insurance a financially relevant product.
The article, probably written at least 50 years ago, was resurrected by Marvin Feldman, a prominent Ohio insurance agent and industry authority, in 2006. Feldman notes in an accompanying commentary that he was unable to identify the original author, and while the article can be found in a number of publications and websites, none of these sources cites an author either. Feldman also acknowledges he had to reword some of the article because the original syntax reflected a different era. Still, the financial and social concepts at the heart of life insurance remain relevant to the challenges and aspiration of today’s world.
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January 29, 2010
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If the early announcements are any indication, 2010 could be the Year of the Roth IRA conversion. How do we know this? Well…
An August 27, 2009 article from Morningstar (news.morningstar.com) calls the chance to convert to a Roth IRA “the planning opportunity of the decade.”
In an article for the Detroit Free Press, on November 19, 2009, Susan Tompor reported “the Roth IRA conversion is definitely building buzz.”
On November 24, 2009 Forbes.com led with “Get ready to be bombarded with information about Roth IRA conversions.”
Admittedly, three sources by themselves do not make a trend, but they are representative of the general media buzz. What’s the big deal? Here’s the story:
Roth IRA retirement plans have the following features:
- Eligibility to make deposits to a Roth IRA is dependent on your income level.
- Deposits receive no tax deduction.
- Once you have held the Roth IRA for at least five years, and are at least age 59 ½, withdrawals are tax-free.
- There are no required minimum distributions from a Roth IRA at any age.
- Roth IRA assets can be left to children or other heirs.
A change in tax law, effective 2010, broadens the ability of owners of Traditional IRA accounts to convert them to Roth accounts. This is what the fuss is all about.
Beginning in 2010, the income limits on Roth IRAs will be eliminated, so investors of all income levels will be able to convert their Traditional IRA assets to Roth IRA assets. This is significant, because prior to this change, only those with a modified adjusted gross income (MAGI) of $100,000 or less could execute a conversion.
Reasons to consider a conversion to a Roth IRA
You may pay less in taxes. If you convert your Traditional IRA balance to a Roth IRA, you’ll pay taxes on the amount being converted. But because of recent market volatility, your account balance may be lower than it was when the market was stronger. In effect, you may pay less in taxes.
If you convert in 2010, you have the option to spread the tax burden over two years. When you convert to a Roth IRA, you will have to pay taxes on any deductible contributions and investment earnings. But, if you make the conversion in 2010, you can pay the taxes in 2010 or you can spread the taxes over the subsequent two year, 2011 and 2012.
There are no required minimum distributions. Unlike Traditional IRAs, Roth IRAs do not require that you take minimum distributions when you reach age 70½. That means your account can continue to grow tax-free until you – or your heirs – are ready to withdraw the money.
Reasons to not convert to a Roth IRA
Money. The Roth conversion isn’t a freebie. In order to convert to a Roth IRA, you must pay income taxes on the Traditional IRA as if you had cashed out. If you pay the tax from funds in the IRA account, it will decrease the transfer amount and diminish the tax-free growth that might occur over time. Further, if you use funds from the IRA and are younger than 59 ½, the amount used to pay the tax may be subject to an early withdrawal penalty. “A Roth conversion is expensive. There’s a big up-front cost to doing this,” Tim Steffen told Tompor. Steffen is a financial and estate planning manager for Robert W. Baird & Co. in Milwaukee.
You think you’ll be in a lower tax bracket in retirement. If your financial situation is such that you anticipate future income will be much lower than it is today, paying the tax now may not make sense.
You have a short time until you intend to withdraw the funds. Money transferred to a Roth IRA must remain in the account for five years, or it will lose its tax-free withdrawal status.
It goes back to: What’s your tax bracket? Do you have the funds outside the IRA to pay the tax? And what’s your time frame for needing those assets?” said Jill Garvey, vice president and regional manager for the wealth planning group at Comerica Bank.
Another twist:
What might happen to tax rates in the future? In the Detroit Free Press article, Garvey points out that the current federal income tax rates expire at the end of 2010. If Congress takes no action to renew these rates, the highest tax rate would jump to 39.6%, up from 35%. And with the deficit ballooning, it’s not unthinkable that Congress might authorize even higher marginal tax rates.
The conversion decision is “a little more art than science,” according to John Carl, president and founder of the Retirement Learning Center in Brainerd, Minnesota. “How much [in] taxes are you willing to fund now for a lifetime of tax-free income?”
