The secrets of successful financial planning inside tips from an expert

Types of Professionals Credentials, Real and Imagined Methodology, the “Big Secret” CHAPTER 2: FINANCIAL POSITION, BUDGET, AND CASH MANAGEMENT Prudence and Priorities Three-Tiered Cash R

Copyright © 2018 by Dan Gallagher

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Library of Congress Cataloging-in-Publication Data is available on file.

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Print ISBN: 978-1-5107-2530-0

Ebook ISBN: 978-1-5107-2531-7

Printed in the United States of America

To Laura, mother of our four; wife for life.

TABLE OF CONTENTS

INTRODUCTION

How This Book Is Organized

The Six Components of Personal Financial Planning

Firms and Compliance Departments

Fee-Only Equals Unbiased?

Types of Professionals

Credentials, Real and Imagined

Methodology, the “Big Secret”

CHAPTER 2: FINANCIAL POSITION, BUDGET, AND CASH MANAGEMENT

Prudence and Priorities

Three-Tiered Cash Reserves

Budget Tracking: Target vs Actual

Debt Strategy

CHAPTER 3: RISK MANAGEMENT (PROTECTION PLANNING)

Disability Insurance (DI)

Carrier Claims Reliability

CHAPTER 4: ACCUMULATION PLANNING

CHAPTER 5: INCOME TAX MANAGEMENT

The “Three Tax Categories” Concept

A Long List of Tax-Controlled Growth and Tax Minimization Strategies

CHAPTER 6: RETIREMENT PLANNING

The Order of Returns and Losses

Rollover Decisions and Income Planning

Social Security Decision Support

Medicare

Long-Term Care

Lifestyle, Attitudes, and Mindset in Retirement

CHAPTER 7: ESTATE PLANNING

Titling Property

Special Real Estate Considerations

Stretch IRAs and Beneficiary Forms

Trusts and Their Uses

Non-trust Strategies for Minimizing Estate Shrinkage

CONCLUSION

References

Resources

Index

For more than three decades, until my December 2017 retirement, I’ve asked clients about thefinancial strategies and experiences they had prior to our engagements Roughly two-thirds hadobtained great professional guidance, but had switched because of retiring advisors or a change ofresidence However, about one-third of my clients had one of three problems that kept surfacing:

• They did little to no planning, ignoring professional advice but occasionally taking ideas from magazine articles or other impersonal sources.

• They diligently planned, using self-help books or software that offered strategies that were not customized to the client’s specific situation.

• They engaged human advisors who gave them bad advice (biased or incompetent) or bad products (inappropriate or noncompetitive) This includes professionals who used ghostwritten books to subtly promote their own financial products or fee-based services.

The first and second problems were usually caused by fear or disrespect of financial professionals,even though most professionals really do offer sound advice and problem-solving products At best,these three problems led to inefficient or costly results; more often they led to financial disaster

Real human experience stories, especially the tragedies that most of these are, help us learn andmotivate us to act True accounts stay with us because we see a path to avoiding danger Althoughsome of these accounts show certain advisors employing guile, or issuing self-serving advice toclients, not to mention poor judgment by some clients, don’t get the wrong impression: these are rarehorror stories from three decades of observation, and they are far from the norm for advisor behavior

or even client error They are admonitions They are reminders to pray, or to at least havecompassion, for the victims I do not want anyone to make the mistakes we will explore I want you tobenefit from the information provided here Buy copies of this book for your adult children and pre-retiree/retiree friends This book can help you, and those you care about, avoid financial pitfalls Itcan help you think about money as something to steward wisely rather than to hoard in fear or riskgreedily I have no products or advice to sell

This book is different from other personal financial planning books for consumer use Most topicsherein have engaging narratives of real-life drama, success, and wrenching failures These eventsrippled through time in their effects upon individuals and families I have known, with whom I havecried or celebrated Much of my advice runs counter to commonly held beliefs among the writers ofsensational news, regulators, and industry professionals But every strategy discussed here is justified

or derided in a way that enables you, the user, to determine whether it is good or bad for you in yourspecific situation, because I specify the conditions under which the strategy may be sound

Knowing the conditions under which a strategy can help or hinder reduces the risk involved indoing one’s own planning Knowing the conditions under which a professional will makerecommendations in your best interest is crucial to coordinating your strategies (newsflash: fee-only

advisors are not the only professionals who must and will work in your best interest) Understanding

the conditions that bear upon your product and advisor choices are what enable you to becomeconfident—not merely emotionally, but validly—in your decisions We will explore optimaldecision-making as well

Finally, as the title implies, I will identify numerous little-known—even some intentionally

withheld or mischaracterized—strategies: boom and bust indicators, restrictions upon consumer

choice, good-versus-poor value factors, and others These issues are crucial to understand when

planning for success with your money and other hard-earned assets that you have the responsibility

and privilege to steward

How This Book Is Organized

Chapter 1 is about types of professionals and who will be best able to help you It clarifiesprofessional designations, “captivity” and degrees of “independence,” analysis work you can relyupon yet obtain free, paying fees, and when commissioned brokers may be relied upon versus whenthey may not This chapter, like the others, has “secrets” and “little-knowns” of success you’lldefinitely need There are new developments in services, including practical tips on the fiduciarydebate and regulatory environment that affect you Do-It-Yourself (DIY) software and online robo-planning, new phenomena, are also clarified to help your decision-making The planning processitself, updating plans, and when to just focus on a few components are also explored in chapter 1

The Six Components of Personal Financial Planning

Big problems can arise if you don’t coordinate and integrate these components carefully, so eachcomponent has its own chapter You might be tempted to skip chapters 2 and 3, thinking that you have

a handle on your budget and insurance strategies Skipping any chapter, especially these foundationalones, would almost certainly cost you some efficiency, which equates to real money and importantoptions There are some very scary real-life accounts of intelligent adults who assumed they knew all

… and lost big! Ever heard of someone losing money in a money market account, or losing theirdisability payments while on an approved disability claim? Hmm, what’s that they say about the threeparts of the word “assume”? What does it make out of “u” and “me”? Chapters 2 through 7 cover thesix financial planning components:

Chapter 2: Financial position (including cash and credit management and budgeting)

Chapter 3: Risk management (non-insurance and risk transfer techniques)

Chapter 4: Accumulation planning (strategies and the truth about financial and

non-financial investments)

Chapter 5: Income tax management (including considerations most brokers always say

to “talk to a CPA” about)

Chapter 6: Retirement planning (tips for the young, for seniors, from medical to lifestyle

and everything in-between)

Chapter 7: Estate planning (health care powers of attorney versus living wills, and

much, much more)

All of these topics connect to each other, and some integrate deeply, such as tax management andaccumulation strategies Picking optimally efficient strategies for your individual portfolio mightdepend on having an insurance product (risk management, like long-term care insurance) performdouble duty with accumulation strategies, tax management, and retirement planning Likewise, certaintax-advantaged pure investments may not be discussed in detail in the accumulation chapter becausetheir use is primarily for retirement income planning So, if you skip a chapter, you might miss

important discussions that you assumed should be only in your chosen chapters Topics are labeledwithin chapters to help you judge which to focus on in a detailed read versus a skim.

What’s New

There are several little-known changes and trends in financial products themselves; these areexplored in the applicable chapters, mainly chapters 4 and 6 (accumulation and retirement) Onefinancial product, of which even many professionals are unaware, is new on the market since 2014:Qualified Longevity Annuity Contracts (QLACs) It’s still evolving in 2018, and so is the supplierlist Yes, there are new things under the sun! There are significant trends in some product categories,too, including some still-little-known changes in the last decade in some composite investments:mutual funds, investment trusts, derivatives, and risk-hedging products Changes are brewing, too,with equity-indexed annuities Design and tax treatment of life and annuity products are also changing:for example, drawing a death benefit from newer life policies while alive in event of terminal illness

or to pay for at-home or institutionalized nursing and custodial care There are also hybrid policiesfor long-term care expenses that can be for ordinary income (no premium loss if long-term careinsurance (LTCi) is unneeded), and that preclude premiums being required These trends and newproducts are clearly described and “prescribed” to help you decide whether and to what extent theyare needed in your situation

Supplemental Resources

This book provides extensive detail, key references, and an index Supplemental resources and a blogare online for my valued readers: AuthorDan.com If you are a business owner, this book can helpyou and would be an appreciated gift for your employees (they’ll see that you care) But financialplanning for business entities is a different—and just as crucial—“to-do.” I’m working on a book allabout that, so look for it in the future

Ready to finally get your finances as close to optimized as possible? Great Let’s get started!

Chapter 1

ADVICE, ADVISORS, AND WHAT’S NEW

The following experience did not end well for anyone involved

Frank’s wife Lu felt a twinge in her neck as she jerked her head left, away from the overdue mortgage notice, toward her husband’s shout.

“Bastards!” he yelled, crushing the annuity carrier’s letter.

“What?” she gasped, simultaneously wiping away tears and rubbing the back of her neck.

“These people actually refuse to take my whole rollover! They want to know what I want them to do with the half they won’t accept The rollover was almost nine hundred thousand and I chose them to get away from market risk into this pension thing Chester advised me on Almost a million dollars, and they have the nerve to tell me that?”

“Says here, Frank, that your income is zero now and expenses are four thousand monthly,” Lu said, reading the letter “Where did they get that? Our expenses are twice that anyway.”

“I made a hundred forty thousand until the layoff, and I can hit that again anytime now I don’t know why it says four

—” He paused and looked again, and his mouth fell open “Says some financial report has my other assets at zero but that my application shows another million in something called ‘nonqualified’ mutual funds If I were worth two million,

we could retire early What is this?”

“Frank, calm down You’re already so over-focused on getting re-employed, you forgot to pay the mortgage.”

“I did not It’s auto-debit from checking and we had …” He watched a tear escape Lu’s eyes.

“Hon, the homeowner’s dues and the club and several other things come out first, and you wanted the vacation paid with cash, not on the credit cards, so—”

“Our credit is going to crash.”

“Didn’t Chester say you could take income right off the bat from this new IRA until he got you a new job?”

“Right, and there’s no surrender charge on that, but he said his fee for coaching and job consulting would be less if I paid in lump and … He’s got this thing all in a spreadsheet and he knows what he’s doing He’s been a career and investment coach for over a decade I hope he won’t see me as some lower-priority client now that the investment is half what we expected, but I can’t figure out how this—”

“Everything will be fine, hon Call him Monday and get it all put into the pension annuity, just like he advised, and then

it will be there if you don’t find the kind of job you want and you have to keep looking At least we have the option to start the annuity early It’s almost what we need for the mortgage and debt, anyway.”

“Yes This letter is obviously some mistake Chester will fix this, just like he found the best annuity by being different from all those shyster brokers he showed me articles on Why anyone would use a broker, I cannot fathom Those guys don’t care about your career or income or retirement like Chester and people at a professional career-focused shop like his Watch, he’ll fix this Monday Anyway, this can’t be real Who ever heard of an investment company that wouldn’t take your money? This is America, isn’t it? I get to pick what I invest in, don’t I?”

Turns out, Chester had correctly calculated that the income from the rollover annuity would cover most expenses …

if they waited a year to take income; no income without penalties prior Frank and Lu had told Chester that they would put their vacation—a tax-deductible one due to Frank’s interview schedule and possibly starting a business consulting for his old employer and others—on credit and that Lu was about to start a job, but that fell through So Chester had them roll the entire 401(k) into the annuity Chester knew that because of the regulatory environment annuity carriers must deal with (more on this later), these carriers have become so intimidated by regulators and the legal environment that they are de facto forced by the government to deny people full investment choice Carriers design their applications, and sometimes check financial sources, to enforce what is actually the government dictating to consumers that they cannot invest more than half of their investable funds in insurance products; roughly half must be

in other forms of investment Frank wanted all existing investable funds to be in an annuity that was his personally owned pension; he wanted all new savings from any new job’s income to go into at-risk mutual funds, but he wanted

to protect the existing assets To maximize the sale and to satisfy Frank’s desired strategy, Chester had lied on the application Frank had signed and hoped random examinations would not be made For his part, Frank felt he could trust Chester, and it was Frank who had pushed for this two-phased strategy of diversification Chester had also used

his role as a career coach and job hunter for-fee to simplify things for Frank Chester made the rollover decision appear as a no-brainer he could be most trusted to handle because “career coaches work for fee and only for the client and find investments that have minimal commission and maximum consumer value.”

