Nowhere in the US Constitution or Declaration of Independence does it say that anyone is entitled to certainty in anything. All we can do is be as prepared as we can for the uncertainty life throws at us-particularly in the field of finance. Dealing with financial challenges requires careful planning. Regardless of whether you will face unemployment, sickness, or something worse, you can take steps now that will help you and your loved ones in the future. You can also fix damaging behavior and improve your management of risk. Being happy and accomplishing your goals could be as simple as saying "yes" to an opportunity. In this financial guidebook, you'll learn how to balance demands from family, friends, and colleagues; embrace challenges you face with your spouse or significant other; pick investments that match your risk tolerance; pay for college, retirement, health care, and other major expenses. Preparing for financial challenges now will pay off in the future. Build wealth, take advantage of opportunities, and discover a better way of managing your finances with Leveling the Playing Field.
Leveling the Playing Field—Part I
What You Need to Know to Develop a Financial Game PlanBy William E HauensteiniUniverse, Inc.
Copyright © 2012 William E Hauenstein, MBA, CRPC
All right reserved.ISBN: 978-1-4759-3471-7Contents
Preface...........................................................................xiAbout the Author..................................................................xiiiIntroduction......................................................................xvii1. PREPARATION....................................................................12. FINDING YOUR BALANCE...........................................................173. UNDERSTANDING CHANGE AND EMBRACING IT..........................................214. RISK...........................................................................295. PLANNING ESSENTIALS............................................................376. EDUCATION PLANNING.............................................................517. RETIREMENT.....................................................................598. RETIREMENT DISTRIBUTION PLANNING...............................................699. HEALTH CARE....................................................................7310. LEGACY........................................................................7711. COMPENSATION..................................................................9112. PUTTING IT ALL TOGETHER.......................................................97Appendix A—Questions to Ask a Financial Adviser.............................103Appendix B—Time Budget Worksheet and Instructions...........................109Appendix C—Lifestyle Planning...............................................113Appendix D—Risk Tolerance Questionnaire.....................................117Appendix E—Questions to Ask an Estate Planning Attorney.....................127Appendix F—Family Budget Worksheet..........................................133Appendix G—Identifying Your Financial Values................................137Reference Websites................................................................139Bibliography......................................................................141Disclaimers.......................................................................143Index.............................................................................147
Chapter One
Preparation Someone is sitting in the shade today because someone planted a tree a long time ago. —Warren Buffet
Success, however you define it, doesn't just fall into your lap; it is earned over an extended period of time.
Section One—Factors to Consider
Prepare to succeed. We have all heard the clichés about how practice and preparation are essential for success, and we all know that the more effort one puts into preparation, the more likely success will follow. The difficult thing to figure out is this: "What do I practice and how do I prepare?" The answer depends upon many factors, including time, knowledge, ability to trust, understanding, and innate ability. Let's discuss each of these factors.
Time
First, and foremost, is time. The clock never stops, and neither do the demands placed upon us. Everyone has the same 168 hours per week. What we choose to do with those hours is, hopefully, more controlled by our choices and desires than by necessity or the demands of others.
According to the 2010 American Time Use Survey (US Department of Labor, Bureau of Labor Statistics, 2011), an average American's day is composed of sleeping for eight hours and twenty- three minutes; performing work and work-related activities for four hours and twenty-four minutes; watching television for two hours and thirty-one minutes; leisure and sporting activities two hours and nine minutes; household chores for one hour and forty- one minutes; eating, drinking, and personal care for two hours and one minute; leaving two hours and fifty-one minutes for everything else, such as education, shopping, caring for household members, telephone calls, e-mail, social networking, and religious activities.
Since this is an average, your day is probably much different, and you are wondering how you accomplish so many things in such a short period of time. Many of us forego sleep to work extra hours or take the children to their soccer games, while others are retired and spend more time volunteering or babysitting the grandchildren. Since time is the one thing none of us can manufacture, it is our most valuable commodity.
The point I am trying to make is that time is valuable and you need to invest it wisely, or many of the things you want to accomplish in life will be left for someone else. Today is the beginning of the rest of your life. Treat it that way and you can accomplish anything you set your mind to.
Please see Appendix B for a Time Budget Worksheet. Its goal is to help you understand which tasks you spend your time doing and then manage your time effectively so you can accomplish those things that are most important to you and your family.
Knowledge
You've probably heard the expression "knowledge is power," but what does that mean to you? For many, knowledge, when combined with personal experience, provides them with the basis to confidently make prudent decisions.
For example, if you know a stove is hot, you won't touch it with your bare hands. Alternatively, if you do not know whether the stove is hot or cold, will you assume it is cold and lay your hands upon it? Probably not, because you may have been burned by a hot object before, remember the pain, and approach the stove with caution (better safe than sorry).
Okay, now let us assume that you will receive an extra $500 per month of income from writing a jingle used on a television commercial as long as it is deemed beneficial in the company's advertising strategy. So what do you do with that extra money? Since the income is not guaranteed, you should not increase your fixed expenses by that amount; instead, you should treat it as a windfall and use it to your best advantage. "What could that be?" you ask. You might add it to your children's college fund, your retirement plan, or to the savings for that family vacation you have always dreamed of.