IRA Help is Everywhere. To assist you in your decision, many financial companies are offering Roth Conversion Calculators on their web sites. But this is a transaction that probably can’t be decided by answering a few questions or entering some numbers in an on-line calculator. A consultation with your tax advisor is a must, as well as the financial professionals who will be handling the conversion paperwork.
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December 15, 2009
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Here’s a common paradigm for work & retirement:
1. You work to produce an income.
2. You save some of that income and
accumulate a pile of money.
3. When the pile is big enough, you stop
working and live off the accumulation.
Here’s an alternate paradigm:
1. You work to produce an income.
2. You save some of that income to
generate more income right now.
3. Over time, your income from savings
grows.
4. At some point, your only “work”
is to continue growing your income
from savings.
What do you think? Do you see the two options as the same thing phrased differently, or do the two approaches reflect distinctly different perspectives and strategies?
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December 8, 2009
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In a very short time electronic communication, specifically the Internet, has effected a sea change in the way people conduct their basic financial transactions. Beginning with direct deposit and automatic withdrawals, then progressing to account transfers and online payments – for everything from utility bills to credit cards – much of our individual financial life is conducted instantly in a paperless environment. We don’t have to go to the bank, put the check in the mail, or wait for a monthly statement. Almost everything we want to know about our money, and want to do with it, can be accessed and executed with a computer keystroke.
Taking this blink-of-an-eye technology one step further, a number of businesses have developed online programs to aggregate, organize and update your financial information. Your bank accounts, credit cards, mortgages, investments, insurance policies – even your legal documents – can each be accessed on a unique, password-protected website. Constantly updated, this data can be formatted to provide all sorts of up-to-date consolidated financial information, such as personal financial statements, performance reports on investments, lists of assets for estate planning, etc.
Some of these management programs are offered by banks and other financial institutions for their customers. Others are independent online ventures marketed to the general public. Depending on the features and/or your customer relationship, the institution offering the management service may or may not charge a fee. Even if you don’t pay a fee, understand that every management program has some profit incentives for the provider. In-house programs will attempt to find products that match your financial data (“We noticed you have $10,000 in your checking account. Have you considered our SuperSavers program?”), while most online programs for the general public are supported by affiliations with retailers and merchants (“Want to maximize your grocery savings at FoodWay? Why not use our in-store SuperSavers program?”).
In theory, these tools allow a person to take immediate, accurate financial snapshots of their financial condition at will, and help answer questions like, “Can you afford that big-ticket purchase? Are your investments due for a rebalancing? Did you have positive cash flow this month?” Questions that might take a few days to answer (or often get resolved with little more than a “guesstimate”) can be addressed with a high degree of certainty in the time it takes to log in, configure some report variables, and hit “Enter.” That’s powerful stuff.
Ah yes, but remember the previous paragraph begins with the words “In theory…” The bane of every computer program is user error, also known as “garbage in, garbage out.” These financial management programs deliver on their promises only if the information is correctly configured. And in spite of the best intentions of programmers to make their products idiot-proof, the biggest hurdle in making online financial management programs work their magic is getting them set up correctly.
And even the techno-geeks admit this can be a problem. Here are snippets of an online review-and-comment thread regarding a problem of a highly-recommended online financial management program, started by a computer science graduate working in the financial services industry. (Specific company and institutional names have been deleted.)
Reviewer: (The program) lets you put transactions in buckets – and naturally it will get a few wrong to start with – but you can set up rules to classify new transactions how you like.
Comment: I just tried (the program) and it’s not really simple to use.
Comment: I tried to setup an account at (the program site). I found out that (my bank) and (investment company) did not support the (program) site/ software. What to do, what to do?…. could someone suggest another software that is better?
Comment: (The program) does support (investment company), you just have to set it up after 8pm EST and before 8am EST, because (investment company) doesn’t want the access to slow down the site for others.
Keep in mind this is a program that receives overall positive reviews from the reviewer and many of those commenting. Still, user error is a definite possibility, even for computer- and financially-literate individuals. And the greatest likelihood of user error is right at the beginning; if you don’t set it up correctly, the program may not update correctly, and all you’ll get is bad information in an instant.
Getting Technical Assistance
People who really care about their automobiles have always known the value of a good mechanic. And as the personal computer has become a fixture in our lives, many of us have developed our own “tech support,” whether it’s a friend who works in IT, a local computer company, or even the service department of the big-box retailers. In the same way, the real value of an online financial management program might be the personal assistance that comes with it.
