Category Archives: Financial Planning

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. It’s completely misleading when activists, politicians, and the media refer glibly to “millionaires and billionaires” as if the two are almost interchangeable. Someone with a net worth of one million dollars isn’t even close to being in the same category as someone worth one billion.

Here are a few more examples to clarify the difference:

• One million seconds from now is about 11 and a half days away. One billion seconds from now is about 31 and a half years in the future.

• A million hours ago was 114 years in the past, early in the 20th century; our ancestors were using electricity and telephones. A billion hours ago was over 114,155 years in the past; our ancestors had evolved into Homo sapiens but were still using primitive stone tools.

• Put one million ants on one side of a scale and a female Asian elephant on the other side. The million ants, at around six pounds, would hardly register against the elephant’s three tons. Put a billion ants on the scale, however, and they would balance or even outweigh the elephant.

• One million pennies stacked on top of each other would make a tower nearly a mile high. One billion pennies stacked on top of each other would make a tower almost 870 miles high.

• If you earned $45,000 a year and stashed it all under your mattress, you’d have one million dollars at the end of 22 years. To accumulate one billion dollars at that same rate, you’d need the help of your many-times-great grandchildren, because it would take 22,000 years.

In today’s world, being a millionaire represents financial security, not vast wealth. At a withdrawal rate of 3%—the amount most experts consider sustainable—an investment portfolio of one million dollars will provide an income of $30,000 a year. Combined with Social Security, that would be enough to live comfortably but not lavishly in retirement.

Three percent of one billion dollars, on the other hand, will furnish an income of $30 million a year; definitely private jet and gated estate territory.

If millions and billions aren’t challenging enough, here’s a quick look at trillions. One trillion is a million millions, or a thousand billions. It would take one thousand elephants to balance the weight of one trillion ants. Astronomers estimate the number of stars in our Milky Way galaxy between 100 billion and 400 billion; not even close to a trillion. No wonder it’s so hard for most of us to wrap our minds around information like, “The current US national debt is more than 18 trillion dollars.”

Becoming a millionaire? It’s not only achievable, but wise if you want financial security in old age. Becoming a billionaire? You’d better plan to invent something amazing, write several dozen international best-sellers, or build an incredibly successful business. Becoming a trillionaire? Don’t waste your time thinking about it. For good reason, the word isn’t even in the dictionary.

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Dangers of Comparing Diversified Portfolio to US Stock Market Returns

It may be entertaining to watch Donald Trump point his finger and curtly say, “You’re fired!” When a client says the same thing to me, it isn’t so funny.

I’m especially not amused if a client fires me because their diversified portfolio is underperforming the US stock market and they abandon the strategy. The result is often a financial travesty.

The February issue of “Inside Information,” Bob Veres’ financial newsletter, puts a name to this phenomenon: “frame-of-reference risk.” The term is used by Roger Gibson, Chief Investment Officer, and Christopher Sidoni, Director of Investment Research, of Gibson Capital in Wexford, PA. Veres reported on a presentation they gave at the American Institute of CPAs (AICPA) Personal Financial Planning conference in Las Vegas in January.

Gibson describes “frame-of-reference risk” as clients’ tendency to compare the performance of their diversified portfolios with current returns in the US stock market. He points out, “If the discrepancy gets too painful, they will fire you and abandon a diversified approach at the wrong time.”

Based on the emphasis the media gives the US stock market, one could easily conclude US stocks must be the largest, most important asset class in the world. Not at all. US stocks represent less than 10% of the world’s wealth and make up 10% to 20% of most diversified portfolios.

Neither do US stocks consistently produce the best returns. In the 1970’s, commodities dwarfed US stock returns. In the 1980’s, international stocks led the way. In the 1990’s, US stocks were the stars. In the 2000’s, the leader was real estate.

Yet most investors judge the performance of their portfolios by US stocks. They may compare the returns of a diversified portfolio with news reports about the S&P 500 and the Dow, which together include only 530 companies.

