financial freedom

By Karen Hube, Barron’s

The true measure of financial success isn’t how much money you make — it’s how much you keep. That’s a function of how well you’re able to save money, protect it, and invest it over the long term.

Sadly, most Americans are lousy at this.

Even after a decade of steady economic expansion and record-breaking stock markets, almost two-thirds of earners would be hard-pressed to cover an unexpected $1,000 expense — a medical bill, car repair, or busted furnace — and more than 75% don’t save enough or invest skillfully enough to meet modest long-term retirement goals, according to Bankrate.com.

Even wealthy families aren’t getting it right: 70% lose wealth by their second generation, and 90% by their third. “Shirtsleeves to shirtsleeves in three generations,” as a saying often attributed to Andrew Carnegie goes.

What’s at the root of these bleak data? Stagnant salaries amid rising costs of health care, education, housing, and other big-ticket necessities have put a major strain on folks of all ages. But advisors point to a deeper issue: an almost universal lack of financial literacy.

“This is a much bigger problem than most people are aware of,” says Spuds Powell, managing director at Kayne Anderson Rudnick Wealth Management in Los Angeles. “I’m constantly amazed at how common it is for clients, even sophisticated ones, to be lacking in financial literacy.”

Advisors are increasingly stepping in to help, trying to fill what they say is a gaping void in the educational curricula of high schools and colleges. Many see it as their responsibility to boost financial literacy on a number of fronts, ranging from educational meetings for clients and their children to spreading the word through blog posts to speaking to groups in schools, credit unions, and other organizations.

“We as a profession have to be the loudest advocates for financial literacy,” says R. Michael Parry, president of Liberty Wealth Advisors in Stamford, Conn., who blogs about financial-planning basics and helps the Fairfield County, Conn., chapter of the Financial Planning Association host educational events.

Becoming educators is not just the right thing to do, Parry says, “it elevates the status of our profession and helps us move away from the 20th century construct of advisors as salespeople on commission to being seen as fiduciaries.”

The good news is that the basics are not complicated. University of Chicago professor Harold Pollack famously summed up personal finance rules to live by and achieve financial freedom on a single index card, which went viral and was, ironically, turned into a book called The Index Card. We culled our list of 10 principles after conversations with advisors and other experts. If they seem obvious, congratulations on your financial savvy.

1. Set goals

Before doing anything else, identify your short-, medium-, and long-term goals. This is a simple exercise you can do with your feet up, but it creates context and purpose for a financial plan and can prevent you from veering off track and squandering your earnings, says Doug Levasseur, a national financial planning specialist at BMO Wealth Management.

“This step is a huge motivator,” he says. “The earlier you set your goals, the sooner you’ll feel inspired to work toward them.”

2. Know what you’ve got and what you need

No matter what your age or wealth level, always know two numbers: how much money is coming in and how much is going out. Tally up your rent or mortgage costs, utilities, food, gasoline, and other necessary expenses. If you can’t cover your costs, adjust your lifestyle, Parry says. “It’s not that complicated: spend less than you earn.”

Think hard about wants versus needs so you can make conscious decisions about which discretionary expenses you want to keep. You may decide to keep your Netflix subscription but ditch your afternoon boost at the juice bar.

Don’t shrug off small, unnecessary expenses — they add up, says Brian Levitt, chief investment strategist at Oppenheimer Funds and a designer of a financial-literacy program the firm launched last year to provide key lessons for advisors to share with clients.

Average families waste 16% of their income on unnecessary expenses such as lottery tickets and unused gym memberships — all of which should be eliminated, Levitt says. “This is not about depriving yourself of experiences and opportunities to go places and enjoy life. It’s about knowing what you value most — if you value X,Y, and Z, then you can’t be wasting your money on A, B, and C.”

3. Save systematically

Put savings in the same expense category as your electric bill: mandatory and automatic. Save regularly with each paycheck by setting up an automatic transfer of funds out of your paycheck so you’re not tempted to spend the money.

