LISTEN (mp3audio) (20:16 min)

Buzzwords, Trends, and Unintended Consequences
Here are a few financial particulars currently receiving a fair amount of attention in the financial press:

BUZZWORD: PHASED RETIREMENT

The combination of a struggling economy and declining asset values has affected a sea change on older American workers. Instead of anticipating an early retirement filled with leisure and travel, a new set of expectations have appeared. For some, the prospects for retirement have been postponed; for others, the only option appears to continue working as long as one is able.

But even these adjusted objectives face a daunting challenge: The realities of aging. Even if we are healthy and have employment, most of us face the prospect of declining capacity as we get older. As we age, we can’t work as hard or as long as we could when we were age 30 or 40. This reality can put some people in a bind: In their current circumstances, they don’t have enough time to “catch up” for retirement, and they don’t have the physical capacity to earn more to make up the difference.

Enter the idea of “Phased Retirement.” The term can refer to a broad range of scenarios, but all generally revolve around two ideas: (1) the individual continues working, but usually with a reduction in the number of hours on the job. (2) In concert with the decreased workload, the individual supplements his income with previously accumulated retirement assets.

Phased retirement could take many forms. In fact, many individuals that we might currently classify as “semi-retired” are actually implementing a phased retirement strategy. As an example, it could be a person who retires from 40-hour-a-week employment, takes a part-time job, and draws Social Security and/or a small amount from his/her retirement account. In this form, the possible configurations of phased retirement are endless: part-time work, independent consulting, or seasonal employment combined with irregular withdrawals, or period certain annuity payments, etc.

However, some versions of phased retirement may actually require some restructuring of pension and retirement plans. Consider the situation of a long-term employee with a high level of technical skill and experience. The employer may find great benefit in retaining this employee, even on a part-time basis, so a plan where the employee works three days a week and draws a partial retirement might seem ideal for both parties.

But what if most of the employee’s retirement assets are held in the company’s 401(k), or are in the form of a company pension? Many retirement plan rules prohibit active employees from receiving retirement plan distributions while still employed. And if there is a pension plan, how will the employee’s ongoing earnings affect payments they are receiving concurrently?

Even if you think your accumulation plans are on track, there may a phased retirement in your future. Numerous studies have shown that older workers are valued for their experience, knowledge, work habits, commitment to quality, and proven ability to work in a team environment. Regardless of age, good employees are worth retaining, and as the population glut from the baby boom generation recedes, it is becoming harder to find younger replacements. Especially if you are an employee with highly specialized skills and a long tenure with one employer, you might receive an offer that’s too good to refuse.

The concepts contained in a phased retirement program also upend some paradigms of conventional retirement planning. It is possible, even likely, that a phased retirement program will experience income ebbs and flows. There may be periods when the need to supplement income from assets is quite high, but these times could be followed by stretches where the individual has excess income and is saving during retirement. This fluctuating state of affairs could greatly impact decisions about where funds should be allocated, and which ones should be distributed. Given these changing dynamics, it may be time for you to consider phased retirement strategies and the types of financial products that meet these objectives.

TREND: “STRATEGIC DEFAULTS”

“Go ahead. Break the chains. Stop paying your mortgage if you owe more than the house is worth. And most important: Don’t feel guilty about it. Don’t think you’re doing something that’s morally wrong.”

As outrageous as it may sound, that’s the lead sentence to Kenneth R. Harney’s November 29, 2009 LA Times article titled “Professor advises underwater homeowners to walk away from mortgages.” The professor in the article is Brent T. White, a law professor at the University of Arizona, and his comments were probably the first to articulate, and justify, a growing trend among homeowners. His opinion is, if the home you own is now worth a lot less than what you owe on your mortgage, walking away from your home and defaulting on the mortgage may look like a prudent financial decision – even if you still have the financial resources to make the payments. Say hello to the “strategic default.”

A strategic default is the decision by a borrower to stop making payments on a debt despite having the financial ability to make the payments. While businesses may regularly implement strategic defaults (typically on mothballed facilities), only recently has the approach taken hold in the personal real estate arena.

Strategic defaults usually occur after a substantial drop in the house’s price so that the debt owed is considerably greater than the value of the property. This results in a negative equity situation where the homeowner is significantly “underwater,” so much so that the prospect of ever returning to a positive equity position is considered unlikely.

Borrowers who strategically default are often called “walkaways,” and statistics indicate their number is increasing. A September, 2009 joint study from Experian and the Oliver Wyman consulting firm estimated that close to a fifth of troubled mortgages in the U.S. involved borrowers who were strategically defaulting. Google the term, and you’ll even find web sites offering “strategic default calculators,” supposedly helping you decide if it’s time for you to walk away.

Ethical? Logical? Practical?
For most people, reneging on a financial obligation is seen as a last resort, something to consider only when all other options have been exhausted. After all, the only reason people and institutions extend credit is because they assume they will be repaid. Individuals who don’t repay their loans ultimately increase the costs of borrowing for everyone. Brian Faith, a spokesperson for Fannie Mae, the government-sponsored mortgage lender, told Harney “there’s a moral dimension to this as homeowners who simply abandon their homes contribute to the destabilization of their neighborhood and community.”

But some commentators would argue there are unique factors at work in the residential marketplace that justify using a strategic default as a pre-emptive financial strike to minimize future financial distress. Some think the moral arguments for repayment go far beyond what is required. In the January 10, 2010 NY Times Magazine, Roger Lowenstein states the general terms of a mortgage, and the consequences of default:

Mortgage holders do sign a promissory note, which is a promise to pay. But the contract explicitly details the penalty for nonpayment – surrender of the property. The borrower isn’t escaping consequences, he’s suffering them.

So you’re not really breaking the contract. The contract remains valid, and the stipulation for nonpayment follows through according to contract.

For some homeowners, the size of their mortgage and the magnitude of decline in their home’s value have resulted in an investment loss that can never be reversed. The only logical financial decision is to cut one’s losses and start over. Feeling some guilt and shame over defaulting might be natural, but that doesn’t mean it isn’t a wise business decision. As Lowenstein says, “The average homeowner is allowed to take a cold business approach as much as anyone is.”

Right now, the cold business approach seems to indicate owning a home doesn’t have the value it used to, either as an investment or a financial priority. In a January 7, 2010 Time.com article, William Clark, a geography professor at UCLA, said the housing mania of the last decade led many buyers to see their homes as speculative investments — “high-flying stocks that happened to come with wine cellars and four-car garages.” Today, “with the sudden run-up in foreclosures, you’re starting to see people ask, is housing a good investment?” he said. “In fact, it probably never was.” Lita Epstein, in a February 6, 2010 article for AOL’s Daily Finance, cited a January 2010 Transunion trend study that found people were maintaining car payments as their first priority, credit cards second, and mortgages last.

Of course, a strategic default isn’t as simple as simply sending your lender a good-bye note and the keys to your house. And the consequences of strategically defaulting aren’t limited to just losing the house. Because of the variations in state laws and lending agreements, most “default experts” recommend obtaining legal representation. Second mortgages, especially those written as lines of credit, may not be released in a walkaway. Epstein’s article notes that credit scores will average a decline of 100 to 125 points as a result of the mortgage default. If there are late payments prior to the default, Professor White cautions the hit to one’s credit history could be as high as 300-400 points. Besides the services of an attorney, you may require tax counsel as well, because some states may assess taxes on forgiven debts after a short sale or foreclosure. And beyond all the financial and legal ramifications, there’s also the issue of finding another place to live, moving one’s belongings, and handling the increased stress that comes from a major lifestyle upheaval.