Financial Technical Assistance
One of the value-added aspects of working with financial professionals can be their assistance in helping you establish and operate an online financial management program. From formatting the accounts and the initial data entry to the generation of regular reports, the knowledgeable assistance and support from a financial specialist can make a big difference in the benefits you receive from online financial management.
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December 7, 2009
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A November 11, 2009 article in the Wall Street Journal titled “529 Plans – More Parents Are Becoming Dropouts” notes diminished participation in what “have been pitched as the ultimate college savings vehicle.”
In brief, 529 accounts allow investors to contribute after-tax dollars into an account that typically offers a range of mutual funds and other investments. Distributions and earnings from the account are tax-free as long as they’re used for higher education. 529 plans are sponsored by states, and their investment options and fees can vary widely.
Why the decline in participation? There are several external factors: Many individuals have experienced a decline in their ability to save, due to unemployment or underemployment; they just don’t have the money to save. In addition, the stock market collapse triggered some high-profile fund implosions, complete with accusations of mismanagement, exorbitant fees and lawsuits.
The nature of government programs
But the internal design factors of 529 plans may also account for the decline in participation. Like many other government-sponsored savings programs, 529s are singular, stand-alone vehicles that “don’t play well with others” from a financial standpoint. These government sponsored programs create a separate bucket with a new number or acronym – IRA, 401(k), HSA, 529, etc. – and once the money goes into the bucket, it is expected to leave the bucket under very specific circumstances, such as retirement income, medical expenses, or a college education. It is difficult to transfer funds from one bucket to another, and penalties are assessed for any alternative use of the funds. These restrictions can make it difficult to integrate a government-sponsored plan into the larger financial picture, especially when money is tight.
A tax benefit, but at what cost?
The principal incentive with government-sponsored savings plans is usually some form of tax break. But as the Journal article noted, “in today’s jittery investment environment, some consumers are forgoing the tax benefits of a 529 to retain the flexibility to use the money for whatever they wish.” Tax breaks are legitimate financial incentives, but especially in tight economies, many consumers are finding that financial flexibility and control hold a stronger attraction. As Michael Singer, a 49-year-old teacher who recently lost half of his value in a 529 account, told the Journal, “Any new money going to my kids’ college education is going into something that I manage myself.”
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November 30, 2009
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“The wise man does at once what the fool does finally.” – Niccolo Machiavelli
“Sully” is Capt. Chesley Sullenberger, III, the pilot of US Airways flight 1549, who flawlessly executed an emergency landing of his Airbus A320 in the Hudson River on Jan. 15, 2009, preserving the lives of all 155 passengers on board. As a result of his heroic response, Sully became an instant celebrity.
Unlike many media-manufactured celebrities, the individual behind the deed turned out to be just as impressive. Speaking with genuine modesty, Sullenberger credited his training and vocational commitment as the elements that prepared him to perform coolly under pressure. The public’s positive response to Sullenberger’s action and his explanations created a demand for more information. This summer Sully collaborated with Wall Street Journal writer Jeff Zaslow to write Highest Duty: My Search for What Really Matters. The book, released October, 2009 not only recounts the details of the emergency landing, but devotes significant time detailing the upbringing and character-shaping events that equipped Sullenberger to handle the challenge of safely landing a plane on the water with both engines out.
For Sully, the ability to perform the unexpected under pressure was the result of a lifetime of preparation. In an October 14, 2009 WSJ column about writing the book, Zaslow discusses Sullenberger’s diligence in preparing for circumstances he might face as a pilot. This diligence was more than safety checks or reviewing accidents experienced by other pilots. Sully also believes one aspect of preparing well is having the right mindset. He tells Zaslow:
“In so many areas of life you need to be a long-term optimist, but a short-term realist.”
When you consider it, being a long-term optimist and short-term realist is a pretty solid financial philosophy as well. Things may happen, some of them bad, some of them good. Some issues may be hazardous, other benign. But on the whole, if the short-term items are handled appropriately, the long-term prognosis is over-whelmingly favorable.
This perspective usually resonates with people; at a gut level they know it is true. But quite often, other perspectives on personal finance subtly influence us to ignore or override this approach, particularly the short-term realist part of the equation.
Here’s an example: When asked, what do most Americans state as their primary financial objectives? The frequent answer: “Retirement.” This is certainly a worthy long-term objective. But applying Sully’s mind-set, what’s the best way to prepare for positive long-term success? By addressing the short-term issues realistically.