Last I checked, Chester still had his insurance/annuity license Frank still trusted him—or maybe felt his career was

in Chester’s hands and he had better help Chester Frank confided that he protected Chester by taking responsibility in writing for lying on the application Nothing more came of the matter, except this: I showed Frank a far better annuity and showed him that Chester was appointed to sell for only two carriers, and that Chester’s commission was about the same as other agents’ Frank could not change annuities, having gone well beyond the thirty-day free-look period for switching back Frank had the other half of his funds sent back to the old 401(k), and when the market corrected,

he sold those funds and put it all into the money market account of the 401(k) … having sustained an 18% loss That loss would not have occurred had this American citizen been allowed to invest as he chose Three cheers for that career coach and for the regulatory environment? I think not.

This account leaves several questions unanswered What are these licenses? Who is best to trustwhen investing? Might the current regulatory environment actually deprive Americans of theirconstitutional right to choice in investing—or might the “nanny state,” irritating or not, help more than

it harms? How can all of this be navigated for optimal personal decision-making?

Let’s examine the types of professionals you may encounter and use: their function, their expertise,what conditions create trust, and who represents the best interests of whom Since these professionalsoperate in a regulatory environment, let’s examine industry self-regulation, the legal or litigiousenvironment, and direct governmental regulation At the end of this section, you will be wellequipped to make wise decisions about keeping or changing the professionals you use But first, let’slook at the connection between media, regulation, and public perception of trustworthiness, and howindividual consumer decisions can be hampered—to their financial disadvantage—by a growingtrend of distrust

It was 1995 when I sat in my Williamsburg, Virginia, office and opened my Newsweek magazine to the financial

section I grimaced at its cartoon, which depicted a stockbroker and a CPA picking a consumer’s pocket The article itself proclaimed that its writer was saving the public from unscrupulous financial professionals who preyed upon the ignorant; that this behavior was rampant What cynical sensationalism! I immediately thought of a CPA friend of mine from church, an honorable man named Starbuck We both had young children and were family men, respected in the community.

This sort of thing will cost us business if it keeps up, I recall thinking, and make people shy away from needed advice toward less-than-optimal self-help Worse, it could keep people from the help they need.

Since then, I have seen these sorts of depictions and generalizations increase, and noticed it getting harder to market or close a relationship that both the client and advisor need Our businesses did grow, but it got progressively more expensive to draw people to attend seminars, respond to ads, and engage in a relationship Sure, we all have read about consumers being done wrong I personally have never had a consumer complaint In my research for this book, I found zero studies that found any greater propensity for dishonest dealings among financial professionals than among any other category of professional consulting or sales.

Stories of dishonest and incompetent planners do exist; quite a few are in this book! The reasonpeople may get the impression that financial professionals harm clients more frequently than otherprofessionals is that there is so much at stake that it’s frequent news The importance of financialdecisions, especially ones dealing with the totality of one’s finances, is huge Big rip-offs alwaysmake the news, and differing philosophies about earning commissions, et cetera, make for sensationalmedia items that generate suspicion about motivations and honesty This is all very high visibility

Cerulli and Associates is the financial industry’s most respected marketing research company, andits various studies found that consumer propensity to respond to and to engage financial professionals

is about one-third as likely as it was in 1987 when I entered the industry What do you suppose has

caused consumers to be so jaded toward this industry’s products and professionals over thirty years?

I submit that consumers’ willingness to trust has been severely marred by media reports on threetypes of news: sensationally bad financial professionals (whether generalized or high-profile likeBernie Madoff), government “having to” add increasing regulations on product producers, andindividual advisors/brokers These three types of news items diminish public trust and esteem for theindustry and the servants of consumers, and they cause consumers to fear to make decisions they need

to make

Did you know that, in order to obtain Errors & Omissions (E&O) insurance—which is required tooffer fee-advice or products to the public—an advisor or broker must agree to not defend him- orherself or publicize details of a consumer complaint that he or she contests? The E&O insurer, not thebroker or advisor, decides whether the case will be settled If the professional wants to proveinnocence, he or she is not allowed to do so! The behind-the-scenes regulatory environment iscausing financial professionals to retire early, reduce what they are licensed to offer, and to restrictwhom they serve This environment has even caused manufacturers of investments to put up red flags

in their marketing materials, which scare off investors It has caused manufacturers to placerestrictions on what business they will accept, restricting the public’s buying and advisory choicesand, in some cases, tempting manufacturers to lie on product applications

Complex is “bad”?

I was one of the invited speakers at a seniors’ luncheon in Charlotte, North Carolina The hostorganization picked one professional from each of several areas of service to seniors There was aMedicare expert from the government, who was very helpful and clear-speaking There were twodifferent types of safety experts from local firms, and a well-respected annuity salesperson After theannuity specialist finished, I was to speak on long-term care strategies, and I rose to prepare theprojector The host asked me to wait for an impromptu speaker, a compliance auditor from the NorthCarolina Insurance Department

The auditor promptly derided annuities as a category, proclaiming them complex and inferring thatthis constituted poor consumer value From my seat, I heard two couples almost immediately decide

on certificates of deposit and balanced mutual funds, respectively I never got to discover whetherthey passed on annuities, but I also wonder whether they ran out of income years later, since—for alltheir good and useful purpose—neither category of products offers guarantees of lifelong income, andone can lose substantial market value That regulator had actually influenced people he had never met

to abandon a whole category of products that they likely needed, at least to the degree that guaranteedincome could be matched up to guaranteed-to-pay-out expenses Yes, there is a way to calculate theminimum one should have in an annuity for this specific purpose, matching guaranteed income toguaranteed-to-incur expenses

To finish the account of this event: the regulator-speaker caused so much worry with his talk that

my own presentation was sabotaged Half of my talk was on a new type of annuity that doubled as ano-more-premiums long-term care insurance policy This product, which was new at the time,provides several times one’s deposit in long-term care insurance (LTCi), plus new tax and Medicaidqualification advantages, and can be used for regular income if the owner no longer wants the LTCi.But, presumably because of the regulator’s implication that annuities were bad (he knew nothing ofthis new type, I discovered later), not a single attendee showed the slightest interest on the responsecards

Did the regulator, or anyone who generalizes implied advice, adversely bias consumers to avoidproducts that they actually needed? Almost certainly so.

Regulation

Don’t get me wrong here Without regulation, disclosures and license standards would not exist toprotect consumers from the likes of Chester, discussed earlier But did the vast amount of regulationover the years protect Frank from Chester, anyway? And is it really the case that we can only trustgovernment to be the regulators, or might industry self-regulation work best? As it happens, in NorthAmerica, industry self-regulation actually does account for most regulation anyway! Let’s explorehow that works and how both government and industry self-regulatory bodies work to helpconsumers These are things you must know in order to protect yourself and be on the lookout for therare but real shyster After all, it’s not that there are more dishonest or incompetent financialprofessionals per thousand; rather, the problem is that you rely upon these people for far moreweighty decisions than most buying decisions you face This is why the question of “fiduciary status”has become such an issue today The Department of Labor has issued a directive making fiduciaries

of all individual sellers of and advisors on qualified retirement funds and IRAs A 2017 ExecutiveOrder has required a reexamination of the impact of this upon consumer choice, and thatreexamination may result in change or discontinuation of the regulation

Fiduciaries

A fiduciary is a person or firm that acts—legally or contractually—in the best interest of another.Legally, fiduciaries are in a position of trust and obligation toward the person they agree to serve andmust place that person’s best interests above their own Some have incorrectly interpreted this tomean that their compensation must be “reasonable” in order to do this, but that standard has not been

in American law or regulation until recently because, traditionally, market forces set prices, andfiduciary duties are about care owed once the relationship is formed There is another reason forcompensation not being a part of this: Constitutional law clearly forbids government from settingprices, except to deal with monopolies and national crises Fiduciary duties grew from thedevelopment of the Law of Agency (way back in the Elizabethan days of jolly old England), by which

an agent owed fidelity to a principal (a client) in defined weighty matters such as realtyrepresentation, legal representation, and any contractual agreement that formally established such arelationship Of course, fair dealing is a legal obligation of agents to all parties involved, regardless

of his or her duty to all For example, a real estate agent, a financial planner contracted to work for aclient, and an attorney cannot lie to others in order to advance the best interest of their client Anagent can also represent two or more opposing parties, provided the agent obtains consent from allclients and takes steps to avoid advantaging one at the other’s disadvantage

Over time, standards of care have developed to enable agents of investment companies orinsurance companies to serve their principals (the company, not consumers) with fairness to theconsumer As noted above, the consumer knowingly allows this by acquiescing to the fact that thebroker may not have every investment available to evaluate for a given recommendation or

assignment to find “the best” for the client The broker finds the best available Why? Would you

expect a store that offers food to obligate itself to find the very best green beans and offer only that

brand? No But what is at stake is far more important than a so-so meal versus a fantastic meal So thestandard of care has developed to generally mean two things: (1) The product and actionsrecommended are as optimized for the particular client as humanly possible, and (2) the best

available product is sold Again, not all brokers have the same product mix, and not all brokers have

the same analytical tools and talent pools to optimize a client’s finances

Different advisory and sales functions are regulated by different organizations These can overlapbecause advisors have multiple licenses Investment Advisor Representatives or IARs (fee-only andfee-and-commission advisors) are prohibited by regulation from giving you testimonials of clients(presumed in the law to be misrepresentations) No kidding Get to know the human being Stateinsurance departments do not usually publicize discipline history, but all do answer direct inquiries

So check the website or write to them State and Canadian provincial insurance departmentssubscribe to a common disciplinary database, so you need not check with multiple insuranceregulatory bodies If you think there may be a problem, check with the professional’s manager and/orcompliance department first You can also use FINRA.org’s complaint or BrokerCheck function forany concerns about securities and hybrid insurance/securities Fee-advisory firms and individuals areregulated simultaneously at the federal and state level, depending upon the magnitude of the advisorypractice, so check at both levels (search for your state’s corporation commission, then find the

“investment advisor” link) The federal site is SEC.gov

How do you maximize your chances of finding the right professional for your needs? A CertifiedFinancial Planner (CFP) is trained to make the right referrals and to work in your best interest, even ifnot functioning as a member of a firm with Registered Investment Advisor (RIA) designation, becausethe CFP code requires it, regardless of any state or federal law It is best to start with acomprehensive examination, similar in concept to a family physician performing an annual physical

If you find, in working with a CFP, that active management of money is needed, that is the service thatrequires disclosures in writing of the advisor’s history and specialties That document is a FormADV Part II, or a brochure containing the same information Most people just sign to say they’ve read

it, but it is important reading, mainly because it does show specialties, licensing, and education.Being regulated as an investment advisor or as a representative of one is not necessarily about fees It

is about advice given on any of three securities management issues:

1 Prescribing the selection of money managers

2 Acting as a money manager with discretion to adjust the portfolio

3 Prescribing (not merely offering or discussing) a specific asset allocation percentage for specific asset classes of

securities (if recommendations are limited to a specific allocation to guaranteed non-securities assets, this is not investment advice requiring registration)

Prescribing an asset allocation means defining specific percentage breakdowns in order to attain aspecific target return and minimize volatility associated with that target return, or to maximize likelyreturn for a given upper limit of volatility These two mathematical procedures result in an “efficientportfolio,” but there are many efficient portfolios one could prescribe The “secret” is to find the

efficient portfolio considering your income draw That additional constraint changes the math A

good IAR will use Monte Carlo simulations (explained later in this chapter), and an expensivedatabase feeding that modeling, to determine the “efficient portfolio” for you, in order to discover thelikelihood of exhausting assets during one’s life This diagnostic procedure is more complex thaneven the previously described two ways to prescribe a portfolio, but it is the best way to devise anasset allocation However the portfolio is allocated, with or without Monte Carlo simulation support,

it is one of the three services that triggers the requirement for Investment Advisor Registration.