There are also alternatives to a strategic default, such as loan modifications and short sales. Cristine Gonzalez, an AP reporter writing an article posted January 8, 2010, on creditbloggers.com, notes that an increasingly prevalent form of loan modification is one in which the lender reduces the principal amount. Besides resulting in a lower balance and payment, a loan modification usually does not change one’s credit score.

If nothing else, the surge in strategic mortgage defaults should reinforce the necessity to accurately assess the true financial benefits and costs associated with home ownership. As Professor Clark said, too many people perceived “buying up” (i.e., buying the most expensive home one could afford) as a great investment strategy that came with extra perks like a swimming pool and a great room.

But a strategic default isn’t a wealth-building strategy; at best, it’s a way to hit the financial re-set button – with a damaged credit history and a slim chance of getting a mortgage for the next three to seven years. So while an online calculator may indicate a strategic default may make financial sense, it’s not easy, and not without wide-ranging financial consequences. Better to have made a good housing decision at the beginning rather than hoping to escape a bad one later.

UNINTENDED CONSEQUENCES: ROTH IRA CONVERSIONS = TAX WINDFALL
In an ironic twist, the perception that the US government is about to do something undesirable in the future may reward that same government in the present.

A tax provision enacted in 2006 established that owners of IRA and other tax-deferred retirement accounts would be allowed in 2010 to convert these accounts to Roth IRAs, without limitation. (In previous years, the eligibility to convert to Roth IRAs was limited by income – the more you made, the less you were able to convert.)

Converting to a Roth IRA entails paying any previously deferred taxes now, on both the deposits and gains. In exchange, the Roth format means freedom from future taxes on principal, income and gains, whether distributed to you or your heirs. As Donald L. Luskin, CIO at Trend Macrolytics, stated in an April 15, 2010 Wall Street Journal Opinion essay, “the tax and estate planning benefits are so compelling that the wealthiest Americans are likely to convert in droves.”

Since the middle of 2009, this expanded opportunity to convert to Roth accounts has been featured prominently in the financial media, and the expectation has been that many individuals will take advantage of the provision. But recent events have perhaps provided even more incentive for conversion.

With skyrocketing national deficits and the need to fund the new health-care provisions, the consensus expectation is higher taxes, particularly on America’s most wealthy households. Luskin says the strong possibility of higher tax rates in the future means “the very wealthiest Americans, who control most of the eligible assets, have utterly irresistible tax incentives” to convert in 2010.

Of course every account converted today in the hope of avoiding higher taxes tomorrow means more revenue now for Uncle Sam. How much more?

It’s hard to say for sure. Combining data from several sources, Luskin estimates the total amount of funds eligible for conversion is somewhere in the range of $9 trillion. Approx-imately 60% of the $9 trillion, or $5.4 trillion, is in the hands of the wealthiest 10% of American households. If only 10% of those funds are converted ($540 billion), and taxed at 35%, the result is a “$189 billion revenue surprise for the U.S. Treasury.”

But if the political momentum to increase taxes picks up, the conversion response could be larger. In Luskin’s study of a USAA survey, he finds it conceivable that up to 35% of wealthy Americans could make the change to Roth accounts. The resulting tax bonanza would be $662 billion in “bonus” tax revenues, nearly enough to cut the budget deficit in half. That’s big money!

Luskin’s commentary provoked prompt and opposing responses from some financial experts. In a letter to the editor on April 20, 2010, Douglas Geig II, a CPA from Brecksville, Ohio wrote:

If you are young and beginning your career, you may not want to put any of your savings in a tax-deferred account. In other words, pay the taxes on your savings today at relatively small marginal rates. Sadly, if you defer this tax (and if you are successful and responsible), your future tax burden will be tremendous, as effective tax rates skyrocket to fund our nation’s escalating deficits.

Jack McManemin, CFP in Salt Lake City, begged to differ:

Although tax brackets in general may be higher in the future, what matters is a person’s own tax bracket. Many people, after retiring, will find themselves in lower brackets as they live off their portfolio without income from a salary.

Once again, the question of tax deferral comes down to whether it’s best to pay tax on the “seed”, or on the “harvest.” And once again, the final answer will only be revealed at liquidation. You must make a deposit decision today, not knowing what tax consequences will be when it is time to make a withdrawal.

When dealing with tax law, economists regularly discuss the principle of unintended consequences: changes in tax law will almost certainly result in changes in taxpayer behavior, usually to minimize or avoid the tax. But the final twist in this guessing game is that the individual uncertainties about the future will most likely result in more people choosing to pay taxes today. How strange is that?

The government certainly didn’t anticipate this outcome. Luskin says in 2006 the Congressional Budget Office projected only $8 billion in revenue from Roth conversions for 2010 – and never adjusted that number in successive years. That’s a long way from Luskin’s low estimate of $189 billion, and even further from $662 billion that is projected if a large contingent of Americans decide for conversion.

Are You Ready to be Converted?
For most IRA and qualified retirement account owners, the biggest challenge to conversion is determining how to pay the taxes. The ideal arrangement is usually transferring the IRA balance in full, while paying the resulting income taxes from other non-qualified accounts, such as bank savings, life insurance cash values, or investments held outside the retirement plan. Taxes could be paid from the IRA accumulation, but this will decrease the amount converted, and depending on your age and other issues involving your account, may also result in additional penalties for early distribution. With a Roth conversion, the devil is often in the details.

WANT TO REMOVE FUTURE TAX OBLIGATIONS FROM YOUR RETIREMENT ACCOUNTS? THIS YEAR MAY BE YOUR BEST CHANCE!

WANT TO DO IT RIGHT?

THEN GET PROFESSIONAL HELP!

Filed Under: CONTROL, FLOW, MOVE, SEE, THINK | Leave a Comment

LISTEN (mp3 audio) (2:20 min)

Quickly, consider what’s happened in your life in the past five years. Skim through the ups and downs, the major events and memories. If you have the opportunity, make a list. As you go through the list, sort those events and memories in two categories, “I wish I had…” or “I’m glad I did…” What do you find?

If you’re like most of us, you probably have items in both categories.

Like:

“I wish I had exercised more.”

“I wish I had taken that job offer.”

or

“I’m glad I saw the doctor.”

“I’m glad we took that trip.”

Here’s another question: For those “I wish I had…” situations, would it have taken very much to change them to “I’m glad I did…”? Possibly quite a few could have been changed with a small action on our part.

Conversely, when it comes to “I’m glad I did…” events, how many great benefits and positive memories were triggered by small decisions, or modest actions that were never anticipated to deliver great results?

In retrospect, many of the major events of our lives may have tipped on small things. Five years from now, it’s likely that many other small actions, either taken or left undone, will deliver the same impact.

The famous early 20-century American journalist H.L. Mencken, wrote “Remorse is the regret that one waited so long to do it.”