Realistically, one of the best ways to sustain a long-term saving plan is to first establish some cash savings, typically equal to three to six months of income. A financial cushion can absorb unexpected expenses without requiring either an end to long-term saving or expensive withdrawals from a retirement plan.
Realistically, one uninsured incidence of disability longer than 30 days could seriously delay or derail any retirement plans. Implementing a disability income replacement program solves this short-term challenge.
Realistically, the best time to buy life insurance is when you are young, healthy and most insurable. If circumstances deny you the time to build a retirement fund, life insurance steps in to replace your earning and saving potential.
Realistically, the longer debts remain outstanding the greater the long-term lost opportunity costs that compound against you. Planning (and acting) to become debt-free is a short-term action that will undoubtedly deliver long-term dividends.
Realistically, some of this might sound boring, and not very sophisticated. But when you consistently address your short-term economic realities, it makes you a long-term optimist.
DO YOU WANT TO GIVE YOUR LONG-TERM PROSPECTS THE BEST CHANCE TO SUCCEED?
BE DILIGENT ABOUT YOUR SHORT-TERM FINANCIAL REALITIES.
DOES PERSONAL FINANCE MEDIA “FLIP” SULLY’S PERSPECTIVE?
Just for fun, check the covers of the most popular personal finance magazines at your local bookstore rack. What do you see? How about these headlines, culled from current issues:
• “Put Off Retirement? No Way!”
• “The Best Time to Invest in a 401(k)? Now!”
• “How to Be a Better Investor”
A sizable chunk of words, column space and conversation in the personal finance media is devoted to long-term activities, like investing and retirement planning. Nowhere to be found in the headlines or as a lead story: debt, disability, life insurance, emergency savings. Even the things to do “now” (i.e., the supposed short-term things that require immediate action) are really long-term items. Why don’t the short-term realities get more ink?
Perhaps personal finance magazines figure most of their readers have already taken care of their short-term financial realities. But any quick study of Americans’ financial habits will find most of them underinsured, deficient in savings and carrying significant debt.
Another possibility is the feeling that long-term financial issues, like saving for retirement, must be addressed even if the short-term realities aren’t under control: better to start making deposits in a 401(k) at an early age and possibly have to borrow from the account than wait until the short-term issues, like debt and insurance, are resolved.
It’s not that the majority of the financial media is against savings accounts, insurance, or debt reduction. Probably the biggest reason the short-term financial issues receive less attention is because they aren’t attention-getting. There are no extraordinary gains, or tantalizing potential fortunes. The short-term issues are not often inspiring or heroic.
Interestingly, Sully acknowledges the ordinariness of his own situation, saying he is not comfortable with being called a hero for his actions. “A hero runs into a burning building,” he says. “Flight 1549 was different because it was thrust upon me and my crew…I don’t know that ‘heroic’ describes that. It’s more that we had a philosophy of life, and we applied it to the things we did that day.”
Sully received correspondence from people saying similar things. One that he found most touching said:
“It’s clear that many choices in your life prepared you for that moment when your engines failed.
“There are people among us who are ethical, responsible and diligent. I hope your story encourages those who toil in obscurity to know that their reward is simple – they will be ready when the test comes. I hope your story encourages others to imitation.”
Heroic incidents, including financial successes, are inspiring. It is good for us to know about them. But much of the success we see has a foundation of diligence and preparation. And it wouldn’t hurt if the process of laying a successful foundation received a little more press.
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November 23, 2009
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Suppose you owned an asset with a market value of $500,000 in 2007. Because of the economic turmoil of the past two years, that same asset is worth $300,000 today, and is rather illiquid – i.e., there aren’t very many buyers, even at the reduced price. Suppose this asset is your home.
Is it likely that your home, and other personal residences, will regain their lost values? And if so, how long will it take?
Providing accurate financial predictions for the future is difficult even for experts, but residential real estate is particularly hard to figure because the issues impacting homeownership go beyond falling prices. In fact, it’s possible to consider that the United States is on the cusp of a great societal change regarding the “American Dream” of owning one’s home. And since a personal residence often constitutes both the biggest purchase and largest asset in many Americans’ financial lives, the future of residential real estate could have a significant impact on their overall financial well-being. Some things to consider…
A Quick Recap of the Bubble:
Encouraged by government programs to expand homeownership for all Americans, lenders were able to make loans to home buyers with poor credit, questionable income and limited savings. As more people became prospective homeowners, the demand for residential housing went up, both for existing homes and new construction. Increased demand drove a subsequent increase in real estate construction and prices, and the housing boom was ignited. According to the Case-Schiller U.S. National Home Price Index, average residential home values increased almost 90% from 2000 to 2008, an annual increase of just under 8%. In some parts of the country, the increase was even higher.