More complex items can be broken down into parts to determine how each part may affect the overall choice. In other words, one should consider the many inputs when analyzing a complex situation. One example is relocating your family to another state or country for work. Factors to consider are not just quantitative but also qualitative. Quantitative factors can be compiled with a calculator or spreadsheet, while the qualitative factors must be given a quantifiable number to add to the formula. Quantitative factors include such things as income, benefits, cost of living, etc. Qualitative factors include quality and availability of education, how much more or less you like your new job, climate, social events, proximity of friends and family, and cultural activities. You should also weight each factor based upon its importance to your situation. Yes, this is an analytical approach and may not appeal to everyone, but you can see how thinking through the process can help you make a more informed decision.
For many, the development of a detailed financial plan will turn information into knowledge, thus providing the roadmap to follow.
Ability to Trust
Many of you will recall that when Ronald Reagan uttered the phrase "Trust, but verify" at the signing of the Intermediate-Range Nuclear Forces (INF) Treaty with Russia in 1987, most everyone in the audience was laughing. Just as the Seinfeld show was a series of episodes about "nothing," President Reagan's maxim evoked a laugh because it is true.
With the uncertainty that prevails in today's economic, social, and political realms, with the media blasting stories that cause us to wonder if our best times are behind us, no wonder many investors have given up and become savers, trying to preserve what wealth they have. Here is a quote that summarizes this mind-set very well:
The average American family has lost 9 percent of their household net worth in just the last three months of 2008—the fastest disintegration of wealth in more than seven decades. In fact, the majority of families were reporting a drop of 25 percent in their household worth in the past year alone. Pretty pessimistic stuff ... our national confidence is in pieces, our personal expectations shattered. Trust has collapsed. We have little tolerance now for promises and pledges. We don't trust anyone anymore. (Luntz, 2009)
So, with that as our backdrop, how do you know when it is okay to trust what someone has told you? After independent verification, of course. The thing about human beings is that we are human, able to make judgments, opinions, statements, even without knowing both sides of the argument. The search for truth is elusive but should be on everyone's agenda when you make a decision that can affect not only yourself but many others. As my father told me many years ago, "You have been given the ability to make up your own mind, but doing so without independent research is merely espousing someone else's opinion."
Here is an excerpt of a newsletter article I wrote in early 2011:
One big problem now is uncertainty. With the earth shifting beneath our feet because of government intervention (regulations, incentive programs, monetary policy, changes in accounting standards, etc.), no wonder businesses are reluctant to invest for their future as the game may change. I have always said that if you change the rules of the game, you change the game. It is difficult to predict the outcome of change and its overall impact on various industries. This "collateral damage" should be quantified as much as possible and not create a systemic breakdown of our financial system. So, with all the recent changes, how's that working out for you? Is your portfolio performing to your expectations? If you are lucky enough to be the recipient of a pension, is it safe? Are you enjoying the volatility? Well, it seems the only time when markets are not volatile is when they are closed. Headline risk, fast trading, and lower volume are all reasons for higher than normal volatility. The market is trading on rumors, and that is not a good thing. Don't get caught up in that. Sometimes it is better to be out of the market or have downside protection strategies in place to preserve your wealth. I believe most would choose to not be poor than to be rich, and I am not just speaking about money.
Understanding
Understanding is the essential component that turns information into knowledge and ultimately into wisdom. In math, one must understand the concept of the operation you are trying to solve. There are infinite possibilities for addition, so it is impossible to memorize each potential equation. If you understand the basics of addition (e.g., 1+1=2 or 2+4=6), you can solve any addition problem placed in front of you. Some will say, "I will just take out my calculator or smartphone and I do not even have to understand why; it will give me the correct answer." This is true of simple, impersonal subjects, but there is no calculator or smartphone for determining which condiment tastes better on a hamburger, be it ketchup, mustard, mayonnaise, or some combination. You must learn these things for yourself through trial and error.
Small purchases or commitments do not demand painstaking research, but creating and implementing financial, investment, and legacy plans should. For example, most investors are trying to maximize the value of their account with the minimum risk. Sound familiar? There are many risks to consider, and each are important, some more and some less at different points during your lifetime. For those beginning the planning process, it is important to know the basic components of the type of financial plan you are working on, gain an understanding as to what the inputs to those components of your plan mean, and understand how they may affect your overall situation now and in the future.
Innate Ability
The Constitution of the United States of America states clearly, "All men are created equal and are endowed by their creator with unalienable rights that among these are life, liberty, and the pursuit of happiness." It does not say that we all have the same abilities or that one life is worth more than any other.
