Synergy in Financial Planning

Synergy has become a popular term these days. There are books available on synergy relating to food, clothing, fitness, and physical and mental health to name a few. As you might expect, the concept of synergy also applies to financial planning. As a comprehensive fee-only financial advisor, I see the benefits in my clients’ progress because of synergic effects.

Synergy in financial planning can only be achieved through connectivity. Think in terms of Sir Isaac Newton’s Third Law: every action has an equal and opposite reaction. Every personal finance move or decision creates a reaction in another area of your financial life. The key is to create positive reactions and not negative reactions.

For example, buying a home that is too expensive will create negative synergy to your cash flow. It will create a scenario that will produce a negative snowball of reactions that can lead to saving less for retirement, a negative cash flow, and possibly bankruptcy.

While negative synergy can create a downward spiral, positive financial synergy can spur tremendous financial growth. An example we can all relate to is saving for retirement. Money contributed into a 401k is tax-deferred; therefore, the contributions will reduce your tax bill. This is positive synergy. The excess funds created by the tax reduction from the initial 401k contribution can now also be contributed into the 401k. The more money contributed the greater the tax reduction. The greater the tax reduction the more cash is freed up. This is just one example of financial synergy between two areas of personal finance: taxes and retirement.

There are many areas involved in personal finance. Estate planning, retirement planning, taxes, insurance, cash flow, goal setting, investments, and education planning are some of the more common topics involved with financial planning. Imagine the traction that can be generated by constructing a financial plan by integrating all of these pieces. The positive momentum becomes exponential!

Families may employ various professionals to handle their personal finances. A CPA takes on taxes, and a broker covers the investments, while an attorney handles estate planning. Unless these professionals communicate effectively the power of financial synergy is lost. The right hand must know what the left hand is doing. Whether a family uses various professionals or navigates the financial landscape solo, efficient synergic decisions are a must for financial success.

Effective financial planning increases efficiencies across all financial areas, which is synergy. If you feel you are leaving money on the table somewhere in your financial world or feel a lack of connectivity, you should contact a fee-only comprehensive financial planner.

The True Purpose of Financial Planning

As a financial advisor, I've found my clients ask a broad range of questions concerning their financial situation. However, these questions are all elements of one basic question: "am I going to be okay?" Here is a sample of the types of questions you should be asking yourself:

• Am I going to be able to retire by the age I have targeted? Can I afford to retire early?
• Once I retire, will I be able to maintain my current standard of living?
• If something happens to me, will there be enough money to take care of my spouse, children, and parents?
• What if I live longer than I anticipate? Will I have enough money to support myself?
• Can I afford to contribute to my favorite charities?
• Can I pay for my child's education? My grandchild?
• Can I afford to start my own business?
• Do I have the ability to take my family on an extended vacation?
• Will I be able to pass my home on to my children?
• Can I afford to leave my job to pursue something I am passionate about?
  

Of course, this is but a small sample of the type of questions people may have, but the point of each question is really "can I afford to live the life I envision." Interestingly, notice that none of these questions have anything to do with achieving a high rate of return, or what the next hot stock will be. Thus, the true purpose of financial planning is determining how we can live the life we desire, not how to maximize our investment accounts.

Should I Take Distributions from my Taxable Account or IRA?

It is commonly considered sound financial planning to take withdrawals from taxable accounts before withdrawing money from an IRA. Assuming the funds have been invested at least a year, withdrawals from taxable accounts are subject to favorable capital gains tax rates (no more than 15%) as compared to IRA withdrawals that are taxed at ordinary income rates (as high as 35%). Additionally, why not take distributions from a taxable account and maximize the tax-deferred benefit of the IRA?

Allow me to suggest one scenario where the traditional logic may not hold. Suppose an older individual is more concerned with passing assets to heirs than outlasting their nest egg. Further, assume this individual is in a reasonable marginal tax bracket (25%) and their heirs are in a higher tax bracket. Does it make sense for this individual to take distributions from their IRA now and pay taxes at the more favorable rate of 25% in order to prevent their heirs from paying taxes at a higher rate later? Absolutely. In addition, if this individual dies and leaves an appreciated taxable account to their heirs, the heirs receive a "step-up" in basis on this account, meaning all growth will be passed tax-free.

