Paul Ferraresi

How a person spends money is far more important than how he or she invests it. It is much easier to reach retirement goals by deciding how to live, rather than how to invest. Deciding what to do with the money we earn – how to spend it – is what brings about peace of mind, not how much we make or how much we have.

The late Loren Dunton, founder of the non-profit National Center for Financial Education in San Diego, wrote about his lifestyle decisions to buy new cars and spend weekends in Reno, instead of investing a hundred dollars each month in a mutual fund when he was in his late twenties. That fund would have been worth over a million dollars today.

AN EXPENSIVE CAR

Perhaps you think the difference between a full-sized car, fully-equipped, and a compact is only about $10,000. Actually, it is more like a million dollars. Consider this, borrowing $25,000 for a new car over four years will cost about $634 a month, while borrowing just $15,000 will cost only $381 a month.

If one saved the difference of $253 each month for 35 years, earning an 8% average rate of return, it would swell to $580,352. However, that is just the accumulation of the funds. What about the earnings as the funds are withdrawn during retirement?

If one were to get monthly payments of $4,479 from that sum from ages 65 to 90 (and some predictions say there may be over 250,000 people over the age of 100 in America in the 21st century), the total amount collected would be $1.3 million.

This is the magic of compound interest. However, it is not retroactive! One must save now to enjoy the benefits of compound interest in the future.

WAITING TO INVEST

For instance, if the difference in the example above were saved for only 25 years it would grow to just $240,000. Paid out at $1,857 a month, the total would be $557,000. It is amazing that the difference in saving an additional ten years is about a half million dollars. However, the monthly difference in payments of $2,622 monthly shows how today’s lifestyle decisions can be worth a million dollars in retirement years.

When should people begin saving money? Never soon enough. If ten years could mean a difference of $2,622 in retirement income each month, can you imagine what 15 or 20 additional years of savings would mean when you reach age 65?

JUST A LITTLE POSTPONEMENT

For some, no doubt saving now would be easier if there was more current income. People 17 to 23 years old may think: “Me save? Are you kidding? I am just getting my education and besides I want to have a good time. When I get out of college and start my career, I’ll start saving.”

People 24 to 30 may be tempted to think: “You don’t expect me to save now? I have only been working a few years. Right now, it is important to dress well. I’ll save later.”

From 31 to 42, the reasoning may go something like this: “How can I save now? I am married with small children. Perhaps when they are older I can think about saving.”

Those 43 to 55 wish they could save now. However, many just do not, saying they cannot because of children in college and education loans to pay.

From 56 to 65 most recognize the urgency to begin saving now. However, money is tight. It is not easy for people that age to better themselves. It is tough to break years of over-spending habits. “Maybe something will turn up,” many say.

At age 65 and older, it is too late to begin saving money. You cannot save when there is no income. Many older people live with their children and are dependent on Social Security, which is inadequate, since Social Security was only designed to be supplemental.

If the choice between cars can impact retirement income, imagine the possibilities when applied to lifestyle choices such as a home, vacations, dining out, entertainment, wardrobes, furnishings, etc.

Try to develop the art of money accumulation now. Begin by saving every day. Start today!

With some of the financial scams that have taken place recently don’t you find yourself feeling a little sorry for those that were taken? I become confused when I hear that people placed all of their savings into one investment!

Come on, no one should put all their eggs in one basket. There have been many cases in which individuals have placed all their money in their company stock. Later, after the company went bankrupt, all their investment monies were evaporated. People began to blame their company for the loss. In reality, the individual made the mistake by being greedy and not diversifying.

When you see someone do something beyond common sense, you say…gee, that was stupid. You see, everyone needs to be responsible for their actions. Unfortunately, in this country the tide has changed and no one wants responsibility for anything.

I came across a blog about frivolous lawsuits that have resulted in ridiculous warning labels like:

• “Remove child before folding,” on a baby stroller.

• “Harmful if swallowed,” on a brass fishing lure with a three-pronged hook.

• “Never iron clothes while they are being worn,” on a household iron.

• “Shin pads cannot protect any part of the body they do not cover,” on shin guards.

I can only imagine what financial advisors will now have to print on their ADV and application forms to alert clients to the obvious as this irresponsibility sweeps the country.

All of this raises the question: What is your responsibility as an investor to minimize the risk of fraud or failure in the management of your account?

Your steps:

• Do your due diligence.

• Work with financial advisors that have credentials and maintain ethical conduct.

• Develop an Investment Policy and Asset Allocation.

• Do not invest in anything that you cannot handle a loss level greater than your tolerance.

• Make sure your advisor uses an independent custodian.

• Do not invest in anything you do not understand.

• Evaluate your advisor, not just on performance, but on his/her ability to listen, communicate, and respond to your concerns.

Funny how investors never praise an advisor when their portfolio goes up, but they criticize or sue when the portfolio goes down. This thinking is a true portrayal of the American attitude today of…”I am not responsible for anything that goes bad in my life.”

If you want someone to take care of you so that you never get hurt, well, that brings to mind a saying I learned long ago…“Beware of someone who offers to take care of you, for your caretaker may soon become your jailer.”

I have written many times in this blog about the special Roth conversions available in 2010. My summary of all the long-winded blogs was that a conversion will probably cost you more in taxes than you think, and you will still have strings attached with the Roth. There are far better alternatives for you.