Registration as an RIA or a representative of one was created back in the 1930s because of thevariable valuation nature of securities, including bonds Hence, recommending the purchase of avariable annuity for which the seller merely suggests options for asset allocation, or recommendingfixed interest insurance products and suggesting the allocations for interest calculation methods, doesnot qualify as investment advice Stockbrokers do recommend specific securities selection andgeneral asset allocations, but they have an exemption in the law

Stockbrokers may or may not be Investment Advisor Representatives, as their specialty is to informyou of appropriate securities for your goals and enable you to buy or liquidate them This may soundlike investment advice, but it is exempted because the selection of active managers, rather than merelyasset allocation or selection of mutual funds, is the service that an IAR provides Likewise, aninsurance agent may recommend less risk because of some analysis, and suggest that a portion of yourportfolio be liquidated and put into products that offer some forms of guarantees, but that does notinvolve the ongoing active management of a portfolio nor the selection of a money manager; it mayseem so, but the insurance agent is really giving general advice as to asset allocation and then toutingthe merits of managers available for the client to select in a variable annuity or a variable lifeproduct

Is it “bad” if an advisor is not an Investment Advisor Representative? No—it simply means that theservices offered do not include active management of securities (keeping in mind the stockbrokerexemption) or advising on specific asset allocation by asset class (see the accumulation planningchapter) In fact, the IAR registration merely means that the advisor has passed a test that measuresunderstanding of investment advisor regulations and law and a bit about basic portfolio theory SomeIARs might tout their registration as a qualification If you read that in an IAR’s literature, then you dohave important information: it means the advisor has distorted the meaning of his or her registration,which in turn could indicate that the representative may exaggerate other things, such as productfeatures and benefits You only need an IAR if there is reason to believe you need active moneymanagement Financial planning is about much more than this

Firms and Compliance Departments

Firms as well as individual professionals may be researched online now, but note this about firms:There is no investment or insurance manufacturer that has never had any lawsuits, settlements, orfines Keep this in perspective and realize that when bad practices are discovered and dealt with,these manufacturers do fix their systems For example, when Wells Fargo got disciplined for havingaccount reps open numerous bogus accounts for people so some of its managers could get bonuses,the damage to individuals was limited to the account fees; the bad apples got purged To assume thatWells is still bad now would be inaccurate, and cause you to miss evaluating a fine firm that couldbenefit you

Justifiable public impatience grew over the last century whenever scams or even individual abuseshit the news Regardless of sensationalism and bias that may or may not exist in some media,something had to be done to limit abuses, and that means power, either contractual or regulatory Bothevolved The investment and insurance industries both devised self-regulatory organizations for fear

of regulation being imposed without much free market perspective To sell products or advice,professionals—all agents of some sort—had to agree contractually to rules and enforcement, or else

they could not have access to financial products or legally sell advice Laws filled the gaps, such asregistration and audit of fee-only and fee-and-commission advisors The carefully designed systems

of the entire world evolved, led by the US model But no system is perfect, and it remained possiblefor harm or small-scale inefficiencies of advice or sales to disadvantage consumers, either throughnegligence or deception

In the last twenty years, compliance departments within financial firms have grown huge Theymonitor email and other communications, prevent ads and other communications from over-promising

or misrepresenting, and deter a host of other complicated bad acting The monitoring technology alone

is impressive and even shrouded in secret so as not to be easily evaded To place this in perspective,consider that a tax preparer is a compliance agent for the IRS, despite the fact that he or she does thework your government requires of you As a society, a majority got used to this method of doing “taxbusiness,” the personal income tax system as a way of paying national bills Fine, but consider whattax consultants are, to a great degree: They let you do only what tax law allows, thereby functioning

as compliance officers for you To some extent, they are government agents So within investmentproducing firms and brokerages, a third type of enforcement has arisen: internal compliancedepartments If you feel bamboozled or poorly guided, appeal to this department simultaneously withyour advisor’s manager; your complaint may go nowhere otherwise But know that this three-tieredcompliance system—internal, self-regulatory, and legal (not to mention potential lawsuits)—is a veryexpensive system for protecting you Unfortunately, it is essential, despite a few excesses that irritateindividual professionals Why essential? Again, the stakes are high, and that’s why we care aboutmore than regulation and enforcement; we must focus on who really will serve your best interest

Are the currently delayed regulations, which make all brokers and financial advisors fiduciaries toclients, workable and needed beyond the existing system of monitoring and enforcement? In currentform, they actually force product issuers’ reps to recommend competitors’ products Are we nowcrossing the threshold, as many professionals complain, of regulation harming the public more than ithelps? The recent regulations have sowed confusion and fear among honest professionals Cerulli andAssociates has begun tracking an uptick in retirement of advisors There may also be a trend ofadvisors limiting which products they offer so as to avoid what they feel are onerous burdens ofpaperwork and interference in their investment and insurance recommendations Some have gone tofee-only advice and—note this—they may refuse to evaluate the quality of financial products that theydiagnose are needed by their clients Imagine: You get a great financial plan, then essentially hear,

“You’re on your own as far as selecting which products to buy.” That has started to happen

There are State Farm agents and other one-brand or limited-brand agents who are retiring because

of lower commissions (which are in turn due to the costs of regulation and compliance) They knowthey cannot shop the market for the best product They can only offer very fine and competitive onesand lack a way to evaluate the best, let alone offer products that compete with those of theiremployers Yet there is a very good reason State Farm and some other carriers became so strongnationally: fine, honest agents, genuinely caring of their clients and offering extremely competitiveproducts from their principals Perhaps the business model of captive agents is a dinosaur—I do notknow I must admit that when I had clients, I was totally independent or almost so for most of my

thirty years so I could be more competitive The bottom line for you is that you deserve the best accounts and the most able advice, not merely some mix of “good” and great.

Fee-Only Equals Unbiased?

You may have encountered ads that tout fee-only advisors as unbiased because they do not earncommissions News flash: They are just as susceptible to bias as commissioned advisors! The fee-only model can actually be detrimental to the consumer Fee-only advisors earn most of their feesfrom asset management, either personally managing the buy-sell-hold decisions day-to-day or byearning a fee from the money management firm they select for the client’s account The larger thataccount, the greater the fee But what if the client’s best move is to buy a single-pay life or long-termcare policy, or what if they might need a fixed/guaranteed annuity to match up to their guaranteed-to-incur expenses? Well, purchasing such lump-pay products would take away major chunks of theassets available for the fee-only advisor to manage, hence the same potential for bias with fee-onlyadvisors as with commissioned ones Get an individualized analysis that identifies which types of

accounts are most prudent for you to own, given your individual needs You must trust the human

being, and not distrust merely on the basis of method of compensation A secret to finding this is toask the advisor to show you financial plans in which he or she recommended product purchases andthe rationale (with client names removed), or to demonstrate that his or her firm routinely handlesboth products and fee-based advice

Through all this history, stock brokerage, insurance brokerage, and advisory “houses” from MerrillLynch to Ameriprise to Wells Fargo expanded their product mix But was it to find the mostcompetitive product in every category? No For complex reasons of constitutional law, producers ofproducts like mutual funds or annuities experience market competition that keeps them trying to offergreat stuff; it’s not regulation that improves products These firms are not held to the fiduciarystandard as their individual representatives are (or soon likely will be)

Now, imagine this: The new regulations decree that the reps are, individually, fiduciaries chargedwith having your best interest at heart Yet the employers of these firms produce their own brandproducts and select a mix of competing products to sell alongside their own These employers are notheld to the standard Firms use two criteria to select products for sale

1 Maximizing profit margin for the shareholders (the commission a rep gets is just a part of this larger “gross

concession to the dealer,” or GDC) Shall we declare that these firms must earn no profit? Is that fiduciary? On the surface, it seems fiduciary, but what of incentive to compete, to innovate and improve? Historically, these two “social goods” have been absent for consumers in command economies and sectors where profits are regulated rather than determined by competition The harder it is to explain a product, the more skilled the rep must be to explain it, and this is among the factors driving commission level A limited partnership composed of real estate or oil leases has a higher profit potential for the consumer than most products, but also has a very high GDC.

2 The other main factor brokerages use in selecting products to broker is minimization of lawsuits from people

claiming that commissions or potential surrender charges are high or hidden (whatever “high” means) So they sell

“restricted illiquidity” products, like back-end mutual funds, REITs, and annuities, but ignore some potentially superior ones whose liquidity limitations are above average Yes, this lawsuit intimidation factor has become that significant

to brokerages Recall the earlier example of annuity carriers having become leery, accepting only about half of what one can invest, so the legal environment restricts consumer choice The income you get from annuities that have high potential surrender charges is almost always higher than those the large brokerages sell Why? Because the annuity company can get a higher return if it’s confident that its accounts will not be demanded to liquidate

frequently; this enables it to guarantee higher income to the consumer However, brokerages have become

intimidated by lawsuits over high surrender charges, allegedly improperly committed to via bad advice, and so a new industry standard has evolved: None sell annuities with surrender charge schedules longer than six or seven years, nor with starting potential surrender charges higher than five or six percentage points They instruct their reps to tell consumers that this is a better value because of the lower surrender charge, yet they cannot disclose that the

income is very much lower in these than in annuities with greater surrender charge patterns.

“Oh, no problem,” says one consumer “I’ll just buy Vanguard funds or its no-load in-or-out annuity,

or I’ll buy from my mutual insurance company because they don’t make a profit for shareholders That

will maximize my value.” Hmm A little common sense here: What are the odds that one company,like Vanguard, Fidelity, MFS, or any other you name, has all of the very best-managed funds andannuities—all the best? No such company has ever claimed to the public that they did, for that would

be an obvious untruth Even those who have the best of “whatever” for a few years eventually loseresearch staff or managers, or have random losses And does Vanguard offer an annuity thatguarantees against market losses, yet pays interest based upon the market? No, that innovation occurswhere the profit margin allows innovation and carrier risk-taking; true risk transference is sold toconsumers No one can deny that Vanguard, Knights of Columbus, Thrivent Financial, and MassMutual built their brands on serious resources that enable them to stay very competitive But there is,actually, profit in their products It just does not go to stockholders; it is split between personnelcompensation and consumer dividends of one form or another

So, what is actionable here? You need not only an advisor who is willing and able to find you thebest courses of action as to the planning aspect of your finances, but one—perhaps not the sameperson—who will find the best product in each category that you need Let’s focus now on individualprofessionals and their services and relationship to you

But first, consider this before we examine types of professionals: For complex constitutional lawreasons, the new fiduciary rule can only cover IRAs and tax-qualified plan advice and product sales.Therefore, the rule that applies to a professional who advises or sells in connection with theseproducts does not apply even when that same individual provides or advises on any other form ofinvestment, referred to as “nonqualified or non-qual,” and that extends to credit products anddisability or long-term care insurance Does that mean you are “at risk” of bad advice or worse using

a professional for everything other than IRAs and 401(k) advice? No People are people, includingadvisors They go to synagogue, care about your kids and you, love their spouses, and are kind toneighbors and animals You can come to trust them using the usual mix of indicators Use the advicethat follows in the next section, but because of the high-stakes nature of this advice, keep the potential

of complaint to authorities in your back pocket

Types of Professionals

Insurance agents: Many insurance agents have become quite sophisticated in their analytical

abilities Most fee-based financial planners are or were licensed insurance agents It is an old andhonorable profession, whether expanded to include other topics within financial planning or not.Historically, polls of public trust in professionals have usually placed insurance agents in the top two

or three Perhaps this is because of the very deep personal issues surrounding the financial losses theyinsure against: death, disability, loss of homes and businesses, costs of replacing deceased ordisabled key employees, and certainly the costs of health care for human beings As previously noted,agents are fiduciaries to the carriers for which they sell, whether they are statutory employees of theproduct issuer or not More than half represent multiple carriers and do not hesitate to switch torepresenting another if the new carrier has better products for consumers They have always knownwho triggered their compensation, even if the check has the carrier’s logo on it: You, their client Iuse the word “client” even though agents owe fiduciary loyalty to the carrier How can that be?Insurance agencies, at least non-captive brokerages, have evolved to focus on consumer value andappropriate sales

An appropriate sale is one that can be documented to fill a need The applications even ask

questions about need, and they include forms used to document whether a “replacement” or product

switch is truly in the client’s best interest These can be falsified, so always read what you sign, and

get a copy—at least after processing of the forms

Many people see insurance agents as beneath them on the social ladder Don’t view anyone thisway, even if he or she paints your fence or digs your ditches Humans all have infinite worth, andtheir work is service to their fellow human beings; a genuine service work has dignity, from art toplumbing to being a politician For this reason, though, practical fee-advisors and other financialprofessionals who hold insurance licenses often try to de-emphasize the insurance aspect of theirwork This shyness can cause you to think that insurance is some minor issue, a lower priority thanseeking investment gain In the risk management chapter, we will examine the fact that after cashreserves and budgeting-related issues, insurance is the prudent person’s first priority But first, back

to insurance agents

Some people mistakenly believe that an insurance license makes the agent a competent generalist—some even believe that there is one type of license for all insurances There are several, and you needspecialists in each area unless you find one or two agents who have broad expertise and licensure.This is because the agent should have access to multiple carriers to shop the market for you in theproduct categories you need

Distinct insurance licenses in most states are as follows:

• Life (normally includes fixed-rate annuities) and disability (in some states, health is a separate license)

