Financial Literacy

Nothing highlights advantages and disadvantages better than a real-life side-by-side comparison. In this case, a colleague was the executor for the modest estates of two relatives, in the same state, only a year apart.

The background: relative #1 kept meticulous records so she refused any kind of estate planning beyond a Will. Relative #2 had performed no estate planning beyond setting up a Revocable Living Trust and then placed his assets into it (re-titled the house and a few financial accounts). This was no fancy estate plan, just the most basic mechanism that every estate planning attorney would recommend for most people.

So how did these estate plans work out? Settling the estate of relative #2 consisted of two phone calls and a few paperwork filings. Extremely easy, very efficient, and the entire estate was settled within a few weeks.

The estate of relative #1 (who had a Will and meticulous records) took two years, triple the attorney fees, court drama, and one of the assets was unable to be maintained during some of this period, reducing its value for the heirs. All of this occurred within a state with a “relatively easy” probate process with low fees.   

My colleague now says: “It is a rude burden to pass on an un-prepared estate without a revocable living trust.” She calls it irresponsible and unloving to dump all the work and expense on heirs. She will no longer be the executor for estates without some minimal planning. She says, “If they aren’t willing to let me help them upfront – which reduces my burden and expense by 80% with a couple steps, then they can find someone else.”

If you owned a small laundry mat, you’d probably subscribe to all kinds of industry publications. This way, you’d keep up with: technology changes, trends, risks, best practices, new income sources, and more. Reading these would simply be a prudent business practice. For many people, their retirement accounts are among their largest assets and yet, very few read the trade journals to have any idea what is going on. I am not referring to fluffy retail magazines but the publications that industry professionals read – such as finance journals and financial planning publications. A few things I learned from reading these this week.

1. Betterment.com is offering a 2.69% savings account to lure new accounts with FDIC insurance. (I opened one myself to earn more on savings).

2. Target Date funds may not work as planned, even though this is the MOST commonly selected fund for 401(k) plans. Research is indicating that stock equity exposure should be a U-curve over time, instead of constantly decreasing. The low-point of the ‘U’ is the date of your retirement.

3. The U.S. Department of Labor wants to allow the worst financial product into 401(k) plans: annuities. Annuities are the most overpriced, complicated, and problematic investment product that, in my opinion, are suitable for almost nobody. Yet, the U.S. Congress is considering exposing more savers to the insurance wolves. No surprise that the congressman who introduced the bill has received huge donations from insurance companies and Fidelity Investments.

The investing landscape is always changing, and some fairly important news items (like those above), are available but very few people make themselves are aware of them. Managing your money is an unavoidable and tiny part-time job for everyone: so how are you allocating your investment time each month?

Cyril Parkinson wrote an essay in The Economist magazine published in 1955. Included is his First Law that, “Work expands to fill the time available for its completion.” As you can imagine, this concept can be applied to numerous behavioral traits, which includes all aspects of managing money. Parkinson’s Second Law states, “Expenditure rises to meet income.” The remedy for all types of Parkinson’s Law applications is the exact same: you must set your own internal limits. Exert your willpower, creativity, and planning to set and enforce your own personal limits. In the case of money, this means that without your own limits you will likely find yourself spending all of your income, leaving nothing for maintenance, repairs, or replacements, let alone emergency savings to investments.

You have likely heard a few of these self-imposed money rules before:

• Save 10% of your income
• Save 50% of any salary increase
• Save 100% of any inheritance or unexpected money
• Purchase only used cars

These rules may be appropriate to your situation, or maybe not, but you must discover, create, and refine some of your own personal money rules and limits. Otherwise, you may end up like the average person that falls into the rut of Parkinson’s Law with scant savings, no retirement assets, and unnecessary financial struggle.

I spoke with a long-time friend who enjoys talking about investing opportunities. He is savvy about investing in real estate, oil and gas, stocks, etc. This time he was telling me about what how he trains his young grandkids with lessons in how to think about money. This is how he explained it to me:

1. Priorities and budgeting.He takes them to a dollar store and allows them to buy one item – anything that they want. The store is just like life to a child, there are too many things to evaluate to buy. In life, we have too many options in things you can do, paths to go down, careers, investments, and more. They have to figure out how to narrow down the many into the few, and then down to the single one – to the exclusion of all the others. And they learn the value of a dollar. As they get older, he raised their budget from $1 to $5 and then $10, so they must keep track and learn budgeting in its most basic form.

• Stock investing. Once they reach age 12, he buys them $100 worth of a stock for Christmas. They choose the stock together and talk about the company and products. Past selections have included Nike, Apple, and Amazon. Each quarter, he goes over their portfolio and talks to them so they begin to look at the world as a potential business owner searching for sales and profits.