An article in Baron’s magazine may have found other reasons why people are not converting. A Fidelity study found only 7% of investors will convert to a Roth IRA. Also, even with all the media hype, education, and bank/brokerage flyers, more than 88% are unaware of the opportunity. Another reason why people are holding back, the survey found, was government mistrust. A TD Ameritrade survey found that 36% of those who are most ideal for conversion suspect that Washington will change the rules later. Thus, rule changes will mean that the money coming out of Roth will be taxed to reduce the national debt. (This is exactly what happened to Social Security benefits…that is, up to 85% of your benefits can be taxable. Hmmm…taxed once when you earned the money and then taxed again when you receive it. Are you screaming yet?)

There are far better alternatives than IRAs, 401(k)s, and Roth IRAs. Contact us at 713-871-5919 and we will be glad to present them to you. If what you always thought to be true…turned out not to be true…when would you want to learn about it?

Popular wisdom tells you the best way to build a nest egg is to maximize your company’s 401(k) plan. Popular wisdom also held that the sun rotated around the earth, the Titanic could not sink, and the Berlin Wall would never crumble. That’s my way of saying that I think you can construct a stronger nest egg if you funnel money into a personal non qualified retirement plan versus a 401(k) program.

Many people feel that by placing the maximum amount into their 401(k) plan and IRAs they will have great benefits, but these qualified plans are also time bombs.

Assume a couple is making contributions of $4,000/year into their IRA or 401(k) for 30 years. Their total 30 year contributions would amount to $120,000. That is, their…

1) Annual IRA/401(k) Contribution = $4,000 x 30 yrs = $120K Total contributions

Assume they are 34% combined marginal tax bracket for state and federal taxes.

2) Tax Bracket (Income > $67,000) = 34% (Fed + State)

Then, their tax savings would be $1,360 per year, or, $40,800 over the 30 years.

3) Tax Savings = $1,360/yr x 30 years = $40,800 Total

Now, assume they invested the $4,000 per year and obtained a hypothetical 10% annual rate of return for 30 years. They would amass a nest egg of $727,773.

4) $4,000 @ 10% for 30 yrs = $727,773

Let’s assume in retirement they could still earn 10% annual return. Then, without touching the principal they could withdraw $72,700 of annual income per year.

$727,773 X 10% = $72,700 per year withdrawal

Since they are retired, the kids have moved on so they have lost those exemptions; they mistakenly paid their home off so they lost those deductions; They will also be receiving Social Security benefits, maybe they have a pension or are working part-time, which will now place them in as high or higher tax bracket as they were in prior to retirement. Let us assume they are in the original combined state and federal rate of 34%. Their tax bill on the $72,700 withdrawal from their IRA/401(k) would be:

$72,700 income from IRA/401(k) X 34% tax bracket = $24,700 Tax bill

So, in the first two (2) years of retirement they will pay $49,400 in taxes. This $49,400 is far in excess of the $40,800 they saved in taxes during the accumulation years (see Section 3 above). Additionally, they will pay the $49,400 in taxes every two years for the rest of their life. Also, they will have to pay income tax on the $727,773 nest egg when it is withdrawn, plus possible estate tax of 45%. Hmmm! Whose retirement were they planning? Theirs or Uncle Sam’s?

In the first 20 months of retirement, every dollar of taxes saved during 30 years of deductions will be paid back. In fact, a person living a normal life expectancy will pay back over 10 times in taxes, on a qualified retirement plan, during the retirement years than the taxes saved during the contribution years.

For an average couple, they will pay over $500,000 in taxes from their IRA/401(k) from age 65 to 85½ for the privilege of saving $40,800 in taxes while they were working.

Why didn’t someone tell me the rest of the story?

The Recovery and Reinvestment Act of 2009 has a variety of tax savings that may benefit you.

Most people spend and concentrate mainly on their homes and autos. Here are a few tax incentives in each area that may save you tax dollars.

If you have a house or a car, going green will be easier.

• Green Homes - Clients who install solar panels or make other energy efficiency improvements to their homes will receive substantial write-offs for their efforts. A credit of up to 30% is available for expenses incurred in 2009 and 2010. You could even install solar panels to heat your pool and it will count. In the past, the benefit was only a 10% credit.

The maximum credit has been raised from $500 to $1,500, combined over two years, with specific limits for different types of improvements. For example, furnaces are limited to $150. A previous limit of $200 for windows has been lifted, but the specifications for windows to qualify have become stricter.

For certain green home improvements, there are no longer any dollar caps. For example, that $1500 cap does not apply to geothermal heat pumps, solar water heaters and solar panels. Wind energy systems and certain fuel cells are also exempt from the cap. You can claim the full 30% of the purchase price for these, and they can be expensed. To see exactly which home improvements qualify, go to:
www.energystar.gov/index.cfm?c=products.pr_tax_credits.

• Green Cars - The government hopes more people will start driving clean, plug-in cars. Hybrid electric cars now qualify for a tax credit that starts at $2500 and phases out after the manufacturers sell 200,000 vehicles. The credit is calculated according to the power of the vehicle. If the car has a battery with at least five kilowatt-hours of capacity, your credit is increased by $417. For every kilowatt-hour thereafter, up to 16, you add an additional $417. It could be worth as much as $7500.