You Need a Financial House First

That person staring back at you in the mirror has a personal finance plan that is hard to argue with or ignore. Your reflection is probably suggesting to you what it suggested back at the turn of the calendar year: to save more, spend less and focus on getting your debt in line. Intimidated by what is obviously an imperfection in your financial life, you agree. Again. Something needs to be done.

Those mirror conversations are often forgotten as soon as you walk away from your own reflection. And with good reason. Only when you are looking directly at yourself do you see someone who has made these types of promises before. Once the two of you part ways, the reality of past decisions thwarts many of these well-intentioned pledges to do better. The question isn't what is better - that answer we know - it is more like how can you do better?

Improving your personal finances is much easier than you might imagine. So let's look at why your reflection is suggesting an overhaul in the first place. You can't avoid the idea that retirement or at least the time of retirement is closing in, often quickly. You can't dodge the fact that in order to retire at all, let alone comfortably, you need to set aside larger portions of your paycheck. No one has ever told anyone they are saving too much. Everyone, on the other hand will suggest that you and millions of others just like you, aren't saving enough.

In this scenario, they will tell you to max out your 401(k). To do this, the average American with the average paycheck in the average 401(k) can set aside $17,000. This number for this average person amounts to almost a third of their paycheck. And most will agree, this is an austerity measure that will not happen no matter how much the financial profession points out its wisdom. The over 50 crowd can toss another $5,500 into these accounts in order to play catch-up pushing the total contribution in this "maxed-out" situation to almost half of the average wage earners paycheck.

Knowing you are under-contributing often is the first roadblock in doing what you've told yourself you need to do. Resignation sets in and the next time you are in front of that reflection you quip: "I'll never retire" or "I'll just have to work longer". These will, without any argument help you achieve your retirement goals. But in suggesting that lengthening your work life is an adequate solution, you are subtracting from your retirement life. Think of it this way: If the speed limit is 55 mph and you drive 45, you will arrive at your destination; it will simply take longer as as you watch your fellow cohorts pass you, you will become discouraged and this will begin to weigh on the journey.

So forget the limits. Instead focus on the percentages: five percent (5%) of your paycheck contributed and producing a modest return will net you about 25% of the income you currently own, ten percent (10%) will get you about 50% of your current wage while fifteen percent (15%) will get you very close to 75% of what your current income is. Of course you will need to contribute and do so over a span of at least 20-years. But is much more do-able that the whole number that is the maximum contribution.

But even if that is do-able, as I suggest it is, something will have to give. A recent New York Life survey, done as they suggested, across the kitchen table, portrays the average American as someone who will try and manage their debt better. This is translated into spending less. Debt as we all know works against you in many different ways. More than simply spending what you don't have and exceeding what your paycheck brings, the cost of servicing that debt acts as a direct subtracting to that 15% and any return you might get in your plan.

So not only will you need to contribute more but at the same time, you will need to draw down that debt faster. What that reflection in the mirror is suggesting is often too austere for even the most parsimonious among us. Who looks at themselves in the mirror and says: "this year, I live on 30% less." While this might be excellent practice for the retirement you probably will experience, it is quickly dismissed.

Fourteen percent of those surveyed in the New York Life conversation with an agent revealed you will seek help. What you are doing is trading the reflection for a person who will tell you what you have told yourself. Of course this suggests that this financial professional has access to better tools to do what you have promised yourself to do. Ironically, they don't. For a fee, they will tell you what you already know.

Fear might be a motivator and many have taken to making these threats. But fear also brings a natural human reaction: to run in the opposite direction. Comparing where you are now with where you will be because you have done so little so far is a from of this fear. So is comparing you to your cohorts.

The simplest solution: 5, 10, 15. Contribute 5% to your retirement, 10% to your debts and 15% to your mortgage. A five percent contribution to your 401(k) will not impact your take home pay and will probably meet your companies matching contribution. A ten percent increase in payments to your debts will shave years and hundreds of dollars off of the interest you might pay. A fifteen percent payment towards the mortgage principal will reduce the length of your loan by as much as ten years. Doing this will have you arriving at the point of retirement with no debt and no mortgage.

Once the plan is in place and you have done this for five years, begin increasing the contribution by a single percentage point each year. This will be much easier to do as the debt you own is paid off and once the mortgage is satisfied, you will find your reflection congratulating you. This is far better than the criticism it once offered.

Talking Investments on the Radio

Every weekday, I host a financial talk radio show online. The Financial Impact Factor Radio with Paul Petillo, Dave Kittredge and Dave Ng is the one place where talk about money comes alive. Tune in whenever you like. Archived version of the Financial Impact Factor can be found here.

