The Prosperity Blog

W-2, 1099, or Schedule C? It Doesn’t Matter, Because Everyone is Really “Self-Employed”

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“Those who spend too much will eventually be owned by those who are thrifty.”
– Sir John Templeton

The Sun Sets On Industrial Age Employment

Some commentary on current events, from a long-term perspective:

On July 17, 2009, US Bureau of Labor Statistics reported the national unemployment rate as 9.7%, the highest since 1983. In several states, unemployment is well over 10%, and is even as high as 20% in some metropolitan regions. This is a major employment upheaval, one that significantly impacts the financial lives of a large segment of the populace.

If the future is consistent with past history, many of those currently unemployed will eventually find their way back into the workplace when the economy rebounds. But those who return to work will find their employment landscape fundamentally and permanently changed, because it is quite likely this “Great Recession” officially marks the end of lifetime employment.

Lifetime employment was one of the crowning distinctions of the modern Industrial Age. Beginning in the post-war 1940s, it was characterized by steady employment, guaranteed pensions, and employer-provided benefits. As a result, millions of blue-collar American households ascended to middle-class affluence; they bought homes in the suburbs, sent their kids to college and after 40 years of service, retired to a life of relative security and ease. At the same time, the white-collar professional and management class grew as well. Every now and then some observer might moan about the dehumanizing aspects of factory work or cubicle life in the corporate maze, but throughout history, there’s never been a socio-economic model that delivered so many financial benefits to so many people on such a stable basis.

However, in a world where the only constant is change, Industrial Age lifetime employment could not last forever. The power technologies that fueled the Industrial Revolution (steam, electricity and the internal combustion engine) laid the foundation for the micro-technologies of the personal computer and the Internet, ushering in the Information Age. And while government policymakers may strain mightily to preserve the “old world” of lifetime corporate employment, every indication is that changes are not only on the horizon, but already here. Even American automobile manufactures finally recognized it. Unless you are working in government (including education) or the military, lifetime financial security, courtesy of your employer, is a thing of the past.

Self Employed in the Information Age

Going forward (if you haven’t experienced it already), these changes will have huge implications for your individual finances. In the emerging Information economy, workers will find it to their advantage to think and act as if they were self-employed. For some, this means adopting some different paradigms and acquiring some different financial habits.

Fluctuating Income, Multiple Sources

First and foremost, the nature of your work and income may change. You are less likely to remain in one industry, with one employer, doing one job, receiving one paycheck. Instead, work is more likely to resemble a series of long-term but temporary assignments with several employers (sometimes at the same time), with periods of unemployment and self-employment. This is particularly true for younger workers. As Maureen Sharib, an employment “sourcer” from TechTrak, put in a July 14, 2007 commentary:

“Today, there are 149 million people in our nation’s workforce. Every year, approximately 50 million people leave their jobs. And approximately 50 million find new jobs. That means one-third of our workforce turns over each year because of new opportunities. And the average American has had nine jobs by the time he or she is 34 years old because of new opportunities.”

Not only are tomorrow’s workers more likely to experience regular employment changes, they will also encounter different forms of payment. While government prefers making as many workers as possible W-2 employees because income taxes are withheld by the employer, the just-in-time, low-overhead pressures of the Information economy make it financially desirable for companies to limit their full-time employees and consider out-sourcing or contracting. For many, this could mean the end of regular paychecks.

Combine frequent job changes with non-W-2 compensation and the inevitable result is irregular cash flow, one of the major characteristics of self-employment. Successful self-employment requires strategies to manage these fluctuations and still pay the bills.

Portable, Personal Benefits Packages

As you move, you must either maintain or perpetually re-establish your benefits package. When the “company man” was the default career path, the trip included employer-provided benefits. That scenario is no longer on the table for most workers.

Even in holdover Industrial Age jobs, the cost of providing benefits has skyrocketed (particularly for health care), so most employers require employees to share in the costs. Alternately, employers reconfigure their work force so that fewer employees are eligible for any benefits. The structure of Information Age employment puts the responsibility for benefits more directly on the worker.

If offered, group disability and life insurance protection may be an inexpensive way to obtain income protection, but these options are usually limited to active employees – if you terminate employment, you can’t take the coverage with you (you may be able to convert  life coverage to an individual policy, but the costs are no longer at group rates). This leaves you either hoping your new (and often temporary) employer will offer similar benefits, or hoping you are healthy enough to qualify for similar benefits on an individual basis. The older you get, the more problematic this arrangement becomes.

In the long run, securing a personally-owned package of portable (and permanent) benefits may be a better option, particularly for disability and life insurance, where premiums and coverages for individual policies can be guaranteed to remain the same for specified time periods. In addition, healthy individuals who obtain permanent coverage at a young age may realize some long-term savings because younger, healthy individuals usually subsidize the costs of insuring older, less healthy people in group policies.