In sum, the individual can either pay capital gains tax on their taxable account and leave the IRA assets to their heirs to pay taxes on at a higher rate, or they can pay taxes on the IRA account at a lower rate than the heirs would be subject to and pass the taxable accounts on tax-free.

Benefits of a Financial Plan - Part 1

One of the primary purposes of a financial plan is to identify how clients can achieve their financial goals while exposing themselves to the smallest amount of risk possible. For instance, I recently worked with a couple who just transitioned into retirement. This couple was accustomed to living a lifestyle that required $72,000 of gross income. However, this client's million dollar nest egg was literally cut in half during the bursting of the credit bubble in 2008, and consequently, the clients were incredibly risk averse. In fact, their portfolio was 100% cash, and they didn't want to invest in anything that wasn't 100% guaranteed.

The couple was on pace to receive $36,000 annually from Social Security. Research indicates that a portfolio utilizing only money market investments (CDs, Treasury Bills, etc) would have achieve an annualized rate of return of 5.86% since 1970 (and a return of only 3.72% since 1926). Assuming annual inflation equaled 3%, a $500,000 portfolio growing at 5.86% would be able to provide an inflation-adjusted annual income of $28,014 until the clients were 90 years old. Obviously, $36,000 from Social Security and $28,014 of portfolio income would equal a total income of just over $64,000, not enough to enable the couple to continue their standard of living.

Knowing these clients were extremely risk averse, I looked for investment options that would raise annual income but still allow them to sleep at night. I found that since 1970, a diversified portfolio consisting of just 10% stock, 30% bonds, and 60% cash would have averaged an annual return of 7.45%. In addition, during the last 39 years this portfolio had only one year where it did not achieve a positive return, and that was during 2008 when it lost just .10%. Thus, history indicates that this portfolio is extremely unlikely to endure significant losses, but the higher return would provide an inflation-adjusted income of $33,097. This would bring the clients' total projected annual income up to $69,000.

At this point the clients were able to determine if they could be happy living on an annual income that was $3,000 less than what they were accustomed to. As you might expect, it was determined that this income would provide for all their basic needs, but the couple wanted to know what type of portfolio would enable them to continue their exact standard of living. I found that since 1970, a portfolio consisting of 10% stock, 60% bonds, and 30% cash produced an annualized return of 8.36%, which after adjusting for inflation produced an annual income of $36,190, enough for the couple to continue their current lifestyle. However, this portfolio came with a slightly increased level of risk. During the last 39 years, the portfolio produced a negative return twice - a -1.19% return in 1994, and a -.77% return in 1999.

After careful deliberation, the clients decided they were willing to accept the small additional risk of the 10% stock, 60% bond, and 30% cash portfolio in exchange for keeping their anticipated annual income steady. Both clients were further comforted when I pointed out that the 30% cash portion of the $500,000 portfolio ($150,000) would provide over four years of income necessary to supplement Social Security and keep their annual income at $72,000. Thus, even if the markets crashed, they would essentially have four years of cash under their mattress to provide for them while the economy recovered. Further, the 60% bond portion ($300,000) of the portfolio would provide an additional eight years of income if necessary. Consequently, the clients would have over 12 years of funds available without having to touch their investments in stocks, allowing the market plenty of time to recover from a catastrophe. By comparison, it took the U.S. stock market seven years to recover from the Great Depression.

This is an example of how Net Worth Advisory Group utilizes retirement planning tools to identify the target rate of return necessary for a client to achieve their financial goals. We can then consider that target return when developing a customized portfolio for that client. This process allows us to develop a financial plan that will guide our clients to the retirement they envision while minimizing risk. Of course, the lower the risk the higher the probability that the plan's projections will come to fruition.

The State of the American Consumer

The Financial Industry Regulatory Authority (FINRA) surveyed nearly 1,500 American adults, and found that nearly half of respondents have difficulty covering monthly expenses and paying bills. Of these, 14% said it was very difficult to keep their noses above water, and 35% said it was somewhat difficult.

