The Prosperity Blog

One of Those Details That Needs Regular Attention

Perhaps you noticed an item from the week of December 3, 2007 that appeared in the major wire services…

A wealthy London widow who had outlived both her husband and lone son, repaid the kindness shown to her by a family that owned a Chinese restaurant by leaving them a $21million inheritance. The woman, Golda Bechal, had stated in a 1994 will that she wanted Kim Sing Man and his wife, Bee Lian to be the beneficiaries of her estate upon her death.

Sad and alone following the deaths of her husband and son, Ms. Bechal became close friends with the couple that operated a Chinese restaurant in her neighborhood. The three of them not only met regularly at the restaurant and Ms. Bechal’s apartment, but also traveled together on vacations to other countries. When Ms. Bechal died at age 88 in January 2004, her five nephews and nieces contested the will, asking the British courts to declare it invalid, claiming Ms. Bechal suffered from dementia. However, after more than three years of deliberations the court awarded the inheritance to Kim Sing Man and his wife, saying, “it was not irrational to leave the bulk of her estate to Mrs. Man, the daughter she would dearly wished to have had, and her husband.”

You may never have $21 million to pass on, but the above story illustrates the challenges of settling an estate, especially when significant assets are involved. While it is possible to contest almost every will, there are several things you can do to make it less contestable.

Have it drafted by a professional. A hand-written will, although it may be valid, is not recommended. A handwritten will is called a “holographic will.” It is valid in about 25 states so long as all material provisions and clauses are entirely handwritten. However, because most handwritten wills are not as in-depth as a professionally drafted will and because they are oftentimes not properly written, they are not recommended. Courts can be unusually strict in determining whether a holographic will is authentic.

Have all changes and updates prepared by a professional. A will may often contain a provision or schedule, listing specific assets and their intended beneficiaries. Some people may try to amend this section by hand at a later date. In general, any handwritten annotation is much easier to challenge, even if witness signatures are present. Revisions (generally called codicils or amendments) should be made with the same care and attention to procedure as was given the original document.

Make a will review a regular part of your financial check-up. If it’s on the list, you’ll get used to doing it. If you do it regularly, it won’t take much time.

Checklist:

  • Have your will drafted by a professional.
  • Have all changes and updates prepared by a professional.
  • Make a will review a regular part of your financial check-up.
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Financial Pep Talk ('cause you might need one right now)

Remember Eeyore? You know, the pessimistic, depressed, grey donkey from the “Winnie the Pooh” stories? (If you do, you’re probably trying to impersonate Eeyore’s voice from the Disney cartoons, aren’t you?) From Eeyore’s perspective, things were always heading for disaster. Even when things were looking up, Eeyore was sure that it was only setting the stage for something worse.

As you read the financial headlines, there are moments where you might wonder if everyone writing or speaking about financial topics had suddenly become Eeyores. All the bad news means only more bad news: rising oil prices, dropping stock market values, defaulting mortgages, declining earnings, downsizing companies and outsourcing jobs. As Eeyore might say, “Oh my, it’s all bad news. ”When the bad news starts to cascade, it seems the conditioned response is to adopt a bunker mentality – pull back, pull out and hole up. Cut your losses, cut your expenses, cut up your credit cards. But maybe now is not the time to cut and run.

Read this excerpt from “Killing Sacred Cows” by Garrett Gunderson:

I’m constantly amazed at how much financial advice I hear boils down to cutting expenses. Now, am I saying that cutting expenses is inherently bad, or that it is not useful in the proper context? No. But to enjoy better results, instead of asking, “How can I cut my expenses” we should ask “How can I be the most productive in this moment?”

How can I be most productive in this moment? Isn’t that a good question on which to base your financial decisions?

Much of the macro-level economic fallout is the result of poor decisions by institutions and large groups of individuals. But if you’ve been making good financial decisions, it’s possible you are well-positioned to take on some outstanding opportunities – at very favorable prices.

If that’s the case, now is the time to act, not pull back. Even if some of your financial
history isn’t that great, are your problems going to be solved simply by tightening your
belt? Put it this way – what’s going to pay off that home-equity loan faster – an extra
$100 each month, or a $1,000 increase in monthly income? As Gunderson says, “we
should produce more than we consume, and the best way to do that is usually to focus
more on increasing our production as opposed to focusing on decreasing our consumption.”

How can I be most productive in this moment?
When you first process that question, you may think of it primarily in terms of generating more income through your work, business, or investment opportunities that you already know about. But answering the question doesn’t have to be a solo project. Now might be the ideal time to ask the financial professionals that serve you for their insights as well.

An old Hebrew proverb says there is wisdom in a multitude of counselors. So it seems logical that having two or three other people helping you become more productive can only work to your benefit.