Your Own Financial Management Systems

Not only must your benefits package be portable, but so must your financial management systems. All employers are subject to regulation regarding taxes and withholding for the employees on their payrolls. This includes the requirements to pay the employer’s portion of FICA and Medicare taxes, plus withholding on income paid to employees. However, when workers are paid by the job or under 1099 conditions, the responsibility for these taxes falls on the worker, not the employer. This increases the possibility that you may have to make quarterly estimated tax payments, at both the state and federal levels. (Even if you receive a W-2, you may be considered a “non-statutory employee,” in which case the employer will not manage your withholding requirements.)

This means your tax return will probably require more than a 1040-EZ form. It also means you’ll want to keep records for deductible expenses, as well as earnings.

Additionally, employers typically handle automatic deductions for qualified retirement plans, like 401(k)s, and often facilitate direct-deposit transactions, making it easy to execute long-term saving objectives. But if you’re not eligible to participate in a company’s plan, where will you put retirement savings – and how will you deposit the money? These issues must be addressed by your financial management system.

You are the Pension Fund Manager

Beyond finding the financial vehicle and making the deposits, you are responsible for creating your own pension income from these savings. Unlike the Industrial Era job, there are no formulas based on average salary and years of service to determine your retirement benefit. Instead, it’s up to you to answer questions like: How much funding will be required? When will you be able to receive payments? How big will they be? In addition to figuring out how to best accumulate the funds, you must also become your own actuary and determine how they will be distributed.

If You Can’t Handle Self-Employment, Will the Government Bail You Out?

Consider the brief listing above of additional assignments: Insurance, Accounting, Retirement Planning. For the typical employee at the end of the Industrial Age, all these assignments were handled “in-house:” It was group benefits, a W-2, and a pension. Now, the trend is that these are being replaced by the individual. Not surprisingly, it appears many individuals are not up to the challenge of functioning as self-employed independent contractors. Statistical evidence seems to indicate that too many people are under-insured against the difficulties of life, and under-funded for retirement.

This collective poor performance has compelled government officials to seek legislative fixes, using taxation and regulation to guarantee minimum levels of financial well-being. The legislative push for national health care is the most prominent example of current government initiatives, but in the past year, other items have been considered as well, including an idea to establish mandatory all-inclusive Government Retirement Accounts (GRAs) as replacements for company-sponsored 401(k)s.

Some might think that broadly-available government programs for insurance and retirement might serve as suitable replacements for Industrial Age company benefits, sparing individuals the challenges of self-employment. But anytime government enacts policies that seem to restrict or resist market forces (such as out-sourcing, globalization and the Internet), there are usually unintended consequences.

For example, economists have regularly documented that minimum-wage laws typically lead to either a decline in employment or inflation. While those who are currently working at low-wage jobs do make more money, employers often consider hiring fewer workers or raise their prices to accommodate their increased labor costs.

What might be the unintended consequences in some of these government proposals? Suppose the law requires companies over a certain size to provide health insurance or be hit with a fine. Depending on the cost, one practical response might be to shrink the company (or perhaps divide it), to fall below the threshold. After careful analysis, another option might be to pay the fine, but not provide insurance. Even if the company conforms to the proposal, the insurance coverage may not be a plan that matches the individual’s medical needs.

Because no one knows how the national health care issue will play out, the above comments are pure speculation. Perhaps politicians can actually craft a utopian solution that delivers far beyond our wildest dreams. But the pragmatic response, considering history, is to assume that government initiatives will not restore Industrial Age benefits to the Information Age economy. Better to think and act as a self-employed individual than hope for nationalized group benefits.

(Even with mandated nationalized programs, you still end up functioning as an individual. Think of Social Security. When it comes time to apply for benefits, you aren’t part of a union, or some other select pool of beneficiaries. You don’t have a Human Resources advocate to guide you through your options – you’ll go through the bureaucratic maze on your own, or hire expert assistance – just like a self-employed person would.)

You Might Be Self-Employed, But You Don’t Have to Do Everything Yourself

30 years ago, a successful self-employed individual understood the necessity of a team of financial advisors. Finding someone to keep books, secure insurance, oversee investments, prepare returns, was part of the cost of doing business. This hasn’t changed. If you’re self-employed, you will almost certainly benefit from expert assistance.

One of the fortunate side effects of the Information Age is the expanded access to expert services and technologies. When computers occupied entire floors in corporate offices, only big businesses could deliver the benefits of advanced technologies. Now, a personal computer and an Internet connection can bring all sorts of expertise right to your doorstep. And the technology far surpasses anything that was produced by a 1970s main-frame program.