To make ends meet, 9% said they've taken a loan from their retirement accounts during the past 12 months, and 5% have taken a permanent "hardship withdrawal." Only 49% of respondents have a "rainy-day" fund consisting of enough money to cover three months of expenses in case of illness, job loss or other emergencies.

Household expenses during the past year exceeded income for 12% of those surveyed, and were roughly equal to income for 36%. One out of three respondents said they had a large and unexpected drop in income during the past year because of the economic downturn.

Finally, when it comes to financial literacy, 37% thought their financial knowledge was at the top of the scale. However, only 30% were able to correctly answer a basic question about interest rates and inflation, plus a question about risk and diversification.

4th Quarter Earnings

Fourth-quarter earnings results begin this week, and expectations are high.

According to Thomson Reuters, earnings for S&P 500 companies are expected to nearly triple on a year-over year basis. Any increase would mark the first time since second-quarter 2007 that earnings were higher than the same quarter a year earlier. It would also end the longest stretch of declines since S&P began keeping track of operating earnings in 1991.

Similar good news is expected for revenues, which among S&P 500 companies rose 2.5% from the second quarter to the third. Analysts are forecasting a 7.6% increase in revenue during the fourth quarter.

Payroll Report

Today, the Labor Department reported that nonfarm payrolls (jobs) decreased by 85,000 in December while the data for November was revised upward and now shows a gain of 4,000 jobs. For some perspective, today's chart illustrates the percent increase in the number of jobs for every decade since the 1940s (the data goes back to 1939). As the chart illustrates, the number of jobs at the end of a decade has been anywhere from 20% to 38% greater than 10 years prior. That 20% plus growth has been the case until the decade just passed during which the number of jobs basically ended the year where it began. This subpar job growth is particularly noteworthy because the US population increased by 10% during the time frame.

Retirement Planning Workshop at LaCaille - 1/27

Net Worth Advisory Group will be teaching a retirement and financial planning seminar at LaCaille on Wednesday, January 27th at 7:00 pm. Both those who are retired and individuals who will be retiring in the next 12 months are welcome.

We will be covering many of the topics outlined in Ray LeVitre's book (The Retiring Boomer’s Financial Handbook) and each guest will receive a complimentary copy of the book. Mr. LeVitre, our firm's managing partner, will be available to address questions after the presentation. Here are the details.

Date: Wednesday, January 27, 2010

Location: LaCaille

Time: Dinner at 7:00, Presentation at 8:00

RSVP to Lon Jefferies at (801) 566-0740, or lon@networthadvice.com.

Thanks for your continued confidence. Please let us know if there is anything we can do to enhance the services we provide. We love our jobs, and appreciate your business.

10-Year Performance Figures

I thought I would pass along these one and ten-year performance figures for various asset classes, which was published in the Wall Street Journal. A couple of observations:

• Many investors have known for a while that the decade could actually see stocks decline in value, but did we realize the S&P 500 was close to losing 25% and the NASDAQ nearly 45%?

• With the exception of oil and gold, all asset categories had a relatively difficult decade. For example, the +88.0% rate of return achieved by junk bonds over the ten year period equates to just a 6.5% annualized return. Considering that the average rate of return on stocks over the past 100 years has been close to 10% per year, it was hard to make money during the 2000’s.

A Great Start to 2010

January is often a great fortune teller. Since 1900, when the Dow is up in January, median gain for the year is 10.4%. When it is down in January, median gain for the year is .3%.

The market got off to a great start, up over 1.5% during just the first half of the first trading day of the year. The ISM's gauge of manufacturing showed growth for a fifth straight month, rising to 55.9 in December from 53.6 in November. Economists had expected a more modest uptick to 54.1.

Additionally, the U.S. dollar fell against both the yen and the euro. A weaker dollar makes U.S. products less expensive in foreign markets. Additionally, a weaker currency makes foreign products more expensive in the U.S., leading Americans to buy local products, which supports the national economy.

More importantly, the Labor Department's report on employment comes out Friday, and there are high expectations. The buzz is that this report may show jobs were actually added to the economy in December — the first time that would've happened in two years. Estimates are around 30,000 to 40,000 new positions.