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 What about the earnings as the funds are withdrawn during retirement?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!

There are people that get into financial trouble due to outside circumstances. Medical emergencies, loss of job or a family crisis are some reasons. The majority of financial trouble stems from simple over spending.

Spenders who need outside help may benefit from the support of a more frugal friend who would be willing to act as a money mentor or spending coach. If you recommend to a friend Debtors Anonymous, don’t be surprised to hear a quick “no.”

Some people are too ashamed to admit that they may be damaged in this way. You may have to think of other solutions, such as a financial recovery counselor. (Karen McCall and her associates at www.financialrecovery.com and Bari Tessler’s group at www.consciousbookkeeping.com are two valuable resources.)

Two more tips: Once you’ve developed guidelines for an overspending friend, or yourself, take care not to call it a budget – a word that free-living boomers mentally translate as “ball and chain.” Refer to it instead as a spending plan, or a spending, saving, and investing plan, or even a financial growth plan.

Those of you who may be in denial about this I ask you to describe three scenarios: (1) what happens if all your dreams come true; (2) what happens if outcomes are just so-so; and (3) what happens if you have made mistakes that force you to change your lifestyle. What will your life be like? How will you feel? What will your friends and relatives say about you?

I suspect that when you reach scenario # 3 the last question may unleash shame, regret and many pent up feelings. Find out the reasons for overspending. Just like people who over eat, over indulge in alcohol or drugs the actions are symptoms of inner turmoil.

How do you teach your children the proper values and responsibility as it relates to money? Although this is not part of traditional financial planning, I get this question often with clients that have children.

Parents want their children to be self-sufficient and financially literate, but many are unsure of how to achieve these goals. They often look to me for help or education programs to help raise financially fit kids. When I was a child, very few families were very wealthy. Consequently, we learned the value of money quickly and every day. Today, many parents have high incomes (when your household income is over $75,000 that places you in the top 7% of income earners) and lavish their kids with everything they demand. At the same time, they are picking the kids up in high priced autos that, just a generation ago, one spent on a new home. The parents tell the kids to be more prudent with their money, but, the children are watching their parent’s actions.

Parents should begin discussing and educating their children about money at an early age. I have had clients come to the office with a child ready to go to college in 2 years, and the child has never had any responsibility for money. A child should be able to make good decisions about money before 10 years old.

Unfortunately, a report conducted by Strategy One, polled 1,100 American teens and found 62% believe they are prepared to handle adult financial responsibilities after high school. Yet, in the same survey only 41% knew how to budget, 34% knew how to pay bills, and 26% understood how credit card interest and fees work.

The Early Years

When children are in elementary school, parents should point out the advantages of starting to save and invest early. Around age 5 is a perfect time to provide an allowance so the child can make some of his/her own decisions. The parent should use trips to the grocery store to teach the child. If the child has money to use they can participate in the spending process.

After the child learns to spend, then, the next step is money management. The allowance should be distributed among different colored jars; spending, saving/investing, charitable giving and a fourth for education. This is a way for children to learn and see what their money can do for them. This helps families show their value system and for the kids to learn that money is not just for spending. The children can learn they can get whatever they want, but it takes time and discipline.

Parents should keep children and young adults aware of their financial situation so they can learn from their parents’ actions. Parents should discuss through large purchases with their spouse or another family member within earshot of the child. Keep in mind parents, although the kids may not be picking up their messy rooms, they are picking up their parents’ money thoughts and messages. Parents can and should teach their kids to be good consumers. In so doing parents will solidify their own skills.

In the Middle Ages

Around junior high school age is where investing should come into the education process. Kids could start setting money aside in, say, a custodial account. Maybe the incentive is for the parent to tell the child if they invest properly and make money, then, it is theirs to keep. If they invest poorly it is okay, but, they must write out what the learned from the experience. At this age some interesting stocks for the young teens may be in McDonalds, Coca Cola or Adidas. These stocks would have a connection for the child. As you go through the annual report with them the child begins to notice more and more. Disney is another stock children can get, relate to, and become excited about. Parents must emphasize to a child that it is okay to make a mistake when investing the first time. Above all the kids must learn that investments are volatile.

The Later Teen Years

As the child becomes a high school senior, send them to the website www.feedthepig.com for tips on how to save money and to receive a weekly email. In addition, there are courses that would be helpful like AIG’s “Kids Investing for Dollars and Sense” (KIDS). It has work sheets and internet based activities that parents can review with their children.

Parents, along with their financial advisor, should begin conversations with the child about what a 529 Plan is and the impact on their life. This is the time a serious discussion of debt, how to keep a budget, and why it is important to stick to it.