It is understandable that some people choose to hold onto the past as long as possible; they will do everything possible to preserve the status quo. But contrary to efforts by politicians to “preserve” or “create” more Industrial Age jobs, the free-market trend is toward a new era, and a different paradigm. Specialized self-employment comes with a new set of challenges, but also better ways to overcome them.

Here’s a simple checklist. As a self-employed individual, how well have you…

  • Made allowances for fluctuations in
    cash flow?
  • Established good management systems?
  • Secured your insurance benefits?
  • Prepared a spending plan for retirement?

YOU ARE SELF-EMPLOYED. BE YOUR OWN BOSS.

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Financial Literacy Question: Adjusted for Inflation

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At an intellectual level, everyone understands that inflation affects prices – the same product or service costs more because our money is worth less. But at the same time, technology and other economic factors can also have an affect on prices, which is why computers and other electronic technology devices seem to get cheaper all the time, even with monetary inflation. So it can be hard to tell if the things we buy are really more expensive than they used to be.

This is why economists have developed the idea of adjusting for inflation. By taking the price for a similar commodity from the past and adjusting that number for inflation, it provides a method for comparing prices from different eras.

Question: According to the GasBuddy website (www.gasbuddy.com) the average price for a gallon of gasoline in the United States on June 25, 2009 was $2.63. Adjusting for inflation, how does this price compare to the average price in 1979?

A.)  Higher

B.)   Lower

C.)   About the same

 

And The Answer Is… 

The correct answer is “B”.

Using data from the Consumer Price Index, which the Bureau of Labor Statistics uses to calculate inflation, $2.63 today is the equivalent of .79 in 1979. From historical information provided by the Energy Information Administration, the average price of a gallon of gasoline in the United States in 1979 was .86 per gallon. This means a gallon of gas is 8% cheaper today than it was 30 years ago.

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BANKRUPTCY: Proceed With Caution

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Rebecca Wilder, the pen name for an “economist working in the financial services industry in Boston, MA,” had this headline in a December 28, 2009 newsneconomics.com article.

The Hottest Trend in 2009: Declaring Bankruptcy

Jane Bryant Quinn kicked off the New Year with these comments in the January 12, 2009 issue of Newsweek:

Go bankrupt in 2009. If you’re reaching the end of your rope, don’t try to hold on. Save what you can

Either these commentators know their stuff, or a lot of people are following their advice. A June 3, 2009 USA Today article reported that consumer and commercial bankruptcy filings are on a pace to “reach a stunning 1.5 million this year, according to a report from Automated Access to Court Electronic Records…In May, the number of bankruptcy filings reached 6,020 a day, up from 5,854 in April.”

This is sobering information, especially in light of legislative reforms enacted in 2005 that made it more difficult to use bankruptcy as a legal procedure to erase debts. And while most of the increase in filings is due to the financial distress inflicted by a struggling economy, a change in attitude may also be a factor.

Some may now see bankruptcy as a pre-emptive measure rather than an act of last resort. Quoting Bryant: “The right time to go bankrupt is when you’re financially stuck but still have assets to protect.” As more people file for bankruptcy, the social stigma diminishes, individuals are taking a closer look at the legal and financial merits of a bankruptcy filing.

An Overview of Bankruptcy 

Bankruptcy has a long history, going back to ancient times, because there have always been people who find themselves unable to pay their debts. While not an ideal solution, the process of bankruptcy provides a structure for resolving this dilemma, for both debtors and creditors.

The word bankruptcy comes from the Latin bancus, the tradesman’s counter, and ruptus, broken. (In Rome at the time of the Caesars, a merchant or tradesman unable to pay his debts would have his bench in the market place either broken or removed by a court-appointed official, who would then auction off the bankrupt person’s property to the highest bidder.)

The first English bankruptcy law was passed in England in the late 1500s during the rein of Henry VIII, and provided the foundation for basis for bankruptcy laws in the United States. Under both Roman and English law, bankruptcy was not something an individual chose; rather it was forced upon them by their creditors. Besides the seizing of assets, creditors could continue to demand repayment of all outstanding debts. If the debtor failed to repay, some laws allowed for imprisonment and even physical punishment.

Today, there are two basic forms of court-authorized bankruptcy: liquidation or reorganization. In the US, liquidation is known as Chapter 7 Bankruptcy, which refers to the chapter of the bankruptcy law that allows your assets to be sold off. Reorganization bankruptcies can fall under Chapters 11, 12 and 13, with 13 applying to most individuals. Chrysler and General Motors both filed under Chapter 11. When you file for bankruptcy, the court prohibits your creditors from taking action to collect debts without the approval of the court.

