Step 3: Invest 

There is nothing better than having your money work for you. But how do you do it? You finally have your expenses under control and you are making periodic contributions to a retirement and/or investment account. Now you have to think long and hard about what your goals are, how you feel about risk, and what your time horizon is. In other words, how much longer do you plan on working? How much longer do you plan on living? What kind of life do you want to lead after retiring? These are all questions that will directly impact your investment strategy. 

If you don’t follow the financial markets then you probably need some help figuring out exactly what that investment strategy should be. And not just today, but on an ongoing basis. The economic environment changes and your investments should change over time to reflect the opportunities and risks in the market at any given time. But with so many ‘financial advisors’ out there, how do you choose the right one? For starters, be wary of financial advisors that sell you mutual funds with front-end loads. With a front-end load, you invest approximately $95 for every $100 you put in. The other $5 goes to the financial advisor. Not exactly the best way to make your money work for you. 

You should look for someone with a fiduciary responsibility to manage your account with your best interests in mind. Not their own! If you hear the words ‘suitable’, ‘suitability’, or anything similar to describe an investment, run for the door. More often than you would care to know, these investments are being recommended because they are beneficial to the person recommending them. Instead, find an investment advisor that is ‘fee-based’ only. That means they charge you a percentage of the assets they are managing. They are not paid by the mutual funds and they are not on commission. If the person has a CFA or CFP designation, there is a good chance you have found the right person. Someone with the CFA designation has taken an oath to do what is in the best interest of the client at all times. For more information about the CFA designation, go to www.cfainsitute.org. The investment advisor should be asking you a detailed list of questions to understand your investment objectives and risk tolerances. They will then manage your account accordingly, checking in with you not less than once a year to understand any changes or updates to your situation. 

Don’t forget, however, that it is your money. Make sure you understand the strategy the investment manager is employing and that it is consistent with how you mutually agreed that your portfolio will be managed. If something doesn’t make sense, ask the investment manager to explain their methodology and ideas in more detail. They should be able to clearly articulate why your portfolio is invested the way it is and they should be able to explain it in language you could understand. If they can’t explain it or you can’t understand it, you may want to consider moving your account to someone else. People who manage investments are smart people but your investment strategy should make sense. It’s not rocket science. 

With a sound investment strategy and regular contributions to your account, you will be well on your way to improving your financial situation. Continue to keep expenses within budget and make sure you pay yourself first.

Step 2: Budget

Now that you know how much income you have and what your expenses are, set up a budget. First and foremost, pay yourself!!. I can’t stress this enough. We already mentioned 401K’s and IRA’s. You should allocate a reasonable contribution to your own retirement. If you leave this item for last, by the time you are done budgeting for all other items, you won’t have anything left. Pay yourself first!! If your employer has a 401K plan, you should contribute whether or not they match your contributions. If they do match, then you should at least contribute the amount that would maximize your employer’s contribution. After all, this is free money!! What dollar amount should you contribute to your retirement account? Well, it will depend on how much you could afford, but you should also figure out how much you should contribute to increase the probability of retiring with enough in your account to live the life you want in retirement.  An investment advisor can help you calculate the amount you may need to contribute and the amount you will need to have at retirement.

Once you figure out the monthly contribution to your retirement account, you could start filling in the other budget items. You may have to adjust the original retirement account contribution but try to adjust all other line items first. You don’t know how much to allocate to each expense? Well, you just calculated all of your expenses in a previous step. Start there!! You may find it an eye-opening experience to see how much you spend on certain items. There is a good chance that your total expenses have exceeded your income in previous periods. That’s why we are going to develop a budget. This is the hard part: To get your expenses in line with your income, you may have to make some tough choices on where to pare back spending. Finally, once you set your budget, STICK TO IT. It takes a bit of discipline and record-keeping but it will be well worth the effort. 

There are a variety of software programs available that can help you track your budget. I actually found some very good ones that can be used on your iPhone. Go to Apple Apps and look up ‘Budget’. There are also some programs available that can automatically download your bank account information. Quicken is a very popular one and Quickbooks also has a budget function. If you’re not sure which one works best, ask your accountant to guide you. After all, they may ask you to provide them with some of these expenses when they prepare your taxes. If you prefer, you can even track your budget expenses the old-fashioned way..on paper. The key is to make sure you budget and track your expenses.

