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Ditch Your Fragmented Approach to Finance
Ditch Your Fragmented Approach to Finance
The following is adapted from Stress-Free Money.
Before one of my clients began working with me, he and his wife decided to sell a property and reinvest the proceeds into a different property, in an attempt to avoid hefty tax consequences. That sounds logical enough. People do it every day.
However, he and his wife learned after-the-fact that their transaction didn’t qualify for the 1031 tax-free exchange they’d tried to do on the realtor’s advice. As a result, this couple got hit with a surprise tax bill for hundreds of thousands of dollars. As retirees on a fixed income, they were forced to raid their monthly income-producing investments, essentially making unanticipated fire sales in order to cover the unexpected tax bill.
That’s the danger of a fragmented approach to personal finance. Unless you have an integrated plan to refer back to, all the pieces of your financial life aren’t going to come together neatly. All too often, working with a CPA or considering tax concerns represents a fragment of your financial life rather than a part of an integrated whole. The temptation will be to evaluate every decision as a standalone transaction, when it’s not. They’re all moving parts of your financial plan, and for them to function well together, you have to ditch your fragmented approach. When you do, you’ll reap the following three major benefits.
#1: Avoid Nasty Side Effects
As the example above shows, a fragmented approach to personal finance often has unintended side effects. They aren’t always quite so major, but these side effects can, nevertheless, have a significant impact on your finances over time.
For example, you’ll end up with lower tiers of service and higher tiers of expenses. In other words, you will typically overpay and be underserved. If you have money, insurance policies, and investments all over the place in different hands, you’re effectively a small client at each of them and will usually get less service and attention. If you had a single, consolidated plan, on the other hand, you’d get a higher level of service at a lower cost.
In contrast, an integrated financial plan includes coordination among professionals on your behalf and regular, proactive communication. A financial advisor can help develop the plan and coordinate the professionals involved, such as lawyers, insurance agents, CPAs, and so on. An advisor doesn’t replace those professionals but rather keeps the whole team aligned with your overall goals. One way or another, though, all the pieces of your financial life have to work together rather than in silos, and you will avoid the unintended consequences that come with a fragmented approach.
#2: Stay on Top of Coordination
Another benefit of coordinating moving parts is that everyone on your team will be aware of life changes. When these changes happen, there are legal documents and various forms that need updating. If they’re not, there will be major consequences.
I remember when a colleague back at Merrill Lynch had a situation in which a high-income client of theirs was married for just two years in his early twenties, got divorced, and then later married someone else for over twenty-five years. His $3.5 million life insurance policy went to his ex-wife whom he hadn’t seen in over twenty-five years—all because he hadn’t updated the beneficiary forms. It was devastating to his widow and children. This tragedy was the result of a fragmented financial life and the lack of a trusted financial coach in charge to help coordinate all the different professionals and moving parts.
Life insurance can be an Achilles heel in another way, too, if everything isn’t coordinated. Another common example of this comes from a client who had four different life insurance policies when he started with us, all for different amounts and all requiring monthly or quarterly premium payments. He said he wasn’t sure why he had them all—they’d just been recommended by his friend, who was his insurance agent. Together, he was paying $3,000 per month—that’s $36,000 a year—for life insurance, and he couldn’t even articulate why.
If your life is financially fragmented and you don’t know your cash flow numbers, you’re operating in the dark.
#3: Too Much Is Not Always a Good Thing
Sometimes, financial fragmentation leads to overconcentration in particular areas. If you have three financial advisors or brokerage firms, it’s a little bit like having three doctors. You might end up getting prescriptions for ibuprofen from all of them, but each might not realize the others have also prescribed ibuprofen. If you take all the ibuprofen they’ve each prescribed, you could overdose.
In short, if you think you’re being smart with your money by talking to a lot of different professionals, you can actually end up with a lack of diversification, more risk, and worse results. By the same token, it’s not safe to take certain medications together—doing so can make you sicker or even kill you. It’s the same here: investing in every possible opportunity under the sun recommended by a slew of different advisors who aren’t talking to each other isn’t necessarily less risky—it may actually be more so.
If you think because you get statements from Wells Fargo, Bank of America, JP Morgan, and Morgan Stanley, that means you’re diversified—think again. We call this brick-and-mortar diversification. You’ve successfully diversified where your mail comes from, but not necessarily where you are invested.