Chapter 7: Liquidation 

In a liquidation bankruptcy, you put your personal property in the hands of the bankruptcy court, which sells it and uses the proceeds to pay your debts (or as much of your debt as possible). Once the process is completed, old creditors have no further claim of payment, but the bankruptcy stays on your credit history for 10 years, which may result in restriction or denial if you attempt to borrow money during that time.

Under the new law passed in 2005, you may not have the choice of filing a Chapter 7 liquidation bankruptcy. If your income exceeds the median income for the same size family in your state, you must submit to a bankruptcy means assessment. This test essentially establishes a budget for you, based on a minimum standard of living. If after imposing this budget, the court believes that you have $100 or more per month in disposable income that you could apply towards your debt repayment, you may be pushed into a repayment plan under Chapter 13, instead of qualifying for Chapter 7.

Chapter 11, 12 or 13 – Reorganization 

In any reorganization bankruptcy, the filer submits a repayment proposal to the bankruptcy court. Payment plans usually cover three to five years, and not all debts receive equal treatment. The law requires that some debts must be repaid in full, while others may require a percentage, and some may not be repaid at all.

There are some debts that cannot be discharged or “forgiven.” These include debts you forget to list in your bankruptcy papers, child support and alimony, most student loans, fines and penalties as a result of breaking the law, tax debts, and judgments for personal injury or death caused by driving while intoxicated.

During the repayment period, the court will place restrictions on how you can spend money. In many cases, wages will be garnished by a trustee of the court, who will make the payments to your creditors.

Provided you make your payments as promised, it is possible that creditors will grant you credit at the end of the repayment period. But the bankruptcy will stay on your credit history for six years.

Asset Protection in Bankruptcy 

Bankruptcy laws allow filers to exempt certain types of assets from liquidation for settlement with their creditors. Typical exemptions include homesteads or personal residences, qualified retirement accounts, college saving accounts and some types of trusts. These exemptions are designed to keep filers from losing everything, but often create some potential ethical and legal challenges – with significant adverse financial consequences if abused.

Federal government allows each state to determine which assets are exempt, and there can be quite a variation in which assets qualify. Some states have generous exemptions, some do not. When individuals are contemplating bankruptcy, they may realize that certain assets might be excluded from bankruptcy if the asset could be transferred to someone else. Or they might conclude that it would be advantageous to establish residence in a different state, because the bankruptcy exemptions are more favorable. This awareness leads to what some bankruptcy attorneys call “exemption planning.”

While some measures can be taken to enhance the status of exempt assets, individuals must understand that “transfer of assets prior to filing is generally a ‘no-no,’ “ according to Leon Bayer, a Los Angeles Bankruptcy lawyer with 29 years of experience, in a legal guide posted on avvo.com.  Bayer continues: “Do not hide, conceal, transfer, or falsely encumber non-exempt assets. Doing so carries the risk of being prosecuted for committing bankruptcy crimes, it is likely to result in the denial of a bankruptcy discharge, and the trustee can still recover such property, or its value, from whoever it was given to.”

The Importance of Correctly Positioning Assets 

Indirectly, the issue of bankruptcy emphasizes the importance of forward-thinking risk management. While you know you can’t expect to transfer assets in anticipation of filing bankruptcy, the ramifications of a possible future bankruptcy may cause you to consider how your assets are owned right now. In the event of a financial setback, one that might result in either bankruptcy or a lawsuit, which assets would you want protected? Planning (and action) undertaken now might be your best defense against sacrificing years of hard work to satisfy creditors or litigants.

Nobody wants to file bankruptcy. Nobody wants to be in an automobile accident, either. But while most responsible individuals recognize the value of auto insurance, a much smaller percentage actually follow through on securing “insurance” on their assets, either through the vehicles they use, or the financial structures around them.

Because of bankruptcy’s complex legal issues and the variations between different states, it is important that any asset transfers be supervised by competent legal counsel. The licensed insurance or investment professional you work with should be made aware of your intentions, as they can provide assistance with the details of properly titling assets, from the perspective of their industry expertise.

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STATISTICS: Full of Sound and Fury, Signifying…What?

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Is this a bull or bear market?

It depends on your perspective.

The Standard & Poor’s 500 stock market index is a mathematical calculation of the collective value of selected U.S. stocks. On March 9, 2009 the Standard & Poor’s 500 Index closed at 676.53, its lowest closing value in well over a decade. On June 15, the same stock index finished at 923.72, a 36.5 percent increase in a little more than three months. Since financial analysts often identify a bull market as one in which values rise more than 20 percent over a previous low, the recent run-up certainly seems to qualify as good news for stock market investors. Except…

As the retirement planning website dshort.com succinctly reported on June 15, 2009, “The S&P 500 is 36% above the March 9th low, but 41.2% below the October 2007 high.” A bear market is usually identified as one where values are 20 percent below a previous low.

