First Steps on the Path to Financial Independence

My hunch is that most people would agree they “should” invest for the future. My second hunch is that many of them don’t know how to start and are afraid of making serious mistakes.

One of our resident planners, Sterling Gray, summed up that fear eloquently in a post on the Kahler Financial blog: “I noticed that my friends and colleagues . . . saw retirement planning as a dark, treacherous terrain that they could never safely travel alone. Unsure of where to turn for help, they often chose to ignore saving for retirement completely . . .”

Here are some pointers to help you take the first steps into the unfamiliar terrain of investing.

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Pot Pie Portfolio a Tasty Investment Recipe

From Rick Kahler

I have a complaint. The pot pie at one of my favorite restaurants doesn’t taste like a pot roast. I keep complaining, but nothing changes. I am thinking I may need to find a new restaurant because their cooking skills are just not living up to my expectations.

Or maybe I need to adjust my expectations. How can I expect a pot pie—a savory pastry with a mixture of potatoes, vegetables, and beef chunks—to taste like a beef pot roast? Even though beef is an ingredient in a pot pie, no reasonable diner would expect the two meals to taste the same.

But that same reasonable diner might be perfectly comfortable expecting that their diversified investment portfolio should produce the same return as US stocks. This is just as unrealistic as it is to expect pot pie and pot roast to produce the same taste.

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Fewer Americans Living In Poverty

Fewer people in the US are living in poverty. According to the October 2017 annual report of the Hamilton Project of the Brookings Institute, the number of Americans living in poverty declined by 13%, or 6 million people, in the two years from 2014 to 2016. That’s encouraging news.

Not so encouraging is that 40.6 million people still live under the government poverty level. This is about one out of every eight Americans. The department of Health and Human Services sets the poverty rate at $32,580 or less for a family of six and $16,020 or less for two people.

Who are those officially classified as poor? Continue reading

How to Make Sense of Big Numbers

If you are not a natural number cruncher, you may be like one of my clients who says, “When I see big numbers in an article, my brain just skips over them.” Unfortunately, skipping over numbers can lead to serious misunderstandings. Here are three questions to ask that can help you clarify those big numbers.

1. What’s the time period? The reported cost or savings of something is completely irrelevant unless you know the length of time over which it is calculated.

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Huge Difference Between Millionaire and Billionaire

Would you like to build up a million-dollar nest egg by the time you retire? For middle-class earners, that goal is challenging but possible if you start at age 25 and save $1750 a month. Many married couples could do this by maxing out their 401(k) contributions. Or you could take the route that many people follow and build a small business into a million-dollar asset.

What if you want to accumulate a billion-dollar nest egg instead? Starting at the same age of 25, you would need to save $21 million a year. Good luck with getting any employer match on that.

There’s a vast difference between a million and a billion. Continue reading

What’s Right About Business Profits

I recently had a conversation with a teenager who was annoyed at Disney’s ongoing promotion of the movie “Frozen.” The young woman’s point was that Disney is a creative company and, by pouring so much time and resources into promoting “Frozen,” it was robbing its loyal customers of new material.

My response, that perhaps the reason Disney is promoting the heck out of this movie is because a lot of consumers must want more and are willing to pay more, wasn’t well received. “Disney has all the money it needs. They don’t need to continue promoting old material.” I suggested that Disney won’t always have all the money it needs if it doesn’t profit from its popular hits. That didn’t go over well either.

The concept of profit seems to be increasingly maligned and misunderstood. Every organization, whether it is “for profit” or “not for profit,” needs to make money in order to continue to exist. There is nothing wrong with making money and a lot of things right with it. An organization can’t pay its workers or purchase goods and services from other businesses if it doesn’t make money. And, unless it has a monopoly, a business can’t make money unless it’s providing a service that consumers want.

I would guess most people would agree up to this point. The friction seems to come when we try to parse profit into “fair” and “unfair,” “enough” and “too much,” or “reasonable” and “greedy.” These are all subjective terms. My definition of profit can be significantly different if I am a shareholder of Disney with my future retirement depending on the company’s success than if I am a consumer forking over $400 so my family of four can make memories at Disney World for a day.

As a consumer, though, it’s your responsibility to be aware of the way the seller is making money and to make informed decisions about whether a product is worth what you are being asked to pay for it.