Between 1994 and 1999, Gibson’s multi-asset class strategy delivered a 13.05% return, which paled in comparison to the US market’s 23.55% return. He lost one-third of the assets he managed in 1999, as clients fired him. They abandoned their diversified investment strategy at just the wrong time to save themselves from the 2000-2002 US stock market downturn, when real estate and commodities soared. Gibson’s multi-asset class portfolios did 9.96% from 2000 to 2005, when US stocks rang up losses.

This pattern, familiar to many financial planners, is the sad consequence of frame-of-reference risk.

Another aspect of that risk is our human tendency to stay in a comfort zone where most of our neighbors are doing pretty much what we’re doing. One client even told Gibson, “I would rather follow an inferior strategy that wins when my friends are winning and loses when my friends are losing, than follow a superior strategy that at times causes me to lose when they’re winning.”

Unfortunately, this tendency can lead us into disasters. Diversified portfolios are once again underperforming the US stock market. Predictably, an increasing number of investors are abandoning diversification, right in time to get nailed.

Gibson and Sidoni’s conclusion seems to be that educating clients to stay the course is a no-win game. In their view, advisors need to craft a less efficient, lower-return long-term strategy that clients will consistently follow rather than a more efficient strategy that clients may abandon in mid-stream.

While that view seems pragmatic, it really misses the mark. Instead of dumbing down portfolios to match client’s dysfunctional money scripts, it would be a better outcome if advisors concentrated on helping their clients uncover and modify the money scripts that are driving their self-sabotaging behaviors. This approach can help keep clients from saying “You’re fired!” at the wrong time for the wrong reasons.

Investing Money In Happiness

It turns out money can buy happiness, after all—sometimes.

Having a good income and the security of money invested for the future don’t insure happiness, of course. They do, however, give us a foundation that can make it easier to find happiness. Part of the secret to using money to foster happiness is knowing what to spend it on.

First, spending money to lift your mood—the whole “retail therapy” idea—does not lead to happiness. It provides only a momentary sense of pleasure, which often in the long run fosters unhappiness.

There are ways to spend money that do create happiness. Here, based in part on several posts about money and happiness by Dr. Jeremy Dean on his site Psyblog, are a few of them:

1. Experiences. Research says you will find greater happiness spending your money on experiences rather than on stuff. Experiences live in our memories much longer and give us more emotional enjoyment than things, which can quickly lose their importance. In fact, just the anticipation of planning an experience often creates happiness. And if you want to take the happiness level up a notch, take a friend along with you.

2. Exercise. The number-one strategy people can use to feel better, increase energy levels, and reduce tension is exercise. Exercising can mean spending money on a gym membership, a personal trainer, and equipment. However, exercising can also be inexpensive. Walking, for example, requires little more than a pair of good walking shoes and—at least here in South Dakota—a warm winter coat.

3. Stuff that will provide you experiences. Buying things that create or are necessary for experiences count as happiness spending. Music is an experience that research says is a mood enhancer; even sad music can bring pleasure. Spending money on music might mean buying concert tickets, but it could also mean buying recordings, an iPod, smartphone, speakers, and similar equipment.

4. Stuff that supports doing what you’re good at. What are you good at and really enjoy? PsyBlog says spending money for things you excel at typically creates happiness. A set of golf clubs and a budget for green fees could be a great purchase if you’re good at golf—or even if you aren’t so good at the game but you enjoy it for the exercise and time with friends. The same goes for buying things to support hobbies, such as art supplies, garden plants, or quilting fabrics. Maybe you enjoy helping others, so charitable giving or spending money on volunteer opportunities would increase your happiness. I love researching almost anything, so spending money on research data can be a mood lifter for me.

5. Coaching/Therapy. Few things are more valuable for long-term happiness than hiring a good coach or therapist. Research shows talk therapy to be as effective as or better than antidepressants. In my co-authored book, Conscious Finance, I describe how spending $80,000 on therapy was the best investment I ever made in my own happiness and well-being.