So Is It A Bull Market Or Still A Bear? 

Yes.

Which means…it may be a secular bear market.

A “secular market” is defined as one where the long-term trend is up or down (i.e., bull or bear), but punctuated by periods of significant counter-trends. A secular bull market will include some bearish periods, a secular bear market will still have some bullish moments.

According to investopedia.com, secular market trends since 1900 have lasted from 5 to 25 years. During this time there have been three secular bull markets and three secular bear markets. The last secular market was a bull – the long-term trend was upward – and began in 1983. When did the bullish trend end? It depends on your perspective. Some sources will say 2000, others point to 2007. One of the characteristics of secular trends is that it takes awhile to identify them.

An Analysis of Secular Bear Markets and Secular Bull Markets since 1900, issued by amateur-investor.net in June 2009, identifies the secular bull and bear markets using S&P 500 data. But the time period from 2000 forward ends with a “?”; in other words, after nine years there’s still no conclusion on whether the long-term trend is up or down.

Statistics may accurately represent historical events, but still need a framework in which to interpret them in order to be useful. The perspective matters as much as the math.

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Will You Stay-the-(Financial)-Course or Make a Change?

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In any election, at every level, the basic issue presented to voters is, in some fashion, a question of whether to stay the course or make a change. 
 
When the vote is between candidates, one (often the incumbent) is a proponent of staying the course, continuing things as they are, while the other candidate offers a change – a new list of priorities, a new way of doing things. When the vote concerns an issue (taxes, public funding, laws) the decision is still whether things should stay the way they are or be changed. How you decide to vote depends on your perspective. Your decision to stay the course or pursue change doesn’t really hinge on facts, but on how you interpret the facts. 
 
Similarly, your financial decisions are really based on your financial perspective. And just like a voter, you must decide: should I stay the course or is it time to make a change?  

A New Direction

Because of the ongoing economic crisis / turmoil / downturn / depression, many people are looking for fresh financial direction. They want someone to help them stop the losses – the loss in their retirement account or stock portfolio, the loss in their real estate values, the loss of their job.

The losses people have experienced are facts. But before you make another financial decision, you may want to first reconsider your financial perspectives. While a financial loss may be an indicator that some things need to change, the specific actions to correct the situation depend almost entirely on your financial philosophy.

In a segment of life that seems to be dominated by mathematical data, the idea of looking first at your “financial philosophy” – whatever that is – may sound a bit “out there”. For many, their overriding financial philosophy is pretty simple: “I don’t care much about the ideas; I just want to do whatever makes the pile of money bigger.” But because mathematical assessments can only be made about the past, you can’t make future decisions based solely on which decisions produced the biggest pile last year, or last week. Instead, you need a financial perspective that can interpret the events from the past in a way that gives some direction for the future.  

Are The “Incumbent” Financial Philosophies Still Valid? 

Historically, the past three decades produced several significant trends that influenced conventional financial thinking. As a result of recent events, each of these developments, once thought to be almost a “sure thing,” is receiving skeptical scrutiny.    

As values have plummeted in a manner not seen since the Great Depression, people are asking… 

Is The Stock Market Worth the Risk?

After three decades of trending upward in a steady, profitable course, it was common for financial observers to conclude that the financial markets offered the greatest opportunities for investment reward. And the expansion of the mutual fund industry meant even small investors could reap big-time profits.

However, the steep declines since the all-time highs in October 2007 have left many people reeling. Investors may have always known that returns aren’t guaranteed, they may have even experienced periodic short-term losses. But the majority of investors never expected to see 30% to 50% of their account values wiped out in one year. Very swiftly, planning for next year’s retirement became planning to keep on working, and hoping for enough time to recover from the losses.

As real estate values have declined, and foreclosures continue to glut the market, people are asking…

Does It Still Make Sense to Invest in a Personal Residence? 

The realtor’s mantra is, “Your home is your greatest asset.” Buy in with as little down as possible; use the appreciated equity to keep trading up. It wasn’t unusual for a $5,000 down payment on a starter home to result in a $1 million mansion 10 years later. And if you didn’t use the equity to trade up to a larger residence, you could always open a home equity line of credit to tap your gains.

Every part of this scenario worked – until the economy slowed. Defaults and foreclosures started to pile up, and housing values started to level off, and then drop. In a flash all that equity vanished – poof! For some, the loss has turned them upside down – they owe more than the house is worth – and they face two choices, neither of them good. They can continue making mortgage payments, knowing it may be years before the payments result in any equity. Or they can simply walk away, taking a hit on their credit history and losing whatever they had invested.       

As employment has become more tenuous, people are asking…

Should I Keep Maximizing My Qualified Retirement Plan? 

