Monthly Archives: April 2017

Getting Wrong About Investing

Starting a business takes a lot of savvy. Many entrepreneurs border on genius when it comes to their particular niche, and that’s why people are willing to invest in, buy from, and do business with them. While a particular entrepreneur may thrive in her/his field, they may struggle in one common arena: Personal wealth management.

Entrepreneurs spend so much time garnering investments that they often don’t take the time to make any of their own. If you’ve ever started something you probably know all too well how easy it is to invest in a project, with no promise of a return. You pour all your time, energy and in this case money, into a venture hoping that it takes off (and eventually pays off).

One founder has set out to solve this problem. Paul Adams, CEO and Founder of Sound Financial Group, has a passion for helping fellow entrepreneurs reach personal financial success. As a result, his Seattle-based investment firm manages millions in capital for its clients. Paul has some great insights on where and why founders often struggle to manage their own personal finances.

Personal Wealth Management Tips

1. Legacy vs. Retirement Dreams

When most of us think of retirement, we think of vacations, houses and no debts. Adams and Sound Financial recommend an alternative perspective. Instead of putting your focus on how you’re going to spend your savings, think about the legacy you plan to create. “First, cast your vision of the future; then set an intention for any financial advising relationships you engage in, establish a plan and strategy and track your progress going forward.” Having this mindset helps vision driven founders find purpose in their financial planning.

2. Selecting the Right Kind of Assets for Long-term Withdrawals

Adams also details that “Anticipating a lifetime of withdrawals from a defined asset pool over an indefinite period of time is a complex challenge for which there is no simple solution. Pursuing this challenge can require creative approaches and persistent vigilance.”

Once you retire/exit/sell you’re essentially out of a job, so you’ll need to have saved well.

Solution? Plan for market fluctuation and have clear expectations of what your desired retirement lifestyle is going to cost. You’ll need to ensure that your investments are able to meet those expectations.

3. Your Business is Great, But it Might Not Be Great for Investment

The other mistake entrepreneurs make when relying on their businesses for personal success is banking on a sale price down the road. “I know entrepreneurs that have based their retirement plans on the current value of their business. The problem is, 10 years from now when they plan to sell, no one might be willing to purchase it for that price. It’s important to create a strategy that doesn’t rely on such variables.” Adams shared.

Loving your business is great. It’s natural for founders to believe that their ventures are also worthy of personal investment, but startups are risky and markets are volatile by nature, so you shouldn’t just rely on your ventures for retirement funding.

4. Mistakes in Calculating Net Worth

So much of getting a business started is pitching to the right people and selling the value of a venture. It’s not uncommon for entrepreneurs to present the best version of things in order to get people on board. Unfortunately when it comes to self-valuation things get a little tricky.

Often entrepreneurs simply calculate the most current value of the business and use that as a baseline for their own net worth. Adams shares that “There’s a difference between your personal balance sheet and that of your business. Entrepreneurs who are new to financial management also make the mistake of including the wrong assets in their calculations.

Vehicles, homes and similar assets have real value, but they shouldn’t make it into your net worth calculations unless you plan on selling them soon and not replacing them.”

Measuring your net worth is a critical part of your financial strategy because it helps you determine what investments you need to make to plan for retirement. An inaccurate assessment of your current worth may lead to shortfalls down the line.

5. Don’t Make Commitments Without Having Them in Your Existing Plans

Adams shared “I can’t tell you how many entrepreneurs get themselves into trouble by committing to things without including them in their financial strategy. Expenses like vehicles, college tuition or a better house are easy to aspire to or promise, but planning for them is a whole different game. Whenever you want to commit to something in the future for you or your family, start including it in today’s plans.

The key is having the patience to incorporate these goals as a part of your long-term strategy. It also requires a degree of self-awareness and self-control. You have to be able to realize a want or a desire and postpone it until you can assess its impact.

So to recap, Adams recommends that you:

  1. Plan your legacy before you plan your retirement,
  2. Plan what your retirement withdrawals will be based on both the kind of assets you have and the lifestyle you plan on living,
  3. Don’t base your retirement on the future sale price of your ventures,
  4. Accurately measure your net worth to help determine what’s needed to accomplish your retirement goals,
  5. Don’t commit to expenses before including them in your strategy.

Many leaders and founders spend more time managing the success of their business than their own finances. The fact of the matter is you’ve worked hard to achieve the success you’ve earned, so you owe it to yourself to manage it well.

Some Techniques to Catch Up on Retirement Savings

Small business owners bear the burden of saving for their retirement and shouldn’t count on the sale of their companies to provide the financial security they seek. Many owners often plow extra cash back in the business rather than socking it away in a tax-advantaged plan. The good news: growing older entitles you to make “catch-up contributions” designed to increase savings as retirement approaches.