The economic bad news you hear and read shouldn’t be dismissed; some things are not going well, some companies are in trouble, and some people are struggling. But while economic bad news may give you information to adjust the specifics of your financial circumstances, it shouldn’t change your outlook.

Whatever the situation, the best response is:
How can I be most productive in this moment?

“PRODUCTIVITY TRUMPS ACCOUNTING”

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The Ugly Math of One Bad Year

Last Updated: September 2, 2020

Here’s an easy riddle:

Up.
Down.
Down some more.
Up.
Down in a hurry.
Up.
Up again.
Down, then up in the same day.

Who am I?

  • A) A Bipolar mood disorder
  • B) The stock market
  • C) A roller coaster
  • D) All of the above

Those answering A) may want to consider professional help. Those answering C) are having more fun than the rest of us. For all those who quickly identified with B), keep reading. Even if you aren’t aware of the exact numbers, you probably understand stock markets have been somewhat erratic in the past few months. They move up, they move down; there’s no significant trend. Combined with the fall-out from the sub-prime mortgage situation, some people warn that investors may be on the verge of sustaining some substantial losses.

Historically, loss would not be an unusual occurrence. Recessions, depressions, and bear markets have been a regular part of the financial landscape just as much as upward trends, booms, and bull markets. History suggests that even with the ups and downs, the long-term returns are worth it, so we have been conditioned to accept some losses along the way. That doesn’t mean that financial losses from any financial decision are trivial things.

Loss Aversion Theory Abounds

Losing money is a concept that perhaps doesn’t get as much attention as it should in financial programs, and in many ways, the losses you incur may have a greater impact on your total wealth – and your mental psyche – than the gains you make.

Research from the Journal of Economic Perspectives shows us that loss aversion, the tendency to focus on avoiding losses instead of acquiring gains, occurs because losses have effectively twice as much psychological impact as the same amount of gain. Although this study was conducted in 1991, several more recent studies have confirmed these findings again and again.

Because we feel twice as much pain from a loss as we feel pleasure from an equivalent gain, we work harder to avoid these losses – often to a fault. When markets are especially volatile, loss aversion (and our associated ego in admitting we made poor financial choices) often results in rash decisions leading to losses that can impact our finances for years to come.

There are several mathematical examples to illustrate this idea.

Here’s a simple illustration.

Suppose you have $10,000 in some non-guaranteed financial vehicle (i.e., the account values may fluctuate). For three years in a row, the account delivers a 10% annual return. At the end of the third year, your account would have grown to $13,310. Here’s the progression:

  • Beginning balance: $10,000 Annual Return
  • End of Year 1: $11,000 (10% increase)
  • End of Year 2: $12,100 (10% increase)
  • End of Year 3: $13,310 (10% increase)

Three out of four years you gained 10%, right? Now consider the impact of the one bad year: The average annual return was more than halved. Through the first three years, the average annual return was 10%. However, the one bad year reduces the average annual return for the four-year period to just 4.62%! In order to get back to averaging 10% a year, your account must earn over 34% in the fifth year! Look at the math. Here’s what comes from five years of steady 10% annual returns:

  • Beginning balance: $10,000 Annual Return
  • End of Year 1: $11,000 (10% increase)
  • End of Year 2: $12,100 (10% increase)
  • End of Year 3: $13,310 (10% increase)
  • End of Year 4: $14,641 (10% increase)
  • End of Year 5: $16,105 (10% increase)

If there’s a blip in the fourth year, making up for it in one year requires a steep increase.

  • Beginning balance: $10,000 Annual Return
  • End of Year 1: $11,000 (10% increase)
  • End of Year 2: $12,100 (10% increase)
  • End of Year 3: $13,310 (10% increase)
  • End of Year 4: $11,979 (10% decrease)
  • End of Year 5: $16,111 (34.5% increase)

Even if you spread the loss over multiple years, it would take six years of earning 13.75% each year to average 10% for 10 years, all because of one bad year.

  • Beginning balance: $10,000 Annual Return
  • End of Year 1: $11,000 (10% increase)
  • End of Year 2: $12,100 (10% increase)
  • End of Year 3: $13,310 (10% increase)
  • End of Year 4: $14,641 (10% increase)
  • End of Year 5: $16,105 (10% increase)
  • End of Year 6: $17,716 (10% increase)
  • End of Year 7: $19,487 (10% increase)
  • End of Year 8: $21,436 (10% increase)
  • End of Year 9: $23,579 (10% increase)
  • End of Year 10: $25,937 (10% increase)
  • Beginning balance: $10,000 Annual Return
  • End of Year 1: $11,000 (10% increase)
  • End of Year 2: $12,100 (10% increase)
  • End of Year 3: $13,310 (10% increase)
  • End of Year 4: $11,979 (10% decrease)
  • End of Year 5: $13,626 (13.75% increase)
  • End of Year 6: $15,500 (13.75% increase)
  • End of Year 7: $17,631 (13.75% increase)
  • End of Year 8: $20,055 (13.75% increase)
  • End of Year 9: $22,813 (13.75% increase)
  • End of Year 10: $25,950 (13.75% increase)