The conventional wisdom was “a path to a bountiful retirement was through maximum contributions in an employer’s 401(k)”. The tax deduction on deposits and the tax deferral on the earnings could make for some gigantic long-term compounding opportunities. With automatic withdrawals and loan provisions in many plans, it was easy to keep pouring in the maximum from each paycheck, and take some out for emergencies. And savvy investors didn’t have to accumulate years of service or wait until age 65 for a pension – retirement could happen on your timetable.

But a few things misfired. It turns out almost no one was a savvy investor – not the employee who asked his co-workers for advice or the professional money manager. And many of the outstanding loans became due in full when employment was terminated. For some who lost their jobs, their only financial resource was their retirement account, and many withdrawals resulted in income tax penalties.

As budgets get tighter, more people are asking…

How Much Debt Should I Carry? 

Credit is the grease of commerce. It allows people to obtain things now and pay for them over time. The use of credit makes people homeowners – and business owners – sooner. For manufacturers and service providers, it boosts sales – of cars, computers, office equipment, travel, everything. Smart and industrious entrepreneurs have used credit as the springboard to turn great ideas into fabulous fortunes.

Of course, there’s also the recognition that your ability to borrow is dependent on your ability to repay. You can’t borrow indefinitely – at some point, you have to pay it back. Or you have to declare bankruptcy and start over. Right now, there’s a sense that many Americans have reached their credit limit.

And What About the “New” Financial Candidates? 

As some of the incumbent financial philosophies have staggered, a host of options have emerged. Many of these ideas aren’t new, but circumstances have given them renewed relevance.

The fallout from the declining markets, rising unemployment and the credit crunch have resulted in greater government involvement in what once was considered the “private sector” of Americans’ financial lives.

  • There has been a massive infusion of government stimulus spending and bailout assistance from AIG and TARP to Chrysler and GM.
  • As the United States government takes a more direct role in “managing” the national economy, the short-term result appears to be increased government borrowing and higher deficits, along with greater government regulation over products, transactions and compensation.
  • The administration is actively seeking to re-structure the tax code, offering incentives and/or credits to home and car buyers, re-evaluating the estate tax and considering new “sin” taxes on items such as beer and soda pop.
  • Government is also looking to reform the health care system, including a government-sponsored insurance alternative, and digitizing the medical record system.

Regardless of your political persuasion, these government initiatives represent potentially significant changes in the financial landscape – for businesses and individuals. As Jon Meacham and Evan Thomas put it in their cover article for the February 16, 2009 issue of Newsweek: We Are All Socialists Now.  If that’s true, what impact will it have on your financial philosophy?

Is it Time For a Change? It Depends 

Is there a new economic paradigm? Have the losses and government intervention fundamentally changed the rules and strategies for prosperity? As was mentioned at the beginning of this article, how you vote depends on your perspective. For some people, nothing has changed, even with all the apparent economic turmoil. A value investor probably still sees great opportunities in the stock market. A person looking for a home might find fantastic bargains among foreclosures. And a true free-market libertarian already felt the United States economy was essentially socialist – the only difference was the degree.

For others, the events of the past 18 months are forcing them to re-evaluate their approach to financial decisions. A June 2, 2009 Wall Street Journal article titled “Americans Get Even Thriftier as Fears Persist” begins with “Americans are saving more of their paychecks than at any time since February 1995.” “New Horizon, New Behavior,” a survey from Barclay’s Wealth released on June 15, 2009, reported that 68% of wealthy investors are staying out of the stock market – even though 88 percent believe there are profitable opportunities – because they can’t tolerate the risk of loss. As for the possibility of the United States becoming socialistic, a March 26, 2009 Washington Post article reported that many college graduates “now see the government as an employer of choice.”

So…Even though things have changed, you can still make a strong case for staying the course – or making a change. It all depends on the financial philosophy you use to interpret the events.

Times May Change But Good Philosophies Are Timeless 

It’s quite likely that many of the people who feel whip-sawed by the current economic shake-up are those who believed that financial conditions were static – what was happening now would continue in the future. They saw the stock and real estate markets always going up, their employment conditions stable, and their access to credit infinite. If so, that was a faulty interpretation.

Financial history is full of ups and downs. While the events of the past 18 months have been somewhat unusual in their severity, they are not uncommon; in fact, the peaks and valleys occur regularly.

One of the characteristics of a good financial philosophy is that it provides insight and direction to make it possible to thrive in all circumstances – not just the particular trends of the moment.