The earlier you get started earning interest on your savings, the less you’ll have to save over the long term to meet your goals. This is the beauty of compounding — a phenomenon that should inspire even the most reluctant savers.

When you earn interest, the earnings are added to your principal, and then further interest is applied to the total of your principal and earnings. “Think of a snowball at the top of the hill. You push it down the hill, and as it gains momentum it grows exponentially — that’s your nest egg compounding,” Powell says.

Consider what happens if you invest $10,000 and earn 6% per year. By doing nothing other than reinvesting the earnings, your money will more than triple after 20 years. After 40 years, your account would be valued at more than $102,000, according to an analysis by the Vanguard Group.

Once you understand the power of compounding, you can appreciate the huge opportunity cost to making mistakes early on in your financial life, says Michael Finke, chief academic officer of the American College of Financial Services, noting, “They can ripple through your entire lifetime.”

It’s important to become aware of the cost and opportunity of small decisions. Set a lofty goal of saving 15% of your earnings, but don’t abandon the whole idea if you can’t swing that much, advisors say. If you start with 5%, gradually increase that by a percentage point every year. Many 401(k) plans give you the option of boosting your savings rate each year. Check that box.

4. Invest in your retirement plan

Sock money into a retirement account such a 401(k) or individual retirement account. They are either tax-free or tax-deferred, and may allow you to invest pretax money or take a deduction for after-tax investments.

Your first priority should be to take advantage of a 401(k) plan that offers employees a match to their savings. Many employers will match up to 4% of contributions. “Your company is paying you to save for retirement — don’t pass that up,” Powell says, adding that your ultimate aim should be to make the maximum annual contribution of $19,000.

The next-best deal: For singles with adjusted gross income under $137,000 and couples earning under $203,000, invest in a Roth IRA, which allows your savings to grow tax free and with no taxes when you withdraw the money in retirement. You can contribute up to $6,000 — or, if you’re over age 50, $7,000 — per year.

5. Invest for growth

Investments you won’t touch for a decade or more should be fully allocated for growth. This means stocks. Given the swings in U.S. stock markets lately, this may sound risky. But the upsides far outweigh the downsides, Powell says.

On average, a bull market in U.S. stocks lasts 8.9 years, during which stocks appreciate more than 400%, while an average bear market is over after 1.3 years and sees a 41% decline in stock value, Powell says. “One hundred percent of the time, when the stock market has declined, it has recouped losses and gone on to set records,” he says.

Still, not everyone is capable of remaining calm when markets gyrate. Leigh Cohen, an advisor and founder of Cohen & Associates in New York, says that in his efforts to educate clients about financial literacy, he runs scenarios to help clients understand their risk tolerance. “Younger investors want to own Amazon.com and Apple,” he says. “So, I ask how they’ll feel if their $100,000 became $60,000 in a market decline.” Dial back on stocks if you can’t stomach their occasionally treacherous path — even if it leads upward. But do so understanding that you cannot get meaningful, inflation-beating growth without risk.

6. Avoid bad debt

The only step toward financial literacy that requires you to not do something is often the hardest: avoid credit-card debt, and if you use a credit card, pay it off in full each month.

While some debt comes with low interest rates and enables important investments in your earnings power and wealth — a student loan, for example, or a home mortgage — credit cards charge interest rates up to 20% or more.

Remember the snowball effect? That can easily happen to your debt, and it can squash your financial goals. Consider what happens when you charge a new $1,500 laptop computer on a credit card charging 18% interest. According to an analysis by Debt.org, you’ll be billed a minimum payment of $37 each month. If you pay only the minimum, it’ll take you more than 13 years to pay off that purchase and cost more than $3,200.

If life doesn’t cooperate and you need to pay off a big expense over time, get the lowest-interest card you can find for that purpose, and put other charges on a different card that you pay in full.

7. Don’t overpay for anything

Fees, commissions, taxes — everyone from your mutual fund manager to Uncle Sam wants a piece of your savings and investments. While you can’t avoid costs altogether, you can save a bundle over time by minimizing them.