• Medicare supplement: health licensure is a prerequisite

• Long-term care: in all states, health licensure is a prerequisite

• Property, casualty, and liability (aka home and auto)—personal lines

• Property, casualty, and liability—commercial lines

• Insurance consultant (helps companies manage self-insurance plans, usually for health insurance)

• Numerous specialty lines, especially liabilities for dangerous chemical activities, and for specific risks such as Errors

& Omissions for engineers and other professionals)

FMOs make pure insurance and interest-only annuity products available to agents Rarely do FMOshave the ability to broker securities (variable annuities, mutual funds, money manager access, andother loss-and-gain-capable products) Only broker-dealers can sell securities products, and theirreps are referred to as “Registered Representatives.” You can tell these by the business card or ad: Ifsecurities are offered, the communication must name the broker-dealer Money management can beoffered through fee-only Investment Advisor Representatives (IARs) who work for investmentadvisor firms; this special type of securities account involves the rep, or a firm the rep selected,actively making decisions and trading securities, rather than calling you for permission to trade andrather than selling you shares in a management company such as a mutual fund But many FMO repshave “boutique” investment advisory firms, or are reps for those firms, and also make the FMO’sinsurance products available to clients These firms are typically very sophisticated in their trainingand expertise, but you must evaluate that expertise More on how to do that when we discuss IARs

Here’s the drawback for most FMO reps, though, and this is a bit of an industry secret: FMOs havevery limited training programs for technical expertise Reps bring their own, having left majortraining firms, and maintain that expertise through continuing education (CE) at their own expense.Most available CE courses can be quickly zipped through—they are not deep-dives—and so unless

an FMO rep is either from a major training firm or is part of an actual financial planning firm, oddsare that the FMO representative has difficulty understanding even some product details, let alonebroader financial planning issues These FMOs have started to provide their reps software thatanalyzes when a client is likely to exhaust income, and so their value is stronger than in years past

But the software is far too simple to truly optimize finances and even lacks “Monte Carlo simulation”analysis which, as we will see in the retirement planning chapter, is essential to proper assetallocation decisions In summary, reps of large FMOs have the most competitive interest-bearingannuities and pure insurance products but, with the noted exceptions, they also have limited analyticalcapabilities.

What about stockbrokers and financial planning firms that sell insurance products, like disability

coverage or life insurance? These brokerages have thousands of representatives, but unless they can

show you a list of carriers for each product category that is at least a dozen long, do not buy the

policy from that brokerage or advisory firm (the rep may merit your securities business, though).Recall that these broker-dealers limit what they sell to low- or short-surrender charge products,which inevitably pay consumers lower income than longer-surrender charge products These broker-dealers usually have big name carriers only for insurance products, because they need to potentiallydefend their reputations by asserting that they offer only A+ rated carriers

Field Marketing Organizations: Most agents have either very large brokerages that employ them

or are independent contractors using FMOs The roughly other half of agents are either captive(employees of one carrier and have limited choice of other carriers) or they are employees of stockbrokerages or financial planning firms that usually have limited choices of carriers, as discussedpreviously Even FMOs look at profit margin in selecting products and carriers they offer, but most

are laser-focused on winning the case: finding the most competitive product They have even

automated this function, enabling agents who use FMOs to find, nearly always, the single mostcompetitive product that exists, or something very close to it But the largest FMOs have the biggestvolume, which they need in order to make such a large selection of carriers and products available.Otherwise, the agent personally must gain an “appointment” (brokerage privileges) with each carrierand commit to selling a huge volume for each carrier that he or she wants to have available to clients.Here is where you are unlikely to find good value in products unless you go for “large,” really large:Ask the agent to show you whether their FMO has at least 5,000 agents or so (some hit 15,000), sothat you can be confident that the rep has access to all or nearly all competitive carriers and products

Insurance Carriers: But here is another industry secret (at least one not mentioned at the big stock

brokerages): The difference in financial soundness and long-term ability to pay claims of an A–carrier compared to an A+ carrier is inconsequential While I would not buy B+ unless the trend forreserves and other measures of financial fitness were improving, there is no evidence—and the ratingcompanies have never asserted otherwise—that an A– carrier should be avoided in your buyingdecision In some cases, rating companies rate a carrier down a bit just because the carrier mayspecialize and not diversify into multiple insurance lines A good example of this is American Equity,

an A– fixed indexed annuity specialist that has better solvency than A+ carriers Nationwide Life,RiverSource, Prudential, and a host of others From overall A– to the highest A+, carriers are quiteclose in claim-paying ability But if you like your investment advisor rep at Ameriprise or WellsFargo or other large brokerage (notice the license and registration overlap), you can be confident thatthey all have at least very good products

Stockbrokers still come in “plain vanilla” just as they always have, though most do have multiplelicenses and registrations (usually IAR) But if they are IARs, do they really do financial planning?Check and see Odds are, someone on their staff does that, briefs the stockbroker (who happens tohold IAR registration), and then the stockbroker/IAR sells the for-fee advice Is that bad? It can be

Sally had developed a new kind of durable and signal-interception-resistant computer casing at her young firm in Newport News, Virginia Her thirty-person firm sold these to Newport News Shipyard contractors and had worked hard

to get referrals to the Department of the Navy, the CIA at Camp Peary, and several private security firms in Norfolk As her income increased, she had spoken with tax advisors, insurance agents, and an estate planning attorney and knew she needed professional analysis to help her allocate and plan.

She met Jeff, a highly regarded broker and IAR at MegaBrokers, Inc., at the Williamsburg, Virginia, Chamber of Commerce Business Defense Vendors business social Jeff had several assistants on his team, and that impressed Sally far more than other planners and brokers she had met Jeff interviewed her and established rapport, noting her priorities for expanding the business but also her needs for investing in financial composite investments, her fascination with real estate investing, and her need for certain insurances But Jeff was not the person who processed her data into a financial plan His assistant did these plans and found that Sally needed to spend X on insurances, Y on

a company retirement plan, and about $100,000 in nonqualified savings in a tax-advantaged real estate limited partnership product.

Sally was so attracted to the REIT that she put up $20,000 in cash and borrowed $50,000 for her expansion plans After a year, her REIT was producing great cash flow, almost tax-free, so she kept it; she would incur a big loss for liquidating anyway What Jeff had no idea about, though it began to dawn on Sally, was that some business expansion outlays should not be undertaken at all unless they are at a certain level; marketing consultants can find that level with reasonable confidence.

But in executing the financial plan, Sally never set aside ten thousand or so to retain a proper marketing consultant

to discover what that “success threshold” was It was later estimated at a minimum of $150,000 Her $70,000 total expansion outlay did not result in more market share because the resources devoted ($50,000 borrowed and $20,000 cash) was half of what would have produced success and edged out her competitor So, while she was right about the expansion’s merit, she put too little in to capture it Her competitor captured it and she had wasted $20,000 in cash and owed $50,000 to the bank.

Out of fairness, there are two problems in the above scenario: The plan was done by a numbercruncher, and the relationship did not include a broker with broader experience who might haverecognized that the plan could not be done until the marketing consultant’s work was done Stockbrokerage reps almost never do their own financial plans, let alone have business management ormarketing modeling training to recognize that a consultant is needed prior to personal financialplanning being done If you own a business, or have investment ideas beyond the types of investmentsoffered by brokerages, then you need more professionals on your team, such as a broker with an MBA

or a business broker or consultant

Investment Advisor Representatives (IARs): We have seen that IARs show up as

independents or as employees of brokerages, most often in firms that position themselves as financialplanning firms To sell financial advice that includes the buying or selling of any securities, one mustbecome registered as an IAR The exam is mostly about regulation and partially about basicinvestment theory and asset allocation Most IARs are licensed for insurance sales because this area

is basic to financial security and, as we will explore later, must be taken care of prior to riskingmoney on investing—if you would be prudent IARs must have access to expensive financial planningsoftware if they are to properly fulfill their fiduciary duties to clients These fiduciary duties existedwell prior to the recent Department of Labor fiduciary regulation Just because most IARs havepassed their regulatory test and their firms likely do have significant resources to enable in-depthanalysis of financial strategies for clients is no guarantee that the IAR or firm you choose will do acompetent or honest job Odds are that the IAR is honest, but we must explore ability

Financial planning for most people does not have to be done using sophisticated software models,nor does it always need to address all six components of financial planning (especially if the plan ismerely an annual or semiannual checkup) But this fact makes many people assume that they do notneed real financial planning, or that they can do planning themselves An honest IAR will evaluate

whether you can do this yourself or whether you need modular (rather than comprehensive) financialplanning All are obligated to work in your best interest; all are obligated to have a written contractfor service; all must disclose fees, background, and specialties accurately (all of this in writing) Thismakes IARs a bit easier to scrutinize.

The software used is an indication of sophistication If the professional does not use any of the

following, at least as of 2016 through 2018 (because other packages may come on the market), then Iwould question the level of commitment by the firm The cost for a continually updated assetallocation database is very expensive, but the firm must commit to it for the sake of proper assetallocation for the client You need only be concerned about this if the firm is small, a “boutique” firm,because all the larger brokerages and planning firms do have the best or they have contracted for theirown to be developed Here is the list of acceptable software:

NaviPlan

MoneyGuidePro

eMoney

Morningstar Advisor Workstation

NaviPro Planning Suite

All of these have a particular item in common: Monte Carlo simulation, which requires periodicdatabase updates for asset class behavior

Here is the embarrassing industry secret from before the days of Monte Carlo simulation, anessential asset allocation technique: financial planning always includes asset allocation, and thisresults in a modeling of what would likely become of your nest egg as you add to it or draw from it

… and as it could gain return and sustain losses FMOs provide software that is useful, but ituniformly lacks Monte Carlo simulation and supporting database updating Likewise, it is still verycommon for CPAs to use old software or spreadsheets that lack Monte Carlo simulation

What is the old method of projecting one’s nest egg, and what makes Monte Carlo so essential formost financial planning clients’ needs?

There are thirty-two asset classes, which can be reduced to a dozen or so for simplicity in thesoftware packages or spreadsheets that any professional would use The most important question inany planning is when you might expect your nest egg to deplete, or whether you could still have a nestegg if you live to be 100 or 90 or whatever was assumed, given your rate of inputs (new savings,returns, or interest) and losses (expenses or outlays taken from savings, market losses, etc.) The nestegg could be measured, even divided into asset classes such as small company stocks, conservativestocks, corporate bonds, CDs, etc But whether divided into seven categories or lumped into one,some rate of return was assumed for the value entered Subtractions for expenses (usually adjusted forinflation) that exceeded pension and Social Security distributions would reduce the nest egg or thesegment projected, in the case of several asset classes, but each nest egg amount had to be increased

by some assumed return for that asset class or for the whole nest egg The assumed return could bechanged for sets of years, but it was always a known number Anything wrong with that picture?

Right! The future is not known at all Not only were rates of return not correctly known, no marketlosses were assumed (merely some conservatively assumed rate of return) Worse, no early losseswere assumed, and early losses are the worst because they reduce what is actually available to grow.The picture was always better than reality People did see points where they might exhaust assets andtake some corrective action, such as better budget control or increasing their savings, but the mathwas all dangerously flawed Again, for emphasis: if your CPA, insurance agent, stockbroker, IAR, or

other financial planner’s software uses an assumed rate of return, do not rely on that source fordetailed decision-making.

How does Monte Carlo solve this dilemma? It doesn’t, because we cannot predict the future WhatMonte Carlo predicts is the likelihood—the probability—of reaching a target age without exhaustingyour nest egg How? It mathematically simulates the random changes that have occurred in each assetclass, year by year It does include random losses and gains—but these are at the frequency andmagnitude that were actually recorded in decades of real history It adds in savings if and whenyou’re adding to your savings; it subtracts for your expenses if guaranteed income fails to cover those;

it weights the historical results according to the database’s statistics about return, loss, and what assetclasses move with or in opposite directions to each other; all the behavior historically observed forthe asset class replicates randomly How this is randomized is beyond this discussion, but it makesone simulation Then it makes another, also randomized so it is different in the results (perhaps in thefirst year there were losses in some asset classes you use) Then another A thousand results aresimulated and recorded The number out of a thousand when you still had your nest egg at a given age

is your likelihood of success in reaching that age without exhausting assets This information is

crucial If your likelihood of having at least some nest egg should you attain age 95, still drawing

what you need to pay bills, was only 45%, wouldn’t you like to know that? Wouldn’t that be crucial

in making decisions that would improve your odds of success to, say, 90%?