• Investment compounding. He took out a life insurance product on each of the kids that builds up cash value. He pays $100 per month, per child, and around age 21, the annual dividends earned on the policies will be large enough to make the payments to support the policy. This means the life insurance policy will be self-funded at that point, and continue to grow in cash value each year. He goes over the projections with the kids so that they can see how many hundreds of thousands will be available to them by age 45. 

These are great financial lessons and a way to actively engage the kids. These activities are a way to turn vague financial concepts into tangible reality that a young mind can begin to understand.   

Student loans, in general, cannot be discharged through declaring personal bankruptcy. Today, there are $86 billion in student loans owed by people aged 60 and older, with an average amount of $33,811 (according to Mark Kantrowitz of SavingForCollege.com). Every couple months, there is a news feature article about someone living solely on Social Security Retirement and it is being garnished for student loans. The story will then detail the financial struggles that they face. Today, the rule for Social Security garnishment is that it cannot exceed 15% of your monthly payment and the garnishment must leave at least $750 per month for the retiree.

To end up in retirement with student loan balances, several very poor financial decisions have occurred. A few of these may include:

1. Not mapping out tuition and other costs of attendance compared to the savings you or your family have dedicated for this degree.
2. Selecting a college where starting salaries cannot support the level of debt you will have taken out to complete the degree.
3. Needlessly lengthening the number of years in school by switching majors; often or near graduation (or worse, after graduation so you have to return for additional course work). Hint: get involved in your industry and talk to people to learn as early as possible which field of study is the best path for you.
4. Selecting a field of study with little or no market demand or a shrinking industry.
5. Choosing to defer paying your loans, allowing the balances to grow exponentially.
6. Co-signing on loans for other people or your children who have a poor track record of managing money or following through with commitments.
7. Did little or nothing to secure grants, scholarships, or part-time jobs to reduce student loan amounts.
8. Did not fund any retirement accounts for an additional source of retirement income

Yes, of course there are people that have fallen ill and are unable to work. But outside of a rare set of unusual circumstances; many poor decisions have to be made in order to wind up in the middle of a student debt horror story. Every retiree story that I have read or heard about with student loans had made several reckless financial choices that created their financial situation. All decisions with a large financial consequence need to be thought through, planned, and managed until the very end – and student loans are no different.

Who wouldn’t want to live a spoiled life?

Unfortunately, there is a life lesson about earning that most people need to learn the hard way. Earning does not just refer to money; it is also what you gain from putting in focused effort such as experience, practice, training, creativity, grit and more. The lesson is simple: earn first and then reap the rewards later if you want them to be sustainable. A family friend continually rejects this lesson and I fear for the struggles she will face as the consequences pile up. She wants it all, now, and is not interested in earning anything up front. Sadly, the slightest push back of advice prompts defensive anger from her.

Below are some variations of this lesson:

• Study first, play later
• Work first, play later
• Earn first, spend later
• Date first, romance later
• Stability first, family later
• Battle first, relax later
• Plan first, act later
• Your reap what you sow
• Do the work, then enjoy the results
• And of course: No pain, no gain

However you want to phrase the lesson, effort must be expended upfront for there to be sustainable or reliable results on the other side.

Financial infidelity is the term for hiding financial details from your spouse or partner. These secrets can include debts, an extravagant purchase, an investment loss, missed payments, a low credit score, and repossession. For example, a survey from Money magazine found that 22% of respondents admitted to spending money they did not want their spouse to know about.

Financial transparency is a sizable portion of relationship trust. You cannot make sober joint decisions unless you both know all of the details of your real financial situation. Problems arise when partners have very different financial spending priorities. One common method to bridge this gap is to allow each partner to have their own discretionary (or off-books) money as a “relief valve” to spend money without accountability or anyone judging over their shoulder. This must be a known and limited amount to each partner, say $20-$250 per month (depending upon your level of income) that is added into each partner’s off-books fund. Whatever this amount is, it must be a budgeted and an affordable amount that you both agree upon.   

Relationship-financial bumps occur when a partner discovers that the other spent money without notifying or asking the other partner. I separate these into minor or major issues. A minor issue might be an annoyance – some hundreds or low thousands on a selfish item. Examples of this would are likely (for women) clothing, shoes, handbags, and jewelry, and (for men) electronics, hobby/sports gear. Handling this may include discussions about what is underlying the behavior and how possibly both parties may be contributing to the issues. The next level in financial deception is ongoing behavior with secret bank accounts and credit cards.