Alas, the economy softened, and many of the new homeowners with poor credit, questionable income and limited savings proved unable to make their mortgage payments. Large numbers of defaults led to a flood of foreclosures, many of which were unloaded by lenders at steep discounts. With fewer qualified buyers and a glut of homes available at reduced prices, the bottom fell out of the market. The degree of decline varies geographically, but decreases of 30% from 2007 highs are common, with some areas seeing drops as steep as 80%.
Economic Factors
The fallout from declining real estate values has been predictable. First, there are fewer qualified buyers. While reduced prices have motivated some people to buy new homes, the recession has sharply reduced the number of qualified homebuyers – more households are unemployed, under-employed, in transition, or broke. Second, to avoid repeating previous mistakes, banks have understandably tightened their lending requirements, meaning obtaining a mortgage isn’t as easy as it used to be. The end result is a significantly reduced pool of prospect buyers for residential real estate.
A shrinking pool of prospective home buyers makes it harder for existing homeowners to move up, or simply sell their home. When residential real estate was booming, it wasn’t just new homeowners that were buying and selling. Existing homeowners saw a chance to leverage their increased values by trading up to more expensive homes. But with depressed prices, existing home sellers often won’t net enough equity to trade up. And those who would like to sell their home (because of a job change, retirement, or other issues) are finding they can’t afford to take the financial hit of selling in a down market – it makes more sense to stay where they are, or rent out the home.
Geographic Factors
In certain parts of the country, “out migration” is occurring, i.e., people are leaving the area, and overall population is declining. In some areas, the migration reflects declining employment opportunities (such as Rust Belt automotive communities), while other migration may reflect subtle changes in the way people live in the 21st century (more on this in the “Demographic” section). But in any place where the population is declining, the numbers of potential homeowners drop as well, and there’s a strong likelihood housing prices will decline.
The Demographic Factors
Another factor affecting residential real estate is the changing nature of residential housing, particularly as the Baby Boom generation swells the ranks of retirees. Since the end of World War II (and the start of the Baby Boom), the major residential housing trend has been a steady migration to suburban living – stand-alone, one-family residences in subdivisions. According to a September 19, 2009 Wall Street Journal article by Glenn Ruffenach, nearly half of the U.S. population lives in suburbs. These neighborhoods “may have been a good place to grow up. But the suburbs are proving a tough place to grow old.”
He continues:
“Indeed, as the country ages, suburbia’s widely assumed benefits — privacy, elbow room, affordability — tend to vanish. Maintaining yards and homes requires more effort; driving everywhere, and for everything, becomes expensive and, eventually, impossible. (Research shows that men and women who reach their 70s, on average, outlive their ability to drive by 6 and 10 years, respectively.)”
Suddenly, the seclusion of “place of our own” is seen as isolation from extended community. What happens to the residential real estate market if most of America doesn’t want to live in a subdivision anymore?
The Historic Factors
From 1900 to the end of World War II, the national homeownership rate remained remarkably stable at slightly less than 50%; a 1997 report by the Fannie Mae stated the rate was never lower than 43% or higher than 48%. Fueled by the Baby Boom and government-sponsored incentives following the war, the homeownership rate jumped dramatically, rising to 64% in one generation (by 1964), and has remained at this level since.
Is it possible that homeownership might return to numbers similar to the first half of the 20th century? Perhaps. However, as baby boomers age, there may not be enough new homeowners to buy their homes. If the government decides to overhaul the income tax code and eliminate some incentives, some of the mathematical rationale for owning your own home could change.
Dealing with the “ic” factors
For the past few decades, buying a home has been touted as a smart financial decision. The expectation of steadily increasing values, the ability to sell and leverage up to a better home, the access to equity through home equity lines of credit, and favorable tax treatment of mortgage interest led many realtors (and homeowners) to boast “your home is your biggest asset.” Events of the past two years may cause some reassessment.
For many individuals, there is immeasurable intangible value in owning one’s home. This alone could provide justification for buying a home, even taking a mortgage. But while everybody needs a place to live, many of the wealth-building arguments for homeownership might merit a re-examination in light of the changing landscape, both economically and sociologically.
If the particulars of your situation are changing your view of homeownership, there may be ripple effects to other parts of your financial life. You may want to save differently, restructure your mortgage, or adjust your investment priorities, and look at other opportunities.