6. Meditation. The biggest happiness bang for your buck might come from meditation. It isn’t free, but it’s very inexpensive. You will need to attend a class or buy an instructional video or book. I recommend Open Heart, Open Mind by Thomas Keating, but there are many others.

While we know that money by itself isn’t a source of happiness, we also know that having enough money to comfortably meet our basic needs does make us happier. In addition, we can consciously choose to spend in ways that buy happiness. Such investments may not provide financial returns, but they can provide significant happiness returns.

Spenders, Savers, and Successful Savers

Are you a spender or a saver?

According to Scarborough, a market research firm, only 9% of adults in the U.S. label themselves as spenders. This is the percentage who “mostly agree” with the statement, “I am a spender rather than a saver.” On the opposite side, 29% “mostly disagree” with the statement and are considered savers. Presumably, the 62% in between consider themselves to have well-balanced financial habits that include both spending and saving.

Given these numbers, it would seem that most of the adults in this country ought to have healthy savings accounts. Unfortunately, that’s not the case.

According to a report released in March 2013 by the Employee Benefit Research Institute, 57% of U.S. workers have less than $25,000 in total household investments and savings, not including the value of their homes. The Social Security Administration’s current figures show 34% of American workers have no savings set aside specifically for retirement.

Something doesn’t quite add up. Either a lot of Americans aren’t willing to admit that they are spenders, a lot of Americans are so poor that they can’t afford to save, or a lot of Americans are delusional.

Or maybe a lot of us just have different definitions of “saving.” Here are a few money habits that might encourage people to think of themselves as savers, but that don’t necessarily add up to being successful savers:

1. Buying things on sale. Waiting for discounts on items you need and want is a wise and standard practice for frugal shoppers. But you aren’t a saver if you buy bargains that you don’t need, might not even really want, or can’t afford. Maybe that $150 pair of shoes is half price. Yet if they will just sit in your closet, you haven’t saved $75. You’ve spent $75.

2. Having money in the bank. Yes, putting money into a savings account is the first place to start saving and a great habit to teach your kids. But once you have accumulated an emergency fund, keeping your money in the bank isn’t a good savings habit. Over time, savings accounts and CD’s don’t pay enough to keep pace with inflation. Money in the bank may be safe, but it isn’t really an investment because it isn’t growing. Mutual funds that include a well-diversified range of investments are far better places for your long-term retirement savings.

3. Not spending anything. There are times when choosing not to spend money now will only cost you more money later. Failing to maintain your car or do home repairs are two common non-spending habits that may seem like saving but actually turn into spending.

4. Saving for someone else. The time-tested advice to “pay yourself first” usually means taking money off the top for savings before you spend anything. Yet this has another application, as well. Make saving and investing for your own retirement your first priority. It needs to come ahead of saving for your kids’ college educations, weddings, or first homes. This may seem selfish or greedy, but in fact it’s the opposite. When you provide for your own financial well-being in retirement, your kids won’t end up having to help pay your bills.

When we’re asked to label ourselves, it’s normal to tend to choose answers that fit the way we would like to think of ourselves. I’m sure most of us would prefer to think of ourselves as savers rather than spenders. But if we really want to become successful savers, we can’t settle for the money habits we wish we had. We need to look at the money habits we actually practice.

Comparison Shopping for Financial Advice

You can spot comparison shoppers a few aisles away at any retail store. They are the ones carrying articles from Consumer Reports, badgering the salesperson with a million and one questions. People who manage money well are usually big fans of comparison shopping.

If comparison shopping is important before choosing a new refrigerator or lawn mower, it’s even more essential before choosing an investment advisor. Unfortunately, there is no easily available consumer’s report on advisors. Even more frustrating, those selling financial products often have incentives not to be forthcoming with the information that is crucial for comparing advisors.

One aspect of shopping for an investment advisor is knowing what questions to ask. Continue reading