As Jeffrey Kluger writes: “We’re suckers for scale. Things that last for a long time impress us more than things that don’t, things that scare us by their sheer size strike us more than things we dwarf. We grow hushed,” he writes in his book Simplexity “at say, a star and we shrug at a guppy. And why not?” he asks. “A guppy is cheap, fungible, eminently disposable, a barely conscious clump of proteins that coalesce, swim about for a few months, and then expire entirely unremarked upon.” He then suggests that “a star roars and burns across the epochs, birthing planets, consuming moons, sending showers of energy to the limits of its galaxy.” Yet, he points out, “the guppy is where the magic lies.” A star is just a furnace whereas a guppy is a symphony of systems. So it is with the world of finance.

And joining us today on the Financial Impact Factor Radio we have Roger Wohlner, Certified Financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides advice to individual clients, retirement plan sponsors, foundations, and endowments. He recently cofounded Retirement Fiduciary Advisors to provide direct investment and retirement planning advice to 401(k) plan participants. Roger also blogs at Chicago Financial Planner and columnist for USNews and World Report. He has been kind enough to join us today to help us sort through the complexity, the scale we are so impressed with.

That scale, that complex mechanism that Roger has agreed to speak about is the target date fund. If you use one, you should listen to this explanation. If you invest, you should tune in as well.

Listen to Financial Impact Factor Radio with your hosts:
Paul Petillo of Target2025.com/BlueCollarDollar.com and Dave Kittredge and Dave Ng of FinancialFootprint.com

The show is broadcast daily, online at 6amPST/9amEST.

The Forgetful Investor

In 1933, Junichiro Tanizaki, Japanese author and novelist wrote and essay entitled “In Praise of Shadows” in which he offers a cultural view of the differences between east and west; where the eastern cultures appreciate light and shadows, the west is looking for clarity. He wrote: “Find beauty not only in the thing itself but in the pattern of the shadows, the light and dark which that thing provides.” Today we are going to take a look at some of those shadows or should I say, those investments that have been pushed to the edge of the conversation.

Today on our daily radio show Financial Impact Factor we visit elocution corner, a feature on this show that deals with a phrase or word that we toss about with great ease without any real foundation in definition. Today’s catch phrase: set-it-and-forget-it.

We have had numerous experts on the show who have suggested that indexing and using ETFs to index the marketplace is hands down the best way to approach the world of investing. In most instances, we view these types of investments as set-them-and-forget them. They offer a simple way to track the marketplace but also provide just enough confusion that using them as the whole of your retirement plan is now consider not only smart but at the same time suggest that it is foolish to construct a portfolio otherwise.

And here’s the problem I have: if your indexed investment for example follows the marketplace, in other words, mimics its performance, and that performance is well-documented as being about 3.2% over the past decade, why is the target retirement return still north of 7-8%?

Ed Easterling of Crestmont Research authored two excellent books on the subject of market cycles—Unexpected Returns – Understanding Secular Stock Market Cycles … and most recently … Probable Outcomes – Secular Stock Market Insights.

In his latest book,  Easterling lays out four points on market cycles and their effects on investors:

• “First, secular stock market cycles deliver returns in chunks, not streams." This refers to the volatility that makes news on a day-to-day basis and the fact that these swings are often much more dramatic that the overall span of an investor's plan.
• "Second, most investors live long enough to have the relevant investment period extend across both secular bulls and secular bears." This is the time span contingent that suggest that the longer you remain invested, the higher the likelihood you will benefit from those swings.
• "Third, investors do not get to pick which type of cycle comes first." Although you may think you can time the market, our emotions still play a role in how we place our goals and what, if any role the media plays in our decision.
• "Fourth, investors need to be aware that they will likely encounter both types of cycles." To this dollar-cost averaging creates a way to master the market swings by purchasing your investments over time and doing so in an even manner.

Easterling continues: "Those who experience secular bears during accumulation are generally better prepared than investors who are spoiled by a secular bull. A secular bull market is a pleasant surprise to retirees who endured a secular bear on the way to retirement. For retirees who grew to expect a secular bull during accumulation, the unexpected secular bear can be considerably disruptive.”

So I ask my cohosts: is set-it-and-forget-it an investment strategy? Listen to the conversation here.

2012: The six resolutions that matter

This article written by Paul Petillo originally appeared at Target2025.com

Jimi Hendrix once wrote: "I used to live in a room full of mirrors; all I could see was me. I take my spirit and I crash my mirrors, now the whole world is here for me to see." When it comes to the reflection staring back at us, our retirement, like those images, are a search for imperfection. We don't look at ourselves to admire how good we look; we look for flaws. We don't imagine a future; we see the relics of past decisions.