Those sound like good reasons to meet with your financial professionals, and consider ways to address how the “ic” factors of homeownership may affect you.
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November 9, 2009
FIVE-MINUTE FINANCIAL THOUGHT
What if you decided to commit a small percentage of your annual income (1 percent or less) to the establishment of a long-term legacy project? The end result could be an inheritance, or a bequest to a favorite institution or charity. It might take the form of an endowment, proceeds from a life insurance policy, or something else. Who knows how your diligence and commitment with 1 percent or less of your income might benefit future generations?
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October 21, 2009
“Expect the best. Prepare for the worst. Capitalize on what comes.”
- Zig Ziglar
For your own enlightenment, answer the following 3½ questions. (If you can’t remember what happened in 2007, make a guess.)
1. Are you currently saving money on a regular basis?
2. Did you pay income taxes in 2007?
3a. Was your 2007 adjusted gross income greater than $66,532?
or…
3b. Was your 2007 adjusted gross income greater than $113,018?
If you’re reading this post, it’s quite likely you answered “yes” to more than two of the three questions, which means you are a part of a demographic minority in the United States. Whether you know it or not, you have a unique financial standing relative to most of the nation. For an interesting take on what it means to be part of the financial minority, read on. You probably won’t get this type of commentary from the teleprompter-reading talking heads in the national media.
In determining your status as part of the financial minority in the United States, there are two key indicators:
1. Are you paying income taxes?
2. Are you saving money?
In ways you may not have considered, these two financial actions are tightly connected, especially for those in the financial minority. Let’s look at the significance of income taxes first.
YOU are one of the “golden geese” supporting the inverted pyramid (and that might be a good thing).
According to IRS statistics released July 30, 2009, if you reported an Adjusted Gross Income (AGI) on your 2007 federal income tax return of more than $66,532, your household income is in the top 25% of all American households. If the number was above $113,018, you made the top 10%.
While defining the term “rich” is always an exercise in relativity (the term “rich” is often applied to someone who earns or owns more than you), those whose AGIs are part of the top 10% cumulatively earn 48% of all income in the United States. For the top 25%, their incomes represent 69% of all AGI. Collectively, those at the top of the AGI scale have a proportionately higher percentage of financial resources.
Even though it’s possible that some with high AGIs may not pay income taxes (because of other factors like a large number of dependents, high deductible expenses and/or tax credits), those in the top 25% of AGI in the United States paid more than 86% of all the income taxes collected in 2007, with the top 10% accounting for 71% of all income taxes paid. (Note that these statistics do not include amounts paid as FICA or Medicare taxes; the figures are just the amount assessed by the federal government against your income.)
To simplify these numbers, look at it like this:
The top 10% of household incomes…
earn 48% of all US income…and pay 71% of all income taxes.The top 25% of household incomes…
earn 69% of all US income…and pay 86% of all income taxes.
Conversely, those in the bottom 50% of AGI paid less than 3% of all income taxes. In an April 13, 2009 Wall Street Journal opinion piece, former presidential advisor Ari Fleischer says Congressional Budget Office statistics show that 40% of Americans pay no income tax at all. Furthermore, the trend of the past decade, as well as current political sentiment, is for the top income categories to pay even higher percentages of income taxes going forward.
These numbers mean that if you are one of the top 25% or 10% in AGI, you are one of the “golden geese” that is relied on to deliver golden eggs for government use. As Fleischer explains it,
“Picture an upside-down pyramid with its narrow tip at the bottom and its base on top. The only way the pyramid can stand is by spinning fast enough or by having a wide enough tip so it won’t fall down. The federal version of this spinning top is the tax code; the government collects its money almost entirely from the people at the narrow tip and then gives it to the people at the wider side. So long as the pyramid spins, the system can work. If it slows down enough, it falls.”
At first look, being one of the individuals at the bottom of the inverted pyramid who pays to keep things going for everyone else may seem unfair. But maybe things for the wealthy minority aren’t so bad.
The financial minority is larger than you might think
Carl J. Milsted is a theoretical physicist who, according to his weblogs, www.holisticpolitics.org and PaidToBeRich.blogspot.com, “dabbles in economics and political activism.” In a September 11, 2009 article “The Real Secret of the Super Rich”, Milsted makes an extensive statistical analysis of the distribution of income in the United States in comparison to standard bell curve results. His conclusion: There are a lot more wealthy people in the United States than should be expected, at least according to models used to make statistical predictions. In Milsted’s words, “the rich defy the norm. They are way outside the bell curve.”