Financially, we all know we have some things where we say “I wish I had…” made a will, bought that stock, taken that life insurance.” We also know financial mistakes have ongoing opportunity costs; today’s poor decisions often cost us much more in the future.

Life doesn’t come with guarantees. But if you make a conscious decision to add another item to the “I’m glad I did…” category, you can’t help but believe the future is going to be better. The best financial program is one with no regrets. What needs to be done today so that five years from now, ten years from now, you will be able to say, “I’m glad I did…”?

Filed Under: SEE, THINK | Leave a Comment

LISTEN (mp3audio) (5:45 min)

Right before the 2010 Super Bowl, a page 1 article in the February 5, 2010 Wall Street Journal opened with this sentence:

“Investors are sometimes accused of treating the stock market like a casino. Now, one Wall Street firm wants to treat casinos like the stock market.”

The article details the decision of a Wall Street bond-trading company to take over the management of sports betting at a new Las Vegas casino. Lee Amaitis, the company executive who runs the betting operation, says the firm got into sports gambling because “we wanted to turn gamblers into traders.” Using sophisticated financial-markets software, bettors can not only bet on the final outcome, but also make wagers on events during the game, such as whether the next pass might be completed, or who kicks next field goal.

On several occasions, the article noted similarities between investing and gambling. The article even featured a bond trader-turned-professional gambler who said “Wall Street is just a form of legalized gambling.”

Is investing just a form of gambling? For many investors, the answer may be “yes.” But it doesn’t have to be. And it probably shouldn’t be.

In July 2000, Tom Murkco, the CEO of Investor-Guide.com, published an essay titled “What is the difference between gambling and investing?” While Murkco noted that many aspects of gambling and investing might appear similar, there were several distinct and easily defined differences.

For either investing or gambling, the beginning of Murkco’s definition is the same: An activity in which money is put at risk for the purpose of making a profit.

But while the purpose of gambling and investing is identical, the methods by which the purposes are achieved are drastically different.
Here are Murkco’s distinctions:

When someone invests…

• sufficient research has been conducted;
• the odds are favorable;
• the behavior is risk-averse;
• a systematic approach is being taken;
• emotions such as greed and fear play no role;
• the activity is ongoing and done as part of a
• long-term plan;
• the activity is not motivated solely by entertainment or compulsion;
• ownership of something tangible is involved;
• a net positive economic effect results.”

When someone gambles…

• little or no research has been conducted;
• the odds are unfavorable;
• the behavior is risk-seeking;
• an unsystematic approach is being taken;
• emotions such as greed and fear play a role;
• the activity is a discrete event or series of discrete events not done as part of a long-term plan;
• the activity is significantly motivated by entertainment or compulsion;
• ownership of something tangible is not involved;
• no net economic effect results.

When defined this way, it’s easy to see the differences between investing and gambling. It’s also easy to see that because of the methods some people use to invest, their behavior may more closely resemble gambling.

For example, industry studies have repeatedly shown that the behavior of mutual fund investors often accounts for poor investment performance. Because they don’t approach investing systematically, emotions like greed and fear may cause people to make impulsive decisions, with little or no research. Not surprisingly, the results from these methods more often resemble the returns from lottery tickets.

Not Gambling with Your Investments: Easier said than done?
In his book, Snap Judgment: When to Trust Your Instincts, When to Ignore Them, and How to Avoid Making Big Mistakes With Your Money, author David Adler says it’s the psychological component of investing that is the most difficult to manage. Adler contends that behavioral research shows many individuals have an almost over-whelming set of hard-wired dispositions to take gambles rather than make investments. Adler quotes Andrew Lo, an MIT professor of finance:

“The same neural circuitry that responds to cocaine, food, and sex has been shown to be activated by monetary gain as well.”

For some people, the thrill of investing/gambling can be addictive. But when the stakes are one’s financial future or retirement, or your children’s college education, the need for a thrill shouldn’t come by jeopardizing one’s investments.

This imperative to not compromise investing by gambling highlights one of the greatest benefits of working with a team of financial professionals: Besides receiving informed advice, a financial professional can often serve as a protection against gambling with your investments, by encouraging you to make sound decisions based on good research that have a high likelihood of success.

Take a moment to consider the last few major financial decisions you’ve made in the past year. Then look at the list above. Did you make an investment or take a gamble?

Filed Under: CONTROL, FLOW, MEASURE, MULTIPLY, SEE, THINK | Leave a Comment

“Some macroeconomists say if we just study the numbers long enough we’ll be able to design better policy. That’s like the sign in the bar: Free Beer Tomorrow.”

- Russ Roberts, Economics Professor

LISTEN (mp3 audio) (14:12 min)

One of the assumptions of free-market economists is that fully-informed individuals usually act in accordance with their own interests. In other words, they make financial decisions based on what they believe is best for them. However, sometimes people appear to repeatedly act against their best interests; they act irrationally, even when they have accurate information. Why is this?

In January 2008, four economists working for the National Bureau of Economic Research (NBER) published the results of an extensive study regarding retirement decisions. This information caught the attention of financial writer David Adler, who included some of the findings in his book Snap Judgment: When to Trust Your Instincts, When to Ignore Them, and How to Avoid Making Big Mistakes with Your Money (FT Press, 2009).

The primary feature of the NBER study was a pair of simple one-question quizzes given to 1,300 respondents over the age of 50, with each respondent only answering one quiz. A comparison was then made between the two groups. Because you aren’t part of the study, you can take both quizzes – and see the results!

Here’s the setup:
The quiz involves an evaluation of two fictional, identical individuals, in this case named Mr. Red and Mr. Gray (in all, there were seven fictional persons, with names like Mr. Orange, Mr. Green, Mr. Brown).

• Each person made permanent decisions on how to spend a portion of their money in retirement.

• Each has some savings and can spend $1,000 per month from Social Security in addition to the portion of income mentioned in each question.

• They have already set aside money to leave for their children when they die.

The choices are intended to be financially equivalent and based on personal preferences for spending in retirement. You are asked to evaluate which retirement option represents the “better deal.” Read each choice carefully.

Quiz #1
Mr. Red’s option: Mr. Red can spend $650 each month, along with Social Security, for as long as he lives. When he dies, there will be no more payments.
Mr. Gray’s option: Mr. Gray can choose an amount to spend each month in addition to Social Security. How long his money lasts depends on how much he spends. If he spends only $400 per month, he has money for as long as he lives. When he dies, he may leave the remainder to charity. If he spends $650 per month, he has money only until age 85. He could also spend down faster or slower than each of these options.

Quiz #2
Mr. Red’s option: Mr. Red invests $100,000 in an account which earns $650 each month for as long as he lives. He can only withdraw the earnings he receives, not the invested money. When he dies, the earnings will stop and his investment will be worth nothing.
Mr. Gray’s option: Mr. Gray invests $100,000 in an account which earns a 4% interest rate. He can withdraw some or all of the invested money at any time. When he dies, he may leave any remaining money to charity.

Question: Who has made the better choice?
Mr. Red and Mr. Gray selected different options on how to spend their money in retirement. You are asked to evaluate their decisions.

Can you guess which options were seen as the best in each quiz?