In the conventional paradigm, the opportunity for increased return comes with increased risk. Thus, you could argue that increasing your annual return to 13.75% from 10% means increasing the risk by 37.5%. Remember, this is all the result of one bad year! Frankly, there’s very little market appeal to loss prevention. High rates of return grab headlines. (In today’s economic climate, how interested would you be in an accumulation vehicle that averaged only 4.62% over four years?) If you really care about optimizing your wealth, you should expend some energy on avoiding losses. The fewer setbacks, the less you have to catch up.

If you’d like to work with advisors who understand the importance of not losing money, contact Partners for Prosperity today. We never knowingly put our clients’ dollars at risk! Investors who work with us aren’t glued to stock market reports and staying awake at night, because we utilize alternative strategies and proven, guaranteed, accelerated saving solutions.

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Outside-the-box Idea: Using 72(t) to make an "asset transfer"

For those who have most of their savings in tax-deferred retirement accounts, but are intrigued by the idea of buying a retirement home now, there may be a tax-effective way to execute the transaction. Internal Revenue Code IRC Section 72(t) allows individuals to access their IRA accounts penalty-free at any time if the withdrawals are taken as a series of substantially equal periodic payments over the life of the participant. This means you can begin drawing a regular stream of “retirement income” from your IRA at any age. While the income received is taxable, no additional penalty tax is applied.

In order to be considered “substantially equal periodic payments,” the distributions must meet the following criteria:

  • Withdrawals must be on a regular basis, most often monthly, and at least annually.
  • Withdrawals must conform to one of three IRS approved calculation methods.
  • Withdrawals must continue for at least five years or until you reach 59½, whichever is longer.

Depending on the size of your IRA and the cost of the property, these monthly distributions could be used to make the mortgage payment on the vacation home. For many individuals, the additional IRA income may largely be offset by the tax deduction for the additional mortgage interest paid, especially in the early years of the mortgage. The end tax result: more taxable income to report, but also more tax deductions.  By spending some of the IRA now, you lose the growth that could have occurred if the money had stayed in the account. But in this example, the IRA distributions are being used to build equity in the new home. Overall, your net worth is still growing, only the growth is in home equity instead of the IRA. And instead of delaying gratification, there’s some immediate enjoyment.

Note: Not all tax-deferred retirement plans allow for 72(t)-type distributions. Additionally, the calculations required to be sure this “early retirement income” conforms to the law are complex. Do not attempt a distribution of this type without seeking some expert assistance.

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Using a Reverse Mortgage to Stop Foreclosure

Reverse mortgages are touted as a way for elderly retirees to create additional income by
borrowing against the equity in their homes without having to take on another payment.

Instead, the amount borrowed by the homeowner is due only when the home is sold, or the borrower dies. Since the terms of a reverse mortgage are based in part on the age of the borrower (the older the borrower, the more favorable the deal), a reverse mortgage can be a profitable strategy for supplementing one’s retirement lifestyle.

But a December 26, 2007 Wall Street Journal article turned up another use for reverse mortgages: Staving off foreclosures for senior citizens, especially those whipsawed by declining or fixed incomes and rising payments from adjustable rate mortgages. The strategy, used by an increasing number of legal-aid advocates, isn’t suitable for everyone. But in the right circumstances, it can be a financial life-saver. A typical scenario: A senior couple with significant home equity needs cash. Attracted to the favorable terms of an adjustable-rate mortgage (low initial interest rate, minimum payment options), they take on a new mortgage, one they can theoretically afford. Over the next few years, interest rates increase and so do monthly payments. Perhaps because of health issues, increased living costs, or decreased income, the seniors find themselves unable to meet the mortgage obligation, and facing foreclosure. Even though they cannot meet their monthly mortgage obligation, the couple still has substantial equity in their home. With the assistance of a reverse-mortgage expert, the couple uses the remaining equity to negotiate a settlement on the existing mortgage. While they receive no cash out from this arrangement, the settlement eliminates the monthly mortgage payment, and keeps them in their home.

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Knowing the Reasons Not To Do Something

Last Updated: September 3, 2020

“If you can’t explain it simply, you don’t understand it well enough.” Albert Einstein

Ever have this experience trying on new clothes? The fashion consultant raves over each new garment, saying things like: “Ooh, I can’t believe how great that looks on you!” or “Wow, I can’t decide which one I like better!” If you’re like most of us, you probably appreciate the compliments and personal attention. Yet there’s also a part of you that knows some of the enthusiasm stems from being a potential customer. So you take the comments with a grain of salt. Now suppose a salesperson said, “You know, that style just doesn’t suit you. I think this one is a better fit.” What would you think?