Another way of looking at it is that the United States, in spite of its flaws and critics, still offers more financial opportunity to more people in comparison to other countries and economic systems.
The wealth of the minority grows faster – and receives government support.
In general, the amount of taxation imposed by various government entities in the United States is high. In particular, the income tax burden on the financial minority is steep. But while it is true that income taxes have risen disproportionately for the top 25%, their incomes have also increased disproportionately as well. For example, the AGIs of the top 1% rose 50 percent from 2001-2007, while the increase was only 29% for the bottom 50 percent. Simply put, the rich got “more rich” than everyone else over that seven-year period.
This quirky occurrence – the rich getting richer even as they are taxed more – is a unique characteristic of a “mixed economy” where governments attempt to manage the national economy, but do not control it entirely. How does this happen? Here’s a simplified explanation: Taxes, tariffs and other monetary policies are used to siphon some of the productivity of the wealthy to pay for government programs and services (social welfare, consumer regulation, law and order, national defense, etc.). Once governmental units establish streams of revenue, they don’t want them to dry up, because if there is no financial production, there will be no economy to manage. It’s the personification of the golden goose fable: If governments want on-going streams of revenue from their citizens, they can’t kill the ones who generate them. Since they generate and hold a disproportionate percentage of income and assets, governments need the financial support (or at least compliance) of wealthy individuals.
This dependence on the wealthy minority results in what many economic observers call corporatism. According to Steven Malanga (writing in a column for Real Clear Markets on April 8, 2009), corporatism is “the notion that elite groups of individuals…committees or public-private boards can guide society and coordinate the economy from the top down and manage change by evolution, not revolution.” Governments make the rules, but they make them in concert with those who will be most affected by them. And since all governments (at the federal, state and local levels) need money to function, they have a vested interest in maintaining a working relationship with the wealthy minority, despite the occasional populist rhetoric that is broadcast to the other 75% of the population.
On an institutional level, the corporatism mentality explains why some parts of the economy were considered “too big to fail” and received government-sponsored financial assistance, while others were left to wither and die (or go into bankruptcy). On an individual level, it explains why most of the individual tax breaks end up being used by the wealthiest segment of the population. (One example: studies repeatedly show that 401(k) participation increases in proportion to income, partly because wealthier individuals have the ability to save more, but also because the tax advantage is greater for those in higher income tax brackets.)
The idea of governments supporting the wealthy minority may sound like political commentary, but this isn’t a liberal or conservative talking point. Commentators from very disparate ends of the political spectrum say the same thing: The current economic system helps the wealthy – once they get there – and gives them an edge going forward.
A September 21, 2009. Huffington Post article by Dean Baker, Co-Director of the Center for Economic and Policy Research makes this comment:
“It is now pretty much official policy that financial giants…will not be allowed to fail. If their bad investment decisions again bring them to the edge of bankruptcy, the federal government will again rush to the rescue, handing out whatever cash and loans are needed to keep the banks afloat.
“This status gives these banks a clear edge in credit markets against their smaller competitors. If everyone knows that the government can be counted on to come to the rescue of these banks, then there is less risk in lending them money. Therefore, they pay lower interest rates than if they had to borrow in a free market.”
This perspective can be applied at an individual level. Individuals with money get the tax breaks – because they have the money to take advantage of them. Taxable income from capital gains receives favorable tax treatment compared to income from wages. Mortgage interest deductions are for homebuyers, not renters. Just like Baker’s “financial giants,” individuals in the wealthy minority “have a clear edge in credit markets against their smaller competitors” – i.e., they can actually borrow money, and at better rates. And just like wealthy institutions, government-sponsored “bailouts” are always a possibility.
You may not have thought of it this way, but an example of tax law adjusting to support/bail out the wealthy minority is the Roth IRA. As it became apparent that many wealthy individuals might actually pay more income tax when they withdrew funds from their IRAs and 401(k)s than the tax deduction they received for the deposit, the Roth IRA was established. Roth IRAs offer no tax deduction for the deposit, but incur no taxes on either gains or withdrawals. Besides establishing a new type of retirement account, new tax law also made it possible to convert a 401(k) or IRA to a Roth IRA, as long as you paid the tax on the old accounts before reconfiguring them. When the stock market tumbled, many people with IRAs and 401(k)s realized now might be a good time to pay the tax and make the change. As a special concession for Roth conversions executed in 2010, the IRS will allow for the tax payment to be spread over two years, instead of paid in the year the transaction is completed. A rather benevolent gesture by government, wouldn’t you say?
