Monthly Archives: April 2011

10 Commandments of Retirement Planning


For every business venture a person undertakes, the probability of it turning out to be a success will depend on the rules that are in place which govern the day-to-day running of the business. Retirement planning although being a form of saving for a future need, require the same level of financial discipline for a person to accumulate the amount of funds they desire to have during retirement. Certain rules in retirement planning are vital, and a person should always endeavour to follow them, as explained by Sheyna Steiner in the following article on the 10 commandments of retirement planning.

When it comes to retirement planning, sooner is always better than later. Consider this illustration in the importance of time in retirement planning: a 25-year-old who saves $5,000 every year for 40 years will retire with nearly $1 million, assuming a 7 percent rate of return. A 35-year-old who begins saving $5,000 annually will turn 65 with around $472,000. To get close to $1 million in 30 years rather than 40, the 35-year-old would have to save twice as much as her younger counterpart.

Consistent saving as early as possible is key, but other factors will contribute to the success of your retirement plan. To ensure that you arrive at the promised land of retirement flush with cash, incorporate these 10 simple guidelines into your financial planning.

1. You shall get out of debt

Certain types of debt are toxic to building wealth. High-interest credit card debt can fester in your finances and cost more than can possibly be regained through saving and investing. Still, if you have access to a retirement account at work, take advantage of it. (See Rule 5.)

“If it’s costing you a rate of interest and you’re not getting a deduction for it, that would be the first order of business before you do any significant saving,” says Brian Kuhn, Certified Financial Planner at Retirement Planning Services in Millersville, Md.

Mortgages and student loans score a pass due to the deductibility of the interest, but car loans and credit cards can sport interest rates well above yields on aggressive investments.

Pay off expensive debts, and then accelerate retirement savings in earnest.

2. You shall have an emergency reserve

Getting out of debt and saving for retirement will be tough if you have to whip out a credit card to cover every crisis. That’s why an emergency fund is the cornerstone of every financial plan. The general rule of thumb is to save three to six months’ worth of living expenses, but that target can be hard to nail down, says Kuhn.

“We aim for a fixed dollar amount. The fixed dollar amount is whatever number you decide makes you comfortable, like $10,000 cash in the bank,” he says.

Pick an amount, save it up and then don’t touch it — until, of course, the inevitable emergency arises.

3. You shall have a budget

Budgets are not the most exciting topic in finance, but your budget will underlie all of your wealth-building efforts and keep you on track with everyday expenses and savings. Just knowing the regular expenses and bills can help pin down where your money is going. There may be some fat that could be cut, which could translate to more savings.

To further increase savings, pay yourself first. Savings, retirement and nonretirement, should be in the category of necessary expenses that must be paid every month, just like water and electricity.

“Our clients that chose to set themselves up with the checking account debits that automatically take money from checking to savings — those people tend to always have more money,” says Chris Reilly, Certified Financial Planner, senior vice president and retirement planning specialist at Firstrust Financial Resources in Philadelphia.

“The people who choose to wait and see how much money they have left over at the end of the year — the odds are not in their favor.”

4. You shall have a financial plan

Your financial plan will be the road map to retirement.

Don’t get overwhelmed, though. “Once you get through some of the basic variables in the beginning, it’s really not that hard,” Reilly says.

Some of the basic variables include the amount you currently have saved and how much money you’ll need to retire. A rule of thumb is to assume you’ll need 80 percent of your current annual income in retirement. Subtract any known retirement income such as a pension or Social Security, and you have the amount you’ll need per year in retirement.

According to the Social Security Administration, the normal retirement age is about 66 years. Many financial planners recommend running your financial plan to age 100, which means workers need to plan on financing about 34 years on average.

Socking away money probably won’t get you to retirement by itself. That’s where wise investing comes in. Use Bankrate’s return on investment calculator to find the approximate rate of return your portfolio needs for you to reach your retirement goals.

The asset allocation of your portfolio will be based on rate of return as well as your time frame and risk tolerance.

5. You shall use tax-favored retirement accounts

The government encourages saving for retirement with special accounts that give you tax breaks. Funds can be invested before taxes for investors who expect to pay a lower income tax in the future. Or money can be invested after taxes, as with a Roth account, where contributions and earnings can be taken out tax-free during retirement. Investors can open an individual retirement account, or traditional IRA, or the Roth version. These accounts allow contributions of up to $5,000 per year.

Some employers also offer retirement plans. There are several types of employer-sponsored plans, but the most common is the 401(k) plan. It allows workers to save up to $16,500 per year. Some companies don’t offer retirement plans. Workers do have other options.

“There are non-employer-sponsored retirement accounts, such as municipal bonds, Roth IRAs and annuities — both variable and fixed,” says Reilly.

A trusted financial adviser can tell you if a cash-value insurance policy would make sense for your situation. If you’ve maxed out all of your retirement-saving options, it may be a possibility.

6. You shall save

Retirement planning takes time. It takes a number of years to save a substantial sum and even more for the magic of compounding to become apparent. Don’t wait to begin saving for retirement. Save what you can now instead of waiting until you strike it rich or are magically motivated to learn about investing.

“Put $50 a month into a 401(k) plan. That is better than doing nothing; it adds up,” says Herbert Hopwood, president of Hopwood Financial Services in Great Falls, Va.

Retirement planning is not all or nothing. It’s a process. The sooner you start, the less you have to save in the long run. Aggressive investing can amplify your savings, but it’s not a miracle.