As the college years are coming to a close, this period is a time to emphasize that money is not just about spending. Explain what and how a 401K plan works. Share with them that $100/month saved from age 25 to 65, earning the stock market average rate of return will produce $1.2 million for retirement. (Don’t you wish your parents taught you that little gem?)

A Few Closing Thoughts …

• As a young child, my Dad made me read … The Richest Man in Babylon by George Clason. It was a turning point for me in money management. I encourage all my clients to read the book and have their children do the same. If the kids are young, then the parents should help them read and understand the great principles in this great book.
• I work with each client to set them up a “Family Empowered Bank”. This is not a chartered bank, but rather a place where we accumulate and store financial assets, human assets, and wisdom assets. These assets are to be shared with all family members. You see it does you NO good to “dump fish” on the kids … better you teach them “how to fish” with everything you have learned in life. A great financial tool used in the family bank is that as the kids request and want money or things – DO NOT GIVE them the money … lend it to them from the family bank at a reasonable interest rate. Have them pay it back out of allowance or from wages. This exercise will teach them about debt early in life and responsibility.
• Here are a couple of websites that provide information on money camps and instructions for kids on money.

Money Camps, Inc.
www.moneycamps.com

The Money Camp for Kids
www.themoneycamp.com

Independent Means Inc.
www.independentmeans.com

The American Dream Planner
www.americandreamplanner.com

I encourage you to discipline your children with money early, or, later live in regret.

Advising people on their finances for over 35 years, I have seen individuals try the craziest investment schemes to build wealth quickly. Success in wealth building is a slow, methodical process. “Rome wasn’t built in a day, neither was Syracuse, New York”.

My philosophy has always been, is now, and always will be…Discipline or regret. That is true in wealth building, keeping healthy, a spiritual outlook, raising a family, in fact, with everything in life. I watch how young people, just starting off in their work career, do not have the discipline to save and invest. Consequently, in their late 50s they get into exotic, wild, get rich schemes and betting the lottery trying to make a “big kill”. In all cases these hair brained ideas turn out to be losers and the people are penniless as they approach retirement. Side bar: In a similar way I watch on TV as they advertise… “Lose 30 pounds in 2 weeks”. That action requires some drastic lifestyle changes. Sure, you may lose the weight, but, once you are down “30” pounds you return to your old lifestyle and put it back on. If you follow a slow, disciplined change in your eating and exercise habits to a correct lifestyle you will slowly lose and keep the weight off. Funny, it took you 3, 5, or 7 years to slowly put on the weight, so, why not take the same time to take it off. “Paul what are you crazy” you ask. I’m an American and it’s my “right” to demand:

• A headache to go away in 5 minutes by popping a few pills
• My hunger to go away in 10 seconds by eating fast food
• I lose the equivalent of 2 large dogs in 2 weeks

[I could go on and on…]

Like losing weight, if you follow a slow, disciplined approach in investing, you will win.

Let’s look at a few strategies to build your wealth. After many years in the financial advisory profession, I have found a few simple steps to reach the “top level”.

• (Obvious but ignored) You must spend less than you earn. (I can hear your heart rate go up and you are going to shut down this blog article. Right?) I have seen people who earn $40,000 a year save $5,000 of that for the future. I’ve seen others that earn $200,000 a year and spend $220,000. Why? The more people earn…the more they spend. I have seen individuals worth over $50 million spend more than they earn and systematically destroy their fortune. Thus, Rule #1- spend less than you earn.
• Our second step is to commit to and follow a sound, long term investment strategy (I know for most Americans long term is the time it takes to switch TV channels on their remote control).

Too many people invest a little here and a little there. They bail out of the stock market, after it tanks, and get in after is peaks. Or, they buy real estate after it has a great run up. Worse, they invest in all the “get rich” schemes on late night TV.

The “follow the newsletter trend” is a recent doozie. Many investors place their money into those investments that were last year’s winner. [Evidence shows, over the long term, that the “hot” investment last year is this year’s “cold” one, and, vice versa.] This seems on the surface like a great idea, as you follow the advice of a proven winner…wrong! Plus, following a winner makes you feel good- wrong again. This is not about feeling…it is about making money.

The problem is most “feel good” decisions, in the investment world, do not work out. According to the “Hulbert Financial Digest” if you had taken $1 million, in 1985 and, followed the brilliant newsletter investment strategy for the next 21 years, you would have a grand total of (drum roll, please) $365 today. This is an average loss of 31.4 % per year.

In conclusion, that which may be emotionally and intellectually appealing, like the newsletter strategy, simply does not work.

