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Mindset: Planning First

Are you letting yourself down when it comes to financial planning?


Most of my prospective clients know where they stand with investments. We talk about it all the time: what's going well, what they changed recently, how much they made last year. Far fewer know where they are on their personal financial plan. In fact, that's an exaggeration, because most of my prospective clients don't even have a financial plan. When I turn prospective clients into clients, that's the first thing we address.

You wouldn't run a race without knowing where the finish line is. You wouldn't start building a house without a blueprint. Why would you start investing without knowing what you want to get out of it? That's what investing without a financial plan is. Without knowing what you need from your investments, you're likely to take on too much risk or too little; aim for retirement too soon or too late; save too little for your future or deny yourself luxuries while you're in a position to enjoy them. Financial planning is the cure for these ills.



A financial plan can mean many things to different people. For some it's an Excel sheet filled with columns of monthly expenses, tax estimates, and investment performance. For some it's a simple calculator like this one, offered by MSN Money. For my clients, it's a comprehensive accounting of income and assets, expenses and liabilities, and the goals we want to hit in the future. In every case, the goal of a financial plan is the same.: it's to answer the question, "Can I afford the life I want to live, and if not, what can I change to do so?"

When you're starting a financial plan you should consider your own circumstances first. Are you working or retired? How much do you make in a year? How much does it cost you per month to pay your mortgage or rent, your bills, and pay for your luxuries? How much do you have saved, where is it, and how much can you add to it every month or year?


Once you've got a grip on where you are, it's time to look at where you want to be. Are you trying to retire in five years, or ten, or twenty? How much will it cost you to live after that? Are you sending anyone to college? Donating your time or money anywhere? Preparing to buy a home or make another major purchase?


Finally, you need to think about what’s going to change between now and then. Will your family get bigger? Will some expenses end? Have you accounted for unexpected expenses that might start?


It’s with these things in mind that you can start to determine how this affects your budgeting and investing. Let’s talk about three different scenarios that I see often: chasing returns, failing to control a budget, and investing mistakes.



The thing I hear most often from clients before they switch their outlook from investing to planning is “how much will I make?”


To many amateur investors, this is the end-all measurement of success. How much money did they put in, and how much did they get out. It’s a dangerous mindset for a number of reasons, but the biggest problem is risk. If you could get a reliable 7% with minimal risk, or a 13% return with double the risk, or a 28% return with triple the risk, which is the right choice? The answer is: there is no answer. We can’t answer the question, because we don’t have any idea how much risk our client can accept, and we don’t know how much they need to make.


Let’s frame this with an imaginary client, named Ace. Ace is 55, and is looking forward to an early-ish retirement at 60. Ace has set aside $500,000 in his 401(k), has another $35,000 in savings, $190,000 in a brokerage account, and owns his own home with no mortgage. He makes $75,000 per year before taxes, and wants to have enough post-tax income in retirement to cover his estimated post-retirement expenses of $50,000 from retirement until he’s 95 or so.


Ace has, historically, aimed high with investments, pursuing stock-heavy investments with an attempt to beat the market, and he’s asked his investment manager to do the same. His portfolio has produced an average of 12% per year, but with a lot of fluctuation. His financial advisor has been bugging him to start a financial plan for years, and Ace finally gives in. They sit down for a few meetings to sort things out and talk about the future, and what do they find? Ace is way overshooting his own needs. Taking on the risk of an all-stock portfolio to get 12% is just not worth it, because he can live the life he wants with a return of under 7%.


Ace works with his financial advisor to restructure his portfolio to more than halve his risk, aiming for a return of 7 to 8% per year instead of 12. Importantly, Ace and his advisor meet again every year, twice in the year he retires, to re-evaluate and make sure they’re still on track. In another future, maybe Ace lost 30% of his portfolio the same year he planned to retire, prompting him to reconsider and put off retirement for another year or two; or maybe he was exceptionally lucky and continued to do well, passing away with $5,000,000 of unspent money in the bank. Neither of those is Ace’s best result.


Financial planning allows you to define your tolerance for risk. Getting what you need with certainty is better than accepting a 50/50 chance that you’ll make it (with extra) or go broke trying. Only by knowing what it costs you to live the life you want can you and your advisor create a portfolio that gets you there while accepting the absolute minimum of risk.



Sometimes the stars don’t align and, no matter how we tweak the numbers, your investments are not going to support your desires. If you make $50,000 a year, no amount of investing wizardry is going to help you afford a $14MM home in Hollywood.

When developing a financial plan it’s vitally important to understand where the money’s coming from and where it’s going. The easiest change most clients can make is reducing expenses. This is wisdom you’ve heard all your life, likely, from everyone from parents to Suze Orman. This is not to say that you should skip your morning latte or cancel your cell phone bill. In the long run those small changes of a thousand dollars a year or so can add up, but won’t ‘move the needle’ very much. What will change your outlook is choosing a home worth $450,000 instead of $525,000 when you’re looking for a new house; or considering changing companies or positions to increase your salary from $36,000 to $45,000, or get access to a 401(k) with a company match.