The necessity of the wealthy minority to save
If the only things you’re doing as a member of the financial minority are earning a big income and paying taxes, you’re really not in the game. In order to take advantage of your minority status, it is imperative to accumulate assets. You must save – not only for your own financial well-being, but for the preservation of the whole inverted-pyramid/golden-goose system.
Remember, in order for governments to collect revenues, there must be people producing revenue. Someone must be making a profit. And while governments may be good at assessing taxes on profits, governments aren’t intended to make a profit, and don’t know how to make a profit.
Making a profit requires a forward-thinking, future-oriented mindset. People save because they understand that it’s not only what is happening today that matters, but what could happen tomorrow.
Some of this saving reflects a prudent view of the future; that a job may not last forever, and things might have to be replaced. But saving is also the seed money for future productivity. Saving provides the capital that moves innovative ideas into practical use. Eventually some of those innovations will become new engines of progress, improving existing markets and opening new ones. Whether its stems from an attitude of caution or ambition, people who save provide the foundation for a functioning economy.
This emphasis on saving and accumulating assets may read like an “Economics for Fifth-Graders” discussion, but a quick once-over of the facts reveals most Americans don’t understand the importance of saving, or the consequences of not saving. Which is why the economic playing field is skewed to favor the wealthy minority.
How to accumulate assets as part of the wealthy minority
People acting on behalf of government (legislators, political analysts, economic advisors, etc.) may know that saving is a critical component in maintaining a solid economy. Often, they will enact legislation to encourage saving, such as IRAs or 401(k)s, but the governmental perspective on saving and asset accumulation is prone to be short-sighted or incomplete.
Consider that the major purpose of IRAs or 401(k)s is to provide retirement income. That’s a worthwhile savings goal, but there are plenty of other reasons to save. When Bill Gates was 25, what would have been the value of saving in a 401(k) for retirement in 40 years as opposed to investing some of his savings directly in his business? In real life, especially when one is interested in making a profit, the need for capital is fluid, constantly changing. Most government-sponsored asset accumulation programs don’t offer much flexibility.
This leads to another counter-intuitive conclusion: The best way for the wealthy minority to save or accumulate assets is often outside of government programs – so that you can take full advantage of government programs at a later date.
Go back to the Roth IRA conversion example. The sticking point for making the transition from an IRA to a Roth IRA is paying the tax. In order to take full advantage of the potential long-term tax savings and avoid an early-withdrawal penalty, you want to pay the conversion cost from “outside funds,” i.e., from a non-qualified savings or brokerage account.
Along the same line of thought, since many qualified plans now have “catch-up” contribution clauses (another “adjustment” that benefits the wealthy minority), it might be to your long-term advantage to focus early accumulation efforts in places that offer more liquidity, knowing that gains could be poured over into an IRA, 401(k), etc. at a later date.
The Pragmatic Idealist
There are compelling social and philosophical issues regarding the widening wealth gap in the United States between the top 25% and everyone else. In his article mentioned above, Ari Fleischer concludes America would be a better country if everyone paid taxes. Milsted, the theoretical physicist who dabbles in economics, is a staunch free-market supporter who says “I want to narrow the wealth gap by creating more millionaires. I want a society where it is easier to get rich, but harder to stay rich. And in the process we can dispense with many of those pesky government programs.” Those are both interesting perspectives.
But this is not a discussion of the social or ethical ramifications of the gap between the wealthy minority and everyone else. It’s simply a practical assessment of which approaches work best in light of the current state of affairs. As it stands, most people’s economic lives would be better off if they were earning enough to both pay income taxes and save.
If you’re paying income taxes but not accumulating assets, it’s time to reassess your financial behavior. Because for those who earn enough to pay taxes but never acquire the saving habit, the long-term prognosis is they eventually become part of the financial majority.
If you are already saving, it might be time to address the other issue: What percentage of your asset accumulation program is placed into “outside” (outside of government control) sources?
These concepts relating to your position as part of the financial minority may be a bit counter-intuitive, but relatively simple. However, the applications of these ideas can be complex (don’t try a Roth IRA conversion on your own). The practical answer: consult with our team at Prosperity Economics Advisor!
“Expect the best. Prepare for the worst. Capitalize on what comes.”
- Zig Ziglar
Filed Under: CONTROL, FLOW, MULTIPLY, SEE, THINK | Leave a Comment
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