So if you think it’s even remotely possible you could exhaust your nest egg, you need a rep whouses these more sophisticated software packages They are very expensive, and no do-it-yourselfsoftware exists that you can buy reasonably All of these are designed for professional service tomany clients per year To be fair, there are “robo” online services now that use Monte Carlo, andthese enable avoiding the human advisor But will you really want to learn the investment theory,accounting, and everything behind the software to use such services on your own? It’s possible, butperhaps learning another profession just to help one household is a bit much

Certified Public Accountants (CPA): Many people incorrectly assume that CPAs and

accountants are IARs, or that if they are so registered, they are the best IARs because of expertise inaccounting Not so Consider that a natural bias occurs when one’s training is focused on any onetopic For example, CPAs are trained to devise strategies that save on taxes CPAs are no ordinaryaccountants; they are certified by their competency boards in various subdisciplines of personal andcorporate accounting, but not in financial planning for individuals They might learn to use a softwarepackage, but there’s far more to investing, insuring, and so on than accounting and tax matters CPAscan prove their great value by comparing your current strategy’s resulting tax bill (even year to year)and then comparing it to the taxes you pay if you follow their strategies They will invariably beatyour do-it-yourself strategies, and they do more than your tax preparation: they can help with planningfor which asset might be shielded from taxation for some number of years They really can save youbig … on taxes They really can help your business use cash flow and credit more efficiently But

should your question be “What saves me the most on taxes?” or should your question be longer and

more complex, such as “What achieves my personal goals involving money (charity, saving for abusiness, not having to worry about adequacy of income sources, a legacy for children or a special-needs child), and does so with minimum risk of loss or with maximum wealth generated for thesegoals?” The second question is obviously far more complex, even subjective to a great degree, but it

is clearly more about you than about minimizing what you send to the IRS One of many examples isthe tradeoff between liquidity and likely return, the highest-return versions of which involve

illiquidity and the need to keep exchanging the investment with similar ones through the years tominimize recapture of tax benefits Yes, you need a CPA—for accounting, not financial planning(especially so if the software used lacks Monte Carlo simulation or the CPA does not routinely work

in financial planning) In other words, don’t let the tax tail wag the financial planning dog

Other important financial professionals for your team: Small to mid-sized banks and credit

unions employ, usually without direct employment control, IARs, insurance agents, and investmentbrokers The largest ones have huge organizations for these, and they have full compliance controlonsite I have noticed the level of ability and average age and experience to be noticeably less atthese smaller institutions That may make a difference to you because not all planning is by software,and the optimal solution is rarely the first run of a simulation As with most advisors regardless ofindustry, experience is valuable

But I will offer a serious caution:

Lawrence worked in Charlotte, North Carolina, as a leasing specialist for a regional commercial realty firm He also owned some office rental units in town We spoke many times over three years before he became an investment client, which occurred only after a for-fee financial analysis and plan I could always detect that he wanted to do the planning and investing He was uncomfortable talking about his investments, though He spoke professionally, but never warmly, of his banker and his stockbroker (same firm) Nevertheless, he had long expressed worry that the investments available at his brokerage lacked any guarantees and that the annuities available were also as variable as the mutual funds he had: no guarantee as to principal or return.

Examining his portfolio, I found a very limited selection of management companies used for his funds He paid rather high fees for the funds and also for some managed accounts I diagnosed the need for an annuity requiring close to half of his savings This was because he had expenses that would not stop after he retired, and he had no pension; Social Security was inadequate I diagnosed, among other things, the rate of return to reach his goals, and I solved for the asset allocation mix that would most likely provide that return with minimum risk associated with that required return This allocation was radically different from what he had and required far less risk than his current posture forced upon him His current allocation, very aggressive, was recommended by his broker without any such diagnosis ever being done; it was based upon hunches and news flashes from the investment gurus that the bank’s brokerage had in its research department He thanked me, paid his fee, and referred me to several friends, but still did not invest for many months.

Eventually—in the fall of 2008—the market corrected As I had advised him, he took a serious loss, but his realty was worst hit He called me about all the losses and explained that the bank had called a loan (made it due immediately) Much of his portfolio secured that loan He explained in tears, embarrassed and angry, that he only used the bank’s stock brokerage because it offered a low rate on his commercial realty loan Now, he had just days to decide whether to pay off the loan with cash or allow the bank to liquidate already badly devalued securities in his brokerage account There’s much to be said for one-stop shopping, but I know one man who had to climb his mountain over again paying for that decision.

A banker or lending officer, therefore, is not a financial planner or investment or insurance broker,

and again, just because they might have the licenses, I caution against even the temptation to allowinfluence over your credit use to extend or even be assumed to extend to your investment decisions.You are asking for sleepless nights even if nothing actually goes wrong, because you will feelintimidated or influenced by the power that debt and its representatives can have over you

Bank trust departments have money managers Sometimes these are also financial planners.

Remember, though, what financial planners do for you: They examine your objectives and attempt tofind the most efficient way to meet all objectives They optimize using both computer modeling ofscenarios and experienced judgment because optimization is not completely a mathematical problem.Bank trust department officers have the perspective of money management and lending and aredefinitely fiduciaries who make a contract to be that for you But if their professional training is

narrow, say in lending and money management, then their perspective may limit their solutions.Remember the subconscious bias that CPAs are susceptible to: If your primary tool is a hammer,everything looks like a nail Comprehensive financial planning should, for most consumers, addressall six areas of the financial planning process and do so without bias for or against any particularproduct or version of these (mutual funds, managed accounts, life insurance, variable or fixedannuities, equity lines of credit, etc.).

Tax attorneys, business brokers, and other consultants: These experts may have a place

on your team of advisors, but typically they are needed at specific points, either to solve a problemlike readying a business for sale or to deal with a tax conflict I have seen situations when they areneeded at the start of a planning engagement in order to clarify problems and processes that will have

to be navigated eventually (readying a business for sale) or avoided (tax audits and challenges, forms

of a business sale to minimize capital gains tax, etc.)

Estate planning attorneys are crucial for making sure that your estate-related desires are

accommodated They are essential when a client has either a large estate or any complex challenges,regardless of estate size Estate planning attorneys are needed for preparing documents that dictate theaccommodations you want in events of incapacitation, incompetency, partnership or marriagedissolution, death, and many other situations These desires may include provisions in trusts; wills;beneficiary designations for how your estate is managed, distributed, and preserved; and even howyour business may continue while you recover from incapacitation Their services and theconsiderations these specialists help with are explored in the estate planning chapter, but for now,remember this: They are specialists, and even if they broaden their practices to financial planning,their perspective and predominant training has the natural bias of their predominant training Estateplanning attorneys belong on your team, not coordinating your team You run your team, and would dowell to let a financial planner, after an analysis, help you set the agenda for the specialists.Otherwise, personalities will conflict and your priorities will not get well coordinated; you’ll end uppaying for more of the specialists’ time than necessary

Financial planners, especially Certified Financial Planners, are specifically trained to understand

these specialists and to efficiently coordinate their paid time for you The specialists generally do nothave this training The best way to form your team is to have your financial planner coordinate whenthey must be retained Allow your financial planner to head the team, to act for you in your bestinterest This places the advisor with the broadest experience in a position to efficiently integrateanalyses and avoid conflicts You at least need an estate planning attorney (see last chapter) and afinancial planner But make sure—never assume—that the planner’s main competency is financialplanning

Before we move on those do-it-yourself software packages, let’s address the credentials andtraining that should influence your choice of a planner or broker You may not need all of these tohave been achieved by your agent or broker, but if you need analytical work—real andcomprehensive financial planning—then you will want as many of these as possible because usingthat software is far from intuitive, and not at all as simple as doing your own taxes for your business

or yourself!

The training programs provided by the larger financial firms are vast, and they take it seriously.That’s why independents usually come from larger firms and start their own financial planningboutiques or join one Look for broad training in a financial planner; look especially for training inhow to coordinate the efforts of members of your advisory team As noted, sometimes a plan should

not be created until certain specialists have performed an analysis (recall the need for a businessmarketing consultant prior to allocating resources for financial investment) But a well-trainedplanner will recognize these steps during the initial consultation with you; he or she is trained to askthe right questions and is trained specifically in how to recognize when to call in another professionaland efficiently prescribe agendas and time you will have to buy from other specialists.

Credentials, Real and Imagined

The gold standard for personal financial planning, including working with teams of specialists, is the

Certified Financial Planner The CFP Board of Standards has rigorous and, most importantly, broad

education in all six areas of financial planning and related matters CFPs are subject to rigorouscontinuing education (CE) and ethical training every two years, far more than is required forinsurance agents or CPAs who often use helpful software that identifies whether you need an annuity,etc CFP professionals know how to recognize when a software package has suggested something thatmerely appears to optimize a client’s resources and to-dos One cannot simply complete the CFPcourses and exams to become a CFP; one must have a minimum of three years of experience in themajor functions of financial planning before one can use “the mark.” Indeed, it is the US and CanadianCFP board that actually promoted the formal process of financial planning and then conveyed thisabroad to most other countries, and was among the major forces influencing governments to devisefairly similar regulatory structures worldwide CFPs are extensively trained in the related counselingand personal and subjective considerations that influence client desires They integrate thesetechnical analyses among the six areas with the client’s subjective goals in mind, often changing thosegoals and priorities by identifying inadequate resources or incompatibilities Here’s the secret: Use aCFP as your “officer-in-charge,” because he or she has the generalist training to manage the team and

to integrate all six areas of financial planning

So, are the other designations out there bogus? No But the big secret is that one other designation

is now equivalent to the CFP in producing well-trained generalists Many years ago, the AmericanCollege of Financial Services (in Bryn Mawr, Pennsylvania) began a generalist program forinsurance agents who wanted to expand their expertise beyond insurance-related issues It developed

and expanded the Chartered Financial Consultant (ChFC) designation Today, while ChFC training

is slightly more focused on assisting business people and planning for business entities than the CFP,the ChFC is equal to the CFP as training for personal financial planning

The American College had earlier devised an insurance-focused curriculum that produces genuine

experts in personal and business insurance: the Chartered Life Underwriter program The American College also offers the RICP, Retirement Income Certified Professional designation, which is the

premier specialty training program for retirement-related issues affecting spendable income ofretirees An RICP generally has more specific tax strategy training than most CPAs and keeps abreast

of health insurance and related senior issues Any certification from the American College, such as

Chartered Advisor for Senior Living, can be trusted as strong technical training for professionals The Life Underwriter Training Council Fellow (LUTCF) program is another insurance-based, but

somewhat more general, personal and business financial planning designation LUTCF-certifiedpeople are top specialists in their field

The Investment Management Consultants Association offers several certification programs, all

focused on investment management, some highly advanced to encompass broad wealth management

issues facing very high net worth clients This is the premier educational source for wealthmanagement specialties.

Chartered Financial Analyst (from the CFA Institute) and Certified Investment Performance Measurement Program designations: These are experts in securities trading and evaluation,

generally on staff as support for brokerage recommendations (tips) and also in support of mutual fundand money managers They rarely help individual clients unless the amount to be managed wellexceeds a million dollars A stockbroker who has graduated to this level of expertise is a trulyvaluable asset for anyone needing active money management, as distinct from merely asset allocationhelp Whether active management is needed at the consumer level, however, is doubtful; see research

on this in the accumulation planning chapter

Certified Commercial Investment Member (CCIM Institute): Real estate is a major asset

category and a specialty in and of itself There are specialties within this asset category Thisdesignation means commercial and rental realty expertise, including development and decision andfinancing management expertise If you own or want to own a significant commercial property ordevelop one, you definitely need a CCIM to guide you There are other investment-related

designations, such as the Resort and Second-Home Property Specialist (RSPS) certification This

specialist is a must to help your decision-making in this subcategory of realty Residential realty alsohas a number of specialties and expert training certifications For your particular need, visit the

NAR.com website

The International Association of Business Brokers trains two types of business broker Certified

Business Intermediaries are analytically competent brokers of businesses, small to mid-sized going

concerns worth up to five million dollars or so They can determine and justify the value of a businessand represent both buyers and sellers The only caution I have here is this: There are no businessbroker regulators, and generally, even if real estate or leasing is involved, real estate commissionsand like watchdog bodies refrain from getting involved in consumer complaints because it is deemedthat business owners can look out for themselves

Many people believe that if a business has real estate or would transfer rights in real estate, then aRealtor or even a CCIM is needed Not necessarily If the business is worth more as a going concernthan its realty, then a CBI is definitely the better choice to use because the value is derived from itsoperations and values beyond real estate

For deals at and above the five-million-dollar mark, consider using a mergers and acquisitions

(M&A) expert The IBBA-trained expert in M&A is a Master Intermediary, or M&AMI More on

this in my next book on business financial planning

What if a professional you like has none of these or other certifications? These designations arewhat the best-trained specialists take the time to pursue or finish But there are other designations.Again, a genuine financial planner is trained to evaluate these for you because helping you puttogether a team actually is an area of training that a CFP or ChFC has mastered Find and consult with

a CFP or a ChFC to help you assemble your team, and be open to the possibility that one or moreadvisors you like might not be best Yes, as the client, you are in charge of these decisions aboutselection of specialists But using a CFP or ChFC—a generalist—to help you is likely to pay bigdividends in your decision-making

What if a professional has “Senior Advisor” or other credentials so often called bogus in articles

of popular magazines? It is true that many programs have arisen that produce certificates for the wall,yet have scant technical content Since many keep coming up, here is your best general rule: Trust the

American College of Financial Services, the Financial Planning Association, the CFP Board ofStandards, and the various actual academic colleges of strong reputation that devise programs or thatare conduits for these three organizations’ programs Other sources? Let them grow into the bigleague before you place credence.