Step 1: Organize

The biggest challenge I come across with clients is their inability to understand their aggregate financial picture. Typically, they have many different accounts at a variety of financial institutions yet they only use one or two of them. So naturally, the fewer accounts you need to manage, the easier they are to manage.

Gather all your bank account statements, including savings accounts, checking accounts, certificates of deposit, money jar, and maybe even check under your mattress for any cash you stored away during the banking crisis scare when deposits were inappropriately thought to be at risk. Do the same thing with all of your retirement accounts. You may have 401K plans from a previous employer, an IRA, a rollover IRA, and/or a Roth IRA.

Evaluate all your bank statements and determine which ones you really need. You may only need a personal checking account, a business checking account, and a personal savings account. If you have accounts with very small balances or very little activity, they are prime suspects to be closed and rolled into one. And all of your accounts don’t necessarily have to be maintained at the same bank but you may get extra perks for doing so.

As for your retirement accounts, if you have accounts that you are no longer contributing to such as 401Ks from a former employers, you can roll them into a rollover 401K and have all the assets in one place. TD Ameritrade, Fidelity, and Schwab all have fantastic platforms for IRA’s. My preference is TD Ameritrade. If you haven’t done this because you feel comfortable with the choice of mutual funds in your employer’s 401K, think again. The funds in 401K plans are usually not the best of their kind and typically carry higher fees. Don’t be intimidated by the vast number of choices available through a TD Ameritrade platform. Get advice if you have to. Once you set up the account, roll over as many accounts as possible. (Some accounts may not be eligible for rollover)

Once you’ve collected all the information regarding your investable assets, calculate all of your current income. This may include salary, bonuses, commissions, rental income, etc. I like to break down my income to a monthly figure. For example, for income received weekly, multiply by 52 and divide by 12. For bi-weekly income, multiply by 26 and divide by 12. You get the picture. If your income is not predictable from period to period, take a long term average and calculate a monthly figure. Got it? Now you know how much you can spend!

Next, jot down all of your expenses. I know I know, this is a painful process. This is when you realize how much you spend on all the little things that go unnoticed but add up to huge numbers. It would also help if you categorize them into groups such as food, clothing, mortgage/rent, automobile payment, insurance (auto, health, life), telephone, entertainment, personal care, gasoline, daycare, school, credit card payments, and any other expenses you may have. DON’T LEAVE ANYTHING OUT!

The problem is that the SEC requires all new bond issues to be rated. Why? So uninformed, unintelligent, and lazy investors wouldn’t have to do their own due diligence on the bond offerings before deciding to invest. That’s how it was done in the good old days. But that process evolved into one where investors blindly followed the rating provided by one of the big, bad (bad as in not good at what they do) rating agencies. What happened? First of all, they had huge conflicts of interest, getting paid by the very entities whose securities they were rating. Second, they admitted after the collapse of several highly rated issues, that the offerings were much more complicated than they expected. Duh! 

Now they are refusing to allow bond issuers to use their ratings in an ‘official’ capacity. In other words, they will continue to rate the bonds, but ‘you can’t really quote us on that’. 

To some extent, the same analysis can be applied to the three consumer credit reporting agencies. (Transunion, Experian, Equifax) They provide credit scores indicating to banks, credit card companies, etc., the creditworthiness of a borrower. No one knows how they come up with those credit scores, and I bet if you called someone at each respective agency, they won’t tell you. Actually, they can’t tell you..because they don’t know. You can make payments on time for years and your credit score will be 750, let’s say. Forget to make one payment and you’re back down to 550. Ah, the penalty for forgetfulness is 200 points! Now, you have to remember to make those same payments for another 10 years before you get back up to 750. I’m exaggerating of course, but I’ve experienced this first hand. 

Anyway, back to the topic at hand. During this financial crisis, borrowers with credit scores well above 700 ( a very good score) defaulted on many of their debts, including home loans, credit cards, lines of credit, and auto loans. Admittedly, some borrowers lost their jobs, others had burdensome losses on investments, and still others strategically decided not to pay their debts. So can we conclude that someone who defaulted on their debts despite a 700+ credit score was overrated? Perhaps! But how did a $300,000 per year wage earner with $200,000 in credit available have the same credit score as a $20,000 wage earner with $7,000 in credit available? (Sorry, I keep going back to pointing out the flaws in the scores.) 