On that note … see commandment VII.

7. You shall take on an appropriate amount of risk

Investing for retirement is a long-term proposition. That means investors can take on more risk as their investments have a longer period of time to recover from any market volatility. But, even with 40 years or more to invest, not everyone is comfortable watching the value of their retirement account go up and down.

Investing conservatively is not without risk either. Giving up the possibility of higher returns is an opportunity cost that could result in less money at retirement. As there’s only a finite amount of time and money for most people, meeting retirement goals may require compromise.

“If somebody is going to run their plan out at 4.5 percent and it shows they’re on pace to get 70 percent of their retirement objective, then they need to either save more money, work longer or retire on less,” says Larry Rosenthal, Certified Financial Planner and president of Financial Planning Services in Manassas, Va. “Or take more risk. Those are the four choices. Usually it ends up being a combination of all four.”

8. You shall set goals

To stay on track for retirement, set goals within your financial plan.

“As you’re putting money away, it’s hard to say I want my money to grow by ‘X’ amount because you don’t know what the market is going to do,” says Kuhn. “But you can take it in five-year increments — in five years I’d like it to be worth ‘X,’ in another five years I’d like it to be this.”

Monitoring annual returns will let you know if your investments meet the overarching goals laid out in the financial plan.

“If their financial plan says they need a 5 percent return, they have no business being in something that is going to give them the chance for 30 percent returns,” Rosenthal says.

“Maybe a portion, but they need to monitor their portfolio to make sure it is on pace to their financial plan,” he says. “The market is not the barometer. Their plan is the barometer. Are they consistently staying on pace with their financial goals on an after-tax basis?”

9. You shall minimize fees

The more an investor pays in fees, the less is available for investing and compounding over time. Investors can minimize fees by shopping for a low-cost custodian for their IRA and searching for low-cost investments.

When choosing mutual funds, be aware of the expense ratio, which encompasses all of the fees that will be scooped out of the fund’s assets on a yearly basis. According to a September 2010 report from the mutual fund trade association Investment Company Institute, the average expense ratio paid by 401(k) investors in 2009 was 0.74 percent. The average expense ratio for stock mutual funds in general is 1.48 percent.

It sounds like a petty amount, but compounded over 40 years, those fractions of a percent to make a big impact. Whether you use an active or passive investing strategy, focusing on low-cost funds is the best place to begin. Research by Morningstar in 2010 found that expense ratios are the most reliable predictor of performance. Low-cost funds beat their pricey counterparts in every test. Mutual funds can also come with a sales commission, or load, attached. Look for a no-load fund and avoid paying an unnecessary fee.

10. You shall insure your ability to make money

Going through the retirement-planning process can become moot if catastrophe interrupts your ability to make, and therefore save, money.

“Insure your life and your ability to earn a living through disability,” Kuhn says.

The amount you’ll pay for insurance will be based on your age, occupation and income, but you can buy as much or as little insurance as your budget will allow.

“If you have a budget, you’ll know how much you can set aside. Whatever that buys you, it’s better than not having anything at all,” says Kuhn.

The Question of Measuring Financial Progress


Every year, Forbes magazine publishes a list of the 10 richest  people on the planet in terms of net assets. It goes a step further and analyzes the net growth in terms of an increase or decrease in relation to net worth of the previous year. How can this apply to an ”ordinary” person, every year, always try to evaluate yourself to see whether you are growing or remaining at the same spot year after. One thing you should always remember is that never include assets that are meant to cover a future expense, for example, college fund, coz this will only give you the false impression that all is well. The following article by Laura Rowley illustrates not only how to go about measuring your net worth, but also it’s importance.

I recently spoke with a professional financial coach about the value of monitoring your net worth. As many readers know, net worth is all of your assets minus your liabilities. Imagine you sell everything you own — home, car, etc. — and add that to the value of your cash savings and investments, such as stocks and bonds. Then subtract everything you owe — mortgage, student loan, auto loan, credit card debt, etc. That’s your net worth.

My coaching friend plugs all this information into a software program and monitors her net worth on a monthly basis. Obviously, as you pay off debts and accumulate savings, your net worth rises. She feels this is the best way to monitor financial progress.

I used to agree, but I have given up tracking my net worth, because it turned into a feel-good exercise that was disconnected from my goals. For instance, we have been saving for years to cover the cost of our children’s college educations. This is a hefty liability, and right now, those savings exaggerate our net worth. In 15 short years, when all three kids have graduated from college, the money will be gone. (Unless the hereditary gods smile on us, and they get basketball scholarships like their dad did. But we’re not banking on their jump shots.)

Philosophically, of course, we’ll have the “net worth” of educated (and with any luck, gainfully employed) children. But it’s not really fair to include college savings in our net worth when they are, for all intents and purposes, spoken for.

“That’s intuitively correct,” agrees Charles Farrell, principal with Northstar Investment Advisors in Denver. “It’s as if a company looked at its assets and included the pension plan it owes to employees. You can’t do that. It’s not net worth that I consider important, but ‘am I going to have enough money to support myself in retirement?'”

Farrell says a focus on net worth can distract from the primary goal in personal finance, “to create a pool of assets from which you can generate income for your retirement years,” he says. “So whatever supports that goal can go into your net worth, whatever doesn’t really should be looked at differently.”