When you purchase furniture or cars from a company, most likely a salesperson receives a commission. When you buy anything, whether it’s from a tiny part-time business or a huge international corporation, the owners of the company certainly hope to make some profit.

Is the amount of the company’s profit or the salesperson’s commission critical to your need, use, or potential enjoyment of the product? Not necessarily.

For example, if you’re just out of college, living in a cheap apartment, working at an entry-level job that you aren’t sure you want to keep, then a thousand-dollar sofa probably isn’t worth its asking price to you. Its level of quality or how much or little the salesperson or the company might make on the sale is irrelevant. For your needs and your budget, value is probably going to be found at a rummage sale or a second-hand store. And of course, even a second-hand store operated by a charity needs to make a profit in order to raise funds to support the organization’s mission.

The bottom line is whether a particular couch, car, or “Frozen” toilet seat is worth its asking price—to you. If you determine the price is too high or the quality insufficient for your needs, you can choose to “let it go” and look elsewhere. If you do, there is no sale and no profit for the company.

Profits are the lifeblood of business. Without them a business is not sustainable. As a consumer, you vote with your pocketbook every time you spend a dollar. And even to a company as big as Disney, your vote counts.

Look for Hidden Investment Costs

Annuities are popular investments; almost every new client I see has one. Part of any investment adviser’s due diligence is to understand the history and intentions of the investments in a portfolio. When I ask why someone purchased an annuity, the most common responses are: “We didn’t have to pay any fees or commissions.” “There are no ongoing expenses.” “All my money is working for me.” “The principal is guaranteed.”

Any time you read or hear “no fees,” “no commissions,” “no expenses,” “free,” or “guaranteed” used in conjunction with an investment, it’s a red flag. All investments, including annuities, have costs associated with them. You need to ask some probing questions about those costs before proceeding.

Let’s look at the costs for one popular type of annuity, the fixed annuity. This simply gives you a stated rate of return that often can change annually, similar to a bank certificate of deposit.

Suppose Investor A is sold a fixed annuity with a guaranteed return of 3.5%. Investor B invests her money in a plain vanilla portfolio of mutual funds holding 60% stocks and 40% bonds, which has a long-term projected return of 6%.

The insurance company selling the annuity must earn enough of a return on Investor A’s money to cover their expenses, pay commissions, and return something to Investor A. There is no magic formula on how that’s done. The insurance company invests the money in the same asset classes available to anyone. For the sake of this example, it’s reasonable to assume the insurance company would hold the same 60/40 portfolio as Investor B.

The annuity incurs internal costs for administration, managing the money, insuring the return of principal, and commissions paid to salespeople. While these vary somewhat from company to company, a cost of 2.5% isn’t unreasonable.

If the company earns 6% and deducts 1% to recoup the upfront commission paid to the salesperson, 1.0% for management costs, and 0.5% for administrative fees, they pay out the remainder as a “fixed” return of 3.5%. Investor A only sees that 3.5% fixed return. If Investor A wants out of the policy before the cost of the up-front commission is fully recovered (usually 4 to 15 years), he will also incur a “surrender penalty” that is approximately equal to the remaining amount of commission paid to the broker selling the policy.

Investor B’s 60/40 portfolio will have the same 6% gross return as the insurance company’s portfolio. If Investor B purchases index funds from a company like Vanguard, her costs could be as low as 0.10%, leaving her a return of 5.9%.

Suppose Investors A and B each accumulate $1 million in retirement funds. The difference between Investor A’s guaranteed 3.5% return and Investor B’s average and unguaranteed 5.9% return is potentially an extra $2,000 a month in retirement income. Guarantees come with a cost.

Given these numbers, you may wonder why anyone would purchase a fixed annuity. One reason is that many buyers don’t have the confidence that they can invest the money wisely or the stomach to watch the portfolio’s inevitable peaks and valleys. Another reason is that most buyers don’t fully understand the costs.

Unlike stocks, bonds, and mutual funds, most annuities are sold, not bought. I have never had a new client who independently purchased a no-load annuity. The annuities I typically see were sold by someone who received a commission. Commissions are not inherently bad, but in most cases they do inherently create a conflict of interest.

There are always fees associated with any investment. In my experience, the less transparent those fees are, the higher they are.