If you consider yourself a Baby Boomer, the reflection in the mirror is an image that polarizes: we are comfortable in the what the future holds or we are worried. There is good reasons for this feeling of either hope or dispair, with no real middle ground. This group has seen the demise of the defined benefit plan (pensions) and the introduction of the defined contribution plan (401(k)). You have seen the greatest bull market in investing history and witnessed two major crashes that have rattled your confidence in the decade following. You are the first generation to realize that your future is in your hands and you were not ready for the responsibility.

If you are younger than a Boomer, you are the first  generation to have never seen any other opportunity to finance your future than with a 401(k). And you have come to realize that this is not the plan it was intended to be. 401(k) plans were not designed to be the one and only vehicle for retirement. We were sold a notion that this was the end-all-to-be-all plan that would afford us a better retirement than our parents only to find out that it hinged on two extremely volatile concepts: your ability to consistently earn money and your level of contribution. Your 401(k) became your anchor and your wings.

I imagine that many of you will look back on the highlights of 2011 and find yourself in either one or two camps: you were able to hold onto your job, pay your bills and put some money away for retirement or you will be looking back at a year of indecision, regret and the promise to do better in 2012. You may be celebrating simply getting through it or wishing it never happened. To that, I offer some simple resolutions to embrace in 2012.

One: Revisit your idea of retirement. You can promise to save more money for your future, increasing your contribution to your plan or perhaps, in the absence of a plan, begin one of your own using IRAs. But you do this without really looking at that future. Retirement will not be the same of any two of us. For some it will be a life of struggle, an ongoing effort to make ends meet when they may never  met while they were working. For some it will be the realization that the balance between the now and the future relies on a level of personal sacrifice we were smart enough to embrace while we were working. For others, it will simply be a resignation of sorts, a belief that it will never happen.

Retirement is three things: A time when we find new opportunities outside the confines of what we called a career, a place of unimaginable risk and/or a chance to take a breather. It is not a place of no work and all play. It is not a time spent waiting for the end to come. It is not what we imagine because, if we looked closely at that image we see flaws. So we don't look as closely at those who are retired, examine how they live and ask if this is what they had planned. In revisiting the idea of retirement, your concept of that future, consider looking closer. If you don't like what you see, resolve to change it. But don't look away.

Two: Don't reflect on what you've done. You made mistakes; we all have. Some of us took too much risk, some not enough. Some contributed as much to their retirement as their budgets allowed, others did not. Some of us made poor mortgage or credit decisions, others did not. No matter what you did or didn't do, looking back will not improve the look forward.

Looking forward doesn't mean turning your back on on any of those events. It means focusing all of your energy on fixing them. This is a twofold effort, the first being getting the budget you may not have in line with your paycheck and focusing on paying down your mortgage (keep in mind that even if your home is underwater - meaning your mortgage is greater than the value of the house itself - the interest you pay on than loan is eating away at your future invest-able or save-able dollars). Does this mean you should not put money away in a 401(k) plan and redirect every dollar to the day-to-day? Not at all. Keep in mind that a 5% contribution will, in almost every instance, not impact your take home pay.

Three: Don't over think the process. From every corner of the financial world you will hear: rebalance your 401(k). If you chose a minimum of four index funds spread across four sectors, or four ETFs that do the same thing, rebalancing is a waste of time. You diversify so you can capture ups in one market and downside moves in another and your contribution doesn't allow you to buy more when one market moves up and allows you to buy more when it goes down.

We want to think we are in control when in fact, the only thing you actually control is how much money you want to put in. Markets will do what they do best: move. It might be up one day and down the next. It doesn't really matter. What matters is that you do something and in 2012, it should be significantly more than you are doing now.

Four: Stop being selfless. One of the hurdles we are told, for women investors specifically, is their inability to put themselves before their family. This is a cause for concern of course but not  a disaster in the making. Take a good long and hard look at your family and ask yourself: could I spend my retirement years living with any of them? Do they want you to?

Five: Embrace the truth. Now there will be an increased amount of pressure from every financial professional to get advice on your investments. This educational effort will evolve in the next several years from long, drawn out seminars on how your 401(k) works to short, ADD friendly videos that last several minutes and offer key points on what to do. The truth still relies on your ability to put more money away. Five percent will net you 25% of your current take home in retirement. A ten percent contribution over the average working career will pay you about 50% of what you earn today in retirement. Fifteen percent contributed to a 401(k) plan with average (modest) historical returns will allow you to live on 75% of your current income. Can you handle that truth?

Six: Stop worrying about it. According to HealthGuidance.org, you are killing yourself with worry. Michael Thomas writes: "Worrying leads to stress and stress has been linked with a number of health problems. People who suffer from high levels of stress are much more prone to cardiovascular disease, gastrointestinal issues, weight problems and there has even been a link made between stress levels and certain cancers." Instead resolve to do more saving than you have ever done, spend less than you did last year and embrace the reality of what fixed income is. Retirement is fixed income. Resolve to live like that now.