In Quiz #1, 72% felt Mr. Red made the better decision.

In Quiz #2, 79% felt Mr. Gray made the better decision.

But there’s a mind-blowing twist to the study: Each quiz presented the same options! Mr. Red’s plan is the same in both scenarios, and so is Mr. Gray’s!

So, if both plans are the same, why did respondents overwhelmingly choose Mr. Red in the first quiz and Mr. Gray in the second? The answer is “framing.” Our interpretation of new information is dependent in part on the context in which we receive it, i.e., what our “frame of reference” is for a particular scenario. As the NBER researchers put it, “experimental findings suggest that choices are not solely based on material consequences, but instead are filtered through the particular frame that individuals use to interpret choices.”

In these two instances, the “frames” made the difference in the decisions. In the first example, the frame was consumption. The focus was on how much could be spent, and for how long. From this perspective, the emphasis on a larger monthly amount available for consumption, with the guarantee of continuing no matter how long one might live, was seen as most attractive.

The second example was framed by investment. While the numbers remained the same in terms of possible monthly income, the quiz also mentioned that Mr. Red would have access only to the earnings from his investment, and nothing left when he died. In contrast, Mr. Gray had access to his original $100,000 principal at any time, and the prospect of leaving any remainder to heirs.

Analyzing this example, Adler summarizes the effects of framing: “Context can be as important as content when it comes to financial decisions, even very important financial decisions.”

But wait, there’s more…

Beyond the “wow, that’s interesting” factor of the results, both Adler and the NBER researchers believe their study has some significant practical applications.

According to Adler:

“The larger point of the experiment is not just that framing has an impact; it is specifically about how retirement planning is ‘framed’ in the U.S. and how we are conditioned to think about it. Should our financial focus be on building wealth for retirement, or on what we can consume after we retire?”

Jeffrey Brown, one of the NBER researchers, contends we have been conditioned to think about retirement as mostly an investment decision, similar to quiz #2. But in Brown’s opinion, retirement is largely a consumption decision. Says Brown,

“The messages that individuals receive when encouraged to save are all about how much you have in your account and your rates of return. But really you should think about how much can you eat each month, how much can you consume.”

And there’s even more…
If you didn’t already know it, Mr. Red’s retirement decision is a simple description of a lifetime annuity. A life annuity is a relatively straight-forward financial transaction: In exchange for a lump sum payment, an insurance company guarantees monthly payments for your lifetime, no matter how long it may be.

The NBER study (titled “Why Don’t People Insure Late Life Consumption? A Framing Explanation of the Under-Annuitization Puzzle”) is an attempt to explain why some people don’t buy annuities despite their significant financial advantages.

Life annuities are not new. They have a long history, but are infrequently selected by consumers. However, as company pension plans steadily disappear and are replaced by personal accumulation accounts, such as IRAs, 401(k)s, etc., retirees are beginning to reconsider annuities in retirement. But because many potential buyers have an “investment” frame of reference; the idea of “losing” any leftover principal at death is perceived as a strong deterrent to purchasing an annuity.

In contrast, most economists, especially those whose “frame” is consumption, see annuities in a very positive light. You don’t have to worry about outliving your money – ever. If you live beyond your life expectancy, there’s a good chance the guaranteed payments will deliver higher returns than what would have come from traditional investments. Once implemented, there are no management decisions required, and no investment risk. As Adler says, “the wildly enthusiastic consensus among most economists, to say nothing of the insurance industry, is that annuities are a great thing.”

Finally, there’s this…
In spite of all the statistical evidence supporting annuities, there’s still a mental snag for many individuals considering a lifetime annuity. When an annuitant with a lifetime annuity dies, the payments stop (unless a refund feature or term certain feature was elected). There are no refunds of “unused principal.” In a worst-case scenario, someone gives the insurance company a big chunk of change to buy a life annuity, then dies within a short period of time. This possibility, framed from an investment perspective, is probably the biggest reason many people reject a lifetime annuity.

But curiously enough, it seems some of the fears of not living long enough to receive full value from an annuity can be alleviated… by buying one.

Steven Levitt and Stephen Dubner are co-authors of the best-sellers Freakanomics and SuperFreakanomics. Both books take a simple economic idea, that incentives matter, and apply it to a variety of unusual financial, environmental and cultural situations. One of their chapters discusses actions which could lead to a longer lifespan. Among the diverse factors: career choices, winning a Nobel Prize, having a woman doctor…and buying an annuity. Yep, you read that right. Here’s the reason:

“People who buy annuities, it turns out, live longer than people who don’t, and not because people who buy annuities are healthier to start with.  The evidence suggests that an annuity’s steady payout provides a little extra incentive to keep chugging along.”

Wow. Based on this evidence, annuities sound like a financial “silver bullet” and a fountain of youth!

But this article really isn’t about annuities…
Whether or not you should buy an annuity depends on your unique circumstances.

A greater issue is who or what is framing your financial decisions, and whether that frame is the most beneficial perspective for you and your future.

A parallel issue, one that may offend some sensibilities, is whether all frames are equally viable. Specifically, are the consumption and investing frames just two approaches to the same objective, or is one better than the other?

While historical and mathematical arguments can be made for either the consumption or investing frame, there is strong psychological support for the consumption paradigm. In March, the Employee Benefits Research Institute (EBRI) released its 20th annual report on retirement confidence. One of their findings: “Nearly half of all workers would opt for a guaranteed income for life.”

Perhaps this inclination toward security is primarily a reaction to the recent financial turmoil. But more likely, it points to the real value of financial security. Maximized consumption isn’t just a framing option. It’s the better choice for financial success and contentment.

DO YOUR FINANCIAL OBJECTIVES INCLUDE A CONSUMPTION FRAME OF REFERENCE?

HOW MUCH OF YOUR FINANCIAL FUTURE IS SECURED?

Filed Under: CONTROL, FLOW, MOVE, SEE, THINK | Leave a Comment

LISTEN (mp3 audio) (10:12 min)

In terms of financial value, has a college degree reached its “tipping point?”

Since the end of World War II, obtaining a higher education has been touted as one of the surest paths to a higher income and better financial life. Supporting this idea, various government programs have been established to make it possible for more people to afford a college education. Included in these programs are grants, scholarships and work-study options, but the most widely-used assistance plans are student loans, which allow individuals to borrow money in order to finance their education on very favorable terms. (Not only are government-approved student loans generally issued at lower interest rates, but most do not become due until after several months after graduation.)

President Ronald Reagan was not an economist, but he was fond of repeating several economic adages that succinctly expressed his views. Among those most frequently recited: “If you want more of something, subsidize it.” This statement has proven true in higher education; more Americans are attending college – and more Americans are using government assistance to do it. But subsidies, government or otherwise, have other consequences as well.

When the demand for something increases, the price usually goes up as well. A 2008 report from the National Center for Public Policy and Higher Education found that “published college tuition and fees increased 439% from 1982 to 2007 while median family income rose 147%.” In other words, the cost of a college education over those 25 years had tripled in relation to family income.