Financial planners work with you to revise, if needed, an initial plan and they can be decisionsupport for engaging other professionals as well Personal and business financial planners(whichever of the two you may need) help integrate all to-dos and allocations of your resources, andthey can help you set agendas and interview specialists But what if you are a do-it-yourselfer, andhave heard about robo-planners and using your own software?

Software Packages: With all the talk these days about online robo-planning and do-it-yourself

software packages, one would think that the wise course would be to eliminate the possibility ofdishonest or incompetent advice by using this technology These two approaches to “advisor-lessplanning” are nearly identical, except that robo-planning starts with much more interactivequestioning and programmed paths of initial surveying of the client than one finds with a DIYsoftware package Until actual artificial intelligence that also possesses personal concern and insight

is devised, I must offer serious caution with either DIY approach First, let’s examine what happenswith “robo” packages that brokerages now offer clients

One finance industry “secret” is that most brokerages and financial firms have employmentcontracts that severely reduce compensation to the advisor or broker for transactions or managementfees in accounts under $250,000 or so You may have begun to suspect that anyway, since whathappens is that young, less experienced advisors are given these smaller accounts by the producerswho have these helpers on their teams It is a sensible business decision, but it deprives many clients

of the most experienced advisor’s insight If that insight had no value, then I would advocate for planning or DIY packages

robo-As you progress through the stories and facts and “secrets” in this book, you will begin to see whythere is no substitute for human counseling yet As noted earlier, Cerulli studies and a strongconsensus in the industry find that the public is markedly less trusting We all know that people seekless human contact today, but human relationships are both personally rewarding and practical The

US Navy had a saying: “Bad stuff in, bad stuff out.” (Okay, that’s not exactly how it goes, but you getthe idea.) If you enter data, these packages will maximize after-tax wealth while satisfying theconstraints that the “interview” builds during its questioning or input phase

What’s deficient about that? Nothing, except that tax law changes over time and the course of actionthat maximizes wealth could fail to adequately hedge for this, to enable a shifting of strategy Thewealth-maximizing course of action recommended could involve long-term commitment to a product,such as a real estate investment trust (REIT) or other tax shelter, but the client may discover that such

a tax strategy relies on continued tax-sheltered exchanging into similar products over the years or elsetax recapture would result, or other penalties, and it could also involve depriving the client of neededliquidity despite planning for a cash reserve fund Such software packages all assume a particular taxbracket and pace of savings beyond one’s expenses, but these packages never model for what canoccur when a person is laid off long-term or is forced to change professions due to disability None

of these packages explore the personal need to influence children’s decisions from beyond the grave(estate planning is especially susceptible to this limitation of software) None of these packages help

a client make intelligent decisions in deciding how much money to pull from a business for home orpersonal savings use None counsel with a client about the prudence of transitioning from employment

to converting a hobby to a business, not to mention the expenses involved; nor do any counsel a client

to consider changing their budget priorities; none help with decisions of whether to mortgage a home

or asset or which types of credit products to obtain None address investment in oneself (new skills)

at all, yet this is usually one’s best investment! None counsel a client about potential liabilities,beyond the general to-do of “please consider an umbrella liability policy”—but those are not all-risk/all-liabilities!

None of these packages will distinguish between the need for any of the types of lifelong lifeinsurance versus term coverage, because this and many other issues are matters of subjective andexperienced counseling that require human interaction and judgment; they are not mathematicalmodeling problems Likewise, the decision to acquire a long-term care insurance policy as a stand-alone ongoing premium policy, versus a single-premium policy that is also a life or an annuity policy,cannot be modeled (the question revolves around client preference for never having premiumincreases versus committing to ongoing premiums); it also is tied up in the decision to have a commonpool of long-term care insurance either spouse can access versus two policies, one for each Thesesoftware packages cannot account for how couples view money: all shared in common versus asystem of mine, yours, and ours The myriad budgeting decisions, insuring decisions, and investmentposturing and liquidity decisions cannot be modeled, and as a result, the “optimal” set ofrecommendations are left vague or sometimes wrong for a given couple Yes, these packages allsuffer from the impossibility of total customization, despite the strides made in devising these models.The result is always from mathematically modeling a human life; impossible The software is merely

a help (but interpreted as a final answer) in finding optimal courses of action; software can only showcash flows under various scenarios and resulting wealth depletion or buildup

Even if these packages produce a to-do list that makes sense, which products are best forimplementation? Some products are stand-alone and some are combination products; some offerbetter deals for lump deposit and others are easier on the budget (now) if you make deposits orpayments over time Some involve risk in the future but are attractive now (variable rate mortgagesversus fixed, for example, and ongoing but possibly increasing premium long-term care insuranceversus single-premium versions) Will you bet the farm on constructing a tax-free retirement only todiscover that your tax bet was right, but the product underperformed what taxable but more liquidstrategies could achieve? At the very least, you need a real planner for counseling on these issues andalso for product selection

But for robo-planning for anyone who would rather avoid humans, cannot trust, or believes he orshe is a financial planner, DIY software is the perfect solution Here are two ego-whacking truths that

a wise consumer should consider: As Will Rogers once said, “Everybody is ignorant, only ondifferent subjects.” Consider also: If a financial planner you interviewed presented you his or herresume and it looked pretty much the same as your own, would you hire him or her?

The objective of most of these software packages is to meet a constrained goal Constraints includeincome, expenses and savings outlays, and several personal goals, like assuring some of your incomecontinues to a widow or child There are many goals to choose from Most maximize wealth at theend of life, given the constraints you set But is your goal to maximize wealth; to spend it all downwith reasonable surety that you would never exhaust that high level of income needed for suchexpenditures? In the end, estate planning issues and even spiritual issues tend to predominate inhuman lives That’s right: Most, not some, people generate wealth only to find that the form ofownership left them open to lawsuits when someone dies in their pool and wasn’t even authorized to

be there, or they find that they can’t bear to see a starving child on TV while they are eating their

always-sumptuous meal Hmm Eventually, people begin to consider stewardship of their money andresources, rather than optimizing their after-tax wealth Then, the optimization takes on even moreimpossible-to-model dimensions.

Methodology, the “Big Secret”

Whether you are a DIY planner, use a non-RIA broker equipped with helpful but not comprehensiveplanning software, use a robo-planning package (with or without a consultant to guide you), or get anactual financial planner to perform a comprehensive analysis, the challenges of planning methodologyare the same You must understand the big picture to do this in order to interpret your planner’s

“grand plan.” Perspective first: The overall reason that financial planning is so complicated is onlypartly the many inter-workings of tax, budget, investment attributes and the like (as if that’s notenough) The main reason is that to make such complex decisions that have so many variables, allexcept one must be held constant, and then the one variable tried to examine results Then, there must

be successive iterations of this one-variable change and examination of results … over and overagain

There are two main tools for getting this enormous task done Number one is that a competentplanner has seen so many cases of what works well versus poorly over the years that mostpossibilities can be eliminated; what is likely to work well is what he or she starts with Clientsassist this educated and intuitive human judgment factor by being organized (a good budget, completeorganization of recent statements, account descriptions, and client-prioritized concerns) A goodplanner then inputs all these data to modeling software (or a DIYer does, using a robo-planner), beingvery careful to correctly characterize asset classes, policy attributes, tax characterizations (like assetbasis, etc.), debt terms; everything Most people using robo-planners think they are done at this pointbecause it is possible to determine from this input and output, for example, whether current strategieswill likely result in running out of income sources during retirement or failing to achieve variousother goals But obviously, the current results output is merely a starting point

After this, a good planner will find an optimal asset allocation that stretches out the likely assetexhaustion date, and will use some limit of portfolio variability (likely risk to value loss) The bestway, by far, to optimize a portfolio for minimum risk to attain a particular accumulation goal is to useMonte Carlo simulation Only this process links the “efficient portfolio” (asset allocation that has theminimum risk associated with pursuing a particular rate of return) to your retirement budget and otheroutlays to show likelihood of success There simply is no better method yet developed That’s justiteration, or “tweak” number one

Number two may be that the planner realizes that you have a high priority for not exhausting anincome source that covers at least the minimum expenses you cannot get away from The tools for thatare various annuities (pension and Social Security help) To do that, the planner assumes yourportfolio has a constraint: Part is hypothetically assigned to a low, fixed-rate asset class and the cashflow out of the annuity is added at retirement to your other incomes A separate budgeting is done forthose unavoidable expenses and how they may inflate, and this is matched against the total guaranteedincome Likewise, if you specify the need for gifting or for lifelong insurance, or whatever, theseanticipated changes are all modeled and a new asset allocation is given for your pure investments;additional savings that may be modeled (i.e., disposable income identified from your budget and/orfrom recommended belt-tightening or tax savings the planner might recommend you act to obtain) all

get added.

The model continues to change the “recommended” results as new constraints that make sense(your priorities) are added The planner goes through five to ten re-workings of suspectedcombinations of changes to your various strategies, saving each one and eliminating inferior strategycombinations Eventually, by changing only one strategy or assumption at a time, the software hashelped the human find at least the most likely best course of action to reach all goals with reasonableconfidence—or it has shown that some goals cannot be reached fully or at all The planner and clientmust then put their heads together to recheck priorities and possibly to go “on the cheap” for somestrategies in order to have full funding for the most important goals

The reason that discount brokerages have begun adding the optional cost of a human consultant totheir robo-planner platforms is because this process really requires expert understanding of likelybest solutions in order to try those in the modeling; most consumers lack this experience and are farmore likely to miss some solutions that should become constraints A simple example: Suppose youneed long-term care coverage and assume that an ongoing premium policy should be modeled,changing the budget projections But you did not think about future premium increases which, for you,might be best avoided by means of the guarantee available in a single-premium version of LTCcoverage So you underestimate future outlays (yikes) and assume incorrectly that your portfolio isunreduced by the investment in such a single-premium product A few years down the road, youexperience a long and deep market correction and, fearing its worsening, move your portfolio tomostly cash Now you have locked-in losses, some of which would have been avoided in a single-premium LTC annuity product, and then you get a rate increase that nearly doubles your LTCpremium You then have to draw more from your “safe” portfolio A few years after that, you moveback into the stock market, but you have far less to put in now because you realized market losses on

a larger portfolio that you would still have if you had put some into the guaranteed product, andbecause you picked an LTC product whose premiums are now a serious burden Your financial planblows up, and it was all because professional counsel and judgment was lacking in your originalplan Such failures can be caused by missing a tax strategy that the software will not automaticallypropose, or because a pension survivorship decision was poorly informed (no comprehensivefinancial planning has that support in it either) Don’t worry, though, the fact that both professionaland consumer-operated software lacks “experiential judgment” is compensated for throughout thisbook Many of these considerations are “secrets” or very poorly understood strategies and facts thatthis text clarifies

There really is no maximizing solution in the absence of perfect foresight There is only prudentstewardship of money Stewardship is about being prudent in the managing of resources to see to yourresponsibilities and guarantee them, while using whatever else can be generated for moral andprudent purposes Whoever dies with the most toys is not the winner Whoever dies with the mostprudently stewarded resources is a winner

Chapter 2

FINANCIAL POSITION, BUDGET, AND CASH

MANAGEMENT

Prudence and Priorities

Fiscal prudence has many important attributes First, it means building a base of financial securityfirst Then, protect your earning power and assets with insurance and risk-hedging techniques Later,take some risks with savings to build up funds for known future needs, such as funding children’scollege or one’s own further education or specialty training or buying or starting a business Theseare often illustrated by advisors as a building with levels or as a pyramid with a base andsuccessively more advanced levels Consider also that charity, whether tax advantaged or not, is ahelp to the soul and a kindness that will return to you—at least as a sense of satisfaction Meritoriousstewardship of your resources includes good works and perhaps tithing, but prudence places you in aposition to help others

Prudence also means risking only what you can afford to lose It includes prioritizing the allocation

of disposable income toward short-term demands first A prudent individual hedges risk of loss (bothvia insurance and other hedging strategies) and starts with wise allocation of earnings toward knownexpenses first, likely but unknown expenses second, and finally unlikely but catastrophic expenses.Some planners refer to segmented cash reserves as “buckets,” but I will use the term “tiers.” Onlyafter filling these tiers is it wise to start saving for bigger, more long-term goals Goals includebuying a house, funding college, enlarging the cash reserves, buying a business, retiring andprotections for retirement income sources—and then, at the pinnacle, leaving legacies Consider thewisdom and practicality of addressing goals as successively higher levels of a pyramid

These progressions are not “one and done” because you will need to improve and maintain yourcoverages and asset management But this chart does show how early to begin devoting attention andpriority to various resources For example, all six areas of financial planning should be reviewed atleast twice yearly, but the stage of life determines when to focus major resources on specificaccounts, such as Social Security decisions or long-term care policy selection.