Consider the effect of mutual fund and exchange-traded-fund expenses, which typically range from a tiny fraction of 1% to more than 1% of assets per year. If you have $100,000 invested and earn 6% per year, after 25 years your money would grow to $430,000, if you paid no fees. A 1% annual fee would erode $85,000 and leave you with $345,000.

And by sticking with low-cost funds you’ll not only save, but you may also earn higher returns. According to a Morningstar study, 60% of the lowest-quintile U.S. stock funds beat their benchmarks from 2010 to 2015, compared with just 20% of funds in the highest quintile for fees.

Keep an eye on taxes. As your portfolio gets larger, be mindful of holding tax-inefficient investments in tax-sheltered accounts, withdrawing assets from investments in the most tax-efficient manner, and avoid buying a mutual fund prior to year-end capital gains distributions.

8. Protect yourself

Life is full of rough patches — job loss, injury, natural disaster, theft. These unwelcome events may not be only physically and emotionally challenging, but also financially devastating.

Prepare for the worst. Try to build an emergency fund equal to at least six months’ expenses. If that seems daunting, set smaller goals, such as stashing the equivalent of a month’s rent in savings. Then another. Invest the funds in a money market account or short-term bond fund, which can be easily accessed and pays higher interest than a bank savings account.

Meanwhile, don’t skimp on insurance just because it isn’t mandatory, such as renters insurance and disability insurance. Your employer may provide disability coverage for up to 60% of your income, but as your life gets more complicated — marriage, kids — you may want to layer coverage on top of that. If you have dependents who rely on your income, you need term life insurance.

9. Keep it simple

For the vast majority of investors, and certainly anyone just starting out, the best approach is a simple, dirt-cheap, diversified portfolio of index funds that matches the market return. Don’t try to beat the market — ignore hot tips and check your returns infrequently.

Keep your emotions, political opinions, and hunches far away from your investment decisions. Understand that when you most want to sell, it’s probably time to buy, and vice versa. And avoid trendy investments like cryptocurrency.

In addition to the distinct possibility that the fad will peak as you’re buying — remember when 3-D printing was going to take over the world? — niche investments can take a beating if too many investors run for the door at the same time. In Wall Street lingo, it’s called a lack of liquidity, and you can avoid the problem by sticking with big, proven indexes such as the S&P 500.

10. Seek unbiased advice

Make sure your advisor has your back. Look for experts who act as fiduciaries, meaning they put your interests first and avoid conflicts of interest such as selling products on a commission. Demand transparency when it comes to fees. Typically, a fiduciary will charge a fee equal to a percentage of assets or a flat fee for single sessions.

Look for well-respected designations earned through educational programs and ongoing coursework, such as CFP (Certified Financial Planner) or CFA (Chartered Financial Analyst). When considering independent advisors, rule out anyone who doesn’t custody assets with a third party. You can search the Financial Industry Regulatory Authority (Finra.org) for a history of complaints or disciplinary actions.

________________

About LRPC’s Monday Morning Minute

Lawton Retirement Plan Consultants, LLC (LRPC) Monday Morning Minute is crafted to provide decision-makers with important information about the economy, investments and corporate retirement plans in a format that allows a reader to consume the information in less than 60 seconds. As an independent, objective investment adviser, LRPC has access to many sources of research and shares the best and most relevant information with its readers each week.

About Lawton Retirement Plan Consultants, LLC

Lawton Retirement Plan Consultants, LLC (LRPC) is a Milwaukee, Wisconsin-based independent, objective Registered Investment Adviser (RIA) providing investment advisory, fiduciary compliance, employee education, provider management and plan design services to employer retirement plan sponsors. The firm specializes in Socially Responsible Investment (SRI) strategies for retirement plans and is a pioneer in the field. LRPC currently has contracts in place to provide consulting services on nearly a half billion dollars in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or bob@lawtonrpc.com or visit the firm’s website at https://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.

Important Disclosures

This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, a plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges, and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.