A major issue would be a significant financial move that derails future plans. The most common examples I find are: a couple is thwarted from buying a new home when it is revealed that there is a hidden credit card maxed out or an unexpectedly low credit score from secret unpaid bills. Another example is when you open the mail to discover past-due notices for your rent, mortgage, or car payment that you thought were current. Or, the Sheriff’s Deputy rings the doorbell to repossess some items that you didn’t know were financed and past-due. I know two different people that became suspicious and looked up their home at the County Clerk’s office to discover that their husbands had secretly taken out large second mortgages to fund secret addictions (one was gambling and the other was drugs). Both families were left in financial ruin with crushing debts to pay down.

Marriage and communication problems can leach into financial problems. Plus, these minor and major financial issues can be the side-effect or symptom of other problems, such as: fallout from expensive hobbies, addictions, a problem within the relationship, or a psychological issue. Some secret debts may begin small (a drop in pay that a partner hopes is temporary), then snowballs when business doesn’t turn around, and is now too large to come clean to the other partner. Therapist Carleton Kendrick says the chief reasons people lie about money to their partners are pragmatism (secretly planning to divorce), control (revenge spending), guilt (from irresponsible behavior), and fear (afraid of partner’s reaction to the truth).

When someone has been “busted” on financial infidelity there is a common prescription: fully coming clean, address deeper issues by both parties, come to a resolution, make a plan to pay off the debt and the commitment for transparency in the future. (Of course, this can take many days and several thoughtful conversations when both can be calm). However, if a partner continues making infractions, there is a deeper issue that may require professional counseling to work through emotions – a shopping addiction, sexual infidelity, an emotional outlet of stress spending, self-image issues, differing expectations on lifestyle, etc. When there is a major financial issue, or many repeat incidents, it is time to pause and evaluate – is this person “relationship worthy?” Do I want to spend the time, effort, and money to turn this relationship around? There are marriage counselors that specialize in financial issues, but that may not be enough if the spender is unwilling to change or address their issues. At that point, it is time to consider separation options or divorce in order to financially protect yourself.

Housing is one of your largest expenses, so it is important to have your mortgage paid off before any expected date of retirement. This dramatically increases your financial stability to enter retirement and reduce the odds that you may have to go back to work for additional income.

I first learned about using a rental property for retirement housing in a magazine article. A couple wanted to retire on the beach overlooking the ocean. While they both lived and worked a state away from the ocean, it was their retirement dream. They formulated a plan in their late 30s: buy their retirement home today with a relatively small down payment, and then rent it out to pay off the mortgage over time. Their goal was not investment profit, but targeting the accelerated pay down on this beach-front mortgage. Once the mortgage was paid off for this house, the couple had more financial flexibility for their retirement housing. First, as planned, they could move into the beach house when they retire. They would be able to do so comfortably because they would also have the proceeds from selling their current home (hopefully, by this time, the home has no mortgage or a small balance). Second, if their retirement location plans changed, they could sell the beach house to financially support whatever their new retirement plans may be.

I now know a few couples that are or have already employed this retirement-housing strategy for where they want to live when they retire. We did this ourselves by accident: not with a spectacular vacation house, but a rental property with a 30-year mortgage that was paid off in 18 years. This rental home is in a town with a very low cost-of-living. So in the worst financial case, we can always move into this home after the month-to-month lease ends with the current tenants. Without any mortgage, we could move in and have a very affordable housing expense that is just $106/month (for both property taxes and insurance). For a comparison, this is cheaper than any 10’ X 10’ storage unit rental in my current city! This is the power of employing both leverage and inflation over time, using them to your advantage instead of being victimized by inflation.

Using rental platforms like AirBnB and VRBO, it has never been easier to get this strategy up and running as a landlord. You can use a normal property management company or manage it yourself. All that is needed is some rental education and a reserve fund for maintenance and repairs. I recently acquired another rental for just $28,000. If you are going for your beach/mountain access for retirement, you can also use this home for some weekend vacations yourself each year (the tax law changes on this, be sure you are using the current rules).

For your retirement, you can cover one of your largest expenses – housing – for far less money by allowing renters to pay off a mortgage for you.

Last month, people were meeting with their certified public accountant to file their income taxes. At this time of year, I hear all sorts of stories about advice being dispensed by CPAs to their clients. When his or her advice is outside of immediate tax consequences, their advice can be problematic. This is because of the goals and structure of a CPA’s focus. They usually have a goal of reducing this year’s income tax liability instead of the entirety of their client’s financial life. Instead of looking at a lifetime or more, the CPA is looking only at this year or next. Instead of looking at investment portfolio returns over decades, the CPA is looking at the immediate tax consequences of an investment. Instead of looking at a family’s actual financial behavior, they only look at tax tactics. The result of these mis-matching viewpoints can result in poor financial advice from some CPAs. Below are a couple I heard this year:

“You should make a maximum contribution to a new IRA to get a nice tax deduction.” If you review income tax rates over time, they are very low today and these rates are set to expire in 2026. Unless the Republican Party has the majority congress, senate, and presidency, it is unlikely these low tax rates will be renewed in 2026 and so they will go up. Now is the time to do the opposite and get long-term money OUT of tax-deferred accounts, not put money into them. Withdraw money (if you can avoid penalties when under age 59 ½) with today’s low tax rates and place that money into a Roth IRA or some other location that can be withdrawn later and tax-free when rates are higher.