Because higher education costs more money, the Center’s report adds that “student borrowing has more than doubled in the last decade.” The public service web site www.finaid.org acknowledges borrowing is now almost inevitable: “Few students can afford to pay for college without some form of education financing. Two-thirds (65.6%) of 4-year undergraduate students graduated with a Bachelor’s degree and some debt in 2007-08, and the average student loan debt among graduating seniors was $23,186.”

As the cost of education and the amount of borrowing necessary to finance it both increase, the financial value of a higher education begins to decrease relative to its cost. A February 2, 2010 Wall Street Journal article titled “What’s a Degree Really Worth?” presented some calculations that the financial advantage of a college education had diminished by almost 60% in the past decade.

Various data collected from 1999 through 2002 and used in publications by the Census Bureau and the nonprofit College Board showed a college education paid off in an average lifetime earning advantage of $800,000 to $1 million, compared to those without degrees. However, using current numbers reflecting the disproportionate increase in costs compared to incomes, the American Institutes for Research, another non-profit, found the lifetime advantage had diminished to $280,000.

Beyond the possibly diminished advantage in lifetime earnings, the increase in student loan indebtedness may present greater financial dilemmas for college graduates. Student loans are unique financial obligations, and their negative financial impact can last a lifetime.

Particularly in a tight job market, repaying student loans can be a financial hardship when one is just beginning a career. In response, lenders may offer options to postpone or modify payments, but forbearance on large sums can make future payments positively overwhelming. In a February 13, 2010, Wall Street Journal article (“The $550,000 Student-Loan Burden”), Mary Pilon detailed how the student loan debt of a family practitioner ballooned from $250,000 to $550,000 in the eight years after her graduation because of deferrals and charges.

Since most student loan debt is secured debt borrowed from the federal government, it can almost never be erased, even by filing bankruptcy. As www.collegescholarships.org says on its website: “Student loans are rarely forgiven since they are guaranteed government funds dispersed with low interest to all kinds of people with no credit history. You don’t epect the IRS to forgive you on all taxes that are owed, so expect the same treatment with your student loan.”

Jeffrey J. Williams, a professor at Carnegie-Mellon University, writes that student loans “stipulate severe penalties and are virtually unbreakable, forgiven only in death, not bankruptcy, and enforced by severe measures, such as garnishes and other legal sanctions, with little recourse. (In one recent case, the Social Security payment to a person on disability was garnished.)”

Even if you can make regular payments following graduation, the terms are heavy. “Student debt is a long-term commitment — fifteen years for standard Stafford guaranteed federal loans,” says Williams, author of The Post-Welfare State University. “With consolidation or refinancing, the length of term frequently extends to thirty years—in other words, for many returning students or graduate students, until retirement age.” Having student loan payments at age 55 or 65 is a sobering thought.

Because of these sizable long-term obligations, “College student loan debt has revived the spirit of indenture for a sizable proportion of contemporary Americans,” says Williams. “Because of its unprecedented and escalating amounts, it is a major constraint that looms over the lives of those so contracted, binding individuals for a significant part of their future work lives.” Pilon agrees, saying “in practice, student loans are one of the most toxic debts, requiring extreme consumer caution.”

Conclusion: Education Good; Debt Bad; Preparation Essential
In almost every instance, more knowledge and greater skills are valuable, even if the financial calculations seem to indicate the benefits aren’t as great as they used to be. The critical financial questions about a higher education are whether it’s worth mortgaging a significant portion of one’s future to acquire a higher education, and whether using student loans is a preferred method of financing.

In addressing these questions, there is another dynamic. The person who will be most affected by this decision is often financially inexperienced and possesses limited resources. Bruce Necker, writing a “President’s Page” opinion piece in the March, 2002, issue of the Michigan Bar Journal, related that

“One of my friends, a successful obstetrician in Grand Rapids, told me that if she had to do it all over again, she would forgo her medical school education rather than strap herself for her entire life, to decisions she made as a 22-year-old before entering the profession. I hear the same tale from young lawyers. Borrowing is the easy part. Repayment proves to be more difficult.”

In reality, these hard financial decisions about college education are greatly determined by earlier financial decisions made by a student’s parents or guardians. If they haven’t made preparations for college funding, the choices for their children are limited: athletic or academic scholarships, need-based financial aid, or loans. Scholarships are available to a uniquely gifted portion of the population, and need-based funding has decreased with the economic decline. That leaves either loans – or forgoing college.

IS COLLEGE EDUCATION ON YOUR LIST (OR YOUR CHILDRENS’)?  IF SO, NOW IS THE TIME TO EXPLORE FUNDING ALTERNATIVES TO STUDENT LOANS.

Filed Under: CONTROL, MEASURE, SEE, THINK | Leave a Comment

LISTEN (mp3 audio) (5:16 min)

The potential for financial devastation from disability is substantial. For most Americans, the ability to earn an income is their primary financial engine. If something stops the engine, everything else comes to a halt as well.

In spite of the critical need for ongoing income in most people’s financial program, relatively few Americans obtain personal disability income insurance from an insurance company. Some may pick up group disability coverage from an employer, but for most Americans, their primary disability insurance is through the Social Security Administration (SSA).

According to the SSA website (www.ssa.gov), Social Security provides disability benefits for all workers who qualify, i.e., they have “worked long enough and paid Social Security taxes.”

Like other private forms of disability insurance, SSA benefits can only be paid if your disability fulfills or meets a pre-established criteria. SSA considers you disabled* if:

• You cannot do work that you did before;
• SSA decides that you cannot adjust to other work because of your medical condition(s); and
• Your disability has lasted or is expected to last for at least one year or to result in death.

* Please contact the Social Security Administration for complete eligibility criteria. The text above is a summary of those requirements.

SSA explicitly states “This is a strict definition of disability. Social Security program rules assume that working families have access to other resources to provide support during periods of short-term disabilities, including workers’ compensation, insurance, savings and investments.”

Under the law, your payments cannot begin until you have been disabled for at least five full months. Payments usually start with your sixth month of disability, providing your disability is approved (more on this later).

The amount of benefit paid will depend on several factors, including your earnings and family size. In some situations, additional benefits through the Supplemental Security Income (SSI) program may be available. Benefits may be paid until you return to work or reach retirement age, at which time your payments will be disbursed from your Social Security retirement.

In summary, the SSA disability insurance is minimal when compared to coverage available through insurance companies, but certainly is better than no coverage.

But beyond the strict definition of disability, lengthy waiting period and limited benefits, disabled workers face a significant hurdle when applying to receive SSA benefits: The claims process itself.

According to the SSA, the average processing time for an individual awaiting a decision from Social Security with regard to a disability claim is 442 days.

That’s almost 15 months!

And that’s just to get a decision. Approval is another matter altogether, because according to the Social Security and Disability Resource Center (www.ssdrc.com), only about 40 percent of all claims are approved from the initial submission.

If you are denied benefits, SSA offers two appeals. The first is called Reconsideration (in which another 20 percent are approved to receive benefits), and the final appeal is a hearing before an Administrative Law Judge.

How quickly a SSA disability claim is resolved depends on a number of factors, many impossible to determine in advance. As the SSDRC says:

“Social Security Disability and SSI cases can be won in as little as 30 days, or take as long as two years for benefits to be awarded. There is simply no way to predict how long a case will take because unlike other programs (Dept of Social Services, for instance), the federal disability program does not have deadlines for applications or appeals.”