How to Catch Up on Retirement Savings

1. Catch-up Contributions to 401(k) Plans

The maximum salary reduction contribution to a 401(k) plan in 2017 is $18,000. However, starting in the year in which you attain age 50, you can increase the contribution by $6,000, for a total contribution of $24,000. The $6,000 catch up contribution is intended to boost retirement savings for those nearing retirement. However, the additional contributions can be made without regard to prior contributions, so the term is really a misnomer. Both the basic and catch-up contribution amounts may be adjusted annually for inflation. Find more information in IRS Publication 560.

2. Catch-up Contributions to SIMPLE IRAs

If your company has a SIMPLE IRA, the basic contribution amount for 2017 is $12,500. However, starting in the year in which you attain age 50, you can increase the contribution by $3,000, for a total contribution of $15,500. As in the case of 401(k) plans, both the basic and catch-up contribution amounts for SIMPLE IRAs may be adjusted annually for inflation. Find more information in IRS Publication 560.

3. Catch-up Contributions to IRAs

Whether or not you have a qualified retirement plan, you can increase retirement savings through IRAs and Roth IRAs. If you are eligible to make contributions — there are income limits for Roth IRAs and income limits for traditional IRAs for those who are participants in qualified retirement plans — you can increase your annual contributions. The basic contribution to a traditional or Roth IRA for 2017 is $5,500. However, starting in the year in which you attain age 50, you can increase the contribution by $1,000, for a total contribution of $6,500. The basic contribution limit may be increased annually; the catch-up contribution amount is fixed by law. Find more in IRS Publication 590-A.

4. Catch-up Contributions to HSAs

If you have a high deductible health plan (HDHP), you can contribute to a health savings account (HSA) on a tax-deductible basis. The annual contribution limit depends on whether you have self-only coverage or family coverage. For 2017, the contribution limit is $3,400 for self-only coverage and $6,750 for family coverage. However, starting in the year in which you attain age 55, you can increase your contribution by $1,000 (each spouse must have his/her own HSA to make a catch up contribution).

Why is this healthcare-related savings program included in a retirement savings blog? The reason: Funds in HSAs are not subject to any required withdrawals and aren’t forfeited if not used for medical care (there’s no use-it-or-lose-it feature for HSAs). And, in fact, there’s an important retirement savings aspect. Funds withdrawn to pay for qualified medical expenses are tax free but funds can be withdrawn for other purposes. When funds are used for other purposes, they’re taxable and subject to a 20 percent penalty. The penalty, however, does not apply for distributions after age 65. In other words, if you contribute to an HSA and don’t use the money for healthcare, you can use it penalty free to supplement retirement income. Find more information in IRS Publication 969.

Note: The American Health Care Act that is currently under consideration in Congress would:

  • Increase the basic contribution limit to the amount of the out-of-pocket costs for a high-deductible health plan (e.g., $6,650 for self-only coverage and $13,300 for family coverage in 2018)
  • Cut the penalty to 10 percent
  • Allow catch up contributions for each spouse to one HSA
  • Treat over-the-counter medications as qualified expenses (no doctor’s prescription needed).

5. Delay Social Security Benefits

You can begin to collect Social Security benefits at age 62, but the benefits will be reduced for life. You can collect benefits without reduction at full retirement age, which is age 66 for those born between 1943 and 1954. However, you can increase your monthly benefits by delaying benefits beyond full retirement age. More specifically, benefits are increased by 8 percent per year. Thus, a person with a full retirement age of 66 who delays benefits until age 70 would see benefits increased by 132 percent. There is no additional increase for delaying benefits past age 70. Use a calculator from the Social Security Administration to determine the effect of delayed retirement on your benefits.

Simple Money Management Tips for Your Personal Finances

The best financial advice tends to apply to pretty much everyone. You don’t need a spreadsheet of pros and cons and complex scenarios. What you need is a rule of thumb.

There’s no shame in using one-size-fits-all advice. A study of West Point cadets, for example, found teaching rules of thumb was at least as effective as standard personal finance training in increasing students’ knowledge and confidence as well as their willingness to take financial risks. Researchers found money rules of thumb were more effective than teaching accounting principles to small business owners in the Dominican Republic.

Here are a dozen shamelessly simple money rules of thumb I’ve collected over the years. (These address how you borrow and save. If you just want to know how you’re doing with money, we’ve got a quick way to score your financial health, too.)

Personal Money Management Tips

1. Build Up Emergency Savings

You need to be able to get your hands on cash or credit equal to three months’ worth of expenses. The classic emergency fund advice — that you need three to six months of expenses saved — is great, but it can take years to save that much and you have other more important priorities (see “retirement,” below). While you build up your cash stash, make sure you have a Plan B for a true emergency. That could be money in a Roth IRA (you can pull out your contributions at any time without paying taxes or penalties), space on your credit cards or an unused home equity line of credit.