Paul Petillo is the Managing Editor of BlueCollarDollar.com/Target2025.com

Investing in the New Year: Are Mutual Funds Important in 2012?

This article originally appeared at BlueCollarDollar.com and was written by Paul Petillo

"Time is free, but it's priceless. You can't own it, but you can use it. You can't keep it, but you can spend it. Once you've lost it you can never get it back." Harvey MacKay

One of the key elements in any financial transaction is time. If you want to retire, you must consider the amount of time. If you want to borrow, how long you have to pay it back can be translated into dollars and cents. Investing; timing they suggest can't be down but is important nonetheless.

If you are twenty, time is on your side. If you are thirty, there is time left. If you are forty, time is of the essence. If you are fifty, time is running out. If you are sixty, where has the time gone. And older than that, time is no longer on your side. It accompanies us through life like some dark passenger. It reflect back on us from the mirror. And when we look at our retirement plan, it stares at us without guilt or shame. Time is the truth.

When I first began writing these predictions, and I've been churning out these year end ditties for over a decade, many were laced with optimism, some with an urging that we learn the lesson and move forward armed with knowledge of past mistakes, and still others were exercises in reality. In 2012, we have some opportunities and some problems awaiting us, left on the table as we symbolically turn the calendar wiping out 2011. But it won't leave quietly.

So I have a few thoughts about what you can do - resolutions of sorts but not the drastic sort we make and break almost within hours of promising ourselves at midnight.

Increase your contribution I start with this obvious chant for two reasons: you aren't making a large enough contribution and two, I would be remiss in not telling you this right from the start. And I'm not just speaking to those with a 401(k).

There are the millions of you who are forced to (and because of that are not likely to) finance your own retirement through an individual retirement account. We lament at the worker who literally only has to sign up at his workplace and doesn't. And far too often, we say little about the person who has to sign-up (after finding a fund), commit with a fortitude that is somewhat lacking and to contribute some of their paycheck via direct deposit every week or month. That effort, it seems is a much more involved hurdle.

In 2012, the investment world will be little changed. It will roil and confuse and gyrate and possibly even nose dive - just as it has for decades. It will react to news - if not from Europe form China or even the presidential elections (which ironically tend to be excellent years to invest). This will have you second-guessing your investments. But this will only apply if you have no idea how much risk you can take.

Pay attention to diversification You may not be capable of rebalancing, the act of making sure that your investments are directed evenly across many investments. This is much harder than it seems. As long as you are involved - and that is YOU in capitals - the struggle to keep balance will not get any easier.

For the vast majority of us, mutual funds will be the investment vehicle of choice. These investments will see more movement towards fee reductions. Which is a good thing. Fees will and always have been a subtraction of gains. This makes an excellent argument for indexing.

Choosing six index funds across the following cross-sections of the markets will not solve the problem of rebalancing (some will do better than others) but it will provide diversification. Index the largest companies (an S&P 500 fund), a mid-cap fund (the next 400 companies in size), small-caps (the next 2000), an international fund (an index of the largest countries (those with established banking systems even if they are currently troubled and will continue to be so in 2012), an emerging market fund (after international funds, the most risky) and a bond index (one that covers as much fixed income as possible).

Some of you will wonder if exchange traded funds (ETF) wouldn't be just as good if not better than simple indexing. In 2012, ETFs will continue to drill down ever deeper into sectors of the markets that add risk along with the illusion of an index. ETFs will become more actively managed in 2012 offering you more risk at a lower cost. Cheap doesn't mean better. 2012 will be year of the ETF. If you are unsure what these investments are, consider this conversation I had with David Abner of Financial Impact Factor Radio recently to help explain what these investments are and how they work.

Focus on your financial well-being This refers to your credit score. It continues to impact your financial future and will become increasingly harder to ignore. A new credit rating service agency will add to the difficulty in 2012 and not only will the current scoring impact costs such as insurance, it will seek to trace the breadcrumbs of your financial life more thoroughly that the big three do.

There is little likelihood that the job market will increase as many of our returning troops will flood the marketplace, taking numerous jobs from your kids just out of college. Which means another year with your kids at home. The only answer to this problem is to continue to tighten down your budgets in 2012. As I mentioned earlier: "If you are forty, time is of the essence. If you are fifty, time is running out. If you are sixty, where has the time gone."

And you must do this understanding that inflation - not the reported number but the real number in your grocery bill - will still chip away at your wealth. This means you will move in two opposite directs in 2012: saving and investing more for your fleeting future (at least 6% but 10% would be best) and spending less in the present (easy of you don't use credit).

And the housing market will improve for those who have repaired any damaged credit or who have saved enough of a down payment to buy a house. people are still buying and selling. These people have found that while the market is not accessible to all, it is for those that have done right by their personal finances.

Do all of that this may not seem like a new year - but it will be a better year!