Buying the same thing in three places isn’t diversification. If, for example, you’re over-concentrated in technology funds, you’re actually in a very high-risk position despite working with different brokers. If the technology sector dips next year, you’ll lose a lot more money than if you’d truly diversified with a single coordinating advisory team working toward clearly identified goals.
Develop a Stress-Free Mindset
Having a single team working on a coherent plan brings confidence to make financial decisions, even if you never face a crisis. Knowing what to do, how to do it, and why with regard to your finances brings tremendous peace of mind. You’ll have more clarity, less stress, and lower anxiety.
Your financial advisory team should be transparent with their recommendations by tying them back to your goals and sharing the pros and cons of each piece of advice. Your team will know you and your family intimately and will be there to guide you through every big decision, and you’ll be well on your way toward a stress-free mindset.
For more advice on fragmented finances, you can find Stress-Free Money on Amazon.
Chad Willardson, CRPC®, AWMA® is the president and founder of Pacific Capital, a fiduciary wealth advisory firm he started in 2011 after nine years of climbing the ranks as an investment advisor at Merrill Lynch. Currently, Chad also manages a $350 million investment portfolio as the elected city treasurer in his community. He created and trademarked The Financial Life Inspection®, a unique process to remove the stress people feel about their money. He’s been featured in the Wall Street Journal, Forbes, Inc., U.S. News & World Report, Investment News, Entrepreneur, and Financial Advisor. Chad and his wife live in Southern California with their five beautiful children.
How Much Financial Risk is Right for You?
How Much Financial Risk is Right for You?
[social_warfare]
The following is adapted from Stress-Free Money.
This is a true story I witnessed during my early years at a big brokerage firm. A woman walked away from her divorce with $2.5 million, which was primarily invested in one tech company stock, and it seemed to be going up in value each month.
However, this woman’s money didn’t last. She was enamored with tech stocks and was caught up in the hype. Her advisor tried many times to warn her about the risks of being too concentrated in one stock position. At the time, that allocation didn’t seem that risky to her, because she was making so much money. However, after the tech bubble burst and the decline in her account kept accelerating, she refused to believe it was really happening. She hung on until money was literally all gone. She had taken on way too much risk, and she lost everything.
At the other extreme, people often mistakenly assume that risk means there’s a chance an investment could go down in value. In fact, according to financial guru Nick Murray, the greatest risk you actually face is your money losing its purchasing power. If you stash your money under a mattress and lose ground to inflation, you will see how in the future your money might buy half as much as it used to, or more. Inflation is the silent wealth killer.
I’ve seen many stories from both ends of the spectrum—people taking on too much risk and gambling their family’s future as well as people sitting on the sidelines with idle and dusty money, watching the value of it slowly erode. The right way to approach risk—and the way that will take the most stress off your plate—is to find a middle path that suits your goals, age, and retirement plans. You can’t completely avoid risk, but you also can’t get seduced by financial hype. How much risk is right for you? Here’s some guidance to help you figure it out.
No Such Thing as “No Risk”
If you tend to always err on the side of caution, consider that you may not be as cautious as you think. Your financial habits might actually be causing unnecessary risk for the future. When it comes to finance, there is no such thing as “no risk.” Some risks are unnecessary, like the client who put all her money into one stock. Others, though, are inevitable, and no matter how careful you are with your money, you cannot avoid them.
Inflation risk is one of the inevitable ones. There’s going to be inflation over time, and you’ll have to deal with it. Market risk is another inevitable one; if you invest in the markets, there will be volatility. They’ll go up and down in cycles. You can’t completely avoid volatility if you’re looking for growth. It’s a simple fact that investing will be volatile.
That leads us to an important distinction. Volatility isn’t the same as risk. Volatility is the amount that an investment may go up or down in price. Risk refers to your exposure for danger. In other words, you may have a volatile investment that changes when the stock market dips, but it doesn’t make that investment fundamentally unsafe. Chances are, it will rise again in value.
If you’re constantly avoiding volatility, it’s going to come back to bite you. You could get a money market fund, a six-month CD at the bank, and some short-term Treasury bills. The dollar value of your account will barely fluctuate at all. You’ll get a little bit of current interest each year, which will be more than wiped out by inflation and taxes, but you’ll sleep like a baby. But, one day—and that day may not come for twenty years—you’ll run out of money. You actually needed some volatility to overcome the inevitable risk of inflation. When you’re evaluating your risk level, ask yourself, “Am I more worried about volatility or actual risk?”