The bureaucracy and legal procedures involved in receiving SSA benefits has made professional assistance almost a necessity. SSA claims have become a specialized niche for some law firms.

Participation in Social Security is mandatory for almost all Americans who earn an income. And if you are entitled to benefits from SSA as a result of a disability, you should by all means make a claim. But honestly…

Is this the only insurance protection you want in place in the event of a disability?

Filed Under: CONTROL, FLOW, MEASURE, SEE, THINK | Leave a Comment

LISTEN: mp3 audio (28:24 min)

“Don’t be afraid to see what you see.”

- Ronald Reagan

The Quest for Relevant Financial Information

One of the essentials of planning for anything is making reasonable projections regarding the future. If you’re planning a vacation in the Caribbean, you want to go when the possibility of a hurricane is slight. If you’re thinking about starting a business, you want to have an idea of the demand for your goods or services. If you’re going to invest, you want to put your money in places where the likelihood of profit is greatest.
When it comes to your financial programs, what kind of information about the future is reliable for making decisions?

• Is it a mountain chart in an investment prospectus that reads: “Past returns are no guarantee of future performance?”

• Is it a (completely fabricated but perfectly plausible) sound byte from one of the business channels on cable television that drones on like this: “Stocks closed slightly lower today as investors reacted to news that unemployment remained essentially unchanged, while concerns about the effect of a colder-than-expected spring continue to drive futures higher for oranges while dampening new construction in western markets…”

• Is it a book or periodical that blares: “The Insider’s Secret to Real Estate in Today’s Economy?”

If you’re looking for help discerning the future, what can you do with this type of information? Some of it is past history, some of it is happening now. But how reliable are these items in determining what might happen tomorrow, next week, a year from now, or even the next decade?

Before going any further, here’s the disclaimer: What follows is not a list of specific predictions for the future. Rather, it’s a discussion of several macroeconomic (i.e., big view) trends that are already in place today. In the past, these trends have yielded some very consistent cause-and-effect results, and they are worth careful consideration.

No one can predict the future.

Got it?

Demographic trends as macro-economic indicators. These macro-economic indicators fall under the category of demographics. According to the dictionary, “demographics” is:

“…the statistical characteristics of human populations (as age or income) used especially to identify markets.”

Why pay attention to demographics? Demographics can be huge long-term drivers of economic activity. First, they are important because they involve large numbers of people, which means what happens demographically occurs on a large scale, affecting millions.

Further, economic trends powered by demographics have typically played out over long time periods. We’re talking several decades, even centuries. One of the most prominent examples in recent American history is the impact of the Baby Boomers – the dynamic population expansion in the United States that took place from 1946-1964. In one way or another, almost every major financial trend of the past fifty years has the imprint of the Boomers, from the growth of suburbia to the demise of employer pension plans. The ripple effects continue today – and probably will do so for another decade or two.

The long-term nature of demographic trends means many factors in place today are set to play out in a predictable manner in the future. So while no one can precisely project the future, demographics often offer reliable paradigms for future trends.

DEMOGRAPHIC TREND #1:
Depopulation of Industrialized Nations
From an economic standpoint, two demographic categories figure prominently in long-term national wealth and prosperity: total fertility rate and immigration. Put simply, an industrialized economy requires people. People to work, consume, and pay taxes to provide government services. Since people don’t live forever, they must be replaced, either through the birth of children (fertility) or arrivals from other countries (immigration).

Fertility
The Total Fertility Rate (TFR) is a calculation of the number of children each woman bears in her lifetime. Worldwide, the United Nations states the TFR is currently 2.55. In general, a country must maintain a total fertility rate (TFR) of at least 2.1 to replace its native population. (See the graphic below for a representative sample of TFRs by nation.)

Though over-population of the planet has been a concern of some social scientists since the 1800s, depopulation may actually be a greater immediate concern. The demographic trend of many developed nations is for older, declining populations, particularly among the developed nations of Europe and East Asia (China, Japan, and South Korea). This trend, already in place, presents some significant long-term economic challenges. In 2002, economist Paul S. Hewitt wrote a position paper titled “The End of the Postwar Welfare State” that outlined the economic consequences of depopulation.

Like it or not, our current economic and social organization depends on continued economic expansion. Without it, both government and private sector finances will become significantly more precarious. The most rapidly depopulating nations face the prospect of lengthy “aging recessions” characterized by a vicious cycle of falling demand, collapsing asset values, shrinking corporate profits, deteriorating household and financial institution balance sheets, weakening currencies, and soaring budget pressures.

Based on his assessment of the demographic trends in 2002, Hewitt concluded many aspects of “aging recessions” would begin appearing sometime after 2010, and continue for the next three or four decades. This assessment has thus far proved accurate. As of 2009, Japan, Italy and Germany are already experiencing population declines. In the countries of the former Soviet Union, the drop has been even steeper, due to a combination of declining birth rates and increased mortality.

Shrinking populations with a higher percentage of elderly put pressure on governments to continue to maintain social services, particularly old-age pensions. The problem is too many retirees and not enough workers paying taxes. The current recession has only aggravated this burgeoning problem, as evidenced by the financial distresses of the group of European nations, whose acronym is “PIGS” (Portugal, Ireland, Greece and Spain).

Remember that demographic trends often play out over long time periods. Once in motion, demographic trends are slow to change. Even if families in low-TFR countries begin to have significantly more than two children per woman, repopulation may not happen fast enough to replace all the old people dying. In fact, when the TFR falls below 1.7, most experts think a population decline becomes irreversible. Which means the survival of many countries will depend on immigration.

Immigration
Of the countries with the highest TFRs, a high percentage are on the African continent, and all have underdeveloped economies. Many of these countries also have higher mortality rates, typically due to substandard health services, disease, and/or civil unrest, so population may not increase significantly even with higher TFRs. The combination of poor living conditions and limited economic opportunity provides strong incentive for many to emigrate. These are the people that can become the “replacements” for dying populations in other countries.

If you check the list, you will see nations on every continent that have TFRs well below the replacement rate. In other words, there are a lot of places where immigrants would be considered coveted human resources.

But not every country or region that needs outside population support is considered a desirable relocation destination. Some depopulated countries don’t have the economic opportunities, some don’t have cultures that accept outsiders, and others have repressive governmental structures. (There are very few people trying to immigrate to Cuba.)

U.S. Demographics: Near-Replacement + Immigration = Economic Vitality
Compared to other developed countries, the United States has a TFR almost at replacement, and the average has been inching upward over the past decade. In addition, the US remains an immigration destination of choice, both for individual freedom and economic opportunity. Even though immigration (both legal and illegal) has slowed during the recession, an estimated 1.5 million new immigrants have entered America each year during the past decade, according to the Migration Policy Institute.

Joel Kotkin is a researcher of global, economic, political and social trends, and the author of a new book, The Next Hundred Million: America in 2050. Kotkin sees good things ahead for America because of favorable demographics. As he writes in a January 23-24, 2010 “Culture” piece for the Wall Street Journal…

“As many other advanced countries become dominated by the elderly, the U.S. will have the benefit of a millennial baby boom as the “echo boomers” start having offspring in large numbers later this decade…

“Within the next four decades, most of the developed countries in both Europe and East Asia will become veritable old-age homes: A third or more of their populations will be over 65, compared with only a fifth of America… Like the rest of the developed world, the U.S. will certainly have to cope with an aging population and lower population growth, but in relative terms, the country will boast a youthful and dynamic economy.”