For instance, if someone buys a $40,000 car, it’s an asset in the strict sense of net worth, but it won’t help you retire; the same is true of a big house. “If your house goes up in value and you don’t plan on moving, all it does is increase your property taxes,” says Farrell, adding that the real value of a home is that you have a place to live for free in retirement once the mortgage is paid off. “If you bought real estate in California in 1985 and sold 2003, you got lucky,” he says. “But you can’t rely on luck as part of your planning.”

A Better Idea

Thus instead of monitoring net worth, it makes more sense to break out major financial goals, prioritize them and monitor progress toward each one. But how do you measure progress, and ensure your targets don’t conflict or compromise retirement savings?

Farrell attempts to address those issues in his new book, “Your Money Ratios: 8 Simple Tools For Financial Security,” which will be published in December by the Penguin Group. The book offers some fairly simple calculations to give people a sense of whether they’re on track to meet their goals based on income and age, and still save enough to maintain their current lifestyle in retirement.

Farrell first described a capital-to-income ratio for retirement, which calculates the savings required based on earnings and age, in the Journal of Financial Planning. (I wrote about it in this column.) In his book, Farrell adds several other ratios, including:

  1. A mortgage-to-income ratio that estimates the maximum level of mortgage debt someone should carry and still have money left to set aside for retirement;
  2. An investment ratio, which suggests how much of a portfolio to put in stocks versus bonds;
  3. An education-to-average-income ratio, which determines the amount of education-related debt an individual can safely rack up based on expected earnings after graduation.

Why base financial goals on ratios? Farrell says the inspiration came from corporate finance, where “we use ratios all the time to analyze companies on the equity side or fixed-income side,” he explains. “If you look at a number of different ratios it’s a very efficient way to boil down a huge amount of data and get a good picture of company’s finances.”

The difference in personal finance is that those numbers must change over time. “A company’s debt-to-capital ratio might be the same in 1980 and in 2010 and that’s okay, but in personal finance you have a goal,” he explains. “At some point you stop earning income and have to live off earnings from assets, and that requires an understanding of how ratios change over time.”

Keeping the Right Ratios

What I like about the use of ratios is that it imposes discipline on emotional spending decisions. When you do the math based on specific goals, real household income and exact time frames related to age, it becomes crystal clear that you really can’t afford to blow out the back of your home to expand the kitchen, no matter how attractive or tax-deductible the financing may be. At minimum, such calculations help consumers avoid the personal finance debacles that come from winging it (which tend to lead to larger economic fiascos that hurt everyone).

Critics suggest such simple calculations aren’t helpful, because every household’s situation is unique. In the book “Spend ‘Til the End,” for example, authors Scott Burns and Laurence Kotlikoff, a Boston University economist, advocate “income smoothing” — taking on debt when you are young and making very little, and paying it off when your income peaks, to prevent starving in your 20s and oversaving in your later years. For example, a couple with six kids should theoretically save less for retirement than a single person, because the former will experience a sharp drop in expenses when the kids leave the nest.

But Farrell argues that effective income smoothing demands accurate predictions about future earnings (a tough task given increasing income volatility). “I can’t tell you how many people say what they think they’ll make in the future and never make it,” he says. “The ratios benchmark off the reality that you’re living today — that’s what keeps the discipline. If your income pops up, you’re now behind on the ratio. What that tells you is you don’t have the assets to support that new lifestyle in retirement.”

To maintain the higher-income lifestyle in retirement requires ramping up savings, so if someone constantly refers back to the ratio they can stay on track. Moreover, suggesting that a little debt is acceptable in your 20s is kind of like suggesting you can be a social smoker in your 20s. For some people it will morph into a nasty life-long habit.

“If you don’t start (saving) when you’re younger, you’re highly unlikely to wake up one morning and do it,” Farrell argues. “It’s sad when you see people get to the point when they are no longer viable in the workforce and don’t have the assets to support themselves. It’s a serious business, and you have to treat it as a life-long endeavor.”

Adapt to Change or You May Be Left Behind


Once we get used to doing something,  we get comfortable and actually enjoy performing the task, the problem comes in when continuing with the activity causes you to lose focus of your goal. Take the example of the financial crisis that started in late 2007, a lot of companies and individuals took their time to accept that the economic environment had drastically changed, before most of them could adapt to new ideas, it was too late for some of them. The hard lesson of the financial crisis is that whenever times are good, don’t lose focus on the final goal which is financial freedom, and always try to adopt new ideas whenever the economic environment changes. Laura Rowley explains in the following article the importance of adopting to change, and how it affects your final goal.

I’m working on a history book about a company that has grown tremendously in the last half century by doing two things well: listening to its customers and changing as their needs changed. That’s pretty simple — listen, change. Simple, but not easy, when you consider that dozens of its competitors failed over the years. The world changed, their customers changed, the nature of the competition changed, but they continued to do business as usual.

As the president of the successful company told me: “You see your peers not able to adapt, not able to grasp reality, and it’s really the death of a thousand cuts. The key is to change when you have 50 cuts — if wait until you have 1,000, you’re not strong enough to change.”

Enormous shifts in the economic landscape are demanding individuals change — their financial behaviors, their careers, even their sense of identity. Change can be incredibly disorienting, and it’s easier, at least in the short-term, to ignore a new reality, to get stuck, to do nothing, to keep on with business as usual and hope that the pain will stop at 50 cuts. That’s what the automakers did, and we know how that turned out. Long-term, failure to adapt and work through change in a constructive way means recovery will be excruciating, if it comes at all.