Either way, one fact remains: you cannot control risk. However, you can manage and control how you respond to it, how you prepare for it, and how much risk you decide to take on.
Risky IPO Fails
Risk doesn’t always come with a bright red warning label. All too often, people take on risky investments without ever realizing it’s risky. Someone they trust has told them it’s a sure bet, or they heard on the financial news that x investment is going to pay off in a month. They think they’re being prudent, when unfortunately, they’re gambling with their hard-earned money.
That’s what happened when one of my clients who was in the habit of consuming financial media got excited about a particular company’s initial public offering (IPO). He wanted us to invest $50,000 of his retirement account in this stock that was soon to be available to the public. We told him the investment wasn’t in line with his goals, but we could make the small investment for him without it derailing his overall plan. However, as he continued listening to the hype, he decided he actually wanted to invest $500,000. That meant he’d be risking twenty percent of his retirement on a newer, unproven company.
My team and I tried to talk to him and his wife about the request. We tried everything in our power to help them see the risk far outweighed the potential return. After a full week of conversations, emails, and phone calls, we successfully convinced the couple the investment was not in line with their goals. He had real FOMO because all his friends were making big investments in the IPO. However, within the first two weeks, the stock was down sixty-three percent. He would’ve lost more than half of his investment in less than a month, when the money had taken more than a decade to accumulate.
As a financial advisor and professional fiduciary, I’m on the outside of the relationship looking in with objectivity and awareness of the larger plan. That’s important when it comes to evaluating your risk level. A neutral advisor can help prevent you from getting overly enthusiastic about a bad investment just because it seems appealing and exciting in the moment. For the best results, review your financial inspection with an objective, neutral, third-party fiduciary whose team has expertise in different financial planning areas.
Protect Your Hard-Earned Success
So, how do you assess what level of risk is right for you? The best way to do it is to get a neutral second opinion. Don’t trust your own overly cautious gut, because it might be leading you toward the invisible long-term risks of inflation. Don’t trust your pal who has the scoop on the next latest thing. Trust someone who can look at all the facts and decide objectively whether the returns are properly aligned with the risks.
A great fiduciary advisor needs to not only insulate you from short-term investment volatility, but also minimize your long-term regret and keep you from making big mistakes. Protect your hard-earned success by knowing what risk level is appropriate for you to take on, which you can determine by creating a detailed, goals-based financial plan.
For more advice on financial risk, you can find Stress-Free Money on Amazon.
Chad Willardson, CRPC®, AWMA® is the president and founder of Pacific Capital, a fiduciary wealth advisory firm he started in 2011 after nine years of climbing the ranks as an investment advisor at Merrill Lynch. Currently, Chad also manages a $350 million investment portfolio as the elected city treasurer in his community. He created and trademarked The Financial Life Inspection®, a unique process to remove the stress people feel about their money. He’s been featured in the Wall Street Journal, Forbes, Inc., U.S. News & World Report, Investment News, Entrepreneur, and Financial Advisor. Chad and his wife live in Southern California with their five beautiful children.
3 Questions to Determine Your Magic “Retirement” Number
The following is adapted from my best-selling book Stress-Free Money.
Recent studies indicate a majority of Americans have no idea how much they need to save for retirement, so they pick an arbitrary, round number like $1 million or $5 million or $10 million. While having a random savings goal is obviously better than no goal at all, finding a more accurate retirement number doesn’t have to be complicated.
Besides that round number, people who study personal finance can sometimes think the number they’re striving for is the investment return—in other words, the growth they need each year, such as 8 percent annually.
Here’s the truth: both of those numbers are wrong. Forget focusing solely on your calendar year rate of return. Forget your big lump sum, like it’s some treasure you need at the end of the rainbow allowing you to retire into the sunset. Scrap all of that.
If you’re preparing for or nearing retirement (or if you’re already there), there is only one magic number you should focus on: the monthly incoming cash flow you need to be comfortable. Below, I’ll cover three questions you should ask in order to determine that number.
#1: Do You Know How Much You’re Spending?
Finding your number means first looking at your spending. We often ask clients to look at their last twelve months of spending from their bank account, to start. Most banks will easily produce a report categorizing spending for the last year. Whichever method you choose, use concrete data over a one-year period. That allows you to calculate a meaningful average that includes major once-yearly expenses, such as property taxes, insurance, and so on.