But I can’t help it!! I had my credit report pulled and found no less than 19 errors on my credit report. Those 19 errors had an impact on my credit score. I called to ask them what my credit score would be if those errors were corrected, but they couldn’t tell me. 

Admittedly, it’s not always their fault. In one case, I made a payment on my mortgage, on time, and the day after the payment was due, the mortgage company sent me my money back and reported the payment as late! They sent me my payment back!!! Of course, they reported a late payment because as of the day they sent me back my payment, they no longer had my payment, making it late. Funny, but not so funny. I tried to call them to have them send back ALL of my previous mortgage payments going back 8 years, but they said they couldn’t do that. In this case, it was the mortgage companies fault, but the other 18 errors were the fault of the credit bureau. 

So what are we to do when the credit rating agencies and the credit reporting bureaus are incompetent and/or the rating they are providing is unreliable? In my opinion, we need to stop relying on a score. Particularly a score that cannot be explained. Whether it’s a rating on a bond offering or a credit score on a potential borrower. We need to do our own work. I remember my days as a mortgage broker when we had to pull a borrowers credit report and evaluate it ourselves. The credit scores help streamline that process, but as we have already seen, the companies that are relied on to make things easier are horrible at what they do. I’m actually glad the agencies are refusing to allow their rating to be used for public offering documents. It may have unintended consequences like slowing down the bond issuance process and the amount of offerings, but they have too much control as it is, and investors/creditors rely too much on their expertise. (tongue in cheek) We need to go back to doing our own work and coming to our own conclusions.

Our economic growth is contingent upon the growth of small and mid-sized businesses, where 60% of job growth usually comes from. So who should we believe, the bank or the business owner? The business owner, of course. We all saw what a great job the banks did over the last few years. Such a good job, in fact, that they contributed quite a bit to what could have been the biggest economic disaster we have ever seen. We know the facts: Most banks were too lenient with their lending to borrowers that were less than qualified for the types of loans they were getting. I’m referring to mortgages as well as small business loans. So just like you and I tend to drive slower after being ticketed for speeding, the banks have swung the pendulum way to the other side and made loan terms much more stringent. Remember the old saying that the only way a bank will lend you money is if you don’t need it? We’re back to those days!

If you’re a small business owner flush with cash then the bank will be electric sliding to your doorstep to lend you money. But if you’re not flush with cash, then a loan from the bank is just as likely as snowfall in Miami…in the Summer! I’m not saying banks should be as lenient as they used to be. I’m saying that they realize how incompetent they have been in the past about measuring the viability of a business and the risk associated with lending to them. There is a certain level of fear that they will make the same stupid mistakes again.

So the comment that we heard from the loan officer that there is no demand for loans from small businesses was not entirely inaccurate. The second part of that statement should have been that there is not enough demand for loans from small businesses who don’t need loans. How will this whole situation affect our much needed economic growth? Ruh-roh!!

So the employers are getting ripped off. What about the employees? Well, some of the fees within the mutual funds are in addition to fees charged for comparable mutual funds. Have you not noticed that most if not all the mutual fund choices have the insurance company’s name on it? These fees aren’t transparent to anyone looking at the mutual fund fee breakdown but it will definitely show in the performance of the funds. Just compare any ‘Insurance Company’ Large Cap Growth fund or any other fund to an index of the same type or a group of comparable fund peers. Chances are they underperform drastically because of the extra embedded fees that are ‘invisible’ to the naked eye. Or at least to anyone who doesn’t ask for the Fee Disclosure Form.

Don’t buy the assumption that insurance companies are always the best way to protect your assets. For them to do that, buy a policy to insure whatever you want to insure. But don’t assume that because the insurance company is handling your 401K, you’re better off for it. Actually, it’s quite the opposite. And for those of you with a fiduciary responsibility over your company 401K plan, you may be in violation of ERISA laws.

For additional reading, clink on: http://www.workforce.com/section/02/feature/24/37/11/index.html