For instance, I have a friend whom I worked with in television news. When I started in TV in the mid-90s, producing a story might involve five people — a field producer, reporter, camera person, sound person, and an editor. Earlier this year I took a tour of the digital newsroom at a national network, where technology has collapsed all of those jobs into one. One journalist can produce, report, shoot, and edit a story, then post it online. My friend, who used to do just one of those tasks, has been mostly out of work the last few years, and not by choice. Technology is pushing that specialization toward extinction. The death of 1,000 cuts.

Dealing With “Disrupted Expectations”

In his classic book ‘Managing At the Speed of Change’, consultant Daryl Conner talks about what it takes to deal with “disrupted expectations.” People who do it well, he says, are highly focused, organized, positive, and resilient. They are flexible and proactive — they think about what may be next before the change occurs. They communicate early and often as change happens to reduce the accompanying anxiety.

Everyone moves through life at his own speed of change, Conner says, and assimilates it differently. “Regardless of age, position, wealth, status, motive, or desire, no individual, organization, or society can adequately absorb life’s inevitable transitions any faster than their own speed of change will allow,” he writes. “People can face an unlimited amount of uncertainty and newness, but when they exceed their absorption threshold they begin to display signs of dysfunction: fatigue, emotional burnout, inefficiency, sickness, drug abuse.”

On the other hand, sometimes we don’t have the luxury to change at the speed we choose — we have to change first and process the trauma after the fact. My friend Helene, a breast cancer survivor, has informally counseled other women facing the disease over the years. She recalled a difficult conversation with a woman who was procrastinating.

“She was clearly avoiding [treatment], but what she was doing seemed very constructive because she was gathering reams of research for six months,” she says. “I feared distancing her but said, ‘You were diagnosed six months ago and I know you want to make the best choice and find the best doctor — but what you’re really choosing is death. I want you to choose life.’ Who is ready to have body parts lopped off? We can’t ignore our emotional life, but there’s a hierarchy — first you have to stay alive and then we can talk about how you feel.”

A Loss of Identity

Or consider a segment I participated in this week on the ‘Today Show’, about increasing numbers of men going from breadwinners to stay-at-home dads because their jobs were eliminated. Choosing to change careers is hard enough; when it’s forced on you; it usually comes with a wrenching loss of identity. For all the spiritual wisdom that suggests our self-worth is rooted in who we are, and not what we do, the truth is, when you find work that allows you to express your deepest values and best skills, and you’re successful at it, it starts to feel like the same thing.

Psychologist Jeffrey Gardere said: “What we do find is a lot of these dads — after they get through this issue of anger — actually accept the role and they find it’s a fantastic way to get to know a different side of their kids and influence their kids in a different and positive way. A lot of these guys define themselves by being able to make that money and bring it to the home; now…you’re able to explore a new side of yourself and recreate who you are as far as your self-esteem.”

It’s the recreating part that’s the rub. As Conner points out, it takes focus, energy, and commitment to change, whether it’s taking on a new role in a family, adapting to shifts in an industry, or dealing with an unexpected turn in our financial lives. I think the key is to stick to your values but be open-minded and creative about how to manifest them. If the goal is to nurture kids, it can be done with time as well as money. If it’s finding financial peace, there are dozens of ways to adjust spending, saving, earning, and investing to achieve that. If it’s doing a specific job, a passion can be translated into a different medium. Listen, change. It’s simple. But it’s not easy.

When Should You Start Stashing Away Your Cash?


I’m sure most people have heard that starting to save early will have a great impact on your retirement fund, due the power of compounding. A number of economists are now recommending quite the opposite. My argument is this, that the earlier you start saving will not only affect your retirement fund, but it will also instill in you a culture of living within your means, which we all know is the starting point of financial security. So, whenever you consider the aspect of the amount of money saved, also remember the habits that will result because of saving, as illustrated in the following article by Laura Rowley on the importance of stashing away money early in life.

Many financial pundits recommend you start putting away money in your early 20s if possible, because the power of compounding is formidable over time. But lately, a number of economists have been recommending the opposite.

Consider a post from University of Chicago economist Stephen Levitt on his “New York Times” Freakonomics blog last week. It was headlined: When It Comes to Saving, Who Would You Listen to: My Wife or Milton Friedman?

Levitt says that when he was a first-year assistant professor, department chair Jose Scheinkman shared some advice that Nobel Laureate Milton Friedman had given him when he started out: Don’t save too much.

Theoretically, Levitt would be able to make it up in later years when his income was higher. Since the purpose of saving is to smooth out your consumption over time, Levitt writes, you should “borrow when times are bad and save when times are good.” Levitt says he didn’t follow the advice as fully as he should have, because his wife insisted they save.

Milton Friedman may have been an economic genius, but Levitt’s wife has a better handle on real-world money issues. If you’re trying to figure out whether to save or splurge in your early working years, go beyond theory and consider these five issues:

What Goes Up May Come Down

“In academia, you may have a stable salary and pension — but that’s not how the rest of the world works,” says attorney and financial planner Charles Farrell of Northstar Investment Advisors in Denver. “People change jobs and careers, move across the country. Maybe they were making $100,000 and the new job pays $75,000. Or workers in the Midwest go from manufacturing jobs where they made $80,000 a year with overtime into the service industry to find out they’re worth $40,000.”

Jacob Hacker, Yale professor of political science and author of “The Great Risk Shift”, has found that short-term family income volatility doubled between 1969 and 2004. Ten percent of working-age Americans experienced a drop of 50 percent or more in their family income in the early 2000s — up from 4 percent in the early 1970s.