Table of Contents

The Reasons Why, and The Reasons Why Not

When it comes to assessing your relationship with the financial professionals that give input on your financial transactions, one of the things you might want to evaluate is how well these people can explain the reasons not to do something, especially the things that they most often recommend or support.

Example #1:

An advisor or financial professional who recommends participation in a qualified retirement account probably knows all of the benefits of participation–contributions are tax-deductible (and are taken from your paycheck automatically), there are loan provisions, etc. The advisor may try to convince you that since a retirement account is a basic form of saving, and saving is a positive thing, a qualified retirement account is something that offers a benefit to everyone.

Is there ever a reason not to participate in a qualified strategy? What if you are saving for a down payment on a house? What if you have outstanding credit card balances? What if you are still trying to get six months of income set aside in an opportunity fund? Would any of those circumstances change your advisor’s recommendation? From a consumer or client perspective, you want advisors that know both the reasons to participate in a particular strategy or product and the reasons not to participate. Because while most common financial strategies and products have broad application and appeal, they may not be the right fit for your unique situation.

Example #2:

Your insurance advisor for your homeowner’s policy may want to reevaluate your coverage levels at your renewal time each year. There are many reasons why you may need to increase your coverage (and thus pay more for your insurance policy)–your property values may have gone up, you may have added features to your home, or you may simply have realized that you never purchased enough coverage in the first place.

Are there reasons not to add more coverage? After all, you can never be overprotected, right? Actually – you can, and a trusted insurance advisor should help you right-size your coverage levels, not just add to them. Even if you have the opportunity to get a “great deal” on additional coverage, it might be more beneficial to forgo the additional coverage if your property values have gone down or you recently paid off your house. If you are paying for too much coverage, you need a trusted advisor who is willing to have that honest conversation.

Ideally, competent advisors mention the reasons “not to” as part of their dialog with you. Either it comes up in the course of discovery conversations about your objectives, current situation, and financial philosophies, or it is part of the education and explanation provided by the advisor when making the recommendation. If the advisor doesn’t bring up the reasons “not to,” be sure to ask. Getting an answer to the reasons “not to” is like getting a second opinion from the same doctor. Although the proposal will probably stay the same, it should give you an even clearer understanding as to why the proposal was made in the first place.

Two Cautionary Thoughts On the Reasons Not To

1. Beware the critic. Getting a second opinion regarding any financial strategy may have merit. Just be careful about someone with a narrow perspective or an ax to grind. Some people make a living out of fear tactics – they go around warning others what not to do, yet provide very little substance on the best actions to take.

If you’ve had any exposure to the concept of life insurance, you soon pick up on the philosophical conflict between those who advocate term insurance and those who espouse the values of whole life or similar cash value policies. In their little corner of the universe, the divide can be as passionate as that between Yankee and Red Sox fans, or dog people vs. cat people. The respective sides can be quite dogmatic about their positions.

Historically, both types of policies have a long track record in the marketplace. So regardless of what the critics might say, it appears both types of life insurance have a legitimate place in individual programs. Someone with a one-sided perspective is obviously missing what many consumers find beneficial. It’s the same with the evaluation of qualified retirement strategies. Even as they proliferate in the workplace, there’s still a lot of non-qualified accumulation going on as well. Again, the ongoing existence of several approaches to accumulation should be an indicator that all of them have some validity.

2. If you aren’t going to follow this idea, what are you going to do instead? Isaac Newton’s first law of mechanical motion is the Law of Inertia: A body in a state of rest tends to remain at rest unless acted upon by an external force. The Law of Inertia has an application to human psychology as well. Most of us tend to prefer stability and resist change.

When a financial professional challenges you with a new idea, it can be an external force that upsets your status quo. The easiest way to restore your psychological equilibrium is to find a way to dismiss the new idea or strategy. If you’re looking for a reason not to do something–because you’re too busy, too bored, or want to spend the money on something more “fun”–you can always find a reason. A reason to wait, a reason to revisit the issue later, or a reason to push the issue aside.

Before you lock in on your reason not to go forward, entertain one more thought: If a trusted advisor gives you the reasons not to and yet still believes your situation is one where taking action would be the most beneficial, are you sure you want to blow it off? Go back to the department store example. As you try on several outfits, the fashion consultant steers you away from several lesser choices. Then after much review, there’s a moment where the fashion consultant says, “Hey, that’s a perfect fit for you.” Are you going to ignore that input?

Asking financial professionals for the reasons not to do something is a way to make their input even more valuable to you. Getting even better advice and an even better understanding only helps if you act on it. The purpose of getting the reasons not to do something is to get to the best idea of what to do. Take action and reap the rewards.

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