For example, people with a timeless financial philosophy:

  • Have guidelines for their participation in the stock market or other investment opportunities. This doesn’t mean the guidelines are guarantees. Rather, it means there is recognition (and preparation) for what can happen, both positive and negative.
  • Understand the psychological value and true financial costs of home ownership. Besides price of the home and size of the mortgage, owning a home consists of other benefits and liabilities. There may be tax deductions to consider, as well as overhead costs like insurance and property taxes. Profitable home ownership takes all these issues into account.
  • Know when borrowing can multiply their wealth – and when it should be avoided. Just like a home is more than the price and the mortgage, borrowing is more than the interest and length of term. It depends on whether the borrowing is for emergencies or wealth-building. And even those who are debt-free and not currently looking to borrow should be sure they have access to credit.
  • Balance their retirement savings against emergency and liquidity needs. Much of the hype of qualified retirement plans was built on “Plan A” premises – where everything goes exactly as planned. But history shows there’s often a need for a Plan B.

If the events of the past 18 months have undone your financial progress, now is a good time to evaluate whether you would be better served by an adjustment in your financial philosophy. Not only that, it might also be a good time to ask the same questions of the financial professionals you’ve asked to help you with your financial programs, and see if their financial philosophies are ones that work – and are in line with yours.

  • ARE YOUR FINANCIAL PHILOSOPHIES TIMELESS?
  • HAVE THEY WITHSTOOD THE UPS AND DOWNS THAT ARE CHARACTERISTIC OF ECONOMIC CYCLES?
  • ARE THEY DESIGNED TO SUCCEED UNDER ALL TYPES OF ECONOMIC CONDITIONS?

 

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SELF-INSURANCE: A DIY Project that Doesn’t Make Sense

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One of America’s celebrated cultural values is individualism. We idolize people who are self-made, who rise up from their own bootstraps, who can say “I did it my way.” This individualism is part of the American dream, the idea that with enough effort and perseverance anyone can be anything, even President of the United States.

This glorification of individuality not only inspires us to pursue our dreams, it also makes for great marketing opportunities. The essence of the do-it-yourself (DIY) business is if anyone can be or do anything, why not do it yourself?

  • Want to build your dream home? You can do it yourself! (With our plans, our materials, our tools.)
  • Need a will or trust? Write it yourself! (Using our inexpensive legal forms and advice.)
  • Car trouble? Fix it yourself! (The parts store is just down the street.)
  • Don’t want to pay for a tax expert? File the returns yourself! (Download our program!)

From a popular culture standpoint, there can be an almost obsessive compulsion to find ways to operate independently. At the same time, this obsession can lead to a distrust of all large institutions – governmental units, banks, Wall Street, big corporations, even religious organizations. While some institutions perhaps deserve our distrust, it’s not always because they are big. Even in America, some large-scale cooperative efforts often yield better results than going it alone.

In Garrett Gunderson’s 2007 book, Killing Sacred Cows, the author takes on 10 prevailing financial strategies that he believes are harmful “myths” that diminish or deter prosperity. One of those myths is the idea that self-insurance is a profitable strategy.

“Are we better at providing insurance than the insurance companies? Can we provide equal benefits at a comparable price? If so, then we should become an insurance company for more than just ourselves. But if we cannot provide insurance as efficiently as an insurance company, then economically it is much less expensive to use insurance companies.”Garrett B. Gunderson, from Killing Sacred Cows

The “DIY” Version of Self-Insurance

In a nutshell, self-insurance is the idea that you can accumulate reserves of assets and resources so that you no longer need to pay an insurance company to protect you from the risks of life. If your house burns down, you have the money to rebuild it yourself. If your car is involved in an accident, you could make the repairs yourself – and pay for any damage you might have caused.

Self-insurance is the ultimate DIY financial project, and it has many advocates. From the perspective of the DIY financial gurus, insurance is something that should be bought in the smallest amounts possible, for the lowest price possible, and kept for the shortest time possible.

A prime example is self-insuring one’s life. The DIY philosophy is to buy the cheapest term insurance possible in order to devote as much capital as possible to accumulation strategies. In time, the accumulation balance will be large enough so as to make life insurance unnecessary.

Defined this way, self-insurance seems theoretically possible. But is it practical?

Self-Insurance Is Really No Insurance

Insurance is a method where individuals can share the financial risk by spreading the cost of potential loss amongst many people. But when you self-insure your home, you assume all the risk for any losses that might occur on the property. When you self-insure your medical expenses, all the bills that may result from an illness or injury will be paid out of your pocket. According to Gunderson, “there’s no such thing as self-insurance…You either have a way to transfer the risk of loss, or you retain that risk. Self-insurance is really no insurance.”

This might sound like semantics. If you decide you won’t buy homeowner’s insurance because you have a pile of cash, you don’t have insurance, that’s true. So maybe the real question is “if I have enough cash, why do I need insurance?”