When I’m working with clients that are new to financial planning I try to get a sense of everything happening in their lives: changing jobs, buying homes, planning trips, having children, buying cars, starting a business, preparing for retirement. Half of these clients are trying to do too much, whether it’s trying to do it all at once or trying to buy a $1,250,000 home next year and retire at 50. In these cases we have to prioritize. What’s the first thing we want to address, the most important one? What are we okay compromising on? What’s really kind of a pipe dream that we’d like to include but won’t be heartbreaking to give up?


This is controlling a budget, in the terms of financial planning.


Let’s go back to Ace, above. Ace goes back to his financial planner and says he wants to buy a cabin by a lake, so he has somewhere to get away on the weekends. He wants to buy in five years, and he’s checked the market and knows the cabin he wants is priced at about $650,000. He’ll put down $150,000, then have a mortgage of around $32,000 per year for 30 years. Guess what happens to his financial plan?


As you might have guessed from your gut feeling or some napkin math, an expense like that throws Ace’s plan off pretty badly. There’s a chance he’ll be fine with an expense like that, but it’s a slim chance. What can he and his advisor change to make this a reality? No matter how good the investment performance, there’s not a reasonable way to make this possible through portfolio management alone. It’s time to look at adjusting the budget.


Ace’s financial advisor runs some different scenarios, and later comes back to Ace to show him his options: Ace can buy the home if he can also work until he’s ninety, or he can reduce his expectations a lot and look for a cabin in the $225,000 range instead. His advisor’s suggestion, however, is to aim for the middle. By putting off retirement to 65 instead of 60 and going for a cabin with a $400,000 price tag Ace can preserve his chances of meeting all of his other goals.


Having an understanding of what you can change and how it affects your plan can help you make good decisions. This is especially the case during periods of change, like right before you retire or as you’re making a big purchase. Failing to understand how these changes affect your future is accepting the risk of disaster – maybe not now, but soon.



The last of our three big stumbling blocks is putting money where it doesn’t belong.


Part of this is the inverse of the first point, in that you have to make sure your investment portfolio is keeping up with your expectations. If you’ve worked with your advisor to identify that 4.5% is the right return to meet your needs, you have to make sure that your portfolio is making 4.5% overall. That means you can’t have half your wealth in cash (earning 0.025%), and the other half in an allocated portfolio producing 5%.


Many retirement savers take saving seriously, but are averse to putting their money at any level of risk. Some even keep around ‘emergency savings’ accounts with $400,000, $500,000 in them, far, far more than they could need in an emergency. These over-savers create huge drag on their portfolios, making it difficult to achieve their goals by keeping their money in savings, where it doesn’t belong.


More insidious, though, is missing out on tax savings by putting your money in the wrong spot. Your 401(k) can save you huge amounts over the course of your life. A Roth account can save you even more, used correctly. Ensuring that you minimize capital gains taxes, allocate your portfolios according to their tax impact, and understanding when and how to draw from each account can save you (no exaggeration) hundreds of thousands of dollars in the long run. That’s even more true for high earners, and even more so for small business owners.


To provide the simplest illustration, let’s imagine that Ace, above, saves 10% of his income. That $7,500 gets taxed at 24%, so he puts away $5,700 each year for the next five years. At 7%, and letting it sit for 15 years after retirement, he’s got $96,500 in the account, which gets knocked down to $87,275 by capital gains taxes.


If Ace were to put away 10% of his paycheck in his 401(k), with a 3% match, he’s saving $9,750 each year. We’ll add to that for the same five years of employment, then let it sit for the same 15 years after retirement. By the time Ace is withdrawing from that account the balance is around $165,500, a huge improvement over taxable savings. It all gets taxed at withdrawal, and at 15% that leaves Ace with about $125,750 when all is said and done. That’s an improvement of almost 60% in tax savings alone.


If Ace goes one step further and commits $2,250 to his 401(k) to reach his 3% match, then takes the other $5,250 (down to $3,990 after taxes) and puts it into a Roth account, where do we end up? The short answer is with $126,250 in hand after all taxes are paid. This gap widens the longer we let assets sit, and narrows if we have to withdraw early. Roth accounts are the most valuable over a long term with good returns.


Sometimes proper asset location is a matter of inches, sometimes miles.



If you feel lost by now, don’t despair. Financial planning is not a project but a process. You shouldn’t be aiming to do everything immediately in one session, and neither should you think that it’s done after your first meeting. A good financial plan changes with your circumstances, and a good financial planner will help you through all the phases of your career and life.


If you want to learn more about Zenith’s financial planning and find out if it’s right for you, reach out to us.








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