Three-Tiered Cash Reserves

You don’t need a financial advisor to know you need a cash reserve But how that is assembledprofoundly affects your chances of success Optimally, you should use three tiers and assemble aspecial kind of budget—not any old budget—in order to estimate how much cash to place in each.These tiers have specific purposes, ready for specific events, and you will need this structureregardless of whether you are young, approaching retirement, or long-since retired

Tier 1 is the type most people think of: totally liquid cash Resign yourself to scant return becauseyou keep moving money in and out, and no institution will pay much on that The purpose is to placemoney there for a month or two, tops—money that is actually spent on monthly expenses, then

replenished with earnings or other income Keeping this down to known expenses for two months isimportant because the return will be so low Use a checking account and perhaps also a money marketfund Often a fine deal can be had with a money market fund that earns enough interest to coverchecking fees or get them waived Even if you use a credit card for groceries, this fund pays off thecharges before interest is applicable Be sure to read the credit card terms to know when interest isactually applied! This fund is for known, repeating expenses, plus an extra month’s worth for modestdiscretionary expenditures.

Tier 2 is for expenditures that you can reasonably measure if you keep a budget that shows intendedexpenditures versus actual expenditures The extra expenditures represent either spending you shouldconsider trimming or expenditures you know are likely to occur sometime during the year, yet are notprecisely known as to amount or timing Track this budget, using a spreadsheet or Quicken orwhatever, over a year so you can revise your estimate of the needed size of your cash reserves and soyou can get a handle on disposable income (Planners need to have this information to project theeffect of extra savings that you might be able to capture.) Examples of items to place in the budgetinclude maintenance on your vehicle, taking visitors out to eat, replacement of things that generallytake a year to wear out, and vacations Getting reasonable estimates of these expenses requires a two-column budget in a spreadsheet or Quicken or similar software packages If you fail to record what isactually spent compared to what was intended, or if you do not have all categories on the spreadsheet,then you will underestimate your expenses of this type There is merit in expanding the time horizonfor this fund up to five years, and including estimated home repairs and the like This fund shouldreceive excess funds from Tier 1 whenever that first tier exceeds the size you have calculated (fromyour budget) you need It also should be invested in funds that seek the highest return you can findwith no more of an early withdrawal penalty than the interest it is likely to earn in a year; noaggressive bond funds, no stocks at all unless it is a multi-year fund (up to five) Even then, youradvisor must be asked to help you select investments that have minimal risk of market loss That’sbecause when you need these funds, you really need them!

Why an exclamation point? Well, there are other potential expenses to estimate and increase thesize of the fund by that number: What if you have a brief disability or job loss? Tier 2 is for thesecontingencies, not just maintenance items Besides, if you have a fund that can cover a year of likelymaintenance expenses plus all expenses for a year in case you are out of work, then you can save ondisability insurance big-time by getting a six-month or longer waiting period (more on this in the nextchapter) The same benefit can be captured for health insurance, homeowner’s and auto insurance,even the deductible for Errors & Omissions insurance for architects, teachers, engineers, and otherprofessionals All deductibles for the applicable time frames should be covered by Tier 2 How doyou decide the length of time to use in estimating maintenance, possible out-of-work time, contingentliabilities, and deductibles? Again, most people should calculate this for at least one year, and pickinvestments for it that have negligible potential for market loss if you withdraw funds during adownturn Your appetite for risk and your ability to build up the fund will determine this

Tier 3 covers contingent expenses or outlays that have a reasonable probability of occurring, butmight actually never occur It is a ten-year fund (covering from the end of Tier 2’s time horizon out toten years) Because you might never need to access this fund, it should be exposed to whatever marketrisk you are willing to incur, but not as much as for funds destined for long-term goals Counsel withyour advisor and be sure to have him or her model the buildup and use of this fund After this fund isfilled up, excess money should flow to nonqualified investments for longer-term goals, increasingqualified retirement savings beyond the minimum you should always invest (capture the plan’s free

match!), and toward improvements to your risk management, which is mostly insurances but alsoother techniques Do not include college or trade school expenses or buildup of funds to buy abusiness or second home; these are separate funds addressed in the accumulation chapter.

The types of investments generally appropriate for these tiers are in the table below, buteveryone’s situation and risk tolerance is different, so be sure to have a financial planner model theseassets and flows of money so that you can make a decision about what is practical for you This fundcan include life insurance cash values, but be certain to have the planner estimate conservatively whatthe excess is—if any—over what is needed to keep it in force through age 100; if there is not enoughbuildup to do this, do not consider any part of it as a Tier 3 cash reserve You might consider long-term equities-based certificates (equity-linked CDs), the type offered by HSBC Bank, Ameriprise,etc Revise your strategy whenever your income and expenses change significantly, and review theprogress of your plan at least every six months

Notice that filling these tiers cannot happen without income that exceeds expenses Also notice that

a cash reserve is the base support for risk management on the pyramid of financial stability andsuccess But what if you become disabled and cannot earn? Some basic amount of disability coverage

is essential while you build the cash reserve (if you are in the building phase of your life) Up to age

65, you are four times more likely to have a long disability than to die So even if you cannot afford tosave and to get life insurance, be certain to get disability coverage at work; once you get a raise and

at least complete Tier 2 cash reserves, get a personally owned disability policy you can count on ifyou change jobs or get surprised by fine print in the group policy from work (more on that nextchapter, where we will also examine car maintenance warranties and other risk hedges)

Note also that capturing an employer match in a qualified retirement plan is essential, even if yourbudget is tight That’s because failing to do so sacrifices free money! Be disciplined in your spendingfor your sake and for your family’s

What is this “aggressive money market fund” noted in the table above? Everybody knows there is

no risk in a money market fund, right?

I stood up to ask something of fellow financial advisor Charles in the cubicle next to mine We often worked together to help certain clients, and all knew of this team approach to sharing client information Charles’s hand hovered over his phone, actually shaking I thought at first there was a medical problem, but he was just twenty-eight and quite fit As I watched, his eyes moved from his computer monitor to his notepad to his phone and back He picked up a pen and wrote, “John, I have to inform you …” He stopped He looked back at his screen I could not help noticing the gain-loss line: a loss of over $40,000 from the prior day, and there was a red asterisk beside that line It was summer 2008, and accounts large and small were taking a beating The branch manager had instructed us to call and reassure clients, and to have them move money market and other available funds into the securities market to buy in cheap.

My economics training and additional study were enough to cause me to have gotten most of my clients into defensive stances over the prior spring; I claim no crystal ball, but I knew the past year’s troubled real estate market would harm the rest of the economy, stocks, and most bonds as a result.

“Charles? Can I help? Are you okay?”

There was no response He scribbled what appeared to be a script on the pad, then grabbed the phone and swiftly dialed his client A drop of sweat rolled from Charles’s temple, but he did not seem to notice.

“John,” he quavered, “I appreciate your order to switch from the money market to the aggressive funds we discussed this morning but—”

He switched the phone to his other ear, listened, and responded, “Right, it would be a good move But I can’t execute it, John.”

His client’s tone rose, though I could still not make it out.

“John, the main money fund has been devalued and—”

The receiver’s shift in position let me hear the client now It sounded like, “What do you mean, devalued? It’s a money market fund, for Chrissake, a million plus three or four percent interest.”

“John, when I took over your account from the last rep, I didn’t realize it could lose value Its management just attempts to achieve a higher-than-market return by using options and derivatives—”

Charles shifted the phone again, and I could no longer hear his client.

“No, it’s not FDIC ins—”

Unintelligible yelling now sounded from the handset.

“John, it can’t liquidate at all, even though you’ll see almost a twenty percent loss The managers will not redeem shares It’s frozen; no estimate of when funds can release I can’t execute your order, and you’d realize a big loss even if I could.”

As the weeks progressed, the worsening equities market meant that not shifting John’s money market funds to aggressive stocks, as he wanted, actually avoided further losses But John’s other assets took the heaviest beating, down over 60% by the end of October Charles rebuilt the relationship which, after all, he had inherited from a departing representative, and John held on for years to wait out the market correction.

In the end, Ameriprise came up with funds of its own to make investors whole—not all broker-dealers did that—and then sued Reserve Management Co and other such aggressive managers of “money market funds” to try to recover some of the funds it extended to clients.

The lesson here is that you do need a well-trained and astute advisor to at least explain what risksexist and to not let you, the client, assume things that are commonly assumed but wrong

Sometimes the advisor does all of these good things for clients, but the client is impulsive or doesnot fully respect the advisor’s expertise In such cases, even budget and debt management snafus canoccur and have ripple effects that harm financial success in the longer term Consider Bill:

I met Bill, a friend of my wife Laura, in 1987 He first became a client in the late 1990s, soon after marrying Bill’s wife was the higher earner, so when they had their first child, he quit his job and became a stay-at-home dad Bill eventually had reason to suspect his wife of infidelity His life began to crash His wife left for another man shortly before his father died The inheritance was a help, but not enough in itself to fund his dreams So began a trying property settlement negotiation with my assistance concerning his wife’s pension, savings, and an effort to get him to

be serious about budgeting Bill loved the idea of a budget, but rejected the work and lifestyle changes needed to make his financial plan work He spent to avoid depression: meals out, new tools, etc I offered several cautions, knowing he did not take advice well, but had no idea how impulsive his pain had made him.

Bill came to me one day and said, “I don’t need this budget anymore because the mortgage is gone and there’s plenty of room for all those things you cautioned against.”

“Wow So Terri gave in and paid it off, or you got your attorney to make her commit to that?”

“No, we haven’t finished the property settlement But I just paid off my half of the mortgage, and the rest she’ll have

to deal with.”

“I don’t understand, Bill You and she are ‘jointly and severally’ obligated If you paid off your half, I suppose you mean she also paid—”

“I don’t care what she pays, mine is done I just came from the bank and—oh, can I have some of that Merlot?”

“Sure I think you’re going to need a drink if I understand you correctly You still have to pay on that mortgage if she doesn’t Plus—”

“She’ll pay; besides, her payments will be half now.”

“Did you get her to refinance in her own name, then?”

“You’re not listening, Dan No, she didn’t refinance I told you I paid my half off because I can’t sleep having to dip into what’s left of the inheritance and credit cards to make ends meet Now there’s breathing room.”

“Just a minute.” I rifled through my files to find a copy of the promissory note “Bill, there’s nothing about payments reducing when either of you pays this down, and you both are liable for whatever the balance is at any given time Look.”

He resisted my offer of the note’s verbiage and gulped some wine.

“Bill, even if you eventually negotiate a settlement that gets her to pay the mortgage and lets you stay in the house, you both remain on this note Also, the payments can be sought from either or both of you regardless You each are liable for the entire mortgage and paying half down just reduced Terri’s debt by half of what you paid.”

Bill was shocked and shamed His attorney read him the riot act about acting without talking to him first (I was kinder about his impulsiveness but had a similar message) As I expected, Terri laughed and instructed her attorney to give nothing back of this windfall Bill, like so many people I know, remains in our prayers.