As a youngster, my life's ambition was to become a professional basketball player. I would spend time watching Oscar Robertson, nicknamed the "Big O" (O as in Oscar, not a zero!), on our family's black-and-white television (we couldn't afford a color TV) and try to emulate his command of the game. I practiced at the local park or public school even when no one was around and thought about winning the game on a last-second shot or making a steal to prevent the other team from having a chance to win. My plan was on track until about the seventh grade when I reached my current height of five feet, eight inches tall! The dream of playing the "four" (power forward) position (or any position for that matter) in the NBA was just that—a dream—and a few years later a fond memory.
At that point in my life, I never imagined being a financial adviser and author, and little did I know I was blessed with the ability to understand complex financial markets and to help families with their finances. After writing many articles for clients over the years, this is my first book, and I hope it will help you become a better steward of your finances. You might even learn a little about yourself, your current financial adviser, and your family in the process.
What abilities have you been blessed with? Knowing your strengths and weaknesses is important so you can be successful at your chosen profession. As my wife says, if you do what you love, you never work a day in your life. I thank her for believing in me and for providing encouragement and support all these years.
So when you are embarking on the path of making decisions that will impact the outcome of not only your future but those of your family and close friends, carefully think through the factors. After doing so, you will be more confident and have the will to act.
Section Two—Mental: Can You Do It Yourself?
Of course you can. The real question is, can someone else help you which results in an even better outcome (or for those who wish to retire someday, should I say an even better future income)? If you are a specialist in behavioral finance, investments, insurance, taxes, and estate planning, then, you can truly "do it yourself," assuming you have the time. Otherwise, it is probably better to assemble a team of professionals who will work on your behalf to develop and implement a holistic financial, investment, and legacy plan.
The complexity of your current situation will demand more or less from each professional, but each is necessary to maximize your chance of success and limit the risk of failure. Make sure each professional is experienced, has fiduciary responsibility, and has the temperament to work as part of a team that puts your interests first.
You may wish to ask friends and family for referrals and conduct an interview with a questionnaire to help you determine if their business model meets your needs and expectations. Appendix A offers a questionnaire to ask financial advisers. Appendix E is a questionnaire to ask estate planning attorneys. Try to interview at least three professionals so you can determine who is most experienced in handling what is important to you and how he or she can be instrumental in helping you achieve your financial goals.
Personal Biases
Every person is an amalgamation of everything he or she has experienced, and considering each person's unique DNA, these experiences will differ in his or her decision-making efforts. Differing values, priorities, beliefs, etc., shape our future. I will cover some of the cognitive biases people have and how they relate to their personal finances. I do not pretend to be an expert in cognitive dissonance, so the examples and outcomes are elementary but can help explain why people make certain decisions and then wonder why they did so in the first place.
Most people believe they make good choices when buying items for themselves and their family. At some point, when the garage or storage shed is filled with unwanted and sometimes even unused items, they realize that their "impulses" got the better of them. When you see so many items at the consignment shops and secondhand stores that have the original tags still on them, you are glad you are not the only one.
In this example, the conflict is between our belief that we make good choices and that we believe we know what we need in order to be happy. Everyone wants to believe he or she makes good choices, and in fact most people sincerely believe they do. The cluttered closets, storage sheds, storage units (total rentable space as of the end of 2010 in the United States was 2.22 billion square feet, or an area more than three times the size of Manhattan in New York City [Self Storage Association, 2010]) and garages across the world show a different story; most people buy impulsively, and retailers understand this all too well, locating items most needed at the rear and sides of the store with a lot of items that people want in the middle and near the registers. So most people leave the store with more items than they originally intended to buy. This is why most consumers should write a shopping list and stick to it as much as possible. Doing so will help reduce the chances of falling prey to impulse buying. It will ideally leave more money in your pocket and probably help you reach your financial goals as well.
Now let's begin the discussion of cognitive bias as it relates to the financial world. In its truest sense, cognition is defined as a logically based process you perform when making a decision. Since the process is logical, emotion and one's own will are excluded. So, how do we "logically" make a decision? Again, it is not as easy as it may appear at first glance because there are so many biases that we may not even know exist. I will highlight a few of them to give you a flavor and why, for most people, it is difficult managing their financial assets.
Confirmation Bias
One bias that could be one of the many reasons for family arguments is "confirmation bias," which is the tendency to filter information to retain only what conforms to one's preferences and to reject everything else. In other words, if the information agrees with your opinion, it must be right and if it disagrees with your opinion, it must be wrong and therefore discarded. Stubbornness is an outcome of such a bias. You may have heard the phrase "diversification reduces risk." During turbulent, volatile markets, diversification is difficult to achieve because the "normal" correlation between asset classes is no longer "normal." Buying stocks from domestic, international, and emerging markets that are declining/rising in value at the same time is not necessarily better than buying just one of the asset classes. Anyone who has been invested during past bear/bull markets can relate. Warren Buffett has said that "diversification is only for those who do not know what they are doing." Not all of us have Mr. Buffett's talent, so diversification is more prudent than not doing so, but it will not be a complete solution.
(Continues...)
Excerpted from Leveling the Playing Field—Part Iby William E Hauenstein Copyright © 2012 by William E Hauenstein, MBA, CRPC. Excerpted by permission of iUniverse, Inc.. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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