The instability increased more for Americans with at least four years of college than for those with only a high school education. Moreover, if you plan to have children, or have parents who will be elderly when you hit your late 30s and 40s, you may find your income disappears for some period of time. Women spend an average of 11 years outside the workforce caring for children or aging parents.

The risks of an income drop “hit us hardest when we have extended ourselves financially to achieve our dreams,” writes Hacker, adding that, if you face unexpected expenses, “setting aside even a small share of your income for retirement [is] a safety valve you can release by postponing your contributions for a while.”

Don’t Underestimate the Psychological Benefits of Saving

“Being in debt can be extremely nerve-racking, whereas saving regularly and having some sort of nest egg gives you a wonderful sense of control,” says Jonathan Clements, director of financial guidance for MiFy — a new advisory service from Citigroup — and former “Wall Street Journal” columnist. “There’s a real psychic value in having a small pot of money.”

In a paper published in the “Journal of Economic Psychology”, researchers Peter Lunt and Sonia Livingstone found a psychic payoff from saving even among people who had debt (something no economist would recommend given the typical interest-rate arbitrage).

“Those who save up out of their income at the same time as paying off debts (rather, say, than paying off their debts faster) felt more in control of their finances and more optimistic about their future than those who did not or could not save while having debts,” they wrote, adding that regular savers worried less about “unpredictable changes in economic conditions.”

Progressive Consumption Habits Are Hard to Kick

Roy Baumeister, author and social psychologist at Florida State University, studies how people resist temptation and change bad habits.

“Dr. Levitt’s suggestion may make sound financial and economic sense,” Baumeister wrote in an email from a writing retreat in Aruba. “But self-control works like a muscle, and developing good habits of self-control when one is young provides an important psychological foundation for later life.” (Baumeister says his retreat was made possible, in part, by an early savings habit.)

New York financial planner Gary Schatsky agrees. “I understand at age 21 if you’re earning $25,000 and you don’t have the ability to save,” he says. “But if you don’t start early, you’ll forever defer saving until some future period of time when your salary is higher, and allow spending to rise faster than it would have otherwise.”

The Markets May Not Cooperate With Your Plans

In recent months, revolving credit card use has increased at its sharpest rate in seven years, as consumers who were using home equity to “smooth their consumption” find that the spigot has run dry. At the same time, the rules of the game are moving against debtors, as lenders begin to reduce credit card limits and damage credit scores.

Meanwhile, the shorter your time horizon, the lower the likelihood of getting the investment returns you anticipate. “Performance over a long period is better,” says Schatsky. “There are many more poor 10-year [return] numbers than 20-year numbers or 30-year numbers.”

Additional Consumption Won’t Create Lasting Happiness

Buying more stuff in your 20s offers temporary joy and lots of inventory to sell on eBay in your 30s. A host of research — see this, this, and this column – has found that material goods don’t buy happiness.

“You lust after the new car, but three months after you purchase it the thrill is gone and it’s just another thing you drive around town,” says Clements. “Hedonic adaptation is something we cannot escape. The idea that consuming more is going to make us happy is a piece of financial foolishness.”

Meanwhile, running up debt to consume in your 20s may come back to haunt you in your 40s. “If you’re 22, you are wildly enthusiastic about your career and imagine working at it for the rest of your life,” says Clements. “By the time you’re 45, the world doesn’t seem quite so exciting — you start to think about changing careers, downshifting, working part-time. If you started saving diligently when you got into the workforce, all of those are options. But if you spent your 20s accumulating debt, you may have a totally secure job and no option but to go to the office in the morning.”

Finally, as Farrell points out, nobody knows if the consumption-smoothing advice panned out for the great Nobel Prize winner himself: “All I know is Milton Friedman was working when he was 90 — so who knows if he did well or not?”

Graduating to a Happy, Financially Secure Future


It is hard to think that your level of happiness could be affected by the security of your finances. Many people live their life without a care in the world about their financial health, for example, buying things you cannot afford, swiping your credit card as if there is no tomorrow, buy every item that is advertised on media, living beyond your means to impress people who won’t be there when the creditors come calling, I mean the list is endless. But one thing you will notice when it comes to financial advice is that, the rules of the game never change, it’s all about semantics. The following article on graduating to a happier financially secure future by Laura Rowley, although written a few years back, has an important lesson even in the current economic environment.

Every year around this time, the New York Times prints a roundup of commencement addresses. I always find a little inspiration there to cut out and stick on my office wall. This year, its author J.K. Rowling’s address to Harvard grads about the benefits of failure — although if I were to nominate a group for the “least likely to fail” award, it would probably be that audience.

In any case, I had some thoughts for my own commencement address. Here’s what I would tell the class of 2008 about money.

Believe the Clichés

Personal finance advice is so similar, and so often repeated, it’s become a cliché:

  • Live within your means.
  • Set up an emergency fund with three months of living expenses.
  • Stay out of debt
  • Join your company’s 401(k) plan or open an individual retirement account; set aside at least 10 percent of your pre-tax income every year.
  • Invest in a diversified portfolio of mutual funds to help your money grow over time, and make sure you’re not paying too much in fees.

Clichés are easy to take for granted and easy to tune out. But here’s the truth: Believe these clichés. Because if you actually follow the advice, it will transform your life.