So, take from this two lessons:

Budget Tracking: Target vs Actual

First, you must create a budget, with intended versus actual expenses, and make adjustmentsaccordingly This information directs the three-tier cash reserve strategy Be certain to list allexpenses, even those not due monthly but appearing randomly (car expenses, for example, cannotstand alone Expected maintenance is a separate line item from saving for the next car; same approachfor furniture, appliance, and clothing replacement)

Second, even if you are a DIY type, respect and use the advice of professionals prior to majorfinancial and obligation-related decisions Don’t make some large outlay, like a boat, uninformedmortgage pay-down, etc., without either being truly rich or talking to your planner first He or she cancheck your assumptions and model the effects of your desires to advise you well on what is reallyprudent and how it affects your future financial success

Old habits die hard, and more prudent ones get adopted even harder I understand Everyone hasheard “pay yourself first,” meaning to put money away for retirement before you spend money onentertainment or luxury But some entertainment or luxury can help keep you sane Moreover, some

“investment” in fun things you love can make you money later Just don’t let spending become likeeating a half-gallon of ice cream when you’re sad!

What if you were building your three-tier cash reserves but really loved your hobby ofwoodworking? You might waste money on that hobby, or it might become something that can actuallysustain you if you have a layoff Investing in yourself, at least if you do build those cash reserves, canenable you to develop new skills that can get you promoted or a better job Consider buying learningexperiences that have real potential and are personally rewarding Few investments pay off betterthan those that enable you to earn more or to have a fallback career

Bill struggled with abandonment, heartache, and depression in addition to not being the type whotakes advice Mood and anxiety definitely affect your finances and your propensity to seek and

execute good advice After all, you must believe that there is hope in a brighter future.

Develop or hone money habits Stick to a budget, not having all you want but appreciating what youhave Live within your means, with “buyer’s impulse control”; don’t worship cable or phone choices.Save in a self-disciplined fashion Choose “healthy”; volunteer Learn self-reliance; invest in how-tobooks and tools Don’t buy as much house or automobile as you can afford; rather, keep paymentslow Be especially aware of the fact that cars are depreciating—not appreciating—assets, soconsider buying used After-market car and appliance warranties are overpriced; build a cash reservefor maintenance surprises

My old employer from January 2008 to October 2010 used a marketing device called the “DreamBook.” The company stopped doing this, perhaps because people saw it as hokey or even as a ploy toassociate the planner with hope for their dreams But it really was a helpful process that you can do

on your own Take time to write down (no numbers) what you want out of life or retirement Take arelaxing weekend with your spouse to do this Examine every aspect of life; brainstorm from thespiritual to business starts or concerns for your employees if you sell your business (as applicable);every major aspect of life Rate these priorities numerically or rewrite your notes so as to place them

in priority on your paper Share this with your planner A good financial planner will then help youput these dreams in priority and put numbers (financial demands) to how these dreams can becomereality The cost of travel to visit grandchildren, charity, and estate planning arrangements; all ofthese represent financial demands Once they are translated from written dreams to estimates of thedemand on your resources, they can be mathematically modeled If the plan is found impracticable,you and the planner can continue to prioritize and examine strategies that can help make at least mostwork out Then, the plan gets updated at least every six months as circumstances, actual gains andlosses, etc cause you to adjust your course toward the various goals Some dreams must bediscarded, others easily funded, but if you fail to plan, your “winging-it” plan will likely fail

Back to the budget spreadsheet or program for a moment Inflation will affect projections after ayear or so This is easily handled for you by your financial planner (the most detailed planning andmodeling), insurance agent (rough modeling but still useful), or stockbroker (no planning to verysophisticated, depending upon the team that services you) Some line items inflate faster than others(nursing home and in-home care inflate faster than medical expenses; medical expenses inflate fasterthan food, etc.) If you are a DIY type, please be sure to research the reasonably expected rates ofinflation for these various categories If you have a pension, research what expectations the plan hasfor inflating the pension, if at all Look at the history of Social Security inflation (quite a politicalfootball; more so for Medicare) Be patient in researching these estimates online; many different onesare reasonable, and you must make some assumptions If you or your planner make no reasonableassumption for inflation, you are wasting your time, because you will not even approach a realisticpicture of the state of your future finances Don’t forget to model (or have your planner model) thecessation of certain expenses, like work clothing or hobby expenses after an advanced age In fact,travel and entertainment expenses diminish after age 85 or so because most people no longer have thephysical energy or mobility for some of these activities Likewise, Medicare supplement deductiblesand premiums will rise as you find yourself forced to switch to plans that cover more expenses: youare likely to have more maladies even if you are vigorous and healthy now

Anyone can have a torpedo hit their income: job loss, disability, failure or temporary interruption

of income sources, from employer bankruptcy to pension miscalculations and recoupment ofoverpayments to a retiree, or failure of an investment A similar assumption can be made aboutexpenses, leading to exhausting assets due to unforeseen increases in outlays; uninsured liabilities

Think boating or hunting accidents, favors to relatives in need, collapse of the business you sold andreceived an over-time payoff for, or which can only keep up payments if you revitalize it with a cashinfusion; even inflation or war can profoundly increase your outlays It’s even possible for suchfinancial catastrophes to have a double effect of simultaneously cutting your income while adding toyour expenses! This is why a three-tiered cash reserve must be built If your income rises, try not tomatch that with significant spending increases Pay yourself first, both in long-term retirement savingsand in rainy day planning.

Would you keep some savings or other finances secret from a spouse? A fiduciary, such as a CFP

or any Investment Advisor Representative (IAR), is required to keep information secure and private.Others are required to keep it secure, but have no obligation to keep such matters from spouses whoare not clients Of course, other advisors generally do respect a client’s wishes regarding sharing ofinformation with significant others if the client wants things kept confidential For this reason, it may

be best for the client to be spouses in a joint agreement, for the advisor to agree that the client is thecouple as a unit Increasingly, couples do not share unconditionally; they have each individualaccounts or checking, plus a joint account for bill paying (likewise, the cash reserves may or may not

be jointly owned)

Total trust—everything jointly owned except for IRAs and qualified accounts, which can only beindividually owned—reinforces that lifelong bond even though it adds vulnerability If one isconcerned that a spouse may take or abuse money, then one needs to solve that distrust issue first.Many other life issues can fall apart otherwise Of course, trust must be mutual What can happenwhen trust exists in one spouse’s heart, but the other does not fully deserve it?

College administrator Mollie brought home over two thousand dollars in monthly pay (after maximum qualified and Roth IRA savings deductions) Husband Cedrick, a medical architect, had an extraordinary monthly take-home income

of roughly fifteen thousand dollars Their two children attended the finest private school in Charlotte, North Carolina The family traveled extensively; no expense was spared for education, entertainment, home improvements, etc., and

my financial plan called for significant nonqualified savings because they wanted to start or buy their own business one day All expenses came from Cedrick’s pay, as did their enhanced savings program Mollie was in charge of the finances, their joint nonqualified investing, and all of her take-home pay was for her personal use; Cedrick’s pay flowed into their joint account to then be disbursed for the buildup of cash reserves, the business fund, and three other joint investments Mollie handled all of these.

I had tried unsuccessfully to interest them in jointly creating a budget, monitoring it, and making joint decisions regarding the investments, but Cedrick had no interest and Mollie was enthusiastic, promising to allow me to help with that budget but never acting on this Mollie would not allow me to help monitor the budget or obtain copies; I was unsure whether she actually devised one After a couple of years, four reviews of the progress of their financial plan always gained me referrals and praise, but Cedrick was never present for these.

One day, I used a process called back-testing to estimate how much money went to these investments compared

to their take-home pay I deducted for all expenses they reported (but never updated after the initial data gathering) Back-testing revealed that some fifty to sixty thousand dollars could have been added to the investment accounts from disposable income, yet was not I asked Mollie again for a budget, and told her about the potential to reach their goals early if this excess could be added to the investment accounts, but that I needed to model this so they would see more clearly how much of this excess could be devoted to accelerating their goals.

“You’ve done a fine job, Dan,” Mollie said, studying my face and closing my laptop for me, “but are you inferring that I

can’t do this on my own? Cedrick would not appreciate that implication and I’m not sure we can continue as clients if

you think I can’t.”

“I know you can, Mollie, but your asset management wrap fee covers this work; you might as well have me do this,

so you can see precisely what the potential is, and just how soon you could be confident of running your own business Wouldn’t that be useful infor—”

“The discussion is closed, and if you want to keep earning that wrap fee, you’ll drop it.”

Almost a year later, I received a call from Cedrick.

“Can you come over to my office for a couple hours, Dan? Now?”

“Well, I can after three Sure My main resources for reviews and so on are all at my office, though Can we meet at

“No, you don’t have all the resources, not what I’m looking at Three thirty?”

When I arrived at Cedrick’s office, he instructed his secretary to hold all calls and he closed the door behind me.

“Roll that chair over here,” he instructed, pointing to his side of his desk He turned his laptop toward me and cleared his throat awkwardly.

“A PI I retained got me into this You are not to discuss this with Mollie, agreed?”

The screen showed a mutual fund portfolio valued around a $107,000, and Mollie’s name as owner, along with a PO

Box as an address I hesitated in answering Cedrick as I thought back to my conversation with Mollie They were both

my clients.

“Wow Cedrick, I suspected this could happen at the second-to-last review with Mollie I found that you two could be saving more and go into business sooner, but to measure that and project when, I needed her to come up with that budget I’ve been pushing for since we met.”

“It’s not your fault She fooled us both Looks like she’s moving money from our joint account to her own checking, and I’d guess she lets a large balance build up there before moving money to this secret one, just in case I detect her skimming the joint account and demand back whatever recent diversions I might find I suppose she then moves money from her checking into this secret account The cash deposits into this account don’t match transfers to her checking from our joint account.”

“Why is she siphoning off money that ends up in another account in her own name? Have you two been having problems?”

“My only guess is that she suspects I cheated on her I’m away so much, but I never did, and there’s never been anything that would give her that impression; just the frequent travel She’s shown up at my hotel randomly sometimes; nothing to see here, citizens Other than that behavior—and we didn’t even argue because I understand how difficult my travel has been on her—she hasn’t even accused me of anything.”

“What are you going to do? Does she know you know about this?”

“She doesn’t know Can I trust you to keep …”

“Of course The CFP Code of Ethics, remember? I can’t contribute to so much as an argument between you two, and I have to keep confidential whatever either of you restricts me from relating to the other.”

“Did she restrict anything?”

“No, not exactly It’s just that she clobbers me if I ask for a budget or even data to do one for you.”

He stared to shake slightly and turn red “She might even be the one having an affair.”

“What did your PI find on that?”

“Nothing Just that she cries to her friends at restaurants He intercepted lots of messaging stuff If she’s cheating,

he hasn’t found it yet.”

“I doubt she’s cheating, Cedrick You listen to me, listen to your PI.”

“I’m going to confront her.”

“Cedrick, be careful how you do that You could damage an otherwise great relationship, and think of the kids.”

“What would you do?”

“Well, if Laura has a nickel and I have a nickel, we have a dime Remember I hinted that all accounts should be joint and you both should be involved in reviews? Trust but verify, if you must.”

“This is what I verified!”

“You shouldn’t keep monitoring this She might even change the password or move the account What you need to monitor is your cash management account and how she moved money into this But a confrontation or her discovery

of monitoring would escalate things Take her away for a week See how she reacts to your telling her that you finally got into your cash flow and started a budget that you want her to finish with you, then see how she reacts She’ll have

to confess But even if she doesn’t, still be gentle and understanding about what drove you to spy Especially, make her understand why you took off for a second honeymoon, to save your relationship rather than argue.”

“What if she just leaves?” he quavered.

“Cedrick, she loves you You love her You just need to quell her fears And when you two get back, you need to be part of the reviews and budget setting—no more putting that off Let me watch the flows in and out, and make this fund joint Both of you should authorize me to share all details and instructions one of you gives If she balks, you have a bigger problem than money or her distrust of you But if she asks forgiveness and will do this, you’ll have your wife back—and she’ll know she has you.”

“How do we keep this on course without mistrust if your approach works at first?”

“Take her on as many trips as your schedules permit, give each other access to phone accounts After a good budget examination, capture all of this diverted money—maybe more if we can identify frivolous spending Then, work your dream together by saving better You’ll get into your dream business together as soon as my calculations show you can do that confidently Your dream revives and—this is key, Cedrick—it becomes exciting and real because it’s shared and you can see how to reach it It’s sooner than you used to think My ballpark modeling shows it would likely

be just another seven to ten years, but we have to put this to accurate numbers.”

His face told me I had not convinced him His face sank again and a tear hit his blotter.

“Numbers Am I just a cash machine to her anymore?”