Gunderson’s answer: “Producers (i.e., productive, wealth-building individuals) love insurance because it transfers their risk, and they know it saves them money in the long run.” In other words, the more assets and resources you have, the more you should want insurance, not want to get rid of it.

Gunderson provides the following example: “If a person owns a $1 million home and has no homeowner’s insurance, and also has $1 million in cash, where can he invest his cash in such a way as to keep his home protected?”

If he wants to be sure he has fully protected his home, how aggressively can he invest the money? If he is serious about protecting the value of his home, most likely his investment options will be limited to those that are very safe – and lower in rate of return. On the other hand, if a $2,000 annual premium for homeowner’s insurance means he can invest aggressively without fear, isn’t buying homeowner’s insurance a profitable financial transaction?

Risk vs. Return

Mainstream financial commentary often emphasizes the interrelated nature of risk and return in the context of a particular financial product. The typical comment is: higher return vehicles also come with higher risks. But there’s another paradigm for risk and return when insurance is involved. Using insurance to decrease risk in one area makes higher returns possible in other areas. Go back to the example of the homeowner with $1 million. With insurance, the homeowner can pursue greater opportunities and still know one of his financial risks (damage to his home) is covered.

Understanding this connection between reducing risk and increasing return through insurance, Gunderson concludes that the most effective financial arrangement is to buy as much of it as possible, and make it the best coverage available.

The Economic Value of Certainty

When people pool resources to share risk, one of the benefits is a higher level of certainty. Even if something unexpected or undesirable happens – i.e. your house burns down, you suffer an accident – you know you can respond. Knowing that you have decreased or eliminated the risk of financial loss provides a greater level of economic certainty. This certainty allows individuals to make better decisions, pursue bigger dreams, and focus on long-term results.

The value of economic certainty is not just an individual benefit. Entire societies benefit from economic certainty. Historically, tribal and feudal societies often languish at the subsistence level because of economic instability; when you are fearful that enemies or acts of nature may wipe out your wealth in an instant, it is hard to commit time and resources to any long-term projects.

In his 2000 book, The Mystery of Capital, Hernando de Soto declares that capitalism has triumphed in the Western world and failed everywhere else because of two cultural “insurance” factors: the rule of law and property rights. When people know the law will be applied equally and what they have is theirs to use, sell, or borrow against, the certainty allows them to focus on prosperity.

In an August, 2003 opinion paper, financial commentator Les McGuire expanded on the economic value of certainty:

“What people really want, when their minds are opened to the possibility, is the maximum value in every area of their life with as much certainty as possible. Even those who are self-proclaimed risk tolerant are kidding themselves. We should assume that every one has a risk tolerance of zero, meaning that if it was possible, [EDIT AUDIO] they would want every economic choice they ever make to work perfectly. No one really wants to lose money; they just think it is a prerequisite to making big money because that is what they have always been told. If they could make the same returns with no risk, everyone would want to.”

Now, More Than Ever, Insurance Matters

For many Americans, one of the consequences of the recent economic upheaval is the loss of insurance. Maybe they no longer have health insurance or group benefits through an employer; maybe they are currently out of work. Even if they are still paying their bills, these people are feeling the effects of economic uncertainty. They know they don’t have their risks covered.

At this point, some Americans feel that do-it-yourself reflex take hold. “Well, I’ll just have to take care of it myself.  I can do without cable TV; I can eat out less often. I’ll stop paying the premiums or reduce the coverage amounts for these three insurance policies and use some of the savings to create an emergency fund that will cover anything that might come up. I’m probably better off doing that than wasting money on insurance.”

Admittedly, there’s sometimes a difference between what’s ideal and what you can afford. But right now is not the time to try the do-it-yourself insurance program. You want as much of your financial risk to be shared by as many people as possible, not to have more risk put on you. There are a lot of productive things you can do on your own, but insurance definitely works best as a group effort.

That’s why now might be a good time to meet with us and review your situation. Our economic prosperity knowledge might give you options to rearrange your coverage, yet maintain a higher degree of economic certainty that can help you maintain your prosperity plans, and/or reposition you to succeed again.

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Financial Literacy Question: The long-term trend of financial markets

Conventional financial wisdom says the long-term trend of financial markets is generally upward. Even considering the declines over the past 18 months, what was the annual rate of return for the S&P 500 stock index for the 10-year period ending 3/31/2009? (Source: BTN research)

a. 5.2 percent
b. 3.4 percent
c. 1.2 percent
d. -3.0 percent

Answer: d.

The steep losses in 2008 wiped out all the gains from the previous nine years. According to BTN research, this 10-year period represents the eighth-worst decade for S&P investing since the S&P was established. (The worst 10-year period, from August 31, 1929 – August 31, 1939, registered total losses averaging -5 percent each year.)

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