The Roaring 20s

I’m convinced that real happiness comes from identifying your values, and then being brave enough to expend your strongest talents and best energy in their service. I think genuine happiness comes from naming what you care about most deeply, setting priorities around those values, and then translating them into real, concrete goals. Money is one instrument in the toolbox of resources, and people and experiences that help you journey down that path toward the person you were meant to be.

Your 20s represent a personal finance paradox: You have the most financial power that you may ever have because of the phenomenon of compounding. (Someone who saves $2,000 a year for retirement between age 21 and 30 and then stops will have a bigger nest egg than someone who starts at 31 and saves until they’re 65.) At the same time, your 20s can be a bit of a bust in terms of figuring out why you were put on the planet.

It’s a confusing decade — you charge out of college knowing everything and ready to rule the world, and spend the next decade realizing you know almost nothing at all. Then, in your 30s and 40s, you recognize that it’s OK to know almost nothing — and is actually a finer way to approach life, because you really listen to and learn from other people, take risks, and benefit from mistakes and failure. (If you continue to simply know everything, you don’t grow and become an arrogant bore.)

The Ghosts of Purchases Past

So here’s the problem: Many people lurch around in their 20s trying to establish their identities. One day, you pick up a magazine or see a television show that suggests one can establish an identity by buying $500 designer shoes. Or $900 designer golf clubs. Or some other stupid thing that costs a whole lot less to manufacture than you paid for it. Because you weren’t just paying for straps of leather or sticks of iron but for an identity attached to a lifestyle that somebody made up in a brainstorming session in an advertising firm somewhere in New York, or in a scriptwriting meeting in Los Angeles.

And this isn’t entirely your fault. You’re bombarded with signals to buy in a way previous generations were not. There are 1,000 cable channels telling you on a daily basis that your face, body, home, and possessions are in need of an extreme makeover. Technology and credit card companies have made it effortless to act on those impulses.

And then you get into your 30s and 40s and have a better understanding of who you are and why you were put on the planet. You’re now ready to use money as a tool to help walk down that road. That’s when your 20s can come back to haunt you. Maybe you’re still paying the credit card for the $500 shoes and the $900 golf clubs (or for all the money spent in chic bars showing off the shoes, and at golf courses showing off the clubs).

Reality Bites

So you had some fun, but now you’re playing catch up. That’s usually when the magical thinking starts. You do things like buy a house with an adjustable rate mortgage (because you didn’t save up a home down payment). Or you listen to some guru who tells you to put everything you have in gold or oil, or to buy stocks on margin or speculative real estate with no money down.

And maybe you have a couple of kids, and the media that told you to buy the shoes and golf clubs is now suggesting you invest in Suzuki violin lessons, private tutors, and traveling sports teams.

You’re scrambling to save for retirement, scrambling to meet your rising mortgage payments, getting in deeper on that credit card to take a few fun vacations with your kids before they grow up and leave you, and God knows how you’ll pay for college (since the gold-oil-stocks-real estate thing didn’t work for you the way it did for the guru).

And it’s really hard to follow your deepest values, and pursue that thing you were meant to do and become that person you were meant to be, because you’re really stressed out about money.

Happiness Gained

I was a naïve kid from the Midwest living in New York City in my 20s — naïve enough to believe all those clichés my father told me about staying out of debt and saving for retirement. So I did both — it was just something I made a requirement, as routine as brushing my teeth. (And I had a lot of fun at the same time; I just bought my shoes at sample sales, frequented bars with free happy-hour buffets, and traveled to Europe on a shoestring.)

And when I was 37 (which happened a hell of lot sooner than I expected) and working 14 hours a day in television with two kids under age three, I could walk away from my full-time job and start my own thing. My values had shifted, and I knew I had to find a better balance between work and family. I had the luxury of using money to journey down the road in pursuit of my values — not because I had a big win in oil or gold or sold a bazillion get-rich-quick books, but because I had stayed out of debt and consistently saved for almost two decades.

And that has made me happy.

Commence with Being Happy

So here’s my advice:

  • Live within your means.
  • Set up an emergency fund with three months of living expenses.
  • Stay out of debt.
  • Join your company’s 401(k) plan or open an individual retirement account, and save at least 10 percent of your pre-tax income every year.
  • Invest in a diversified portfolio of stocks and bonds to help your money grow over time, and make sure you’re not paying too much in fees.

Believe in the clichés. Follow the advice, make it as routine as brushing your teeth. Because one day it will open up a world of options, and transform money from a potentially huge source of stress into a resource to help you follow your values — and hopefully figure out why you’re on the planet.

How to Talk to Your Kids About the Economic Crisis


A few months back, when the financial crisis was starting to hit home, I talked about the importance of letting your kids know what was happening, and the reason why they would not have everything they desired. They may not know exactly why something happening in New York or Washington could affect a family living in Texas.But the fact of the matter is that America was literally transformed by the financial crisis from Washington, right to the ordinary American family across the country. The story you tell your kids, if you have any, will help shape the way they deal with their financial crisis as explained by Laura Rowley in the following article.

With doomsday financial scenarios screaming from the headlines and television, there’s no question that kids will pick up on the anxiety in the air. Talking to them about what’s happening in both the economy and the family budget is crucial — because the less we say, the bigger they might imagine the monster in the closet to be. But what’s the best broach to this loaded topic?

Needs vs. Wants

First, be conscious of the way you talk about money, and cut out the “poortalk,” advises David Myers, professor at Michigan’s Hope College and author of “The Pursuit of Happiness.”