“Whatever you do, do not pay down that mortgage!” Just because there may be some favorable tax treatment does not mean it is a smart financial move. Where would that money go if not to paying down the mortgage? In this particular case, I knew where it would go – to extra “bonus” shopping. Instead of building equity for more financial stability and options, the money would be spent at a shopping mall: not a good financial move. In another case that received similar advice from a CPA, paying off the mortgage would also be the smart move because it is how they manage their rental portfolio equity. Building equity faster would allow the couple to re-finance and purchase more units, ramping up their portfolio faster.

A CPA is knowledgeable and skilled with the tax code, but it does not mean they are all equally skilled with business, real estate, investing, financial planning, or wealth management. A CPA should be a part of your financial team but not your sole consultant for financial decision-making.

State-run investment accounts promote their 529 accounts as a tax-free vehicle for saving money for your child’s college tuition. These accounts are so problematic that I have never heard of a single success story. Two people I know claimed it was beneficial for them, until I went through the math to reveal that they were 18% worse off than if they had simply saved cash under their mattress. Last week, a relative with a 16-year-old in high school was bemoaning that he didn’t follow my advice and their 529 account keeps losing money.

Briefly, a 529 account is a college education savings program run by each state so no two plans are exactly alike. Although the investment gains can be free from federal and state income taxes, there are many rules on how and where the money can be spent (without penalties), and very limited selection of investment options. There are two types of 529 accounts, a savings program or a pre-paid program. In my opinion, neither of these programs are any good. Let’s go through some of the issues on why you should avoid 529 accounts in general:

1. It is a timing mis-match. If there is a stock market fall then it can take 10-20 years for stock prices to recover to their prior level. So unless you started contributing to the account 20 years before their birth and exit all funds with stocks the day that the child is born – you are in a structurally incorrect product. If there is a big stock market correction when the child is 8-14 years old, it is likely there won’t be enough time for the market to make up for these losses.

2. 529 investment fund options are a prison of poor-performing mutual funds. Mutual funds incur far higher fees than ETFs (exchange traded funds). 529 funds then add an EXTRA layer of fees onto these expensive mutual funds, so they always perform worse than what you could do on your own. Even the “stable fund” that only pays interest offers far less than what you can get on your own because of high expenses. Although 529 account costs have been moving down, they are still the highest-fee location for money.

3. 529 plans are a maze of rules that have been known to change each year. So unlike other financial products, such as life insurance or an annuity, you do not actually know what you are buying until it plays out over time. The whims of the state administrators (politicians and bureaucrats) have dramatically altered plan details over the last 20 years. When it comes to kids, education, careers, training, and timing – you and your family need the most flexibility; but a 529 account is the opposite of flexibility.

4. Only the state and school come out ahead with Pre-Paid 529 plans. The plan’s marketing claims that you are locking-in a tuition price now to save money from tuition price inflation; they are taking on the tuition price risk. However, I have NEVER seen this happen. Instead, either tuition will increase at a lower rate than expected (so you come out financially behind), or tuition will increase at a higher rate and they change the plan rules (so you also come out behind). Basically, the plan administrators will always change the rules so that they do not lose money – which means it is 100% certain that you will come out behind.

If these plans are not so good, what, in my opinion, may be better? Rather than go through the math modeling to prove it, if I had a child born today and wanted to begin saving for their college, this is what I would do:

1. Estimate the total cost of a 4-year degree from a potential candidate school, 18 years from today.

2. Divide that number by 19 years (mid-college age) to get an annual savings goal.

3. Then divide that number by 12 to get a monthly savings goal.

The result is the amount of money that I would put into a simple savings account with FDIC insurance. This way, the account would only ratchet upward with interest income. I would search for a high rate, usually from one of the online bank accounts, and re-check this once a year to make sure the account is earning a competitive rate (today, I’m earning 2.37% at MySavingsDirect). When it comes to saving or investing, the amount that you contribute is far more important than getting an unrealistic and spectacular return that is more likely to backfire. Another college savings candidate may be U.S. Treasury iBonds (these pay interest that is income-tax free and are paying 2.83% today).

It is my view that 529 plans are swamps with many dangers and drains for your money. The lure of saving a few bucks on income taxes is never worth the changing rules, poor investment choices, timing mis-match, and restrictive policies on your money.