While illegal immigration remains a touchy political issue, Kotkin focuses on the positives of newcomers to America, saying “immigration represents a critical component of our next wave of dynamism…What drives immigrants is their optimism in America’s future.” Further, Kotkin believes the United States will continue to have an immigration advantage as “nations such as Sweden, Denmark and the Netherlands have turned against immigration” and “our prime Asian rivals – China, Japan and Korea – remain even more culturally resistant to diversity.”

DEMOGRAPHIC TREND #2:
Rectangular Longevity
Notwithstanding the current depopulation trends in some developed countries, the world’s population has increased dramatically in the past century and is continuing to grow. In the 20th century, the global population nearly quadrupled, with annual growth rates peaking in the mid-1960s. The key factors: Advances in hygiene, medicine and living conditions dramatically reduced infant mortality and increased life expectancy. More babies survive, and everyone is living longer.

And the demographic trend toward greater longevity shows no signs of slowing. Matt Ridley, an English writer on genetics, economics and human behavior writes “experts have been predicting for decades that average life expectancy will level out, but it stubbornly keeps rising. Others have predicted a growing burden of ill health among the elderly. Yet old people are healthier than ever, much of their illness compressed into shorter periods at the end of life.”

Some researchers call this phenomenon of living longer and healthier the “rectangularization of the survivorship curve.” Instead of deaths being distributed across a broad spectrum of ages from childhood to old age in some sort of statistical curve, in rectangularization “almost everybody lives to their full potential age, then dies,” says Ridley.

In this world of rectangular longevity, there are many guesses as to how far lifespan can extend. Some project to age 150, or even 200 within the next century. Science writer Greg Critser, author of Eternity Soup: Inside the Quest to End Aging, suggests that even now living to 115 is realistic. Already, many life insurance companies have recalibrated the pricing and benefits of some of their policies with a “whole life” lasting until age 120.

Applications and X Factors
What to make of these demographic trends? More to the point, how might these demographic trends affect your financial programs? Here are several observations:

Anticipate an extended lifespan. Thirty years ago, a financial professional might offer this paradigm: “You’ll work for 40 years (from 25 to 65), to save enough to live another 20 years (from 65-85) in retirement.” At that time, planning to live to 85 was considered a “top-end” projection of life expectancy. A generation later, it is reasonable to believe most of us will outlive our parents. It may seem outrageous, but a prudent plan should at least touch on the possibility of retirement calculations that run to age 100.

Prepare to work longer. If you are going to live longer, it may be necessary to continue working later in life. Furthermore, in aging or depopulating conditions, working longer may be both inevitable and desirable.
As a way to offset decreased revenues available for social programs, governments may raise the minimum age for receiving retirement benefits, as is gradually occurring with Social Security in the U.S. Similarly, the age 59½ condition for accessing qualified plan assets without penalty could change. Beyond regulatory incentives, depopulation often improves employment prospects – there are fewer workers to fill positions, and it becomes an employees’ market. This means if you want to work, it’s likely that someone will want to hire you.

Self-employment and phased retirement are likely possibilities. A February 8, 2010 Wall Street Journal Small Business Report begins with this statement: “Welcome to the age of going solo.” Some additional comments:

“More Americans are working as consultants or freelancers, either having given up or been forced out of the salaried world of 9 to 5…Evidence now suggest this is our new economic condition. Today, in fact, 20% to 23% of US workers are operating as consultants, freelancers, free agents, contractors or micropreneurs.”

Without a surge of younger, cheaper employees to support pensions and long-term employment, self-employment is a logical business move. In a slower-growing or depopulating economy, contract and consultant work is the most efficient way for employers to harness the job skills of aging baby boomers.

A variation on self-employment is phased retirement. The phrase “phased retirement” encompasses a broad range of formal and informal employment arrangements to allow employees to continue working, usually with reduced workloads, as a transition from full-time work to full-time retirement. These arrangements may include allowing employees to draw partial retirement benefits while remaining employed.
Phased retirement is seen as a win-win for both older workers and employers. Workers can gradually ease into retirement while maintaining a higher income than they would receive if they quit work entirely. Employers retain skilled older employees who would otherwise retire, leaving the company to replace and retrain the retiree, often at higher cost.

Under current tax laws, a phased retirement that includes partial withdrawals from retirement accounts while still employed faces some hurdles in the way of age and income thresholds. But changes seem likely. An August 2008 AARP bulletin noted that the 2006 Pension Protection Act for the first time allowed employers to let workers 62 and older to take distributions from traditional pensions and to continue working.

New forms of retirement saving will be needed. The IRA started as a supplemental retirement plan, then spawned the 401(k) as corporate pensions declined. Similarly, intermittent self-employment and phased retirements will necessitate other formats for long-term saving. The account will probably include some tax incentives for saving, yet allow access under a broader range of circumstances.

Insurance rates will change, for both public and private programs. It doesn’t matter how strenuously politicians avoid the issue, depopulation means government-sponsored insurance and pension plans must change. For old-age programs like Social Security, the options are to increase taxes on a proportionately smaller working population or decrease benefits. Eventually, a threshold for taxation will be reached and the only choice will be to cut benefits. This is already happening in some formerly communist, low-TFR countries in Eastern Europe.

As mentioned earlier, life insurance premiums for some products have been adjusted for longer life expectancies. This may result in lower annual premiums because the insurer believes it will receive payments for a longer time before incurring a claim.

On the other hand, monthly pension and annuity payments may decline as well. Instead of longer periods to collect premiums/deposits, pension funds and insurance companies now face the prospect of making payments to retirees for longer periods.

Current demographic trends favor the United States. In general, growing populations fuel economic opportunities; more people make for larger markets – for goods, services, housing, etc. Since the beginning of recorded time, people have migrated to places where prospects for a better life existed. It is accurate to state that population demographics have a big impact on long-term financial well-being.

But other variables can play a part as well. Repressive political regimes, punitive taxation, wars, disease and natural disasters can diminish or destroy prosperity. Even the strongest demographic tracks can be derailed.

In many ways, the issues reported every day on cable news channels are evidence of the demographic changes moving across the globe. The United States is certainly not immune to the long-term impact of depopulation, immigration and aging society. Many of the political arguments in the United States have their roots in these demographic trends.

Still, in spite of the noisy political squabbles, the demographics say the United States remains a land of opportunity, and has a good chance to continue to be one in the future.

Skipping to the End: From the Macro to You
Here’s a summary for those who blew by the first four pages:
Demographic trends, i.e., the analysis of population statistics to identify markets, can uncover significant, large-scale, long-term economic movements that are already in place. Once in place, demographic trends may take a long time to play out, so understanding these trends may be valuable in shaping future financial plans.

Among the most significant trends currently affecting the industrialized world: Depopulation of developed countries, particularly in Europe and East Asia, coupled with more people living to the limits of extended life expectancies. The result: decreasing populations with an increased percentage of older people, a format that will be unable to sustain social and economic models started in the post-World War II era.