“‘I need that’ can become ‘I want that.’ ‘I am underpaid’ can become ‘I spend more than I make,'” Myers writes. “And the most familiar middle-class lament, ‘We can’t afford it,’ can become, truthfully, ‘We choose to spend our money on other things.’ For usually, we could afford it — the snowmobile, the CD player, the Disney World vacation — if we made it our top priority; we just have other priorities on which we choose to spend our limited incomes. The choice is ours. ‘I can’t afford it’ denies our choices, reducing us to self-pitying victims.”

I’ve always tried to frame finances in terms of choices for my kids. For instance, my daughter came home from a play date once and asked when we would be getting an “extreme makeover” on our house, since compared to her friend’s palatial digs we lived in a shack.

The Landscape Has Changed

I told her we were lucky not to have the disabling injuries, serious health problems, and other woes of the families on the “Extreme Makeover” TV show. Secondly, we could have a bigger home, but then Mom and Dad would have to get different jobs, leave early in the morning, and work late into the evening in New York City. (I work mostly from my home office.) And that would mean I couldn’t drive them to school or have a snack with them when they arrive home, and we wouldn’t be able to have dinner together as a family very often. Fortunately, she agreed that the tradeoff — more time with us — makes it worth having the smaller home. (Of course, she’s not a teenager yet.)

This philosophy is ideal for tough economic times. Rather than scare kids — “We can’t buy anything because Dad lost his job and we have no money!” — we can tell them that the economic environment has changed, and that we need to make different choices about our family budget for a while.

When we hide financial realities, and pretend life is seamless and effortless, we do both ourselves and our kids a disservice. “By keeping crises private, you prolong and intensify the pain and fear you’re feeling,” says Stephen Pollan, a New York consultant and author of “Lifelines for Money Misfortunes.” “You have control here; you can ask for raise, get a new job, cut down on spending. Money is actually one of the only serious problems that is totally within your control.”

Switching Focus

Enlist your kids’ help: Ask them to be creative and think of half a dozen low-cost ways to have fun as a family, or ways to earn more, whether it’s selling stuff on eBay, raking lawns, or babysitting. Asking kids to pitch in empowers them, because you’re acknowledging that they’re capable of making a difference.

Also put economic issues in global perspective. Lately, I’ve been doing that by renting foreign films from Netflix for family movie night. Movies like “Children of Heaven” — in which a poor Iranian boy accidentally loses his sister’s shoes, and they have to share his sneakers in a relay fashion — help my kids appreciate the wealth they enjoy. Or check out “God Grew Tired of Us,” a documentary about three Sudanese refugees who make their way to the U.S., and are astounded by luxuries like electricity, running water, and supermarkets (and genuinely puzzled by the relationship between Santa Claus and Christmas).

Perhaps the most important factor (and the one that requires the most discipline) is to be optimistic for kids, and focus on the good amid the tribulations. In “Learned Optimism: How to Change Your Mind and Your Life,” University of Pennsylvania psychologist Martin Seligman explains that optimists view setbacks in their lives as temporary rather than permanent; specific instead of universal; hopeful rather than hopeless; and external instead of internal.

The Optimistic Approach

For instance, imagine two families whose primary breadwinner loses his or her job. Here’s the difference in the way they perceive their situation:

  • Optimists: “This rough patch will end and the bills will get paid; we’ll tighten our belts for a little while.” (temporary) Pessimists: “We’re going broke!” (permanent)
  • Optimists: “We have the skills, experience, and contacts to find another job; meanwhile, we’re healthy, the kids are working hard in school, and our extended family is supportive.” (specific) Pessimists: “This is wrecking our lives.” (universal)
  • Optimists: “Companies are cutting jobs across the board.” (external) Pessimists: “They thought I wasn’t good enough to keep.” (internal)

Ideally, an optimistic approach will teach kids that while we can’t control everything that happens to us, we can control our attitude about what happens to us. As Viktor Frankl wrote in “Man’s Search for Meaning“: “Between stimulus and response there is a space. In that space is our power to choose our response. In our response lies our growth and our freedom.”

When kids see their parents struggle honestly with challenges, overcome them or learn to accept them and live with them (rather than go into denial or flee from them), they will be better prepared to cope with their own inevitable challenges. Life pitches us plenty of curveballs. Kids who see their family come together, swing for the fence, and keep swinging even when they strike out will grow up more willing to take risks, make mistakes, learn, and grow. That strikes me as a pretty good way to pursue happiness.

No Good Deed Goes Unpunished


We still can’t get it, I mean we did everything by the book and what financial experts were telling us, that is, make sure that you live within your means, don’t accumulate too much debt, always pay your credit bills on time etc. When all was said and done, the outcome of all that advice is that we went through the worst financial nightmare of our times. The lesson here is that there are actions of other people that directly affect us, even when we are doing everything right. What this means is that no good deed goes unpunished as explained by Laura Rowley in the following article.

Eve Pidgeon, communications director for a nonprofit credit counseling service in Michigan, says she’ll never forget the day she realized she owed more than her home was worth.

“I was at work, saying, ‘Can you believe I can’t refinance my house?'” recalls Pidgeon, who had made timely payments on her 30-year mortgage for nine years and has a credit score over 800. “Then a [colleague] said, ‘You’re upside down — like our clients.’ I thought, ‘My God — I am?’ I thought that happened to people who had $50,000 on credit cards and refinanced into adjustable-rate mortgages.”