2. Save 15 Percent for Retirement

If you got a late start or want to retire early, you may need to save more. Run the numbers on your retirement plan. For most people, 15 percent including any company match is a good place to start. Even if you can’t save as much as you should, start somewhere and kick up your savings rate regularly. Retirement should be your top financial priority. You can’t get back lost company matches, lost tax breaks and the lost years when your money isn’t earning tax-deferred returns.

3. And Don’t Touch that Money

Leave retirement money for retirement. When your retirement fund is small, you may feel like spending it doesn’t really matter. It does. Taxes and penalties will cost you at least 25 percent and likely more of what you withdraw. Plus, every $1 you take out costs you $10 to $20 in lost future retirement income. Once your retirement fund is larger, it may be easy to convince yourself there are good reasons to borrow or withdraw the money. There really aren’t. Leave the money alone so it’s there when you need it.

4. Save for College

Get in the habit of putting at least $25 a month aside for college as soon as your child is born. Even small contributions to a 529 college savings plan can add up over time — perhaps the difference between choosing the best school and choosing a school based on its financial aid package. (But if you have to choose, retirement saving is more important. Your kids can always get student loans, but as you’ve probably heard, no one will lend you money for retirement.)

5. Plan and Manage Your Student Loans

Your total borrowing shouldn’t exceed what you expect to make your first year out of school. At today’s interest rates, this will ensure that you can pay off what you owe within 10 years while keeping payments below 10 percent of your income, which is considered an affordable repayment rate. What if you didn’t limit your borrowing and are now struggling? You have options.

6. Cars: Buy Used and Drive It for 10 Years

New cars are lovely, but they’re expensive and lose an astonishing amount of value in their first two years. Let someone else pay for that depreciation and take advantage of the fact that today’s better-built cars can run well for at least a decade if properly maintained. You can save hundreds of thousands of dollars over your driving lifetime this way.

7. Car Loans: Use the 20/4/10 Rule

Ideally, you wouldn’t borrow money to buy an asset that loses value, but you may not always be able to pay cash for a car. If you can’t, protect yourself from overspending by putting 20 percent down, limit the loan to four years and cap your monthly payment at no more than 10 percent of your gross income. A big down payment keeps you from being “underwater,” or owing more on the car than it’s worth, as soon as you drive off the lot. Limiting the length of the loan helps you build equity faster and reduces the overall interest you pay. Finally, capping the size of the payments prevents your car from eating your budget.

8. Make Credit Cards Work for You

If you carry a balance, look for a low-rate card so you can pay off your debt faster and don’t mess with rewards cards right now. If you pay in full each month (as you should), find a rewards card that returns at least 1.5 percent of what you spend. You should regularly review your rewards programs to make sure you’re getting enough value from them. The programs can change, as can your spending and the way you use rewards. (For a “lazy optimizer” approach, check out “Sean Talks Credit: How I Maximize My Rewards with Only a Few Credit Cards.”)

9. Square Away Your Insurance

Cover yourself for catastrophic expenses, not the stuff you can pay out of pocket. Insurance should protect you against the big things — unexpected expenses that could wipe you out financially, such as your home burning down or a car accident that triggers a lawsuit. You want high limits on your policies — and high deductibles, too. Small claims don’t make financial sense in the long run. You may gain some small insurance payments, but you risk a rate increase that could more than cancel out your gains.

10. Choose a Reasonable Mortgage Amount

If you can’t afford the payment on a 30-year, fixed-rate mortgage, you can’t afford the house. You may be able to save money by using another kind of mortgage, such as a hybrid loan that offers a lower initial rate. But if you’re using an alternative loan because that’s the only way you can buy the home you want, you may have set your sights too high. A budget-busting mortgage puts you at risk of spiraling into ever-deeper debt, especially when you add in all the other costs of home ownership.

11. Choose the Right Mortgage Rate

Fix the rate for at least as long as you plan to be in the home. Plans can change, obviously, but you don’t want a big payment jump to force you out of a home you hoped to live in for years to come. If you’re pretty sure you’ll be moving in five years, a five-year hybrid could be a good option. If you think you may stay for 10 years or more, though, consider opting for the certainty of a 30-year fixed rate. (Compare rates on different types of mortgages.)

12. Back-burner Those Mortgage Prepayments

You have better things to do with your money than prepay a low-rate, potentially tax-deductible mortgage. Shaving years off your mortgage and saving money on interest sounds great. But before you consider making extra payments to reduce your mortgage principal, make sure more important priorities are covered. You should be saving enough for retirement. You should have paid off all other debt, since most other loans have higher rates and the interest isn’t deductible. It would be smart to have that emergency fund built up as well and to be adequately insured. If you’ve covered all of those bases and still want to pay down your mortgage, have at it.