As a consequence of these changing demographic trends, many of the paradigms and products related to personal finance may need to be adjusted. This includes length and type of employment, retirement and accumulation planning, self-employment and insurance programs (both public and private).

In light of these conclusions, think of your own financial programs. The following questions might be relevant:

• Are your retirement plans designed to provide income and security to age 100 and beyond?

• Does your career path include working, in some capacity, well into your 70s (or 80s)?

• Are your savings and retirement programs structured to accommodate self-employment or phased retirement?

On reflection, a lot of financial information is just trivia that takes up space and is quickly forgotten. But historically, economic demographics seem to have staying power. The last great demographic trend began after World War II. More than sixty years later, the Post-War demographics are finally winding down, and in developed countries, the rising demographics of depopulation and rectangular longevity are already in place. Do your financial programs account for the possibilities – and perils – of these new trends? Remember, the impact of demographics can span decades, even centuries.

Filed Under: CONTROL, SEE, THINK | Leave a Comment

LISTEN: mp3 audio (03:47 min)

Malcolm Gladwell is the author of the best-seller Outliers: The Story of Success. The book attempts to identify both internal and external factors that seem to appear consistently in the lives of successful people. Rather than simply attributing personal success to ambition and hard work, Gladwell identifies other diverse variables, including the month of one’s birth, the era in which you were born, the occupational background of your parents and grandparents, and how many hours a year people work in your culture. In examining all these items, Gladwell concludes that success is as much about what is around people as what is in them (in the way of natural gifts and abilities).

These external factors don’t deny the value of ambition and hard work. In fact, one of the most significant factors mentioned in Gladwell’s book is what scientists call the “10,000-hour rule.” In an interview that appeared in the March 15, 2009 issue of Bottom Line Personal, Gladwell explains the 10,000-hour Rule:

“When we look at any kind of cognitively complex field — for example, playing chess, writing fiction or being a neurosurgeon — we find that you are unlikely to master it unless you have practiced for 10,000 hours. That’s 20 hours a week for 10 years. The brain takes that long to assimilate all it needs to know to achieve true mastery.”

At first glance, this simply reinforces the old adage that “practice makes perfect.” However, Gladwell takes it a step further: Even people with great natural abilities cannot sidestep, shorten or go easy on the 10,000 hour requirement. The repetitions are absolutely necessary to fully release one’s talent.

The assembly and management of a profitable financial plan probably falls under the definition of a “cognitively complex task”– there are a lot of pieces, some of which may be rather complex in design, and the complexity increases when you attempt to integrate these items to create a functioning whole. Perhaps it’s not as demanding as neurosurgery or as thrilling as performing a concerto before a large audience, but managing your finances isn’t something that fits in the category of “easy.” So it stands to reason that in order to maximize your financial potential, “mastery” of your financial programs would require something similar to 10,000 hours of practice.

• Is it realistic to expect you’ll devote 20 hours a week to becoming the master of your financial universe?
• Is it realistic to devote even five hours a week to the task?
  
• Or is it better to find someone else who has already crossed the 10,000 limit?
  

Whether the 10,000-hour rule applies to your work, or the efforts of those who help you, experience and ability are an unbeatable combination. If you aren’t going to put 10,000 hours into your financial programs, why not make sure you work with someone who has?

Filed Under: CONTROL, SEE, THINK | Leave a Comment

LISTEN: mp3 audio (02:42 min)

Demographic trends, i.e., the analysis of population statistics to identify markets, can uncover significant, large-scale, long-term economic movements that are already in place. Once in place, demographic trends may take a long time to play out, so understanding these trends may be valuable in shaping future financial plans.

Among the most significant trends currently affecting the industrialized world: Depopulation of developed countries, particularly in Europe and East Asia, coupled with more people living to the limits of extended life expectancies. The result: decreasing populations with an increased percentage of older people, a format that will be unable to sustain social and economic models started in the post-World War II era.

As a consequence of these changing demographic trends, many of the paradigms and products related to personal finance may need to be adjusted. This includes length and type of employment, retirement and accumulation planning, self-employment and insurance programs (both public and private).

In light of these conclusions, think of your own financial programs. The following questions might be relevant:

• Are your retirement plans designed to provide income and security to age 100 and beyond?

• Does your career path include working, in some capacity, well into your 70s (or 80s)?

• Are your savings and retirement programs structured to accommodate self-employment or phased retirement?

On reflection, a lot of financial information is just trivia that takes up space and is quickly forgotten. But historically, economic demographics seem to have staying power. The last great demographic trend began after World War II. More than sixty years later, the Post-War demographics are finally winding down, and in developed countries, the rising demographics of depopulation and rectangular longevity are already in place. Do your financial programs account for the possibilities – and perils – of these new trends? Remember, the impact of demographics can span decades, even centuries.

Filed Under: CONTROL, MEASURE, SEE, THINK | Leave a Comment

LISTEN: mp3 audio (9:44 min)

“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?

Filed Under: CONTROL, FLOW, MOVE, MULTIPLY, SEE, THINK | Leave a Comment

• Popular Posts

  • Single-Premium Life Insurance and MECs
  • Demographics & Economics: Is the Future Already in Place?
  • Whole Life Insurance: A Unique Asset Class
  • Life Insurance Policyholders Conclude: We Don’t Want The Risk
  • Accelerated Debt Payoff…
  • 2010: The Year of the Roth IRA Conversion
  • Get It In Writing (Your Finances, That Is)
  • Ideas That Endure
  • 5-Minute Financial Thought
  • Have You Been Framed?

• Recent Posts

  • VOLATILITY UP, INVESTORS OUT (Should We Blame the Machines?)
  • SOCIAL SECURITY: You Might Still Get It –If You Live Long Enough
  • Whole Life Insurance: Complex, Ingenious
  • How a Short Attention Span Can Hurt Your Financial Progress
  • Taming the Invisible Gorilla
  • Should a Second Home Be the Only One You Own?
  • DISABILITY INSURANCE: A Case Study in Illusions?
  • Accelerated Debt Payoff…
  • ASSET TRANSFERS:From Cash to Cash Values and Life Insurance
  • Bugged by Gold?

• Categories

  • CONTROL
  • FLOW
  • MEASURE
  • MOVE
  • MULTIPLY
  • SEE
  • THINK

• Archives

  • August 2010
  • July 2010
  • June 2010
  • May 2010
  • April 2010
  • March 2010
  • February 2010
  • January 2010
  • December 2009
  • November 2009
  • October 2009
  • September 2009
  • August 2009
  • July 2009
  • June 2009
  • May 2009
  • April 2009
  • March 2009
  • February 2009
  • December 2008
  • October 2008
  • September 2008
  • August 2008
  • July 2008

Ready to TAKE AIM AT AcceleratING Your Prosperity?

Learn how by grabbing our complimentary Prosperity Accelerator Pack - a short overview of an approach aimed at accelerating your prosperity – with less worry, uncertainty, and stress.

When you get your complimentary Prosperity Accelerator Pack, you'll also get a FREE subscription to our Prosperity On Purpose ezine as our thanks!

Your contact information is safe with us. Click here for our Privacy Policy.