Finding the real number requires you to dig into your past in order to make the most accurate possible estimate for the future, including the expenses you have today that you won’t have later and vice versa. Here’s a practical example: today, you might be making a hefty mortgage payment every month. However, healthcare will cost a lot more later in life, and if you have more time in retirement to golf, eat out, and go to shows, those costs will go up.
The conventional wisdom estimates you’ll spend eighty percent of your pre-retirement income once you stop working. In general, however, I find people typically fill up their spending to match what they’re used to, even if the spending categories shift over time. Looking back twelve months will give you a clear picture of what you’re truly spending.
#2: What Is the Monthly Incoming Cash Flow You Need to Live Comfortably?
An example of the importance of cash flow comes from a former financial planning client. The couple came to us making more than $300,000 a year. Their kids were in extremely expensive, well-known private schools. The family also had all kinds of higher-end expenses, from the Peloton bike to meal subscriptions to new luxury cars. As a result, despite their relatively high income, they were drowning in credit card debt—more than $85,000 worth.
This couple is not alone in allowing their spending to rise in proportion to their earnings. If you don’t have a plan, and if you view every decision as transactional, then the more you make, the more you’ll spend. Without a strategy, you’re likely to make poor decisions.
The bottom line? Spending should not rise in proportion to a level of income, regardless of what that income is. You need the discipline to save and invest a portion of every paycheck, so that as your income rises, the percentage that you put away for your future will rise in proportion.
Instead of getting hung up on your investment return this year, ask yourself:
- What is the monthly incoming cash flow I need to live comfortably?
- How much does my lifestyle actually cost?
These questions apply whether you’re working or in retirement, and its answer requires you to focus your planning around your spending and future sources of income.
#3: What Are Your Future Sources of Income?
Part of the exercise of using your current cash flow to project into the future involves considering what your sources of income will be when your paycheck stops. Specifically, you’ll need sources of passive income in addition to whatever savings you’ve built up.
If those income sources don’t increase over time, they’ll be eroded by inflation, which means you will be taking a lifestyle pay cut. In addition to your retirement investment accounts, do you have rental property? How much will your Social Security be? Do you have residual business income or annuities or insurance policies to draw from?
Often, people don’t match up all their future sources of income to their actual projected expenses. As a result, they keep putting away an arbitrary amount of savings and hoping it will be enough when they retire. It’s common for people to solely focus on the accumulation phase of life while ignoring the distribution phase of spending.
The important factor is not choosing a “retirement” age or some particular total dollar value in your accounts, but rather whether the income you have will cover what you need to spend over time—a diversified income. That spending number doesn’t have to be a mystery—you can and should come up with an accurate projection today, even if you’re already retired.
It’s Never Too Late
Until you get clear on your goals, determine your actual number, and build a plan from there, you’re going to feel substantial stress and uncertainty. You won’t be able to make big financial decisions without worrying if you can afford it.
There’s an adage that says, “The best time to plant a tree was thirty years ago. The second-best time is today.” It’s best to diversify your sources of income in retirement so that you have a variety of trees, ones that bloom during different seasons and yield not only different fruits, but also shade for your family as part of your legacy.
Even though the best time to plant your tree was thirty years ago, it really is true that the next best time is today. You may avoid dealing with the details of your financial life because you think it’s too late, or you might be afraid to face the facts and potentially realize the gap between where you could be and where you are. However, I encourage you to start the process without delay, because it’s never too late to improve your circumstances and get on track.
For more advice on retirement planning, you can find Stress-Free Money on Amazon.
Chad Willardson, CRPC®, AWMA® is the president and founder of Pacific Capital, a fiduciary wealth advisory firm he started in 2011 after nine years of climbing the ranks as an investment advisor at Merrill Lynch. Currently, Chad also manages a $350 million investment portfolio as the elected city treasurer in his community. He created and trademarked The Financial Life Inspection®, a unique process to remove the stress people feel about their money and is a Certified Financial Fiduciary®. He’s been featured in the Wall Street Journal, Forbes, Inc., U.S. News & World Report, NBC News, Investment News, Entrepreneur, and Financial Advisor Magazine. Chad and his wife live in Southern California with their five beautiful children.