A Canadian immigrant who became a U.S. citizen, Pidgeon bought her home in 1999. Her mortgage broker said she qualified for a $240,000 loan — on her then-salary of $33,000 per year and her husband’s volatile income as a freelance photographer.

Passing Up the Big, Fabulous House

“Calculations for insurance, escrow for property taxes — none of that was considered,” recalls Pidgeon, who has two children. “Of course we wanted a big, fabulous house, but when I crunched the numbers, I thought, ‘If the cost of any one thing in our [budget] goes up, we’re going to be in a deficit every month.’ It put a lot of pressure on my marriage because my husband said, ‘You’re terrible at math; this is a professional who knows what he’s doing, and we should get this house.'”

Instead they bought a quaint 1918 Victorian for $135,000. Pidgeon, who eventually divorced and navigated a job layoff without ever missing a mortgage payment or accumulating high-interest credit card debt, has refinanced twice — from 8 percent to 6.8 percent, and then again to 6.3 percent, always locking in for 30 years. She wanted to refinance again when rates slipped under 5 percent, but widespread foreclosures have depressed her home’s value; comparable dwellings are selling at or below the $117,000 she still owes.

Pidgeon is emblematic of the financial insecurity afflicting millions of Americans who are being punished despite doing all the right things with their money. Hard work, steady savings, and thoughtful sacrifices haven’t protected their jobs, nest eggs, or home values from an economy twisted by fraud and stupidity, coldly indifferent to responsibility and productivity.

Homeowners Underwater

By one estimate, 12 million homeowners — one in six — are underwater on their mortgages. In 20 major metropolitan areas, home prices dropped an average 18 percent in November compared to the year-earlier period, according to the S&P/Case-Shiller Index, released earlier this week.

Unemployment rose in all 50 states in December and surpassed 10 percent in two — Rhode Island and Pidgeon’s home state of Michigan. Moreover, in the year following October 2007 — the stock market’s peak — more than $1 trillion of stock held in 401(k)s and other defined-contribution plans evaporated, according to the Center for Retirement Research at Boston College.

“The new insecurity doesn’t look like the old insecurity — grainy Dorthea Lange photos of Depression-era men and women, their weathered faces projecting despair and helplessness,” writes Yale political scientist Jacob Hacker in his book ‘The Great Risk Shift’. “Those who experience it have homes, cars, families, degrees. They’ve usually tasted the fruits of success, if sometimes only fleetingly. They very rarely end up on the streets or in shelters. For most, insecurity is a private experience, hidden away behind closed doors, felt in quiet despair.”

A Fair Question in Unfair Times

Consider a reader’s comment last week following my column on the difference between optimism and magical thinking. The poster wrote that he was a computer programmer who had been employed for 25 years, worked hard, lived frugally, and was now laid off. His 401(k) had lost half its value and his home equity had declined sharply.

“Please tell me again why you believe I should be optimistic?” he wrote. “Is it that you expect folks (suckers) in my situation to get up, brush off, and once again toil to accumulate wealth that will be seized from me in one way or another?”

That’s a fair question in unfair times. At the very least, we can mitigate the risks of having our hard-earned cash seized in the future by asking ourselves a series of questions:

  1. Do you live within your means? How long could you live without your current income if you lost your job? Do you know exactly how much money comes in and where it goes each month? What areas of your budget could you slash immediately? What expenses can you cut back for the next year and reallocate toward a cash cushion?
  2. If you consistently ratchet up your lifestyle to match rising income, can you divert half of any raise, bonus, or other increase you receive into savings instead.
  3. Have you considered a strategy to obtain severance or other benefits in the event you’re laid off? How up-to-date is your resume and network of contacts, and what would be the first five steps you would take to find a new position? Have you investigated your options for continuing or obtaining health insurance?
  4. If you are living on two incomes, how can you shift your lifestyle and spending to rely on one for needs and the other for wants?
  5. How well do your insurance policies protect you and the people you love? Have you shopped around for the lowest premiums?
  6. If you carry high-interest, revolving debt, what is your plan for eliminating it, and how long will it take?
  7. Do you have written goals — short-, medium- and long-term — for your money that reflect what you value most, with specific dollar amounts and time frames? Do you know how fast the cost of your goal is rising?
  8. Do you understand how your money is invested, how much risk you’re taking, and what expenses and fees you are paying? Do you understand the tax implications of your financial decisions (and your geographic choices)? If not, are you making an effort to learn about these critical areas of your portfolio?
  9. Are you taking good care of your health to reduce the risk of financially devastating medical costs?
  10. Do you give as much energy to your family and friends as you do to your finances? (Losing your shirt is a lot more painful when you go through it alone.)

The Risks We Face

“Studies consistently suggest that we are good at some kinds of risk assessments and very bad at others,” Hacker writes. “And unfortunately, the kinds of risks that we face today — diffuse, interwoven, mounting, uncertain — are precisely those we are most likely to overlook. Economic losses for families are often like system failures in engineering — they cascade from seemingly small events into major crises. Yet few of us worry much about the small events that can set off the chain.”

Pidgeon says she never imagined she’d be in her first home nearly a decade after she bought it, but she is focused on the positive. “If I could [refinance], I could gain a few hundred dollars in my monthly surplus and use it to stimulate the sagging local economy,” she says. “But my priority was to move to the States and make the most of my education and my career, and raise a wonderful family in a safe, comfortable, and loving environment. Whether I’m paying 6.3 percent or 4.5 percent, I feel very proud that I accomplished that.”

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