What are the keys to a sound strategy to build wealth? Well, a successful investment strategy must:

• Work over different time frames
• Provide effective diversification
• Work in both up and down markets
• Be disciplined yet flexible
• Reduce risk and provide down side protection
• Have a good long term track record

The rest is to have patience, self control, patience, and more patience (Ah, patients, said the doctor to the nurse. Ooh, bad pun!)

So, spend less than you earn, commit and follow a strategy, be disciplined and have patience.

Ah, discipline or regret?

* * * * * * * * * * * * * * * * * * * * * * * * * * * * * *

Interesting Tidbit

MORE THAN HALF

Although only 1 in every 38 tax payers (3%) reports an adjusted gross income of $200,000 or more, that group pays for 51% of all federal income taxes.

So, 3% pays 50% of taxes. Is that a fair tax?

(Source: IRS)

A stock purchase here, a mutual-fund investment there, a retirement account or two and before you know it, you’re up to your elbows in dividends and capital-gains calculations. How do you keep track of the continuously changing values of your holdings? And how do you know whether you’re winning or losing?

A gaggle of new financial Websites claim that a combination of social networking and informal transaction logs will help you build a winning strategy in less time than paper methods or even programs like Intuit’s Quicken (www.quicken.com) and Microsoft Money (www.microsoft.com). After examining a dozen such sites, my response is: maybe some day.

Few of the newcomers offer real portfolio management — and none on the scale that Quicken and Money have provided reliably for years on both PCs and the Web. Coincidentally, both multi-product families have just been refreshed — the versions with full portfolio management include Quicken Premier 2008, Quicken Home & Business 2008, Microsoft Money Plus Premium and Microsoft Money Plus Home & Business. They list for $80 to $100, but they’re always heavily discounted.

Although these systems include just about every known financial-management tool, the primary reason to buy them is their ability to download multiple transactions from multiple accounts at multiple institutions for millions of customers daily with nary a hiccup. In fact, all your accounts can be updated in one step. That’s an underappreciated accomplishment, one that even large online brokerages like TD Ameritrade (www.tdameritrade.com) and E*Trade (www.etrade.com) aren’t inclined to tackle.

Both software programs are packed with performance measures for your entire portfolio and its individual holdings over any period you choose — about 100 different ratios and other metrics. Both come fully equipped with tools, charts and reports that aid in cash-flow management, risk analysis and asset allocation. And both have customizable calculators, guides and reports to help with portfolio rebalancing, retirement planning and capital-gains and other tax estimates.

Okay, but isn’t one better? Not really. One pea has more wrinkles on the left side; the other, more on the right. Certainly, the quality of news and analysis on MSN Money is a cut above Quicken.com’s. Yet one of my favorite tools is Quicken.com’s Stock Evaluator, a discounted-earnings (as opposed to discounted free cash flow) tool for finding a stock’s intrinsic value. It lets you examine a company’s growth trends, financial health, management performance and market multiples.

Your decision to buy Quicken or Money will probably turn on which feels most comfortable to you. In fact, their strengths are also their weaknesses: They’re so loaded with features that they can overwhelm the casual user. That’s the opening the new social investing-cum-budgeting sites seem to want to exploit. By mixing just a slice of personal finance functionality with plenty of yak for free or a low monthly fee, they may be able to gain a toehold in the marketplace. Most don’t merit mention.

One of the exceptions is Yodlee MoneyCenter (www.yodlee.com). It’s not as broad or deep as Money or Quicken, but has all the key modules, including a portfolio manager that accepts downloads from brokerages and other financial institutions. Yodlee’s portfolio can be customized with a decent set of performance measures like those most professional money managers use.

Not surprisingly, the company is a well-regarded Redwood City, Calif.-based electronic-payment intermediary that also provides a financial-services platform to 100 big banks and portals. A free service, the Yodlee Website mounts one of the few credible challenges to Quicken and Money.
Another worthwhile site to check out is MoneyChimp (www.moneychimp.com). It lacks electronic data updates, but does a good job with ad hoc portfolio analysis via a battery of financial calculators and supporting articles covering everything from the Rule of 72 to Monte Carlo simulations. The site is clean and navigable — sort of a Reader’s Digest version of The Motley Fool (www.fool.com). The major caveat to interesting sites like MoneyChimp is that you have to keep typing in data from somewhere else.

Go ahead and hop on MoneyChimp for a quick simulation of your retirement options. But if you want more substance, you’ll need at least one site or program that updates all your accounts quickly and easily. For now, that will lead you back to Quicken, Money or possibly Yodlee.